Three reasons behind low inflation


In this perceptive article, as he warns against repeating Japan’s mistakes, Stephen Roach gives three reasons as to why inflation remains low, which are in a nutshell globalization (or the second unbundling), impaired balance sheets (a crisis legacy) and the liquidity trap (low rate environment that renders monetary policy ineffective). His advise — unsurprisingly — is to use fiscal policy instead of monetary policy…

Here is the full quote on the three reasons behind low inflation:

“First, the relationship between inflation and economic slack – the so-called Phillips curve – has broken down. Courtesy of what the University of Geneva’s Richard Baldwin calls the “second unbundling” of globalization, the world is awash in the excess supply of increasingly fragmented global supply chains. Outsourcing via these supply chains dramatically expands the elasticity of the global supply curve, fundamentally altering the concept of slack in labor and product markets, as well as the pressure such slack might put on inflation.

Second, today’s globalization is inherently asymmetric. For a variety of reasons – hangovers from balance-sheet recessions in Japan and the US, fear-driven precautionary saving in China, and anemic consumption in productivity-constrained Europe – the demand side of most major economies remains severely impaired. Juxtaposed against a backdrop of ever-expanding supply, the resulting imbalance is inherently deflationary.

Third, central banks are all but powerless to cope with the moving target of what can be called a non-stationary liquidity trap. First observed by John Maynard Keynes during the Great Depression of the 1930s, the liquidity trap describes a situation in which policy interest rates, having reached the zero bound, are unable to stimulate chronically deficient aggregate demand.”