One pleasant surprise from the financial crisis as IMF ponders missing inflation mystery

By Business editor Peter Ryan

The International Monetary Fund has signalled that inflation appears to be under control despite the trillions of dollars that have been pumped into the global economy in recent years.

For those who might glaze over at talk of inflation and quantitative easing, do not switch off now, the International Monetary Fund wants you to stay tuned.

Listen to my report from The World Today.

"We understand that these topics can sometimes be a little bit dry so we've tried to construct this one as a bit of a mystery story and so we've made a reference to Sherlock Homes and one of his famous cases about the dog that didn't bark," said the IMF's senior economist John Simon.

That dog is inflation, and recently Fido has been in his kennel despite trillions of dollars of quantitative easing - or metaphorical money printing - by central banks around the world.

The IMF and most economists around the world would normally be bracing for outbreak of inflation.

Mr Simon says, in terms of conventional monetary policy, it is a thriller.

"The basic mystery is that during the Great Recession we've seen very large increases of unemployment and in the past when you've had something like that inflation has fallen quite a lot, really there's been very little movement in inflation and the question is why was this?" he asked.

Speaking in Washington at the release of the IMF's World Economic Outlook, Mr Simon said the credibility and independence of central banks meant inflation targeting was working.

"There's been an evolution in central banking such that now it's very possible that we really are reaping the benefits of the low and stable inflation targets the central banks have set," he said.

"So one of the consequences is that we think there are actually substantially cyclical unemployment gaps, which means that there is actually the scope for falls in unemployment as the recovery progresses without there being corresponding bursts in inflation."

The head of investment research at Perpetual, Matt Sherwood, says the IMF's confidence that inflation will remain low is well placed.

"It really has been probably the great surprise in the post-GFC world that, despite the fact the growth's at trend and there's been record stimulus in the form of large fiscal deficits and near zero interest rates, I mean inflation does remain very well anchored," he observed.

"In essence I think the IMF's just really reflecting the data which has been coming out, which continues to show that despite all this stimulus there's very little inflation in the global economy at all."

Mr Sherwood says economists have generally been pleasantly surprised by the tame inflation readings in the face of such low interest rates and large money printing programs.

"I think it's been a great surprise to all economists, because given the amount of stimulus in the economy at present one would normally associate that of course with higher inflation," he added.

The one exception of course is that Japan is using massive money printing to push inflation higher, which is perhaps another challenge for the IMF.

There is also the future of inflation targeting by central banks. The IMF's John Simon says perhaps it is time to consider it should be the principal tool in massaging economies.

"There is a case to think about whether inflation targets as they currently constituted are the best way of maximising the welfare of an economy," he said.

"This is not to say there's any predetermined answer here, it's just saying that you can see, for example in the UK, they've been thinking you know is this inflation targeting regime we have and the precise way we've implemented it the best way to go about maximising economic wealth, happiness in our economy."

Inflation is also on the mind of the Reserve Bank of Australia, and for good reasons.

RBA assistant governor Christopher Kent repeated that low inflation provided scope for another cut to the cash rate.

"With inflation remaining recently well contained, and certainly a bit below the mid-point of the target and expected at the current assessment to remain at target over the next little while, with that in place the board's made it clear there's scope to ease monetary policy further should that be necessary," he said.

While another rate cut is increasingly unlikely because of stronger economic news, the latest consumer confidence reading from Westpac shows Australians are less optimistic because of softer share markets and concerns about the eurozone after the near banking collapse in Cyprus.