View from City Road: The high price for low inflation

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The Independent Online
The Federal Reserve's recent decision to raise US interest rates has caused global equity and bond markets no end of grief. But despite signalling some nervousness about price rises in the US, the rise has not undermined the fashionable view that the world economy is set fair for an enduring period of low inflation.

Measured inflation rates averaged less than 3 per cent last year in the industrial world, a figure that means that the cost of living in many well-off countries has probably stopped rising once unmeasured quality improvements are taken into account.

The National Institute for Economic and Social Research yesterday predicted an even better performance this year, with world inflation then averaging 3 per cent a year in the medium term. The financial markets are exhibiting a similar cautious optimism.

There are several reasons. Non- oil commodity prices have been subdued by excess supply or low demand, and wage increases have been tempered by record unemployment. Oil prices have fallen sharply, and interest rates have been unusually high relative to inflation. Companies facing tougher trading conditions are moving production to low-cost locations, with consumers seeing the benefits.

But most of these are only proximate causes. Fundamentally, inflation has been reduced and looks poised to stay low because policy- makers have increasingly been willing to sacrifice growth and employment to achieve it. As the NIESR warns, the low-inflation scenario is not the result of some miracle in economic performance: 'On the contrary it has required a long period of relative austerity, and is dependent on a fair degree of austerity being maintained.'

The argument for being tough now is that the cost of keeping inflation low in the future will be reduced as people come to assume that prices will remain stable. But this remains nirvana.

In Britain as elsewhere, it remains to be seen whether policymakers can retain their nerve and electoral support long enough for the prize to be won.