Where's the inflation, Mr Shin?

Interview with Mr Hyun Song Shin, Economic Adviser and Head of Research of the BIS, Frankfurter Allgemeine Zeitung, 27 December 2015.

BIS speech  | 
06 January 2016

Hyun Song Shin, Economic Adviser and Head of Research of the BIS, explains why prices are not rising despite the glut of money and why the situation is nonetheless dangerous.

Mr Shin, everybody expected to see inflation this year, but prices are hardly rising. What's happened?

Economists are still struggling to figure out the full story on inflation. The simple stories that people tell are no longer adequate. These simple stories are domestic and short-term: If the economy is depressed, you have low inflation. If the economy is overheated, you have high inflation. We are realising that this cannot be the full story. Otherwise we should be seeing higher inflation by now.

Inflation is only 0.2% in Europe and 0.5% in the US, although the central banks are doing everything in their power to drive it up to 2%. What's going wrong?

Inflation is not only a domestic and short-term phenomenon - the kind of phenomenon monetary policy can influence. Inflation also depends on global and long-term factors. The most important story is global. Ultimately, inflation is falling nearly everywhere in the world.


In the short term, that's down to the fall in the price of oil and other commodities. The low oil price lowers the price for fuel and thereby affects inflation. But there are important long-term stories as well.

For example?

Globalisation and demography. When the emerging economies started to produce for the world markets, we suddenly had a lot more supply, a so-called supply shock, which put pressure on prices and kept them low. That is one global long-term story. Then there are the long-term domestic factors. Even in countries that are not so open to the world market, we have seen inflation falling. One possible reason is demography - although some economists disagree. If you have an old population, there is a greater need to save. That leads to less consuming, so lower demand, which in turn leads to subdued inflation. You can see that in Japan, for example.

How do central banks fit into this story?

If you have a short-term view of the world and believe that a short-term lack of demand is the main reason for low inflation, this is where central banks play a role. You would say: Inflation is not close to 2%, so we have to use expansive monetary policy to help replace this missing demand. But that is too simple, as discussed already. There are multiple factors that alter inflation; not all of them can be influenced by central banks.

Is that a problem?

If you are trying to hit an inflation target irrespective of the state of the economy, you may be introducing other distortions into the financial system that will be ultimately more damaging.

So do we perhaps not have any need for rising prices, inflation?

People tend to associate inflation with situations like the Great Depression. They believe: If you hit deflation, ie falling prices, this will trigger a chain reaction which will lead to some very bad outcomes: a deflationary spiral where prices go down further and further. The problem is that there is little empirical evidence for this phenomenon outside the Great Depression. If you look at recent cases of deflation, you cannot find this spiral. Nor does history support the conclusion that low inflation is always associated with low output and is a sign of a depressed economy.

So everybody is wrong? All those economists and central bankers who feared a situation like the Great Depression after the financial crisis?

The Great Depression was a very singular event. You cannot generalise it. Switzerland, for example, has had a mild deflation during the last few years and the economy is not doing badly. The idea that if inflation hits zero, the economy comes to an immediate standstill, is simply not true. 

ECB president Mario Draghi has been trying all year to reach the inflation target of "under, but close to 2%" the whole year. Is he wrong?

I cannot comment on the actions of individual central bankers, but I should say I am not against inflation targets for central banks. They have been a major achievement in making monetary policy more systematic. But the problem starts when inflation is the only goal and we take actions in order to bring back inflation which have side effects.

What are the dangers?

To understand them, we have to think globally. Central banks have an influence on exchange rates and debt, both domestically and in other countries. For example, if monetary policy in the US is expansionary, the dollar depreciates. For other countries, dollars are consequently cheaper and they borrow more in dollars, so the debt in dollars outside the United States goes up. The same happens in Europe. When the euro depreciates, as it has done this year, then foreigners borrow more in euros.

Foreigners borrowing in dollars and euros? That doesn't sound like a danger.

But it can be over a longer horizon. Emerging markets have been borrowing a great deal in US dollars. $9.8 trillion is the amount that non-banks outside the United States have borrowed in dollars. Of that, $3.3 trillion has gone to emerging economies. This has happened because the dollar has been depreciating for many years. Now the dollar is going back up again. And that is causing problems. Many of the projects that were financed with dollar debt are now being stopped or reversed.

Is that one of the reasons why China is having economic problems at the moment?

Not just China. Corporate investment has been very important for emerging markets, especially for oil and gas firms. If that slows down because dollar debt gets more expensive, then growth also slows down.

What does that mean for us?

The slower growth in emerging markets is exerting a drag on global growth. For example, this year. One of the reasons why US policymakers have been so concerned about global developments has been the slow growth in emerging markets - which hasn't come out of the blue. It is the result of monetary policy.

Central banks caused China's problems?

That is too simple. There are several causes. But monetary policy is one of them.

What concerns you most? That central banks are buying large amounts of government bonds - so-called "quantitative easing" (QE)?

It is not just QE. We have to think about what happened before the 2008 crisis. Central bankers concentrated purely on stabilising output and inflation. They did not think much about the ever accumulating debt and leverage. When that unwound, it hit back and undermined domestic stability as well. That has to change. Whoever thinks "what happens outside my borders does not matter to me" is being short-sighted. We are living in a global village. Keeping your own house in order is inseparable from keeping the neighbourhood in order.

The US central bank, the Fed, last week ushered in a small revolution, raising interest rates after a seven-year low-interest phase. What will happen now?

We are now going through a realignment of global forces. Imagine a table with an array of compasses. All of the needles are pointing in the same direction. But then you move the pole, and all the needles are shifting. That is exactly what is happening at the moment. The needles are financial market prices, growth rates, debt levels. The monetary stance is the pole, and it is shifting all of those needles at the same time. That has an enormous impact.

Should we be afraid of what the new year will bring?

We are looking ahead to a major realignment, just as I said. That is going to have real economy knock-on effects. We are already seeing some effects in the form of lower commodity prices. That is a boost for demand for many countries, like a tax cut. But if you are a commodity producer, this is a very negative shock. Falling commodity prices will also keep inflation low. Whether we will see still larger disruptions depends very much on financial regulation and banking supervision. If they have been rigorous enough, this could mitigate the effect.

German investors are concerned that interest rates are so low. They blame the ECB and Mario Draghi for this. Is that right?

Low interest rates are an intended effect of monetary policy. You can see that long-term rates in Europe are going down, including in Germany. It is no accident that this started in the middle of 2014, when there was first talk of the central bank buying government bonds in large amounts.

Are low interest rates a cause for concern - also for our economy?

Low interest rates can be distortionary. The risk of them falling lower becomes much larger. One could get into a circle. Like a dog chasing its tail.

How so?

It's like in the poem by Stevie Smith, Not waving, but drowning. The idea of the poem is: Here is a drowning man waving in the water and the people think: Oh, he's waving. But in reality, he is drowning. The same can happen with low interest rates. In standard textbooks, they are considered a good thing, stimulating the economy, a sign of exuberance. But there is the possibility that low rates can be a sign of distress and low returns as well. If rates stay low for a long time, this will eat in into the profitability of insurance companies and the solvency of pension funds. They will, in the search for yield, look to buy longer-term assets, which will lower rates even further. In Europe, interest rates fell very fast in 2014 and the early part of 2015.

Then Europe is not waving but drowning?

If you mean interest rates: Yes, on that count, Europe is closer to drowning than to waving. If you mean the real economy: No, the European economy is doing better.

Interview in German (Frankfurter Allgemeine Zeitung)

The interview was conducted by Lisa Nienhaus.