The Inflation Dog Didn’t Bark, But What About the Others?

Erinc Yeldan, Guest Blogger

The IMF released the April edition of its World Economic Outlook (WEO).  One of the key analytical chapters (Chapter 3) of the Report is titled “The Dog that Didn’t Bark: Has Inflation Been Muzzled, or Was It Just Sleeping?”  Its main argument (or rather sort of a mystery that needs to be resolved, in the words of its authors) is that over the course of the previous crisis episodes we used to witness severe increases in unemployment along with a simultaneous fall in inflation. Yet, during the current great recession there has been very little movement in inflation, while unemployment rates soared almost everywhere; —hence the metaphor: inflation (the dog…) does not respond (… bark).  And the alleged mystery is but why?

The WEO suggests two candidates for explaining the mystery: the first one is based on the “structural unemployment has shifted” hypothesis, arguing that “the failure of inflation to fall is evidence that output gaps are small and that the large increases in unemployment are mostly structural.”  The logical policy implication of this argument is that “… the monetary stimulus already in the pipeline may reduce unemployment, but only at the cost of overheating and a strong increase in inflation—just as during the 1970s”. Yet, by itself this argument does not provide much of an explanation, as the underlying causes of this structural shift still remains unanswered.

A second hypothesis that the WEO’s authors unapologetically side with is that “… the stability of inflation reflects the success of inflation-targeting central banks in anchoring inflation expectations and, thus inflation”.  Accordingly, with the hard, and yet valuable, lessons learned over the 1990s, economists and central banks are now better rooted in addressing problems of price instability.  These “lessons” had formed the basis of “credibility” for the central banks, which in turn, are now able to successfully anchor inflation expectations.

The orthodox mainstream inflation targeting (IT) literature had indeed maintained quite a number of venues to pursue this theme, arguing in many forms that those countries that resorted to the IT central banking practices tended to experience more stability in price levels, and that output losses against falling inflation were comparably lower (in contrast to non-IT’ers).  What is cunningly common in almost all such prognostications, however, is the sheer omission of one of the most decisive forms of global division of labor in human history that had been revealed in its fullest extent over the 2000s.  As the USA and the continental Europe claimed to graduate into the post-industrial, high technology service economies producing “finance”, the global manufacturing factories were shifting to the sweatshops of East Asia.  As the global commodity markets were flooded with cheap consumer durables, the US alone had mopped 2 trillions of the 3 trillion dollars worth of aggregate current account surpluses from the global asset markets. This huge income transfer by way of financial strangulation enabled the “West” to suppress global wage demands and maintain low inflation while unemployment got entrenched at historically record high levels that the authors of the WEO refer to as “structural”.

The real question then is why, despite the alleged successes of the IT central banking framework in containing the volatility of inflation, the real evils of high unemployment, low rates of capital accumulation together with erratic rates of output and deepened social exclusion and polarization of incomes had been the observed norm at a global scale.

The authors of the WEO rather conveniently divert attention from these questions and prefer to focus on the “mysteries” of the flatness of the Phillips curve.  The key problem is that ongoing financial globalization appears primarily to redistribute  limited jobs across countries, rather than to accelerate capital accumulation and job creation across the globe. Current growth in the global economy is highly uneven and geographically too concentrated to generate sufficient jobs world-wide and, moreover, is associated with too little fixed capital formation. Under these conditions, price stability, on its own, will not suffice to maintain  true macroeconomic stability, because,  it will not secure financial stability and employment growth.[1]

The dog may indeed remain silent; but what about the others on the street?

[1] See, in particular, Epstein, Gerald and Erinc Yeldan, “Inflation Targeting, Employment Creation and Economic Development: Assessing the Impacts and Policy Alternatives” and the remaining articles in International Review of Applied Economics, 22(8), 2008.

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