Firing on all cylinders?
Despite the strengthening of global activity, inflation remains quiescent. This is creating consternation among policymakers whose models would have predicted a pick-up in wage and price pressure.
What a difference a year makes. Last year the annual International Monetary Fund (IMF) meetings in Washington were characterised by doubts over the outlook for the global economy. This year, as we discuss in the video above, the IMF forecasts for the world economy were revised up and the theme was "seeking sustainable growth".
Leading indicators suggest that growth will remain robust, largely owing to the synchronised nature of the current upswing with the US, Europe and Japan all performing strongly.
Loose monetary policy has certainly played a role, but so too has the recovery in commodity prices and a resilient performance from China.
We have also seen a revival in investment intentions, particularly in the US. Although this has been one of the longest expansions on record, it has been one of the weakest for US capital spending (capex), particularly for business capex.
Explanations for this focus on the changing mix of growth in the US (more growth in labour intensive services, less capital intensive manufacturing) and the difficulty of measuring the cost of technology.
Inflation continues to puzzle: should we give up on the Phillips curve?
The upturn in global growth has lifted sentiment and markets, but investors and central bankers remain puzzled by the behaviour of inflation. Given the tightening of labour markets, most would have expected wages and inflation to be accelerating by now. Instead, we have a "Goldilocks" recovery where growth is not "hot" enough to push up prices.
At the heart of this lies the Phillips curve. It describes the relationship between unemployment and wage growth, such that lower unemployment leads to higher wage growth and vice versa. The problem is that it has not worked during this cycle and as some have argued, has not worked for at least a couple of decades1.
This has created something of an intellectual crisis in central banks as the Phillips curve has been seen as a compass for guiding monetary policy.
An enhanced compass would be useful
Essentially economists come out on two sides of the debate as to the usefulness of the Phillips curve today. The first group argue that central banks should simply recognise that the relationship does not work and find something else to guide policy. The second say we should keep the framework, but work harder to understand the drivers. It's a choice between trying to make the compass work better, and throwing it away.
In our view central banks should not give up on the Phillips curve. Apart from the issue of what to replace it with, there is plenty of scope to enhance the current framework.
For example, adjusting unemployment for factors such as part-time working or temporary contracts could provide a better guide to wage and inflationary pressures. Using global rather than local output gaps is also likely to prove more fruitful.
The coming months could provide a key test as the signs of strength in the world economy discussed above are likely to bring further labour market tightening. An enhanced compass will prove useful.
This communication is marketing material. The views and opinions contained herein are those of the named author(s) on this page, and may not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds.
This document is intended to be for information purposes only and it is not intended as promotional material in any respect. The material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The material is not intended to provide, and should not be relied on for, accounting, legal or tax advice, or investment recommendations. Information herein is believed to be reliable but Schroder Investment Management Ltd (Schroders) does not warrant its completeness or accuracy.
The data has been sourced by Schroders and should be independently verified before further publication or use. No responsibility can be accepted for error of fact or opinion. This does not exclude or restrict any duty or liability that Schroders has to its customers under the Financial Services and Markets Act 2000 (as amended from time to time) or any other regulatory system. Reliance should not be placed on the views and information in the document when taking individual investment and/or strategic decisions.
Past Performance is not a guide to future performance. The value of investments and the income from them may go down as well as up and investors may not get back the amounts originally invested. Exchange rate changes may cause the value of any overseas investments to rise or fall.
Any sectors, securities, regions or countries shown above are for illustrative purposes only and are not to be considered a recommendation to buy or sell.
The forecasts included should not be relied upon, are not guaranteed and are provided only as at the date of issue. Our forecasts are based on our own assumptions which may change. Forecasts and assumptions may be affected by external economic or other factors.
Issued by Schroder Unit Trusts Limited, 31 Gresham Street, London, EC2V 7QA. Registered Number 4191730 England. Authorised and regulated by the Financial Conduct Authority.