Inflation has "barely budged during the Great Recession despite rising unemployment" and "ongoing monetary accommodation is unlikely to have significant inflationary consequences, as long as inflation expectations remain anchored," according to new research by the International Monetary Fund (IMF).
Unlike past recessions, inflation has not fallen sharply during the Great Recession that began in 2008, and the IMF predicts inflation is "unlikely to spike as the recovery strengthens….there is little risk of monetary policy repeating the mistakes of the 1970s and igniting stagflation."
The Fund's research refers to inflation as "the dog that didn't bark" during this most recent crisis and posits that the fundamental behaviour of inflation has changed over time:
Inflation expectations have become more strongly anchored, or resistant to change, reflecting people’s confidence that inflation will remain close to the targets set by national central banks. Second, the response of inflation to changes in cyclical unemployment has become more muted.
The key reason for the anchoring of expectations, according to the IMF, is the independence of central banks. To illustrate this point, the study compares the experiences of the US Federal Reserve and the German Bundesbank during the economic turbulence of the 1970s:
Even though both overestimated cyclical unemployment and were keen on maintaining economic growth, the Bundesbank managed to keep inflation in the single digits while the Fed saw it rise to almost 15 percent. The difference was that while the Bundesbank clearly demonstrated its independence from the rest of government, the Fed felt a responsibility to create a monetary environment that accommodated the upward pressures on prices from government action. Only when the Fed achieved real independence with the appointment of Chairman Volcker in 1979 did inflation begin to fall in the United States.
The conclusions of the study are twofold:
- Assuming central banks remain free from political restraints, continued stimulus is "entirely appropriate" to help pick up the slack in slumping economies.
- The absence of strong inflationary pressure thus far should not "induce complacency" as asset price volatility has caused economic turmoil despite relative stability in consumer prices.
To read the study in full, click here.
Sources: Damiano Sandri and John Simon of the IMF Research Department