| Summary: | Janine Aron and John Muellbauer forecast in early October 2008 that the US was facing one of the sharpest falls in inflation ever experienced and that globally there was more risk of deflation than of inflation2. Three months on, these views are now widely shared. Central banks were relatively slow to react to the transformed inflation outlook. The ECB kept interest rates on hold on October 2nd. Though the Bank of England took part in the international cut of 0.5% on October 8th it was still worried about inflation risks at mid-month. It was only in November that it began to cut aggressively, while the ECB still lags far behind, even by January, with the depth of the global crisis visible to all. Conventional central bank models of inflation put too much weight on recent inflation persisting, and so they miss the turning points for inflation, an important source of policy error. In this article, Janine Aron and John Muellbauer discuss new research on inflation forecasting, which achieves better results, especially at turning points. Their evidence suggests that while annual US consumer price inflation will soon be negative, the risks of serious deflation are low. Core inflation is quite unlikely to drift into negative territory.
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