Over the past 15 years, global consumer price inflation has been reduced dramatically, in advanced and developing countries alike, underpinned by a blend of more effective and independent central banking institutions and, just as important, the demands of globalization. As of 2003, only three countries had annual inflation rates above 40 %, the level above which it is considered to be acutely damaging. In none of the G-7 countries did inflation exceed 3 %. Besides, in many middle-income countries where high inflation had once been almost a permanent feature of the economic landscape, inflation has been brought to well single digits.

Since 2000, annual global headline and core inflation (based on the CPI excluding energy prices) has averaged about 3 %, although this historically low figure has masked some volatility. In the last decade, inflation levels have been unusually low, with emerging fears of deflation appearing. However, from end 2003, with global output growing rapidly and commodity prices rising sharply, headline inflation turned up quickly although still moderate. Correspondingly, deflation fears dissipated and, with monetary policies across the globe still quite accommodative, there have been concerns that inflation could make a comeback.

A significant proportion of the recent rise in headline inflation appears to have been due to higher commodity prices. Core inflation has risen by considerably less than headline inflation and remains at moderate levels. From a regional perspective, headline inflation has increased almost everywhere, but developments in core inflation have varied considerably. The rise in core inflation in the US has been surprisingly steep, possibly partly reflecting a rebound from the abnormally low levels experienced in 2003, although it has eased in recent months. In contrast, the increase in the euro area is not pronounced. Despite substantial monthly fluctuations, some upward trend in core inflation is also discernable in China, other emerging Asian countries, and emerging Europe and Latin America. A key question to monetary policymakers is whether the recent rise in both headline and core inflation will be one-off in nature, or whether it could feed through to wages, and thereby become more entrenched. Such risks would be greater if excess capacity in the economy is small (since labour markets are then correspondingly tight and putting pressure on profit margins) or if inflation expectations are rising.

Looking at the evidence across the globe, we find that firstly, Margins of spare capacity are declining, but in most countries are still significant. With the world economy growing at an average rate of 4.9 % annually, capacity utilization rates are on the rise and accelerating the exhaustion of the positive output gap. Secondly, Inflation expectations have risen moderately, but still appear relatively well grounded. Global inflation conditions have been recently revised to 2.6 %. The largest upward revisions have been for emerging markets, with smaller increases for industrial countries.

Overall, the combination of higher global growth and rising commodity prices will mean that monetary policies will generally need to be tightened somewhat faster than earlier.

Nitish BENIMADHU

Your comments are most welcomed: [email protected]