Inflation fears unfounded, says MPC's Posen

Fears we are facing a period of prolonged inflation are “unfounded”, said Monetary Policy Committee (MPC) member Adam Posen, speaking on a day when UK inflation dropped sharply.

In a speech on Tuesday at the Royal Institute for International Affairs in London, Posen said the political risk set to affect investments in the real economy will not extend to the monetary environment.

“I know there are some people out there concerned that we are facing a coming period of inflation, with central banks untethered, if not actively inflating away government debt. These concerns are unfounded.

“As I have argued for nearly 20 years, independent central banks pursue price stability over the medium-term because there is effective opposition to inflation in those societies that have independent central banks. That remains the case.”

Posen added political opposition to inflation is increasing, and there is not an ideology of “forgiving debtors”.

Yesterday figures from the Office for National Statistics showed UK CPI inflation fell from 4.8% in November 2011 to 4.2% last month, the largest drop since December 2008, while runaway inflation in countries such as China has now begun to moderate.

“The challenge for monetary policy will be to keep inflation expectations anchored in the face of real rather than nominal volatility, coming from both sustained long term movements in relative prices and shorter, sharper real shocks, such as natural disasters,” Posen argued.

“Inflationary wage-price spirals will be rare, and therefore so will be sustained inflation. In fact, deflation will occur more frequently than in the recent past.”

Posen said, given these factors, and the shift in relative economic weights from West to East, there will be a leading global currency, but not a single dominant reserve currency.

“The exorbitant privilege of governments issuing and paying debt in one’s own currency will continue to be more widely shared and continue to reduce in magnitude of benefit - that is what a world with few AAA-rated sovereigns means.”

Meanwhile the global financial system has not been sufficiently reformed, and Europe and the US have a long way to go to recover from years of indebtedness, he added.

“While overt financial panic has ended, and economic recovery is underway in the US and the major emerging markets, there remain significant risks for the West and its economic and thus foreign policy leadership.”

POSEN’S PREDICTIONS FOR 2012

Posen said international economics will return for the next couple of decades to the ‘Old Normal' of 1870-1910, characterised by the following:

1. Globalisation in the form of integration of national economies and markets across borders will continue, with increasing support from important constituencies in emerging markets.

2. As US hegemony, that is relative economic dominance, recedes into multipolarity, the international economic system will have less strict rule enforcement and be subject to greater economic volatility.

3. The erosion of (intellectual and other) property right enforcement will have significant effects on the global division of labour, which will reinforce this multipolarity and income convergence. 

4. Price stability will prevail, with sharper fluctuations around low average inflation driven by real (relative price) shocks, and deflation will occur from time to time.

5. More than one currency will play a global or reserve role, and the benefits in terms of lower interest rates from having such a role will diminish.

6. International diversification of investment will increase, and so will the gross flows of capital, with capital accounts in the major emerging markets moving more towards balance if not deficit.