Despite current low rates, I still often hear people say that higher inflation is just around the corner. I confess that I am somewhat exasperated by these repeated warnings given our current environment of very low inflation. Many times, the strongest concerns are expressed by folks who said the same thing back in 2009 and then in 2010 and, well, you get the picture. OK, five years later we still need to carefully assess this very serious question. Let me offer five reasons why I still see the economic environment as pointing to below-target inflation for several years. First, many commentators see rising commodity prices as a harbinger of rising inflation pressures. Certainly, back in 2008 and 2010 there were instances when energy and commodity prices rose to high levels. This put pressure on inflation and also reduced aggregate demand. There is a lot of evidence that these types of relative price increases result in only transitory increases in consumer price levels. 6 At the moment, even these transitory upward pressures are absent, and the current weak state of global demand contributes to downward pressures. Until something unexpected, and frankly positive, happens with the world economy, commodity prices seem like an even more unlikely propellant for strongly rising inflation than they usually would be. Second, some say a classic warning sign of inflation is the enormous size of the Fed’s balance sheet and the greater than $ trillion of excess reserves sitting on commercial banks’ books.
2  BIS Review 48/2001  Now, let me be clear, I agree with those who argue that the single currency – by eliminating exchange risk within the participating countries – can make a significant contribution to increasing the depth and liquidity of financial markets and reducing transactions costs within the Eurozone. And indeed it already has had that effect, particularly in money and bond markets, especially the corporate bond market. It has no doubt also been a factor encouraging the tendency to, mostly national, consolidation as financial institutions prepare for greater competition from other euro-based institutions in their national markets. All of this is very positive for the competitive efficiency of Euro-zone financial systems both nationally and within the Eurozone as a whole. It is in fact one of the two main potential economic benefits of the single currency, the other, of course, being the positive effect of nominal exchange rather certainty within the Eurozone on trade flows of goods and other, non-financial, services and its impact in more efficient resource allocation. It is also the field in which the UK, through London, has been able to make a positive contribution to the development of the Euro even from outside the Eurozone. So I do not at all underestimate the contribution that the euro has made, and is making, to improving the efficiency of the Eurozone financial systems.