The inflation conundrum in advanced economies and a way out

Paper by Mr Luiz Awazu Pereira da Silva, Deputy General Manager of the BIS, Enisse Kharroubi, Emanuel Kohlscheen and Benoît Mojon based on remarks at the University of Basel, 5 May 2019.

We review the inflation conundrum of advanced economies (AEs). They are currently experiencing low interest rates and low unemployment combined with low inflation. Several medium-term trends in the labour markets can explain why inflation has remained contained in spite of the drop in the unemployment rate. Among these are the ageing of the workforce and the lasting effects of the crisis on the mobility of employees as well as changes in the contractual relationship between employers and employees. These trends imply that the equilibrium rate of unemployment has declined and that the participation of seniors in the labour market has been increasing in AEs. Overall, labour market slack may have fallen by much less than suggested by the drop in unemployment rates. A second factor is that monetary policy has reached its limits, after playing a major countercyclical role during the financial crisis. One possible way out, given the exceptionally low interest rates, is that fiscal policy should henceforth play a larger role than monetary policy in stabilising the business cycle, provided that fiscal space is available. Fiscal policy and public investment might also help to enhance productivity and address climate-related risks. In addition, to the extent that low real rates reflect a shortage of safe assets, issuing more public debt could help to raise the equilibrium real rate and expand the monetary policy space.