An unexpected decline in U.S. consumer prices in October continues a disturbing trend across the developed world. Though central banks' hyper-aggressive monetary policies were meant to stimulate a lot of growth and a little inflation, they've been falling short on both counts.
U.S. prices slipped 0.1 per cent, seasonally adjusted, from their September level, the first such drop in six months. On an annual basis, inflation fell to a four-year low of 1 per cent, from 1.2 per cent the previous month. This is well below the Fed's target rate of 2 per cent – a figure which most central banks regard as ideal, and which some economists even consider a tad low for a struggling economy trying to crawl back to sustained growth.
So much for the doomsayers – including increasingly frustrated gold bugs – who have warned, wrongly, for years that the unprecedented monetary stimulus would inevitably lead straight to the economic purgatory of high inflation. The aggressive easing in the U.S., Europe and Japan is indeed driving up prices of certain assets, but this is not filtering through to normal economic activity. And as long as growth remains sluggish, credit demand weak, wages subdued and competition for consumers' wallets fierce, it's hard to see where the inflationary pressures are supposed to come from in the months ahead.
Instead, we seem to be edging closer to the precipice of a much more intractable problem – deflation.
This is a clear signal that Ben Bernanke and his colleagues should temper their tapering talk. But the Fed has maintained for months that low inflation stems partly from "transitory influences" – which usually means such volatile items as fuel and food – and that the longer-term outlook is for a stable rate at, or close to, its target.
The October numbers, affected by plunging gasoline prices, did nothing to change that assessment. But even stripping out the mercurial stuff, core inflation rose by a negligible 0.1 per cent for the third month in a row.
A glance at the major industrial countries shows that inflation is feeble everywhere but Britain. And even there, the consumer price index slid to to an annual 2.2 per cent last month from 2.7 per cent in September, its lowest level in 13 months. Globally, inflation is expected to come in this year below 3 per cent, the second-lowest level since the end of the Second World War. Morgan Stanley estimates that as many as two-thirds of the 27 central banks with inflation targets, including Canada's, will either miss them or barely reach the bottom range.
Falling retail prices are good news for Christmas shoppers. And a meaningful decline in fuel and other commodity prices ought to boost the spending capacity of the businesses and consumers that use a lot of the stuff.
But anyone who wonders why they should fret over falling prices need only look at that experimental economic lab known as Japan. The country has been mired in a deflationary spiral for much of the past decade. Both shoppers and individuals resisted making purchases and taking out loans, expecting that they would get a better deal as prices kept falling, and borrowing costs kept rising. This year, however, Japan embarked on an enormously ambitious effort to escape, using a combination of enormous quantitative easing and public spending. The result so far: Inflation has climbed to 1.1 per cent, mainly because a weaker yen has boosted the cost of imported fuel. As for core inflation, it has climbed to zero. That's practically a reason for a round of high-fives at the central bank, or the Japanese equivalent, at least.
The euro zone seems headed in the opposite direction, despite the European Central Bank's recent decision to lower interest rates, unless various governments loosen their fiscal screws.
Which direction the U.S. takes is still anyone's guess. But with an output gap totalling more than 5 per cent of GDP, stubbornly high unemployment and subdued wage growth, the Fed needs to consider different ways to get all those bank reserves put to work in the real economy.