Since the GFC in 2007/8 the developed economies have been awash with stimulatory forces including quantitative easing, record low interest rates and increased government spending. This has led to accelerating growth levels driven by an increase in Aggregate Demand – C+I+G+(X-M). Business and consumer confidence has also increased and this has come about by the decline in financial and economic risk.
So you would assume with stronger aggregate demand that the capacity constraints in the supply of goods and services accompanied by shortages in the labour market would lead to inflationary pressure. Yet in some countries core inflation has actually fallen and this creates a dilemma for central banks as although there is growth in their economy the inflation rate is below their target band. A reason for this could the supply side shocks (Aggregate Supply to the right – see graph). The following maybe the cause:
- Globalization keeps cheap goods and services flowing from China and other emerging markets.
- Weaker trade unions and workers’ reduced bargaining power have flattened out the Phillips curve (see below), with low structural unemployment producing little wage inflation.
- Oil and commodity prices are low or declining.
- And technological innovations, starting with a new Internet revolution, are reducing the costs of goods and services.
Sources: Project Syndicate, Economicsonline.co.uk