Dr. Martin Weale is concerned about market sector Unit Labour Costs. OK. Here is what happened to market sector Unit Labour Costs going in to Summer 2011:
They have just tipped out of outright deflation. To be fair, this is current data; possibly the Bank had data saying something different back in 2011. But let’s presume that if Dr. Martin Weale was looking at even vaguely similar data, he must have been arguing for looser monetary policy at the time? Here’s what he was saying in June 2011:
I have, of course, been pleasantly surprised that wage settlements in the private sector have remained low and that private sector regular weekly earnings are rising by less than 2 1⁄2 per cent per annum.
(Yes, Dr. Weale! Like you, people all round the country are celebrating their low pay rises! Hooray for low pay rises, they say! Hooray, hooray! He continues…)
But a more general picture of unit domestic costs excluding taxes can be obtained by looking at the gross value added deflator. This rose by 1 per cent in the first quarter of the year and by 2.4 per cent compared with the first quarter of 2010. So it is consistent with the view that, even after excluding import costs and taxes, there are at present substantial cost pressures in the economy.
Can you see what he’s done there? He did not mention unit labour costs! In 2011, the GVA deflator was a good reason to… well, what did Dr. Martin Weale want to do in 2011? Just check the title of the spech: “Why the Bank Rate should increase now“.
Coming back to 2012, Unit Labour Costs have been rising, and what is happening to the GVA deflator? It rose just 1.2% in the four quarters to 2012 Q4 and has been below 2% for most of the last four years. So is that a “substantial” level of cost pressure, Dr. Weale, or a “pathetically weak” level of cost pressure? What would you say? Or do you in fact cherry-pick the statistics which fit your narrative and ignore the rest?
[Update: I meant to note that the GVA deflator reading which Weale mentioned, of 2.4% over the four quarters to 2011Q1, has since been revised down to 1.0%.]
I am honestly disgusted by this. This is not policy. This is not how the UK’s most powerful technocrats should behave, lurching from arbitrary decision to arbitrary decision. We deserve much, much better than this. Re-appointing the hawks to the MPC is looking like a catastrophically bad decision, absent a tighter (less discretionary) policy mandate to keep them on a tight leash.
… get inflation down. He presents the graph of nominal wages. I’ll put the figure here for the annual rate of change in average weekly earnings, looking at private sector regular pay:
0.7% in the year to March 2013
Weale decides instead that private sector unit labour costs are a clear and present threat to the sacred inflation target, and concludes:
So my own judgement is that a further easing of the rate of growth of cost pressures is necessary before I feel we are in danger of undershooting the inflation target.
Do you like that? “easing of the rate of growth of cost pressures”? Nominal wages are rising, let’s say it again ZERO POINT SEVEN PERCENT, and Weale wants to see an “easing of the rate of growth of cost pressures” before he’d consider easing monetary policy.
In the February Inflation Report we saw the Bank forecasting (and hence, targeting) CPI inflation significantly above 2% on the two year horizon for the first time in four years. In this week’s Inflation Report we saw the Bank revising up its real GDP forecasts for what Chris Giles says is the first time since 2007. What a strange co-incidence that is, eh?
Claire Jones has a nice post covering the improvements to the Inflation Report prompted by the Stockton Review. For the first time, I didn’t have to wait a week for the Bank to publish their sacred Excel spreadsheet with the forecast data. Rejoice! This graph shows how the median forecasts of the CPI rate have moved over the last four Inflation Reports:
The median forecasts have shifted down across the entire forecast period, since February, and now perfectly hit 2.0% CPI on the two year horizon (versus 2.3% in February on the same horizon). The obvious response is to castigate the MPC for yet another opportunistic disinflation. In this case I wonder whether the Bank’s models might only have altered the real/inflation split, since the real GDP forecasts have moved in the opposite direction to inflation; Chris’ post has the graph showing the latter. It would be useful to have the forecast for the path of nominal GDP so we could identify such cases.
It is worth noting here that Mervyn King’s hawkish ITV interview in March seems to have “successfully” capped the rise in market inflation expectations seen earlier in the year, and put a floor under Sterling – at least the latter of these feeds in to the Bank’s forecasting model. King declared in that interview that the pound was “close to properly valued” and insisted the Bank was not going soft on inflation. Great work, Merv!
(The sharp movement in market inflation expectations at the start of January is not a data error, it was caused by the outcome of the RPI methodology consultation.)
So the usual conclusions must be drawn… does the MPC want higher inflation? No. Are they constrained from moving inflation expectations? No. Have the MPC been desperately printing money to raise (or keep elevated!) expected growth and inflation since February? No, no, no.
Christina Romer’s paper links to this brilliant “infomercial” video from the US in 1933, which explains the power of monetary policy – which, by the way, is all about expectations:
George Osborne writes to the Bank of England:
Dear Bank of England, please target 2% inflation! Thanks!
The Bank of England meets and prepares its reply:
Dear George. Here’s the path we’ve set out for the nominal economy. You’re going to get above-target inflation and poor real GDP growth over the next two years, with the CPI rate hitting 2% after that. Is that OK?
Dear Bankers, thanks! That’s really great. I actually want a bit more inflation and faster nominal GDP growth. But instead of telling you to provide a bit more inflation and/or NGDP, I am going to do a £30bn capital spending package over two years. I have told my voters this will raise NGDP! So take it as a subtle hint.
Bank of England to George Osborne:
Erm, really? Do you want us to target 2% inflation or not? We could just target higher NGDP growth, but we’ll probably get even higher inflation too. Shall we do that?
George Osborne to Bank of England:
WOAH. STOP RIGHT THERE. What are you thinking? Please target 2% inflation. Gosh darnit guys, aren’t I making this clear? Can you imagine what Ed Balls would say if I asked for more inflation? I’d be crucified! 2%, 2%, 2%. Got it?
One month passes. Stuff happens… let’s say for the sake of argument that one of our major trading partners tips into recession. The Bank meets to set monetary policy again.
Bank of England to George Osborne:
Well George, we’re going to target 2% inflation like you said. Here’s the path we’ve set out for the nominal economy. Exports are looking a lot worse than last month, but government spending is up! So you’re getting an above-target CPI rate and poor real GDP growth over the next two years. We’ll hit the 2% after two years – is that OK?
p.s. By the way George, the national debt is looking pretty ugly. You might want to think about getting the deficit down.
George Osborne explained the Sumner Critique to the CBI tonight:
What’s more, without allowing inflation to climb even further above target, a fiscal stimulus three years ago would simply have been offset by less supportive monetary policy, with no net impact on demand.
With the independent MPC judging that the risks to inflation and output are evenly balanced, the same is true today.
So, just as the argument for fiscal stimulus three years ago was mistaken, so is the suggestion for a discretionary fiscal loosening now. Because we have sensibly allowed the automatic stabilisers to operate, our deficit is only just falling in nominal terms.
This is an improved version of the wording Osborne used last time. Pedantically correct wording, noting the forward-looking nature of monetary policy.
I had been unsure what I could write about King’s legacy at the Bank of England, but the Governor provided a quote which captures it well. In the press conference today, this is how King responded when asked about the new remit, and whether the Bank needed more discretion:
No I don’t think we need more discretion as such, I think the two key features of the remit which I welcome are, one – reaffirming that the central objective of monetary policy, which is the main role of a central bank, is to meet the inflation target of 2% a year; in other words the commitment to price stability. Nothing is more important than that and the Chancellor has moved – well he wasn’t tempted to go down the path of giving up the target, he’s reaffirmed the commitment to price stability.
Mervyn King coined the term “inflation nutter” in 1997 to describe those who embraced stability of inflation above all else. Governor King in 2013, along with an entire generation of central bankers, will still claim “nothing is more important” than price stability. That is the legacy of King and the rest of the modern-day inflation nutters.