What if global inflation surprises on the upside?

This article appeared in Issue 790 (July 31) of The Edge Singapore

SINGAPORE (July 31): Inflation, or more precisely the lack of it, has become a major point of contention for monetary policy makers and those seeking to understand where asset markets are heading. In general, this year has seen lower-than-expected inflation in developed economies. As a result, central banks in the US and Europe face a conundrum: Their economies have recovered from the ravages of the global financial crisis and subsequent aftershocks, such as the eurozone sovereign debt crises, but inflation data is not signalling a need to raise interest rates.

In the US particularly, where unemployment is low and average growth has been in line with the economy’s potential, there is little reason for the ultra-low policy rates and quantitative easing that were appropriate for a time of extreme crisis. In other words, central banks really should be raising interest rates and reducing the size of their balance sheets. But, the absence of inflationary pressures has deterred them because some policymakers fear the low inflation could reflect underlying weaknesses in the economy and financial system.

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