Investment Desk Bulletin

01 December 2017

Macro: Post Crisis Puzzles

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By Matthew Farrell

Recovery post the 2007 crisis has thrown up some frustrating economic trends, this week’s IDB explores two such puzzles.

Firstly, why has inflation consistently fallen short of expectations and below central bank targets? The reasons are multiple. As global trade has expanded, the world has become increasingly integrated, reducing labour costs and increasing price competition. New technology and online competition led to an ‘amazonisation’ of inflation, with online retailers dropping prices and benefiting from lower overheads. Globalisation and technology have increased the synchronisation of global inflation, therefore we must increasingly look beyond national borders to understand lower inflation trends.

Cyclical elements have also been at play, positive commodity supply shocks have pressed down on headline inflation in recent years, particularly oil prices. Many point to consistently low wage growth for undershooting inflation targets, suggesting that today the Philips Curve (which describes the inverse relationship between unemployment and inflation) has less relevance.

Secondly, productivity growth in the developed world has been surprisingly weak since the financial crisis. Addressing weak productivity growth is essential as it is key to long-term growth. Again, several factors are at play, including low levels of capital investment and low interest rates which have sustained unproductive “zombie” firms that would otherwise have been put out of business. There is also evidence that labour hoarding and falling levels of innovation have supressed measured productivity growth.

It is worth noting that economic forecasts can be inaccurate and mismeasurement could be skewing both trends negatively. Trying to understand these puzzles is crucial because they inform our future economic expectations and are key inputs to London & Capital’s asset allocation decisions. For now it seems the trends of modest growth and subdued inflation remain, reinforcing our preference of income generating assets.