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IMF Sees Inflation Tame If Central Banks Are Free to Respond

April 09, 2013

Monetary stimulus deployed by advanced countries to spur growth is unlikely to stoke inflation as long as central banks remain free of outside influence to react to challenges, according to a study by the International Monetary Fund.

In a chapter of its World Economic Outlook released today, the Washington-based IMF said that inflation has become less responsive to swings in unemployment than in the past. Inflation expectations have also become less volatile, according to the report.

“As long as inflation expectations remain firmly anchored, fears about high inflation should not prevent monetary authorities from pursuing highly accommodative monetary policy,” IMF economists wrote in the chapter called “The dog that didn’t bark: Has inflation been muzzled or was it just sleeping?”

Borrowing costs in the largest developed economies are at record lows. The Bank of Japan (8301) last week embarked on record easing, meaning the four largest developed-market monetary authorities -- including the U.S. Federal Reserve, the European Central Bank and the Bank of England -- are aligned in their commitments to spur growth and return their economies to full strength.

The BOJ’s new policy “is something that we hope will lift inflation durably into positive territory, which would help the economy,” said Jorg Decressin, deputy director of the IMF’s research department. “We see in no way the operational independence of the BOJ compromised at all.”

Price Stability

Inflation stability during the global recession of 2009 may have been due to an increase in structural unemployment, meaning many job seekers didn’t have the skills to compete effectively for positions and influence the wages of those employed, according to the report. Another explanation is that central banks have become more credible at delivering price stability, according to the IMF.

In periods of growth as well, the correlation between inflation and unemployment has weakened, according to the report, which cites the euro region in the early 2000s.

“Emblematic cases are Ireland and Spain,” the IMF report said. “Despite large reductions in unemployment fueled by inappropriately loose monetary policies, inflation did not rise nearly as much as the experience of the 1970s would suggest.”

Asset Bubbles

Still, restrained price increases in the early part of the 2000s didn’t prevent asset-price inflation, including housing bubbles that contributed to the global financial crisis, according to the report.

Using examples of the U.S. and Germany in the 1970s, the IMF warned against threats of inflation coming from political pressures on central banks. Limits on central banks’ independence and flexibility must be avoided, the IMF said.

“The dog did not bark because the combination of anchored expectations and credible central banks has made inflation move much more slowly than caricatures from the 1970s might suggest - - inflation has been muzzled,” the IMF staff wrote. “And, provided central banks remain free to respond appropriately, the dog is likely to remain so.”

In a separate chapter also released today, the IMF reviewed low-income countries that saw their economies take off since the 1990s and found that their increase is more sustainable than similar experiences of previous decades.

That is reflected “in lower inflation, more competitive exchange rates, and appreciably lower public and external debt accumulation,” according to the chapter.

Such countries also have a lower regulatory burden, higher education levels and greater political stability, according to the fund.

Even so, “with their per-capita income level still a fraction of that in advanced economies, they face a long journey toward income convergence,” the IMF said. “Dynamic low-income countries cannot afford to lose sight of the need to sustain the pace of reforms, avoid major macroeconomic imbalances and maintain external competitiveness.”

To contact the reporter on this story: Sandrine Rastello in Washington at

To contact the editor responsible for this story: Chris Wellisz at

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