The temporary factors that set up the scenario for the current era - a strong currency and Asia's collapse - may turn out to be long-lasting.
By DAVID SMITH, economics editor of the Sunday Times.
It was Alan Greenspan, chairman of the US Federal Reserve Board and the nearest thing to a hero among central bankers, who defined the defeat of inflation as the point where prices rise so slowly they cease to affect economic decisions. Inflation is dead, in other words, when you stop noticing it.
This is where we have been for a couple of years, although there remain pockets where prices have continued to rise. The broad picture has been one of inflation so low you wouldn't notice - and falling prices for a range of commodities and products with the worry the balance might tip over into deflation.
Yet, suddenly, eye-catching developments have started to emerge. Oil prices had been languishing below $10 a barrel and global over-supply meant the days when the Organisation of Petroleum Exporting Countries could dictate the price belonged to a different era. Then OPEC did just that, with production constraints that lifted prices to $16 at time of writing, a 60% rise.
Exhibit two is the strength of asset prices, not only stock markets at record levels but also rising property prices. In Britain, sharply rising house prices and inflationary booms tend to go together. Are asset markets the harbinger of inflation's return?
The third factor is world growth. Did inflation die, or was it rocked to sleep by a series of special factors? If you wanted a scenario in which inflation would be reduced in, say, Britain and the US, you would give both strong currencies (cutting import prices); you would engineer a collapse in Asian demand so that oil and commodity prices fell; and you would look for an over-supply of manufactured goods - all those Asians producing but not consuming. Add a weak European economy and it would have been hard not to have low inflation. Britain's underlying inflation rate last year averaged 2.7%, just above the official target. Without those helpful factors, it easily might have been 4% or 5%, and no one, in Britain at least, would have been talking about the death of inflation. If Asian economies are now picking up, and this temporary restraint on inflation disappears, how serious will it be?
There is a parallel here, some would say, with what followed the 1987 stock market crash and last year's Russian crisis, when central banks cut interest rates in anticipation of serious knock-on effects that never came. The cuts merely stoked the inflationary boom of the late 1980s.
The main risk of history repeating itself this way is in the US, where growth has actually strengthened in response to last year.
Finally, the dog that continues to bark is pay. Last year Britain's statisticians suspended publication of average earnings figures due to concern over their reliability. They are back now and show 5% growth over 12 months - not quite on a par with Premier League footballers, whose earnings rose 35%, but not consistent with stable prices. So is inflation returning?
It depends where you are. In the US, talk is of an economic paradigm where technology-related productivity gains mean the economy can grow more strongly, and for longer, without generating inflationary pressures. But that process may be nearing its end: a paper in the New England Economic Review stated that while the factors cited here have slowed the rate at which an overheated economy translates into higher inflation, it has not prevented it. Thus, the more US unemployment falls - and in some states 'help wanted' signs outnumber Coke ads - the more inflation will eventually rise.
In Europe, despite hopes the current economic pessimism will be shrugged off (which in any case is affecting businesses and not consumers), inflation in the big countries will remain very low for some time. In the parlance of economists, the output gap - economy-wide spare capacity - is sufficient to mean that core Europe could grow strongly for several years without triggering inflation. The rise in oil prices came just in time to rescue Germany and France from consumer price deflation.
Japan is different, where the task is to prevent deflation - hence debate over 'monetising' its government debt (a budget deficit heading for 10% of GDP is a lot of debt). Japan, it is said, should engineer some inflation by printing money, or risk falling ever more deeply into deflation.
What about Britain? Over the coming months, we should see very low inflation due to factors already in the pipeline. Headline inflation should drop to 1%, with the underlying rate close to 1.5%, the point where Eddie George has to write a letter of explanation to the chancellor. One hopes this would cause a virtuous circle, notably in very low pay settlements, which in any case are well below average earnings figures, and in creating a climate in which low inflation remains the norm. My belief is we are in a low-inflation era and that, even in the US, any cyclical inflation upturn will be modest. Some of the 'temporary' factors may turn out to be long-lasting.
Better, though, not to talk of inflation being dead. It could cause it to rise up and haunt us.