IMF warns central banks could lose deflation fight

Washington, United States | AFP | 

The International Monetary Fund warned Tuesday that central banks are struggling to beat back deflationary forces and that governments need to spend to help them succeed.

In a new assessment of global economic conditions, the IMF said many countries worldwide are battling disinflation — low and slowing inflation — due to weak global economic growth.

If central banks around the world cannot halt this stall, and if companies and people increasingly believe they can’t halt it, their economies risk sinking into a deflationary spiral — where prices generally start to fall and companies and consumers hold back spending and investment, stalling the economy.

In this case, “countries can’t afford to be complacent,” the Fund warned.

The report said deflationary pressures in many countries are coming from abroad, in the form of sinking prices of both commodities and manufactured goods.

“The breadth of the decline in inflation across countries and the fact that it is stronger in the tradable goods sectors underscore the global nature of disinflationary forces,” the IMF said.

Weak inflation challenges central banks’ ability to use monetary policy to stimulate demand, the IMF notes, because interest rates are likely to already be very low, giving them little room to cut further.

That has been the case with top central banks including the Federal Reserve, the European Central Bank and the Bank of Japan, with the latter two already having taken some interest rates negative.

“Eventually, ‘persistent’ disinflation can lead to costly deflationary cycles -— as we have seen in Japan –- where weak demand and deflation reinforce each other, and end up increasing debt burdens and hindering economic activity and job creation.”

Part of the problem is about perceptions — if people expect that inflation is going to slow whatever the central banks do, it further undermines the effectiveness of monetary policy.

The IMF said there are some signs of that problem: central banks in advanced countries are now “increasingly perceived” to lack much policy scope to reverse disinflation.

“After a long period of stability, certain measures of medium-term inflation expectations have indeed fallen in some advanced economies.”

Additionally, “inflation shocks” — such as Britain’s vote to leave the eurozone, which could slow growth and investment — can add to downward pressure that central banks cannot halt.

The IMF called that “a reason for concern if the undershooting of inflation targets persists.”

Still optimistic, the IMF report said the “most likely outcome” of central bank policies is a gradual uptick in inflation.

It called on governments to use spending, reforms and income policies to boost demand and strengthen inflation expectations.