- 2018-09-26
Why is the global inflation rate so low?
At present, the global economy is at or close to full employment, but the level of inflation remains sluggish (Figure 1). It has been ten years since the global economic crisis broke out. Although the central banks of the United States, Europe, Japan and other regions have been adopting special economic stimulus measures for many years, they are still striving to achieve the 2% inflation target. And work hard. For central banks of various countries, the reasons that hinder them from achieving their inflation targets are nothing more than globalization, the slowdown of China's economic growth, demographic data, and various "temporary factors."
In addition to the above factors, we found that "technology" is another very important but often overlooked reason that causes the inflation rate to never reach 2%. Through data analysis, we have given a long-term forecast of the inflation rate and interest rate trends in the next few years.
Moore's Law, proposed by Intel co-founder Gordon Moore, has become synonymous with the increasing popularity of more powerful technologies at lower costs. With the continuous advancement of technology (for example: faster, more powerful computers, lighter, larger screen TVs, more efficient smart phone applications, etc.), the relative price of technology is also declining. We estimate that lower prices of commercial and personal consumer technology products will lower the Consumer Price Index (CPI) by about 18 basis points (one basis point equals 0.01%) each year.
However, Moore's Law is not only related to technical parts or high-tech products. The chain reaction of Moore's Law limits the demand for a variety of higher-priced products in the market. This is not limited to high-tech products, but covers all aspects of the economy. However, this has not been discussed in recent discussions about why inflation remains so low in a full employment environment.
Because technology can play a significant role in improving production and providing commercial services, companies in all walks of life are striving to reduce production costs. The price of goods or services set by enterprises is often an addition to the marginal cost, and with the continuous adoption of new technologies, unit production costs are shrinking. Over time, the final prices presented to consumers by these companies either continue to depress or grow slowly, and this impact even spreads to industries that are not directly related to technology.
In order to determine the increasingly important role of technology in the production process of the US economy, we have adopted a brand-new approach, drawing on detailed data on industry input and output from the Bureau of Economic Analysis (BEA). In order to quantify the impact of the popularization of technology application on achieving the 2% inflation rate, we first determined the technology input of various industry categories, including healthcare, professional services, education, agriculture, and construction. Subsequently, we compared the actual changes in the prices of products and services in each industry category (that is, the production price index PPI) with the changes in the hypothetical index after excluding computer-based technology inputs.
Moore's Law has a significant impact on the prices that American companies need to charge. Since 2001, the price cuts of computers and electronic products, computer design and services, and other technological inputs have brought a 0.5% drop in production costs and even final prices every year. In other words, if there is no influence of Moore's Law, the average annual inflation rate may be 0.5% higher than the current one. Without the influence of technical factors, the core personal consumption expenditure (PCE) inflation rate may have reached 2%; the Fed’s inflation target may have been achieved several years ago, and the nominal interest rate may be higher.
In the process of continuous efforts by central banks to achieve inflation targets, technology is a critical but often under-recognized challenge factor. To some extent, if companies continue to adopt more technology-intensive processes, the resistance generated by technology will become more prominent. The use of newer and cheaper technology-intensive processes to replace old production processes will increase the weight of technology-related inputs and further enhance the deflationary effect of Moore's Law. Also based on industry data from the U.S. Bureau of Economic Analysis’s input-output table, we can see from Figure 3 that the total cost of technology used in the production process has more than doubled since the late 1990s. Originally, every dollar of output accounted for $0.08 to today’s per dollar of output accounted for $0.20. We have no reason to believe that this trend will be reversed in a short period of time.
This impact is most obvious in technology-intensive industries such as information and communications, professional services, and manufacturing. In industries that seem not directly related to technology, such as healthcare, education, and retail trade, cost savings are small, but they cannot be ignored.
When the global economy is at full employment, low inflation is the final obstacle for policymakers to more actively promote the normalization of monetary policy (and the normalization of monetary policy is currently undesirable for the bond market). Vanguard has always insisted that, in the medium term, structural forces including technology will cause most economies to continue their efforts to achieve sustainable inflation of 2% or higher.
From the perspective of this structural approach, we elaborated a more realistic view on the potential drivers of global inflation. At present, both market-based expectations and survey-based forecasts indicate that inflation levels will remain weak. So, for investors, a very critical question is, in the medium term, what factors can drive the global inflation trend to unexpectedly improve?
In general, our assessment results further confirm our view: for a period of time, inflation and interest rates will continue to be at historical lows. Among the key driving factors that promote the rise of inflation, the use of a gradual method to promote the normalization of monetary policy is the only driving factor with high probability, and the probability of occurrence of other factors is low to medium. Moore's Law and the pace of technological innovation may still be resistance for central banks to achieve the 2% inflation target. If inflation is higher than expected in the next two to three years, it is most likely because the strong global economic growth and loose monetary policy are enough to offset the deflationary effect of Moore's Law.