FOR THE FED, IT´S A COLD WORLD OUT THERE / THE WALL STREET JOURNAL

Heard on the Street

For the Fed, It’s a Cold World Out There

Low prices are stymying policy makers all over the globe

By Justin Lahart

March 10, 2015 3:22 p.m. ET

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 Chinese Premier Li Keqiang set an inflation target of about 3% last week. Photo: Bloomberg News

 

The Federal Reserve faces an inflation rate that has remained stubbornly below what it is aiming at. It has plenty of company around the world, complicating the Fed’s decision on when to start raising interest rates.

Outside of countries that have seen sharp falls in their currency, such as Russia, it is hard to find a major economy where inflation is anything but low. China on Tuesday reported that consumer prices rose 1.4% last month from a year before. That figure would have been even lower but for a shift in timing of the Lunar New Year holiday. Core prices, which exclude food and energy, increased 1.6%.

Compare that with the inflation target of about 3% Premier Li Keqiang set at the opening of the National People’s Congress last week.

Meanwhile, core prices in the euro area rose 0.6% in January, year over year. The European Central Bank, which has just started buying bonds in a program of quantitative easing, has a target of just under 2%.

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The U.K.’s core rate, at 1.4%, was below the Bank of England’s 2% target. In Japan, where the target is also 2%, core prices eked out a 0.2% gain, excluding the effects of last year’s sales-tax increase. And in the U.S., the core version of the Fed’s preferred measure of inflation, at 1.3%, has been below the 2% target for nearly three years.

Because these core measures exclude energy, they only tangentially reflect the drop in oil prices via things like transportation costs. And because they cover a wide number of countries, currency effects come out in the wash. While the dollar’s rise against the euro is damping the prices of imported goods in the U.S., in the euro area it is adding to them.

So this truly is a low inflation world. A big reason why: There is too much capacity relative to demand. Many companies appear to have been geared up for rapid Chinese growth only to be caught wrong-footed as that economy slowed. Growth in China itself has relied heavily on fixed-asset investment, adding to global capacity. Meanwhile, Europe’s ability to cut unneeded capacity—witness its auto industry—has been limited, in part by political considerations.

On the demand side, the recession’s effect on U.S. consumer behavior appears lasting, with people opting to save more income. In Europe, high unemployment keeps a lid on spending.

As the Fed ponders raising rates, with investors watching nervously, its focus is on the U.S. economy, which is strengthening. But low levels of inflation globally should give it pause.

Tightening policy at a time when other central banks are struggling to hit their targets could cause problems that quickly show up on America’s doorstep.