## Structural Factors and Central Bank Credibility Limit Inflation Risks

_IMF Blog, February 19, 2021_

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## Bibliographic details
- Authors: Gita Gopinath
- Published: February 19, 2021

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### Inflation outlook and recent context
- Global economy estimated at -3.5 percent at the end of last year.
- Inflation was below target in 84 percent of countries at the end of last year.
- The U.S. plan for an additional $1.9 trillion of fiscal spending has raised concerns about overheating, but historical evidence over the last four decades makes a persistent surge in U.S. inflation above the Fed’s 2 percent target unlikely.
- U.S. unemployment rate swings: 10 percent in 2009 and 3.5 percent in 2019, yet inflation remained remarkably stable.
- Preliminary IMF estimate: the proposed U.S. package, equivalent to 9 percent of GDP, would increase U.S. GDP by a cumulative 5-6 percent over three years.
- Inflation, as measured by the Fed’s preferred index, would reach around 2.25 percent in 2022.

### Structural factors diminishing the inflation–activity link
- Globalization:
  - Has limited inflation in traded goods and some services.
  - Despite early disruptions, global supply chains have shown resilience and agility.
  - Merchandise trade has recovered in lockstep with the recovery in manufacturing, surpassing pre-pandemic levels.
- Slack in the global economy:
  - Considerable slack remains, with over 150 countries projected to have lower per capita incomes in 2021 relative to 2019.
- Automation and relative price trends:
  - Automation and relative declines in the price of capital goods have largely kept higher wages from being passed through to prices.
  - The crisis is likely to accelerate automation trends.
- Market concentration and profit margins:
  - Dominance of firms with high profit margins has allowed absorption of higher costs without raising prices (example: after the increase in U.S. tariffs).
  - The crisis could increase the market share of such high-margin firms, as smaller firms have been harder hit.

### Role of expectations and central bank credibility
- Inflation expectations have remained broadly stable around central bank targets, supported by independence and credibility of monetary policy.
- Credibility has reduced expectations that monetary policy will be used to keep government borrowing costs low at the expense of higher inflation.
- Japan example: government debt averaged over 200 percent of GDP since 2009, yet inflation averaged just 0.3 percent over the past decade; the challenge has been to raise inflation expectations.

### Policy guidance and recommendations
- Fiscal policy targeting:
  - Well targeted public spending would deliver similar improvements in employment and output with much smaller accumulation of debt, preserving space for future high social return spending.
  - High quality public investment should raise potential output, increase demand, and be central to a comprehensive climate mitigation strategy.
- Caution on historical extrapolation:
  - Exceptional policy measures in 2020 included fiscal spending by G7 countries of 14 percent of GDP—well above the cumulative 4 percent of GDP spent during the financial crisis years of 2008–10.
  - As a result, household savings rates in advanced economies are at multi-year highs and bankruptcies are 25 percent lower than before this pandemic.
  - Pent-up demand as vaccines spread could trigger strong recoveries and defy inflation projections based on recent decades; conversely, delayed bankruptcies could later dampen confidence, weaken inflation, and lead to further job losses.
- Central bank communication and pre-emptive action:
  - Central banks should pre-empt the possibility of sharp swings in borrowing costs via early and clear communications of their intentions to avoid market turbulence.

### Risks and scenarios highlighted
- Upside inflation risk: strong recovery and pent-up demand as vaccine protection becomes widespread could push inflation above recent trends.
- Downside inflation risk: delayed bankruptcies and weakened confidence could dampen demand and reduce inflation, leading to further job losses.
- Market turbulence risk: discovery of new virus variants, transitory swings in inflation, or earlier-than-expected rate increases by major central banks could tighten global financing conditions unexpectedly.

*Source: IMF Blog post by Gita Gopinath, February 19, 2021.*

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## Content in this bundle

- **Statement on Longer-Run Goals and Monetary Policy Strategy**
  - [Statement on Longer-Run Goals and Monetary Policy Strategy (Markdown version)](/monetarypolicy/files/FOMC_LongerRunGoals.pdf.md){rel="alternate" type="text/markdown"}
  - [Statement on Longer-Run Goals and Monetary Policy Strategy (PDF)](/monetarypolicy/files/FOMC_LongerRunGoals.pdf){rel="external" type="application/pdf"}

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_Source: https://www.imf.org/en/blogs/articles/2021/02/19/structural-factors-and-central-bank-credibility-limit-inflation-risks_