Making-up a long-winded inflation story

Nouriel Roubini writes “The Mystery of the Missing Inflation”:

In the United States, Europe, Japan, and other developed economies, the recent growth acceleration has been driven by an increase in aggregate demand, a result of continued expansionary monetary and fiscal policies, as well as higher business and consumer confidence.

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.

Roubini´s premises are false.

There has been no recent (real) growth acceleration. The chart illustrates, showing growth throughout the expansion. Note that in 2014-15, especially for the US & UK, growth was higher than more recently.

Since there has been no “growth acceleration”, even if you believe in the Phillips Curve there´s no reason for inflation to move up.

As the next charts show, there has not been an increase in aggregate demand (NGDP growth) either. In fact, for a large group of advanced economies, aggregate demand growth in this expansion is lower than that observed prior to the 2008-09 contraction.

So there´s no”mysterious combination of stronger growth and low inflation” to explain by appealing to supply shocks.

Aggregate demand growth is low, which leads to low inflation and low real growth. And aggregate demand growth is low because everywhere monetary policy is tight. That´s it. No mystery to solve.


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