The myth of structural disinflation

Peter Warburton - 19 September 2019

Global fixed income managers, aided and abetted by central bankers, have been seduced by a thesis of structural disinflation. This contends that inexorable forces of demography and technology exert a gravitational pull on the rate of inflation in mature advanced economies which conflicts with the arbitrary objective of a 2 per cent inflation rate. It argues, try as they might, central bankers will ultimately fail in their quest to regenerate inflation, unless they reach for the forbidden tools of monetary debasement. This is a distorted characterisation of the inflationary narrative and the policy context. The path to higher inflation will be straightforward once a political determination is made.

On 5 September, Rick Rieder, chief investment officer of global fixed income at BlackRock, wrote a blog entitled “The monetary policy endgame”, in which he articulated the analysis and conclusions outlined above.  His blog is most remarkable for the willingness of a custodian of more than US$2 trillion of fixed income assets to contemplate a world in which “equities, real estate and even hard assets that have historic value-relevance, such as gold” would be preferred.

However, the framing of the “monetary policy endgame” is deeply flawed. The relationship between demography and inflation is highly contentious. In a working paper for the Bank for International Settlements, entitled “The enduring link between demography and inflation”, the authors conclude that “inflationary pressure rises when the share of dependants increases and, conversely, subsides when the share of working age population increases. This relationship accounts for the bulk of trend inflation, for instance, about 7 percentage points of US disinflation since the 1980s. It predicts rising inflation over the coming decades.”  Figure 1 illustrates the point.

Neither can the argument about the impact of technological change and inflation be taken at face value. While comparison websites foster price transparency and information symmetry, it is doubtful whether many of the underlying businesses are profitable, and therefore sustainable. On the other hand, global companies command huge pricing power and market influence. The more control that they exert over global supply chains and the framing of consumer choice, the more profitable they become. If the price-checking technology was overlaid on a marketplace populated by dozens of similarly-sized producers, then a disinflationary bias would result. However, in today’s highly concentrated world, technology is used to reinforce market position and pricing power.

The other arguments that Rieder makes, relating to globalisation and the stability of the crude oil market, also lack credibility as inexorable processes. On many measures, not least the elasticity of world trade to GDP, we have been de-globalising over this past decade. This week’s drone attack on Saudi oil installations is a timely reminder of the vulnerability of the oil market to geopolitical shocks. All the “structural forces creating disinflation” to which Rieder alludes have abated or reversed. The global inflationary tide turned in late 2015 (figure 2) and it hasn’t reversed, despite another sharp fall in oil prices last year.  There are clear limits to this inflationary trend, but they are defined by the policy cage or box that we have built.
We are not waiting for central banks to adopt more radical policies in pursuit of higher inflation. We are waiting for a political upheaval that renders modern central banking obsolete. 

 Figure 1: 

Source: Mikael Juselius and Eold Takats, BIS Working Paper 722, May 2018

Figure 2: 

Source: Thomson Reuters Datastream

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