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Explaining Inflation Inertia

Despite central bankers' concerted efforts, credible price-stability targets have proved elusive in countries like Argentina, where inflation is soaring, and Japan, which can't shake the specter of deflation. What can governments do to influence inflation expectations when central banks’ policies prove insufficient to the task?

CAMBRIDGE – The stubbornness of inflation continues to challenge and mystify central bankers worldwide. Whether they are trying to boost price growth or rein it in, policymakers are effectively wrestling with the same problem.

Consider Japan, which has experienced deflation (a decline in the price level) in 11 of the past 20 years. Since 2016, deflationary forces appear to have receded, but inflation rates have consistently remained well below the 2% target set by the Bank of Japan, despite accommodative policies. The BOJ has maintained the policy interest rate below zero since 2016, capped long-term rates near zero, and expanded the monetary base by about 250% since 2013 via record purchases of Japanese government bonds (JGBs). The BOJ now holds about 50% of the outstanding stock of government bonds. This is no small achievement, as Japan’s government debt ratio, at 238% of GDP, is the highest in the world. And yet, despite these policies, inflation expectations five years out are still anchored close to 1%.

At the other end of the spectrum, there is Argentina’s ongoing inflation battle. The Central Bank of Argentina (BCRA), in connection with an International Monetary Fund program in June 2018, promised to keep the monetary base unchanged. This has forced the policy rate to climb to almost 74%. Nonetheless, the annual inflation rate has accelerated from around 26% a year ago to about 55%.

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