Dear IMF, Here Is What Happened to Inflation

 | Oct 12, 2017 | 9:00 AM EDT
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The International Monetary Fund annual meetings open on Thursday in Washington, D.C., with a crucial question: Where is inflation? Perhaps a better question would be: What is inflation? Or, to be more precise: What has inflation become?

The Federal Reserve trusted the Phillips Curve -- the theoretical relationship between unemployment and inflation that stipulates that as unemployment falls, inflation must rise -- almost religiously. It seems the curve was a false god. Or a "fake" one, to use a more fashionable word.

The big and the great in central banking and fiscal policy will be discussing the paradox of low inflation and low unemployment in Washington until the end of the week. As usual, unfortunately, they are likely to stray very little from the already-traveled path.

Policymakers have been focusing for too long on stoking consumer price inflation while allowing asset price inflation to run wild. But these two types of inflation seem to cancel each other out; therefore, the balance between them needs to be restored with some creative measures.

Major central banks pushed interest rates to record lows and purchased assets such as government and corporate bonds or even, as is the case with the Bank of Japan, equities. These actions have sent stocks, bonds and property prices to dizzying highs, but how many people actually benefited from it?

It seems that middle- and high-income people in the Western world did. If you own a home --or even, as it is all the rage in the U.K. at the moment, a portfolio of buy-to-let properties, bought with interest-only mortgages -- and a portfolio of shares and bonds, you have profited handsomely from the low interest rate bonanza. Indeed, the more assets you own, the more you benefited.

The trouble is, most of the world is asset-poor. For a lot of people, their work is their main source of income, but the measures taken since the financial crisis of 2007-09 have done little to encourage work. Buying bonds and stocks to encourage risky investment is all well, but central banks cannot dictate where the money they create goes in the economy -- nor should they.

A study by the IMF's Fiscal Affairs Department sheds light on the problem. It notes that while global inequality has trended sharply down over the past decades, inequality within countries has increased. This is something that predates the crisis. Inequality has increased in half the countries in the world, and especially in advanced economies.

This makes sense. The push toward outsourcing as part of cost-cutting by Western corporations has meant that low-paid jobs were shifted to poorer countries by companies in advanced countries. Meanwhile, the people in the advanced economies who were doing these low-paid jobs often have been forced to accept even lower-paying ones.

Besides narrowing the pool of jobs available to people with fewer qualifications, this situaiton also has reduced bargaining power by thinning trade union membership. The trend toward "self-employment" in the low-paid and precarious "gig economy," encouraged by so-called disruptors such as Uber, Lyft and Deliveroo, further reduced bargaining power on wages.

This shift has been gradual, and it is better noticed in wealthy cities such as New York or London, where opulence coexists with deep poverty. The Trust for London, a charity focused on inequality in the British capital, found in a recent study that 27% of Londoners live in poverty, with the high costs of housing the main culprit.

Working, it seems, doesn't help: 58% of those poor Londoners live in a working family, the highest percentage ever. This figure has risen from 44% a decade ago and 28% two decades ago. It is no wonder, either: A study by the Resolution Foundation think tank last year found that while London house prices increased by 57% in five years, average weekly earnings fell slightly over the same period.

The London example is an extreme illustration of the polarization between the shrinking ranks of "haves" and the widening ranks of "have nots" in the developed world. The resulting rise in populism has been hiding the real problem by blaming poverty on immigration. If left unaddressed, populism will end up harming everybody, even the rich, because it will lead to forms of government that destroy wealth rather than create it.

There are various programs put in place all over the world to help those on low incomes, but the reality is these are not enough. "Helicopter money" -- giving money straight to consumers to spend -- would work, provided that the money is directed toward the neediest in society, who are the most likely to spend it, rather than to those inclined to hoard it.

The great and the good at the IMF annual meeting perhaps should talk about shifting the burden of taxation from work to wealth. Besides contributing to lowering inequality, such a shift perhaps would restore some of the lost productivity. People taxed less on work and more on assets would spend less time worrying about amassing assets and more time thinking about ways to be more productive.

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