The world economy is slipping into a deflationary trap. That’s the stark warning of the International Monetary Fund in its forthcoming World Economic Outlook:
“Eventually, the economy may end up in a deflation trap—a state of persistent deflation that prevents the real interest rate from decreasing to the level consistent with full employment. Moreover, even if deflation is avoided, a persistent downward shift in inflation to very low levels would not be desirable: lower nominal interest rates would leave little room to ease monetary policy if needed, the economy would still not be far from slipping into deflation and, given stickiness in wages, a weakening in demand would be more likely to cause large job losses.”
The IMF is particularly concerned that governments around the world have failed to do enough to stimulate growth, relying instead on Central Bank monetary policy to kick-start the economy. As Shawn Donnan in the Financial Times notes, the IMF are also concerned about the political direction of the developed world:
“In a thinly veiled rebuke of populist politicians who have called for new trade barriers, such as US presidential candidate Donald Trump, Christine Lagarde warned that the economic risks facing the world were being exacerbated by politics and a growing backlash against globalisation.
“Restricting trade is a clear case of economic malpractice,” Ms Lagarde told an audience in Chicago on Wednesday. “Restricting trade and limiting economic openness is sure to worsen the growth outlook for the world and especially its weakest citizens … We must reverse the trend toward protectionism and restore a climate that supports a rebound in trade.” She did not mention Mr Trump by name.”
Lagarde called on governments to increase public spending on infrastructure projects and to use minimum wage legislation to drive up consumer spending power. She also suggested that countries had to work together to produce a coordinated approach to recovery.
Even this relatively tame prescription is in conflict with the austerity cuts to public spending that have been adopted in the UK and the EU. In practice we are more likely to see the developed countries turn to negative interest rates and another round of quantitative easing (presumably on the basis that if something has failed to work three times, we need to do it just once more to succeed). What was it Einstein said?…