When central banks adopted “quantitative easing” (printing money to buy financial assets) and other unorthodox means to buoy economies holed by the financial crisis, many feared that the result would be out-of-control inflation. Asset prices have certainly soared. But consumer prices have not. Indeed, the growing fear is that rich countries may be entering a twilight zone of ultra-low inflation.
A downward lurch has been most notable in the euro area, where annual inflation dropped from an already low 1.1 percent in September to 0.7 percent in October; a year ago it stood at 2.5 percent. It is now a percentage point lower than the European Central Bank’s inflation target of “below but close to 2 percent”. The ECB lowered its main policy rate to 0.5 percent in May; on November 7 its governing council, responding to the weak inflation figures, reduced the interest rate further, to 0.25 percent.
Elsewhere, too, inflation is low and falling. Almost five years after the Federal Reserve led the way with quantitative easing, inflation is well below the Fed’s 2 percent target (which relates to a somewhat broader measure of consumer prices than the better-known consumer-price index). In August this wider measure stood at little more than 1 percent. Across the G7 economies, inflation has been weak this year and has recently fallen back to 1.3 percent; a year ago it was 1.8 percent. Even in Britain, which has the highest inflation (2.7 percent) in both the G7 and the European Union, the rate has been broadly stable this year.
Slack energy prices have contributed to recent declines in overall inflation. That is a welcome development, boosting the purchasing power of both businesses and households. But core inflation, which by excluding the more volatile elements of energy and food offers a surer guide to underlying price pressures, tells a less heartening story. Across the G7 core consumer-price inflation has been stuck over the past year at 1.4 percent (see chart). On the Fed’s measure it is just 1.2 percent. And in the euro zone, core inflation has fallen over the past year from 1.5 percent to 0.8 percent, matching the record low of early 2010.
One bright spot that has helped to keep G7 inflation from falling further is Japan, where the reflationary drive of Shinzo Abe, the prime minister, is stoking hopes that the past decade and a half of deflation may at last be coming to an end. Overall inflation has risen to 1.1 percent — higher than in the euro area — and core inflation is now at zero. But the immense difficulty that successive Japanese governments have encountered in trying to escape the shackles of deflation serves as a warning of the danger of letting inflation fall too low. Once people start to anticipate declining rather than rising prices, it can be very hard to reverse their expectations.