The IMF's deflation "ogre" has given way to a "lowflation" lithany in a recent IMF blog, which culminates in a call for lower ECB rates. Among other arguments, the well written post points out two key problems from low inflation:
The first problem is the presence of nominal rigidities, i.e. the difficulty of cutting wages and prices. The internal devaluation that countries in the euro periphery need to accomplish requires an inflation differential to Germany and the rest of the core. Nominal rigidity in wages make this adjustment harder to achieve if inflation in the core is low. And where prices must fall but can’t, the adjustment falls on volumes: lower output, lower employment.
But here are some important qualifiers:
1) The nominal rigidities are the underlying problem.
The nominal rigidities are a reflection of labor market inflexibilities...
