NEW YORK – Since the summer of 2016, the global economy has been in a period of moderate expansion, with the growth rate accelerating gradually. What has not picked up, at least in the advanced economies, is inflation. The question is why.
Because stronger demand means less slack in product and labor markets, the recent growth acceleration in the advanced economies would be expected to bring with it a pickup in inflation. Yet core inflation has fallen in the US this year and remains stubbornly low in Europe and Japan. This creates a dilemma for major central banks – beginning with the US Federal Reserve and the European Central Bank – attempting to phase out unconventional monetary policies: they have secured higher growth, but are still not hitting their target of a 2% annual inflation rate.
One possible explanation for the mysterious combination of stronger growth and low inflation is that, in addition to stronger aggregate demand, developed economies have been experiencing positive supply shocks.
Such shocks may come in many forms. Globalization keeps cheap goods and services flowing from China and other emerging markets. Weaker unions and workers’ reduced bargaining power have flattened out the Phillips curve, with low structural unemployment producing little wage inflation.
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