Low Inflation Tests World's Central Banks - Subdued Prices Persist Despite Years of Easy Money; Deflation Still a Threat

From The Wall Street Journal:

Inflation is slowing across the developed world despite ultralow interest rates and unprecedented money-printing campaigns, posing a dilemma for the Federal Reserve and other major central banks as they plot their next policy moves.

U.S. consumer prices rose just 1.2% in November from a year earlier, according to Labor Department data released Tuesday. The subdued price data came as the Fed opened a two-day policy meeting at which the fate of its $85 billion-a-month bond-buying program—an effort to hold down long-term interest rates and drive up the value of homes, stocks and other assets—is a central focus.

 

The downward pressure on prices presents a conundrum for policy makers across advanced economies: Should they respond with even easier monetary policy or dismiss it as a temporary development? 

 

Central bankers worry about inflation falling too low because it raises the risk of deflation, or generally falling prices, a phenomenon that is difficult to combat through monetary policy. Some economists believe weak or falling prices can lead consumers to delay major purchases, exacerbating an economic slowdown. Even without deflation, very low inflation can be a sign of weak demand that weighs on wages, corporate profits and growth.

 

While policy makers have fretted about low inflation for years, their actions to combat it have yielded generally disappointing results. In the U.S., the Fed is wrapping up a fifth year of near-zero interest rates while also carrying out trillions of dollars of bond purchases in an effort to spark stronger hiring and investment. Employers are starting to add jobs at a steady pace, though overall economic growth remains modest.

 

But U.S. inflation has been below the Fed's 2% target for much of the past two years. The central bank's preferred gauge, the price index for personal consumption expenditures, increased just 0.7% in October from a year prior, according to a Commerce Department data released earlier this month.

Fed officials have forecast consistently that inflation would pick up, but that hasn't happened.

 

While China's low-cost manufacturing helped keep prices of consumer goods down in Western nations in recent years, the huge source of supply today risks exacerbating deflation worries in industrialized countries, some economists say. Excess capacity in key industries such as steel, glass and construction equipment has dragged prices down in some sectors.

 

China's growth slowdown also has reduced its demand for imports of items such as iron ore, copper and coal, pushing down prices in a range of global commodity markets.