“It could potentially be damaging to credibility,” said Brent Meyer, an economist at the Atlanta Fed. “If inflation expectations fell below the target level, that would, in theory, make it harder for central bankers to hit that target. And that could be a significant issue.”
Explanations
There’s a blizzard of theories aiming to solve the riddle, each with its own set of monetary policy implications. Most economists believe the answer lies in some combination of these ideas, rather than a single culprit.
1. Slack
One bundle of theories holds that the labor market simply isn’t as tight as most economists believe. It may be, for example, that the level at which unemployment provokes higher inflation is lower than estimated. Fed officials put this threshold at about 4.4 percent, but if it were, say, 3.9 percent, the inflation mystery might disappear.
A related argument focuses on labor market slack. Unemployment is low, but the numbers only count people actively looking for work. Employers can hire people off the sidelines, which has been happening a lot in the U.S., suggesting hidden job-market slack.
Then there’s international labor slack. Many economists estimate that opening up trade to nations like China has added at least 1 billion workers to global labor supply.
Such explanations suggest officials can push unemployment lower than in the past, up to a point. If it falls low enough, or if hidden slack is used up, the labor market may yet generate significant inflationary pressure.
2. Secular Disinflation
Economists see a variety of longer-run structural changes that may put downward pressure on inflation. For example, in an aging population older people save more and spend less; baby boomer retirements drive down average compensation. The collapse of organized labor, growing concentration among employers and exposure to international trade represent others.