It appears my timing could have been better in calling UK macro boring.
Those are not my ideal measures but the closest for which I have good data. The 2.5 year implied RPI has fallen by 0.5% over the last thirty days, to 2.4% as of yesterday, implying a significant undershoot of the 2% CPI target over the Bank’s forecast period (2-3 years). The FTSE 250 is at the lowest level for a year.
I caught a Newsnight discussion on the UK inflation data which was perfectly introduced by Duncan Weldon, who asked the right question: is the fall in inflation driven by the demand-side or supply-side? The studio debate which followed was a little disjointed from the reality in which the UK CPI rate has been a consistently bad indicator of UK demand-side strength. In fact it’s a contrary indicator, since periods of stronger real growth have been associated with weaker inflation and vice-versa. George Magnus would have us believe that the inflation data is giving us textbook (“Economics 101″) evidence of a “chronic deficiency of aggregate demand”. Chronic deficiency!? If you ignore the fact that CPI inflation has averaged 2.9% over the last eight years, sure, Mr Magnus.
But I’d answer Duncan’s question like this. If we see inflation running below the expected path and real GDP above the expected path, that looks like a positive supply-side shock. If we see both falling short, that’s a negative demand-side shock.
Here for each quarter I take the Bank’s median forecast of the CPI rate and RGDP growth from the Inflation Report four quarters earlier, and compare with the outturn:
The unexpected weakness of inflation and unexpected strength of real GDP growth does look like favourable supply-side news so far this year. That’s a backward-looking analysis.
What matters now is policy today, which is forward-looking. If the fall in UK inflation expectations is evidence of a positive supply-side shock then we should see a symmetric rise in UK real growth expectations. So who has upgraded their forecast of UK growth over the last month? The answer is… nobody has… and the fall in the equity markets (and gilt yields) makes it clear that growth prospects are falling too.
The Bank’s defence of inflation targeting as a policy regime, and their defence of the MPC’s decision-making under that policy regime, has always been consistent: what really matters is ensuring that inflation expectations are firmly anchored.
So… do it! Carney and friends have been making hawkish noises in speech after speech through the summer, trying to prepare the ground for rate rises. Does anybody seriously believe that there is even a single MPC member who believes the Bank is stuck in a “liquidity trap”, desperate for higher inflation but doesn’t know how to get there? No: that is just a convenient fiction.
For the MPC, the facts have changed, and policy needs to aim at raising inflation expectations so they are consistent with the target. Bravo to Andy Haldane for shifting in a dovish direction. As for Martin Weale… what can you say.
I’m a bit late with this. With the ESA10 revisions integrated into the national accounts we finally got an estimate of nominal GDP for Q2 in the Quarterly National Accounts. The usual data dump: quarter-on-quarter growth at annual rates (US-style):
ONS q/q NGDP growth rates continue to be annoyingly volatile. For the longer view of growth I’ll compare with the OBR forecasts from Budget 2014, which also shows the contrast with the old data before ESA10 revisions:
2012 does not look quite as bad as it did before. There are a number of things which are mysterious about the 2012 data – mainly the fact that real GDP goes nowhere as employment soars. Really, that data is just weird. If there was a betting market in UK GDP revisions I’d bet 2012 can get revised up further. Fast forward to 2014 and we do see nominal GDP growth at slightly above 5% y/y. That is a good place to be.
Real GDP growth also looks less bad. The Bank have been expecting upward RGDP revisions for a while, it will be interesting to see in the Inflation Report whether this matches expectations.
Prior to the revisions it was harder to make the case that the breakdown of GDP-by-income was consistent with what was happening in the labour market – not impossible, but hard. The updated series for total nominal wage and salary compensation is in fact more consistent with happened to employment (hours worked). Four quarter moving averages, growth rates:
The gap between the lines is (roughly) wage inflation: there isn’t any.
Serious people talk about the public finances facing a dilemma of higher taxes and/or cuts to public services. When I read those discussions all I can think about is nominal GDP. As a non-serious blogger, I reside happily in what Flip Chart Rick calls “Fiscal La La Land”, with my simple solution for fiscal salvation: the 4% solution, raising the inflation target.
Raising the inflation target would raise tax revenues, raise the denominator in debt/GDP, and allows cuts to real wages in the public sector without renegotiating (or reneging on) contracts made in nominal terms, and/or mass redundancies, both of which naturally provoke outrage from public sector workers and many consumers of those services.
Of course, we don’t really need higher “inflation”. And Serious People can’t talk like that, because “inflating away the debt” is unthinkable, it is not virtuous. The virtuous idea of “deflating up the debt” is curiously absent from modern debate, but that is exactly what the British government has managed to achieve in driving nominal GDP 20% below trend since 2008.
Here is the OBR explaining clearly what really matters – my emphasis applied, and read closely:
1.14. If the ballooning of the budget deficit simply reflected the fact that nominal GDP and asset markets had fallen a long way below the paths anticipated for them prior to the crisis – and that in time they could be expected to return to those paths – then there would be no compelling case for a large-scale fiscal consolidation to return the budget deficit to its pre-crisis level, although debt interest costs could be higher for a significant period.
1.15. The case for the consolidation – accepted by both the previous and current Governments, albeit with disagreement about its size and pace – is that the potential level of GDP that the economy can sustain, consistent with meeting the inflation target, is likely to be permanently lower than people thought prior to the crisis. Our latest forecast assumes that potential GDP was around 12 1⁄2 per cent lower than the Budget 2008 forecast by 2012-13 and that it will be 16 per cent below an extrapolation of that forecast by 2018-19. Even the most optimistic external assessments lie well below an extrapolation of the Budget 2008 forecast.
Market monetarists are often perceived as being pseudo-austerians in our opposition to “using fiscal policy”. I think this is backwards. I see “fiscal austerity” as a necessary by-product of the failed macro policy regime called inflation targeting, and nominal GDP level targeting is the best way to avoid “fiscal austerity”.
That is exactly what the OBR is saying above. If NGDP was expected to return to trend there is no case for fiscal consolidation. A difficult fiscal consolidation is required under inflation targeting when there is a permanent fall in the level of potential GDP. The current fiscal consolidation is going to continue being “difficult” as long as productivity growth continues to disappoint. If you want to know how Britain can end up having public finances like Japan, keep watching the productivity figures.
(If this is not intuitive consider what is held constant: if you hold the inflation rate constant, nominal GDP, nominal wages, nominal tax revenues etc must track the path of productivity. If you hold the path of nominal GDP constant changes to inflation rate reflect changes to productivity growth.)
Right-wingers find this message uncomfortable, but are often the first to champion the idea that “falling prices should reflect rising productivity.” That’s right. Specifically, below-trend inflation should reflect above-trend productivity growth, and above-trend inflation should reflect below-trend productivity growth. That symmetrical outcome is what NGDP targeting aims to provide. Right now we have below-trend inflation and below-trend productivity growth. You can’t ignore one half of the equation when it suits you.
The real “austerians” are not the crazy, obsessive monetarists who don’t want to talk about fiscal policy, but the 95% of economists who have a crazy, obsessive belief that 2% inflation targeting approximates optimal macro policy.
UK macro is really quite boring at the moment, and I cannot be happier to report that news. Of course boring events do not get reported as “news”, but that’s why we have blogs. Sure, there is a lot of debate about Scotland and so on which is related to macroeconomics – but UK macro events are not really capturing the headlines. UK GDP updates, labour market news… well, there’s a war on… let’s talk about Putin.
Contrast with the Eurozone. Mario Draghi is exciting! He is doing things. Pulling levers! Fiddling with interest rates. Easing credit conditions, improving financial conditions. Trying to get that CPI rate up… maybe. Oh, and allowing inflation expectations to collapse. That’s news.
Mark Carney expressed a worthy ambition in his statement to the Treasury Select Committee in 2013, that he “would like to achieve an exit in 2018 that is less newsworthy than my entrance”. I think he is well on the way to achieving that. This is how it should be. Central banking should be boring – nominal stability should be boring. If the nominal economy is stable, all the “news” will be “real”, in the sense of being supply-side.
For the first time in years I could not be bothered to watch the Inflation Report live last month, but skipping through the recording, the Broadbent, Carney and Shafik show is delightfully dull. Carney even takes pleasure from his own boringness:
What we’re putting emphasis on, and I know it’s boring and repetitive and it doesn’t clip into a new headline, we’re focusing on the path, the likely path of rates, the limited and gradual adjustment in those rates over the medium term, because of the headwinds that are facing this economy.
First and foremost it’s about the path for rate increases. I know it’s dull, I know it’s repetitive, but that’s the problem with consistency, it’s dull and repetitive.
Bravo Dr. C, bravo. And the annoying cricket metaphors are gone too.
This is what short-term inflation expectations (from gilt yields) looked like when UK macro events were newsworthy:
Quite the roller-coaster. I use the 3.5 year measure because it’s the most complete time series. Note this is RPI not CPI, and RPI at 3% is roughly equivalent to CPI at 2%.
Here is the last year and a bit:
What a dull, dull graph. Carney and the rest of the MPC deserve the highest praise for making macro policy boring.
There is an interesting asymmetry in how people read the macro data.
For a given increase in aggregate nominal spending (income) I think it would be generally agreed that “what we want to see” is a higher volume of output and not much inflation. Does anybody disagree? Anybody out there who would prefer the trade-off shifts towards higher inflation and lower output growth? No?
OK. For a given increase in aggregate nominal income (spending) we can consider the same trade-off between employment and wages. I had taken it as given that we had a depressed labour market and so “what we want to see” is that increases in aggregate income will translate primarily into higher employment.
What we have seen over the last year looks quite amazing. Over the year to the March-May 2014 period, hours worked has risen 3.7%. We only have nominal data for Q1, but that showed a 4.1% rise in nominal aggregate labour income. In other words, the increase in aggregate income has translated almost entirely into a higher volume of labour employed and there is no inflation – nominal wage growth is maybe just positive.
Yet this is seen somehow as a bad thing, see, for example the Guardian here, which puzzles me. Do you have a sticky wage model of the labour market, in which AD shocks can raise/lower employment, or not? Is higher employment in 2014 a good thing, or not? These questions have simple answers for this simpleton blogger.
6.5% is a good news story, and let’s hope they keep coming.
A quick note, file under “Relentless Attack on Inflation”. Thanks to some kind soul on twitter (whose name I’ve forgotten), I discovered that Eurostat have time series which split “administered prices” out of the HICP (= UK CPI).
I have discussed the effect of “administered prices” on the CPI here before, and I don’t have much to add. When energy prices go up because of increasing regulatory costs is that an “administered price” shock which should be ignored, or not? There are no “right” answers, it depends on your views on the appropriate goals for macro policy.
(It would be interesting to drill down into the divergence of the HICP from the HICP ex AP between 2004 and 2008. Tuition fees again?)
I want to clarify since I always feel a bit dirty after doing pessimistic posts about the supply-side:
1) I have very low confidence in any views about “potential output” and whether the productivity data is “correct”. That is doubly true for my own half-baked views.
2) I think the productivity data should have a 0% weight in setting monetary policy. Zero, zip, nada, zilch. And I think nominal wages
and/or incomes should have a 100% weight.
It is this second point which made me particularly angry at Carney’s (latest) hawkish move: the new data this year is telling us that nominal wage inflation is at record lows. Hence we need tighter monetary policy because…? Well, it’s not clear.
It is half true that the UK is looking more like Japan in 2014 than ever before. The CPI rate is below target and now looking kind of “low“. Nominal wage growth is dead. Tax revenues are sluggish; there is a gigantic fiscal deficit and public sector debt is heading up to the moon. The currency is looking pretty strong – something which plagued pre-Abe Japan regularly. Almost everybody is a supply-side pessimist. Our central bankers are hawkish. And even Her Majesty’s Loyal Opposition has been campaigning on the basis that “prices are too high”. (Maybe Ed Balls read all the Japan ZLB literature sitting on his head?)
But that is not the whole picture. I still don’t see any convincing sign that nominal GDP growth is slowing from around 4-5% y/y, a rate which should normally be consistent with the Bank’s mandate. The “low CPI rate” today is as useless a demand-side indicator as the 5.2% CPI rate was in September of 2008 or 2011. Inflation expectations are very stable and consistent with hitting that 2%. Confidence indicators are at multi-decade highs. I think “steady as she goes” would be a pretty reasonable monetary policy if you do want to take the inflation target seriously.