World Economic Outlook October 2016: Global Disinflation in the Era of Constrained Monetary Policy

Tuesday, October 11

Ms. Zsoka Koczan, Economist, International Monetary Fund

Over the past few years, inflation has declined markedly in many countries, with several advanced economies suffering deflation. What are the drivers of the disinflation and what risks does it pose to further economic development? Ms. Zsoka Koczan, an IMF economist, presented the major findings on this subject from the new World Economic Outlook.

On October 11, Ms. Zsoka Koczan, one of the authors of chapter 3 of the IMF World Economic Outlook on “Global Disinflation in the Era of Constrained Monetary Policy,” presented some of its main findings at the JVI.

Ms. Koczan pointed out that in recent years inflation rates in many economies have declined to historic lows. Out of a sample of more than 120 countries considered in 2015, more than 85 percent had inflation that was below long-term expectations (a proxy for inflation targets), and about 20 percent suffered deflation. The decline in inflation is broad based across countries, measures of inflation, and sectors. However, it is more pronounced in tradable goods, as reflected in the manufacturing producer price index and the dynamics of nonfood goods inflation.

The IMF’s analysis identified declining commodity prices and persistent economic slack as some of the main drivers of disinflation. Moreover, excess manufacturing capacity in some large economies, especially China, has spillover effects and also seems to push down import prices. However, a significant part of recent disinflation remains unexplained, possibly, in part, reflecting measurement errors in inflation expectations and cyclical unemployment, as well as changes in administrative prices.

In addition to the observed disinflationary trends, there are growing risks that expectations may become unanchored.

In advanced economies with policy rates nearing their lower bounds, the sensitivity of inflation expectations to inflation surprises has started to increase in recent years. While inflation is projected to gradually recover toward central bank targets, downside risks to this forecast are growing because expectations may get unanchored in the case of further negative inflation shocks. This would threaten the recovery of demand and of the economies in those countries.

Ms. Koczan noted that these risks call for a comprehensive, consistent, and coordinated approach to economic policy. Such an approach should be centered on continued monetary policy accommodation, complemented by growth-friendly fiscal policies and structural reforms tailored to country- specific circumstances.

In many emerging markets, inflation expectations remain less well-anchored than in advanced economies. This gap can be explained by differences in monetary policy frameworks. Improving these frameworks by reinforcing the credibility, independence, and effectiveness of central banks is a policy priority in emerging market economies. The chapter’s results suggested that the adoption of inflation-targeting regimes can help anchor inflation expectations.

During the Q&A session that followed the presentation, a lively discussion centered around the scope for further monetary policy accommodation; the effectiveness of unconventional monetary policies; the extent to which emerging market economies and advanced economies are constrained in their response to shocks; and how multiple central bank objectives (e.g., financial stability) affect policy effectiveness. Another question was whether the IMF had reversed its previous recommendation to implement fiscal consolidation and is now calling for fiscal support. Ms. Koczan emphasized that fiscal policy decisions should depend on the fiscal space available; she argued for a boost in spending on infrastructure in countries that can afford it and for budget-neutral, growth-friendly adjustments in countries with less fiscal space. As for central bank targets, she said that clearer objectives can help better anchor expectations. Ms. Koczan noted that in countries where there is scope for a more aggressive monetary policy response, this could include quantitative easing, negative interest rates, and overshooting inflation targets, though the chapter did not focus explicitly on comparing their relative effectiveness. She stressed, however, that emerging market economies can make significant gains by improving their monetary policy frameworks.

Alexei Miksjuk, Junior Economist, JVI


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