Inflation Likely to Remain Stable, IMF Study Concludes

Inflation barely budged during Great Recession despite rising unemployment

Independent central banks reduce risk that policies to stimulate economy will ignite prices

Inflation expectations anchored, but asset prices still vulnerable to increase

The stability of inflation in recent years reflects two key factors, concludes the research published in the IMF’s most recent World Economic Outlook report. The chapter uses econometric analysis and case studies to examine the drivers of price behavior.

First, inflation expectations have become more strongly anchored, or resistant to change, reflecting people’s confidence that inflation will remain close to the targets set by national central banks (see chart). Second, the response of inflation to changes in cyclical unemployment has become more muted.

Not only has inflation been stable during the recession, inflation was also remarkably steady during the strong economic expansion in the early 2000s. This was the case even in Spain, which by joining the euro area became subject to monetary policies that were too stimulative for its domestic economy. Despite the dramatic reduction in unemployment that resulted, inflation expectations, as well as actual inflation, remained remarkably well anchored.

“An essential element behind the anchoring of inflation expectations is the independence of central banks,” explains John Simon, lead author of the study.

Illustrating this point, the study compared the divergent experiences of the Bundesbank and U.S. Federal Reserve (Fed) in the 1970s. Even though both overestimated cyclical unemployment and were keen on maintaining economic growth, the Bundesbank managed to keep inflation in...