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Among monetary economists, the past few years have been marked by a contentious debate. On one side are those who believe the world’s central banks need to do more to stave off deflation and recession by pumping more credit into the system; on the other are those who fear inflation and stagnation if the banks do exactly that.
To a large extent, the pro-stimulus camp has carried the day in the U.S. and Europe. And yet the results have been unexpected: Despite the aggressive measures taken by central banks to revive major economies, actual inflation around the world has continued to remain at historic lows. The Cleveland Fed suggests the markets think inflation in the U.S. over the next 10 years will remain below 1.5 percent. That’s down from expectations of closer to 5 percent in the early 1980s. Around the world, IMF forecasts released this month project inflation of below 2 percent in advanced economies and around 6 percent in emerging markets for the next couple of years.
The recent past gives these forecasts added credibility. The World Bank reports average annual inflation rates across 175 countries during the first 10 years of the new millennium were below 8 percent. This compares with an average of 66 percent in the decade starting in 1991 and 48 percent for the decade before that. Since 1999, three-quarters of all countries have had inflation rates below 10 percent.
In particular, those numbers reflect a decline in really high inflation. Belarus was the poster child for failed inflation policies last year—it had a 66 percent inflation rate in 2012, the world’s worst. But back in 1993, 20 countries had inflation rates above 66 percent. In every year from 1988 to 1995, at least 10 percent of the world’s economies saw their consumer price indexes rise more than 40 percent a year. Since 2000, that proportion has never been above 4 percent.
So what accounts for growing price stability worldwide over the past 20 years? According to analysis (PDF) by Bank of England economists Haroon Mumtaz and Paolo Surico, the industrialized world benefited from at least one bit of good luck—the lack of an external shock like the oil price rises of the 1970s. But the economists argue that better policymaking at the country level has also been an important factor in reducing inflation volatility.
The growing independence of central banks from the political process appears to have a clear impact on keeping inflation low, according to a statistical analysis of studies looking at the issue by Jeroen Klomp and Jakob De Haan of the University of Groeningen. When central banks in developing countries are beholden to politicians, monetary policy becomes looser in the runup to elections, as economists Sami Alpanda and Adam Honig have shown.
An additional factor in keeping inflation low may be explicit inflation targeting by reserve banks in the developing world, an approach that international institutions such as the IMF long advocated. (Ben Bernanke himself was also an early champion of the idea.) Nicola Baini and Douglas Laxton at the International Monetary Fund found 12 emerging economies that adopted inflation targeting between 1998 and 2002 alone. They suggested that such countries saw lower inflation and lower volatility in inflation over time, without a negative impact on growth or interest and exchange rate volatility. This may be one occasion in which the advice offered by Western technocrats has not only been followed—it’s actually worked.
On the whole, the growing global trend toward price stability is a positive one. There’s no question that runaway inflation is worth combating. High inflation helped collapse democracy in Weimar Germany in the 1930s, as Niall Ferguson has amply demonstrated. Zimbabwe, the last country to experience serious hyperinflation, created additional suffering for its people on top of what they already faced from the misrule of Robert Mugabe. Around the planet, high inflation makes a lot of people unhappy, according to analysis of polls.
At the same time, a little bit of inflation isn’t always a bad thing. There’s no evidence, for instance, that it’s a drag on economic growth: Michael Bruno and William Easterly, at that point both at the World Bank, long ago demonstrated that no clear link existed between growth and any inflation rate that stayed below 40 percent. In many countries, particularly those in the developed world, unfounded fears of even modest rises in inflation may be preventing more robust efforts to use monetary policy to create jobs.
Handing monetary policy to independent central bankers appears to have worked. But elected leaders still need to make sure they appoint technocrats with a heart—and the mandate to use it.