In the United States, the principal inflation measure tracked by the Federal Reserve sits at barely 1 per cent, despite an expanding economy and a tightening labour market. In Japan and the Eurozone, central banks have set policy interest rates at zero and are aggressively pumping money into the economy to avoid deflation – defined as a generalized fall in prices. In both the UK and Canada, the short-term policy interest rates directly controlled by central banks remain near all-time lows.
Almost everywhere, financial markets seem to be discounting the prospect of higher inflation. As Bank of England Governor Mark Carney recently observed, even today, some six years after the bottom of the 2008-09 slump, “there are profound secular and cyclical disinflationary forces at work in the global economy.”
Looking ahead, an argument can be made that we should worry less about the prospect of escalating costs and prices across multiple markets for goods, services, labour, and raw materials – i.e., about inflation. There are several reasons why.
One is an expectation of slower growth in most of the Western economies, coupled with a diminution in projected growth for the world economy as a whole. It is striking that published forecasts from central banks, international agencies, and private sector organizations such as the McKinsey Global Institute all point in the same direction: average economic growth rates, both globally and in the major Western economies, will diminish in the coming decades, compared to the 60-year period that ended with the 2008-09 global downturn. Population aging and declining labour force growth are key factors in such assessments. In a sluggish economic environment, aggregate demand is less likely to bump up against supply constraints – the situation that typically leads to higher inflation. This is doubly true given ongoing advances in technology which are adding to supply capacity in some industries.
A second reason why inflation is likely to be lower in the future than in the past lies in the burgeoning ranks of retirees. As people approach and then enter into retirement, many naturally fear outliving their “nest eggs.” This is especially the case in countries like Canada and the United States, where dwindling proportions of the population have access to guaranteed defined benefit pensions. Inflation is a primary risk to the economic comfort of retired households. A rising fraction of seniors in the population means that more voters will be pressuring governments to keep inflation as low as possible. In Western democracies, older age cohorts already exercise disproportionate political influence, and their clout will only increase as they become a bigger demographic force. Stated somewhat differently, the political constituency for very low inflation is large, and is set to grow over time. This suggests that a scenario of accelerating inflation is becoming less likely in many countries, because of the political priorities of aging electorates.
A third reason why inflation rates have downshifted and may well stay unusually low is the waning power of “labour.” Economists have found that the share of national income accruing to workers has fallen in many countries – particularly since the 1980s. Weaker unions and the greater role that imports play in meeting local demand are part of the explanation. But more important factors are the impact of technological innovation and the declining real cost of “capital” – two closely linked trends that are prompting huge numbers of firms to replace labour with machines and technology. To the extent that workers collectively have less bargaining power, the prospect of “cost-push” inflation driven by broadly rising real wages becomes increasingly remote. Wage pressures have been notably muted in the United States, even as America’s economy has steadily expanded and the unemployment rate has dropped back to the 5 per cent range.
Financial markets in most countries continue to anticipate lower-for-longer interest rates. Such a view is consistent with, and at least in part reflects, a future in which inflation trends below the levels seen in previous economic cycles. As we approach the last few months of 2015, the most pressing economic worry for central bankers and Finance Ministers is not how to contain inflation today or tomorrow, but rather what can be done to achieve even a moderate pace of economic growth over the medium term.
Jock Finlayson is Executive Vice President of the Business Council of British Columbia.