20171211-NATIXIS-What_determines_inflation_in_the_long_term__5页_644kb

Flash Economics Summary

Core Content

The document discusses the long-term determinants of inflation, challenging the traditional monetary theory that inflation is primarily driven by growth in the money supply. It explores alternative theories and variables that may influence long-term inflation, including nominal wages, exchange rates, and nominal interest rates under the Neo-Fisherian perspective.

Main Views

• Traditional Monetary Theory Refuted:
  The monetary theory of long-term inflation, which posits a stable relationship between money supply and nominal income, has been invalidated by empirical evidence. This theory assumed that the price level is proportional to the money supply divided by real GDP, with a constant $ m $. However, data shows that the money supply has grown significantly more than the price level over the past 20 years in both the United States and the euro zone.

• Alternative Determinants of Inflation:
  If inflation is not determined by money supply growth, it may be influenced by other controlled, exogenous nominal variables. These include:

  • Nominal Wages: If nominal wages are set by external factors (e.g., labor market organization), inflation may follow unit labor costs.
  • Nominal Exchange Rate: If the central bank controls the exchange rate, it could be a determinant of inflation.

• Neo-Fisherism as a New Perspective:
  A recent theory, Neo-Fisherism, suggests that in the long term, inflation is determined by the nominal interest rate. This theory is based on the Fisher equation:
  $$
  \text{nominal interest rate} = \text{real interest rate} + \text{expected inflation}
  $$
  Under Neo-Fisherism, if the central bank controls the nominal interest rate and the real interest rate is determined by structural economic factors, then the nominal interest rate becomes the key driver of inflation.

Key Information

• The document uses charts to illustrate the relationship between money supply, real GDP, and price levels in the U.S. and the euro zone.
• Charts 1A and B show that the money supply has increased more than the price level, contradicting the monetary theory of inflation.
• Charts 2A and B demonstrate the correlation between unit labor costs and CPI in both regions.
• Charts 3A and B show the relationship between the nominal trade-weighted exchange rate and CPI.
• Charts 4A and B support the Neo-Fisherian argument by illustrating the link between nominal interest rates and inflation.

Conclusion

The document concludes that the monetary theory of long-term inflation is no longer valid. It emphasizes the importance of identifying new determinants of inflation, such as nominal wages, exchange rates, or nominal interest rates, in order to better understand and manage monetary policy. The choice of which variable determines inflation has significant implications for economic analysis and policy-making.

Disclaimer Highlights

• The document is intended for professional and qualified investors only.
• It is strictly confidential and must not be disclosed to third parties without prior consent.
• It does not constitute a financial analysis or personalized investment recommendation.
• Natixis is not liable for any inaccuracies or omissions in the document.
• The views expressed are the personal opinions of the authors and do not necessarily reflect those of Natixis or its affiliates.
• The document is subject to legal and regulatory restrictions in certain jurisdictions.