Fundamental shifts resulting in lower inflation

Despite a boom in world economic activity and credit and money growth from 1980's to 2008, inflation and interest rates were declining. Here is the reason why.

In the 1980s a number of developments converged that together resulted in an economic shift, causing consistently downward pressure on inflation and (long term) interest rates world wide. The macro economic implications were considerably. Continuous upward pressure on asset prices (mainly real estate) and credit bubbles, which ended badly in the credit crisis 2007 - 2008:

• In response to ever-rising inflation in the 1960s and 1970s, in the 1980s the supply side of the economy (investments in other words) was stimulated far more. This was achieved through all kinds of tax measures that slightly inhibited consumption and stimulated investment.
•  In the 1960s and 1970s, prices were often kept high through mutual agreements, regulations and so forth. From 1980 onwards, people wanted to reverse that situation as far as possible and a process of deregulation began.
• An electronics revolution (computer, Internet, etc.), which made it possible to boost production per employee far more quickly than before.
• The fall of communism, which enabled the combination of cheap labour and modern machinery and technology in many countries in Eastern Europe and Latin America, but in Asia in particular.

Consumers faced with falling housing prices, falling stock prices, and a weakening labor market are unlikely to continue to spend at the same rate that they did in the second quarter; and recent data seem, unfortunately, to confirm this expectation. Exports are likely to weaken as many of our trading partners are facing significantly slower growth prospects in their own economies. Recent data also show little evidence that the housing market has "touched bottom." And firms appear to be holding back on investments until the economic outlook becomes clearer.

The weakening in the real economy is being compounded as so-called "financial headwinds" become more severe. The losses of capital and de-leveraging of balance sheets that have been underway at many financial institutions are continuing to serve as a drag on the economy, as financial institutions focus on restructuring their balance sheets with the consequent tightening of lending standards.