Abstract
This paper investigates whether there has been a structural shift in inflation since a recovery began in the OECD economies. For policy purposes, it is important to be sure that such shifts are significant statistically, are likely to be sustained over the near future and be evenly distributed over the member economies so that no one of them is damaged by anti-inflation measures taken to help others. We approach the problem in two steps: first we examine the circumstantial and informal evidence, and then conduct formal statistical tests for structural changes in euro area inflation in 2015-2016. We find no evidence of a structural change. An even distribution of inflation criterion is the closest to being satisfied, but the other two are far from satisfied in any formal sense. The question remains: why has there been no inflation in the recovery since 2014? To answer that question, we demonstrate how low growth in real wages and self-reinforcing low productivity growth produces slow output growth and low inflation; and how low real wages and productivity in turn lead to low investment. This model fits the data well, down to the lack of labour and total factor productivity, and to the substitution of cheaper labour for excess capital stock. It implies a fall in investment spending (also seen in the data) that extends the period for which the low productivity-low inflation outcomes apply.
Highlights
Inflation in the euro area has not been significant, from a policy perspective, for the past decade—that is, since the financial crisis began to have a real impact at the end of 2008 (Figure 1; all items index)
The question remains: why has there been no inflation in the recovery since 2014? To answer that question, we demonstrate how low growth in real wages and self-reinforcing low productivity growth produces slow output growth and low inflation; and how low real wages and productivity in turn lead to low investment
The implications of a low inflation, low real wages world for investment spending were already implicit in the relative adjustment of inputs discussion in Section 4: the shift to low real wage growth, whether triggered by the fear of automation, globalisation, or a fear that the financial crisis would persist, would naturally lead firms to switch to employing cheaper labour over more expensive capital
Summary
Inflation in the euro area has not been significant, from a policy perspective, for the past decade—that is, since the financial crisis began to have a real impact at the end of 2008 (Figure 1; all items index). This argument is fully supported by the data, in the OECD area at least. Three points about that increase: 1) it still falls short of the 2% Euro-wide target, the mandated ECB target; 2) it is unclear if this inflation was caused by the recovery In Italy, it fell to 0.9% in March and stayed there; in Spain from 3% to 1.7%; and in France it fell to 1.2% from 1.5%
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