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The Challenge of Disinflation

Breaking the Cycle

As an economics student coming of age in the 1970s, it seemed that we would never regain control of the price level. Energy shocks and a series of policy missteps had brought American inflation to nearly 15%. Gas station attendants and grocers couldn’t adjust their labeling fast enough. It took some tough monetary medicine and a deep recession to finally gain the upper hand.

From that perspective, it is difficult to consider today’s very low rates of inflation as potentially problematic. But prices that are increasing very slowly or even falling can be harmful to economic and market performance. Central banks around the world will be working hard during the balance of the year to restore normalcy.

Inflation is falling
It’s been more than five years since the depth of the global financial crisis. Economic performance since then has been positive, but sub-par in the world’s developed markets. As a result, there is a significant amount of unused capacity in factories, unemployment remains elevated, and the prices of commodities have been under downward pressure.

Lots of potential supply and soft demand have produced disinflation, a situation where inflation is falling. Over the last twelve months, consumer prices were up only 1.1% in the United States and 0.5% in Europe. Some European countries are even experiencing deflation, where the price level is in decline.

Falling prices may seem like a good thing for consumers, but when something is expected to be cheaper tomorrow, it may not be purchased today. That kind of deferred spending can damage economic growth. In addition, falling prices increase the real value of debt, making it difficult to reduce leverage when necessary. Japan has endured deflation for most of the past 15 years, and only recently began to show firm signs of recovery.

Balancing act
Many of the world’s central banks have established inflation goals (2% is a common aspiration). These were initially set to bolster price-fighting credentials, but monetary authorities are increasingly realizing that falling far below the benchmark is also undesirable. An inflation objective must be viewed as a target, not just a ceiling.

Corrective action has been applied to keep expectations of disinflation from getting too deeply ingrained. Many central banks have reduced short-term rates as far as they can go, and augmented that action with varying degrees of quantitative easing. We can expect that accommodative posture to persist until there are clear signs that growth is reducing economic slack.

So in a generation, we’ve gone from an excess of inflation to not enough. And we’ve gone from monetary policy that aimed to fight inflation to policy that aims to promote inflation. I guess what they say is true: if you live long enough, you are liable to see just about anything.

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Not FDIC insured | May lose value | No bank guarantee

An investment in Northern Funds is not insured by the FDIC, and is not a deposit or obligation of, or guaranteed by The Northern Trust Company or any affiliate. An investment in Northern Funds involves risks, including possible loss of principal.

Please carefully read the prospectus and summary prospectus and consider the investment objectives, risks, charges and expenses of Northern Funds before investing. Call 800-595-9111 to obtain a prospectus and summary prospectus, which contains this and other information about the funds.

Shares of the Northern Funds are offered only by a current Prospectus and are intended solely for persons to whom shares of US registered funds may be sold. This site shall not constitute an offer to sell or the solicitation of an offer to buy nor shall there be any sale of shares of the Northern Funds in any jurisdiction in which such offer, solicitation or sale would be unlawful.

©2014 Northern Funds | Northern Funds are distributed by Northern Funds Distributors, LLC, not affiliated with Northern Trust.