AOC is right: Inflation is solved. That's why central banks are doing the unthinkable  cutting rates when we've got full employment and the Dow at 27,000.  07/14/2019 11:34:56   Jim Edwards, Business Insider

asdfocasio-cortezAlexandria Ocasio-Cortez is right. Unemployment and inflation are no longer linked in the way that they once were.ERIN SCOTT / Reuters

The economy in Europe and the US is an unusual beast right now. We have full employment, extended GDP growth, and the stock market is through the roof. The S&P 500 has breached 3000, the Dow is at 27,000, and the FTSE 100 is at 7530  all at or near all-time highs.

Normally, these conditions would be screaming for an interest rate rise. The economy ought to be overheating, inflation ought to be spiraling, wages ought to be going up, along with demand, and employers should be struggling to find extra workers and resources to fill their order books.

But the opposite is happening.

The European Central Bank just concluded that it needs to "be ready and prepared to ease the monetary policy stance further" after failing, again, to goose inflation up to its 2% target.

Euro Area Inflation June 2019The European Central Bank has failed to generate inflation despite years of low interest rates.Focus Economics

In the US, Federal Reserve chair Jerome Powell also signaled he will cut rates. "There is a risk that weak inflation will be even more persistent than we currently anticipate," he told Congress.

So what's going on? Why are we living in a Bizarro World where a powerhouse economy generates low inflation, and central banks shovel ever more cash into an on-fire market?

The old relationship between employment and inflation is broken

The answer was touched upon by US Rep. Alexandria Ocasio-Cortez, who is turning out to be a surprisingly prolific generator of debates about the fundamentals of economics.

"Unemployment has fallen three full points since 2014 but inflation is no higher today than it was five years ago," she said in a congressional hearing with US Fed chair Jerome Powell [see mark 2.06.30].

Rep. Alexandria Ocasio-CortezRep. Alexandria Ocasio-Cortez.Jacquelyn Martin/AP

"The economy can sustain much lower levels of unemployment than we thought without troubling inflation," Powell responded.

That, really, is the headline here: inflation no longer exists.

We should be living in the Weimar Republic. But we're not.

Inflation is gone.

Even 10 years of interest rates set near zero no longer generates consumer price increases. The textbooks of the early 2000s said we should be living in the Weimar Republic, or Zimbabwe, right now. Instead, house prices in London have been in decline for more than a year.

Inflation has been solved. We solved it, through our new inventions.

Spotify makes music cheaper. Uber makes taxis cheaper. Google makes information cheaper. Facebook makes advertising cheaper. Amazon makes shopping cheaper. The gig economy makes wages cheaper.

FILE PHOTO: A view of the main trading floor of the New York Stock Exchange (NYSE) during the Uber Technologies Inc. IPO in New York, U.S., May 10, 2019. REUTERS/Andrew KellyView of main trading floor of NYSE during Uber Technologies Inc. IPO in New York.Reuters

The macro effect of all this "solving" is a permanent downward pressure on prices  which is good for workers who don't want their wages eaten away by inflation (but bad for workers who want nominal pay rises).

That notion that inflation is extinct is not obvious

In a note to clients last week, Nomura analysts Rob Subbaraman and Andrew Ticehurst said: "Major central banks seem trapped in an era of ultra-loose monetary policy. Very low interest rates for an unusually long period of time involve diminishing returns and rising costs that make normalisation of monetary policy increasingly difficult."

They worried that the "problem" of low inflation would create "a loop that makes it even harder to normalise."

A low-inflation, low-interest rate environment can definitely create problems:

But low inflation brings opportunities, too.

In a deflationary world, fiscal policy  government spending  is more important than monetarism

Governments now have more fiscal "space" to invest and build.

"In countries with fiscal space, it should be used more forcefully to boost sustainable growth, especially spending on worthwhile things like infrastructure, education and R&D," Nomura's Subbaraman and Ticehurst said. They are part of an ever-noisier chorus of investment bank analysts begging governments to wake up and smell the money.

Now is the time to spend. Not just to create inflation (and avoid deflation, which can be even worse). But to build the energy, transport, defence, health, and education infrastructure we will need for the future. Low cost debt makes this spending cheap.

It's a rare, golden opportunity for governments (and an intellectual defeat for conservatives).

Hopefully, they won't squander it.

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