Technology has been a meaningful driver of the current dynamic between inflation and the bond market. The internet, in particular, is changing the way economic health should be measured and, accordingly, the way investors position themselves.
Our classic monetary metrics are doing a poor job of evaluating the health of the economy, as the digital economy is very hard to measure in monetary terms. Technology has created significant increases in utility absent any real inflationary uptick. In fact, it can be argued that much of the technological development to date — and even on the horizon — is deflationary. This is likely to continue as the next big wave of innovation, the blockchain, strives to eliminate middlemen in many areas of the economy. This mismatch between the metrics and what is really going on in the economy could be causing central bankers to keep their feet on the gas longer than needed.
Technological innovation might cause inflation expectations to be permanently lower. Further, advancements in technology might mean traditional measurements of economic health also need to advance and evolve, particularly monetary aggregates. Modern economic theory is based on the idea that money is the ultimate measure of economic activity. Compensation, trade, commerce and investments are all measured in monetary terms. What if one could create a store of wealth that is different from money, as is occurring with cryptocurrencies? Initially our economies were based on bartering, then we used tokens resembling coins, later gold and then paper currency backed by gold. Then, in 1971, we finished the process of unlinking our paper currency to gold. For decades we have accepted the value of simply paper currency. Why couldn't data encryption also become a store of value? After all, if enough people agree that data encryption has value as a medium of exchange (not unlike paper currency) then it becomes a currency. The challenge for central bankers is that their classic economic tools are unlikely to measure this potentially momentous change until it is very far along in the process of adoption. Therefore, the current policy prescription of low interest rates may be misdirected.
It is unlikely that the central bankers of today, most of whom are classically trained economists, will publicly lead a change in thinking. But they do appear to be concerned with the asset price "bubble" and might choose to allow real interest rates to rise without seeing the classic measures of inflation rise. Comments from November's Federal Open Market Committee meeting indicate that although labor markets continue to strengthen and economic activity appears solid, inflation remains contained at less than 2%. The FOMC Statement noted near-term risks to the economic outlook appear "roughly balanced" but that the committee expects that gradual increases in the fed funds rate are likely.