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Why is inflation low?

| Posted by: Paul Donovan | Tags: Paul Donovan Weekly

  • Why is inflation low? The best argument is that independent central banks (run by economists) are good at their job. Over the last 25 years, more central banks have become politically independent. Over the past 25 years, inflation has been brought under control.
  • Independent central banks are a better reason for low inflation than globalization. Countries that import more do not have lower inflation than countries that import less. Prices of imported goods are not lower than prices of domestic goods. Independent central banks are a better reason for low inflation than technology. Technology changes relative prices, not overall price levels. If online shopping caused low inflation, the UK would have far lower inflation than it does.
  • Inflation in the US and Europe is close to long-term averages. However, average inflation is a little below 2%, creating a problem for inflation forecasters. At these levels, a large part of overall inflation is not driven by markets. Tax policy, controlled prices, administrative changes and made-up prices play a relatively larger role in inflation calculation. Such prices are not driven by supply and demand. They are more difficult to forecast.
  • Recently, non-market prices lowered inflation. There is no guarantee that non-market prices will lower inflation in the future.