Academic journal article ABA Banking Journal

Global Markets: Volatility in a Low-Inflation World

Academic journal article ABA Banking Journal

Global Markets: Volatility in a Low-Inflation World

Article excerpt

As the New Year dawns, the divergence in the economic issues facing policymakers among the major countries has not narrowed from a year ago. With regard to economic performance, sustainable economic recoveries have been established in Canada, Sweden, and Spain. In contrast, Japan has fallen off the recovery path that seemed well established in 1996. In Britain and the United States, the business cycle recovery strengthened in 1997, whereas in Germany, France, and Italy domestic economic activity has remained subpar.

In many ways, the major change wrought across the global economic scene in the 1990s has been a widespread cut in inflation rates. There is a new mindset among central bankers that low inflation is a pre-condition to healthy economic performance. To achieve lower inflation, central banks have to keep demand growth in check relative to the growth of their economies' potential. This has translated into a persistent reduction of nominal demand growth in the major countries (chart). Moreover, the differences among these demand growth rates have narrowed as well. What is implied, then, is that not only will inflation be lower across the major countries, but also inflation differentials will be narrower.

But today's market concern is not especially focused on the odds of higher inflation. In the aftermath of the Asian turmoil, the topic of the day is a further reduction of inflation, perhaps even deflation. But such notions are far-fetched. Weaker growth in the developing world will indeed slow export growth of the industrial countries. But if recent assessments are any guide, the overwhelming expectation is for a slowing of growth in most of the Asian countries, with only a few cases of outright decline in economic activity.

For foreign exchange rates, the most important background influence is the fact that inflation differentials among the major countries have narrowed substantially. This is a sea change for many market participants who have grown to believe that the U.S. dollar is fated to fall persistently against the other major currencies as it has since the early 1970s. However, over the past decade, the reduction in U. …

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