Global inflation maintains low level due to weak economies

A weak global economy and the absence of natural disasters have been keeping inflation abnormally low during the past five years, a report suggests.
Since the beginning of the crisis in 2008, central banks in the four largest economies of the world (United States, China, Europe and Japan) have almost tripled the amount of money into the economy, according to the Kuwait China Investment Company (KCIC).
Economic theory says that such a large amount of fresh money should have created high prices across the world. However, inflation remains weak.
China released last week its June inflation data, revealing further deceleration. Prices rose 2.3pct year-on-year (YoY), a deceleration from May's 2.5pct.
The level of inflation considered "adequate" by Chinese authorities is 3.5pct, but on average, prices rose only 2.5pct in the last 12 months.
The Gulf Cooperation Council (of six states: Kuwait, Bahrain, Qatar, Oman, saudi Arabia and the United Arab Emirates) is not an exception. May data show that growth in prices in the last year has been weak, mostly in the 2 to 3pct range (United Arab Emirates 2.1pct, Saudi Arabia 2.7pct and Kuwait 2.9pct).
The first driving factor of low inflation is the persistent weakness in the global economy. In spite of much analysis announcing a pickup in global growth over the last few years, the recovery has not occurred and it is unlikely to take place any time soon.
Signs of slack are abundant: unemployment remains stubbornly high in Europe at more than 11pct.
In the United States the participation rate remains at historical lows and the credit tightening in China is making many factories operate below potential. This trend shows in core inflation, the part of inflation that is directly related to the domestic activity in each country. Core prices rose 0.8pct in Europe and 1.9pct in the United States.
China, which as an emerging economy is supposed to experience higher inflation, had a core inflation rate of only 1.7pct. The output gap is still large in these economies and there are large pools of resources (labour, factories, machinery, capital) that are not being used.
The second factor explaining these low prices is pure luck. Even in an environment of weak economic activity, food and energy prices can create an inflationary spiral.
Natural disasters such as droughts or floods in food producing countries can spark inflation across the world, particularly in emerging countries where food represents a larger share of the inflation basket.
However, good yields and the absence of weather-related disasters have produced abundant food in international markets, keeping prices low. Over the last 12 months, rice prices declined 5.3pct, soybean prices fell 16.5pct, wheat decreased by 11pct and corn prices declined 43pct.
These are the most important global crops and are a key factor in explaining the current level of low prices particularly in countries like the GCC which are heavily dependent on food imports.
Central banks want inflation back, but not all of it, only the "good" inflation resulting of a healthy level of economic activity. Unfortunately, macro indicators suggest that good inflation is unlikely to appear any time soon. In the meantime let's keep our fingers crossed hoping that "bad" inflation will remain low.