Leaving subdued US inflation behind

Leaving subdued US inflation behind


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12 October 2017

Key points

  • US inflation and wage growth have remained subdued despite eight years of economic expansion and an unemployment rate close to the lows of each cycle since the 1960s.
  • This lack of price and wage responsiveness to developments within the real economy (in other words, a break down in the Phillips curve) partly results from a larger amount of ‘slack’ than is captured by unemployment figures. But in recent years, we find that adaptive inflation expectations (people getting used to weaker inflation) are the most important explanation.
  • Following the stabilisation in oil prices, headline inflation has normalised and inflation expectations should therefore rise. In turn, this should support inflation and, to a lesser extent, wage growth.
  • US Federal Reserve Chair Janet Yellen described the inflation outlook as a "mystery". We acknowledge longer-term structural developments, including the impact of digital technology, that could affect inflation.
  • We expect more cyclical components of inflation to re-emerge over the coming years and forecast inflation to rise by 2.2%, 2.3% and 2.6% for 2017-19 respectively, faster than current market expectations of 2.0%, 2.0% and 2.1%.

Soft US inflation does not automatically discredit the Phillips Curve

US inflation has been subdued this economic cycle, despite the country enjoying uninterrupted annual GDP growth since 2010 and a tightening in the labour market that has seen the unemployment rate fall to lows not witnessed since 2001.

While numerous reasons have been provided to explain this, including the impact of the digital economy, a constant theme has been the associated lacklustre pace of wage growth. This has been echoed in other economies whose labour markets also appear tight, including Japan and the UK and has led to speculation that the Phillips Curve is no longer relevant...

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