Investors often ask, “What’s so bad about low inflation?” Logically, nobody likes to pay higher prices for goods and services, so this seems like a good question. However, the reason the Fed and economists grow concerned about inflation running too low is that “low inflation expectations” can morph into “no inflation expectations,” and this has negative feedback loops into the economy. When consumers expect no inflation, consumption is deferred, which leads to slower profit growth and, in turn, can lead to suppressed jobs creation and even layoffs. It certainly does not lead to wage increases, which are critical – and when absent, can impair standards of living. It is interesting to note that actual inflation does not have to be low; rather, it is inflation expectations that matter and influence behavior. This is why the Fed wants to see inflation at a comfortable, but low, 2% level in addition to well-anchored inflation expectations.
We have been confident that future inflation would be low – lower than the Fed’s preferred target, due to technological innovation and demographics. These observations impact not only U.S. inflation, but also the global outlook. We expect the Fed and other central banks will come around to recognizing the incompatibility of current monetary policy with the low-growth/low-inflation world and, in turn, anticipate easy, and even easier, global monetary policy.