Globalization tricked the central bankers of Western economies and has left them exposed to a new inflation trend, according to Societe Generale’s Brian Hillard.
Hillard argues that monetary policy in many economies has now been fixed around an assumption that inflation will remain in a more limited range. That limited range has now moved higher, as a result of the end of a period of China exporting deflation.
As the development of China has accelerated, two important changes have occurred. First, it has become ever more hungry for commodities, driving up their prices globally. Second, domestic labour costs have started to accelerate, with the result that the export prices of Chinese goods have done the same. These factors are combining to create a potent force for rising inflation pressures around the world. This is why we are seeing the acceleration of import prices in the UK, for example.
The problem, according to Hillard, is that inflation is set to rise and central banks will have to act. But their actions will have consequences.
The forces of globalization over the last decade led to the very flat Phillips curves already mentioned. As western countries start to emerge from the slow growth period following the economic crisis, they will experience a secular increase in inflation pressures from the emerging economies, despite the supposedly large output gaps in the west. And this will push up their inflation expectations. In a flat Phillips curve world, the loss of output generated by the consequent policy tightening necessary to bring those expectations back under control could be considerable. Western central banks are only slowly waking up to this fact.
That loss in output also means a prolonged loss in employment. Hillard reccomends the UK get its inflation situation under control, and then raise its target rate. How this will play out in the U.S. is unknown, but it does go some way to explain Fed Chairman Ben Bernanke’s comfort with rising inflation.