Disinflation Expectations

Simon Wren-Lewis directed me to the Eggertsson & Woodford paper on “Optimal Monetary Policy in a Liquidity Trap“, which has way too much maths for this humble blogger.   But this bit I could understand:

Indeed, our most important general conclusion is that the key to dealing with a situation in which monetary policy is constrained by the zero lower bound on short-term nominal interest rates is the skillful management of expectations regarding the future conduct of policy. By “management of expectations” we do not mean that the central bank should imagine that with sufficient guile it can lead the private sector to believe whatever if wishes it to, independently of what it actually does; we have instead assumed that there is no point in trying to get the private sector to expect something that it does not itself intend to bring about. But we do contend that it is highly desirable for a central bank to be able to commit itself in advantage to a course of action that is desirable due to the benefits that flow from its being anticipated, and then to work to make this commitment credible to the private
sector.

Commenter “asdasdasd” on a previous post pointed out that inflation expectations were crashing.  I wonder if this is what Eggertsson & Woodford had in mind for “skillful” management of expectations?

Here is the data from May – the MPC decision to cease the QE program was announced on the 11th, and it was downhill from there:

UK Inflation Expectations

The implied inflation data uses the RPI index, about 0.5%-1% higher than CPI.  The MPC have successfully compressed market inflation expectations for three years of sub-1.5% CPI growth.  Brilliant work.

HT: asdasdasd

Et tu, Broadbent?

I missed this Reuters report from Monday:

(Reuters) – Bank of England policymaker Ben Broadbent rejected a call from the International Monetary Fund to consider cutting interest rates further, saying it would not help businesses much and could discourage bank lending.

…

“As to whether (policy stimulus) is sufficient at the moment, then clearly it is,” he continued. “The forecasts in May were consistent, two years out, with roughly balanced risks on either side of the (inflation) target.”

“Clearly“??? What world do these people live in?  Oh, that’s right – the world where all that matters is the CPI rate, inflation targeting world.

“Current Stance of Policy Looks Broadly Right”

Markit reports:

UK Manufacturing PMI slumps to three-year low in May

Key points:

• UK Manufacturing PMI at 45.9 in May, from 50.2 in April
• New orders drop at fastest pace since March 2009
• Manufacturers cut back output, employment, purchasing and inventories

Never mind folks, MPC member Spencer Dale is on the case:

“At the moment, our view is that … inflation should slow to around the target at the back end of 2013 and as a result the current stance of policy looks about broadly right,” Dale said in a television interview with CNBC.

Spencer Dale shall henceforth be known as “Crazy Loon, Spencer Dale”.

Guardian Headlines You Didn’t Read Today, Spencer Dale Edition

“Crazy Central Banker Neuters Growth With Weird Obsession Over Inflation”

Reuters reports:

“More asset purchases by the Bank of England may not be warranted even if Britain’s economy continues to struggle, and the bank should keep its focus on bringing down inflation, its chief economist said on Wednesday.”

Warning: Watching this CNBC video interview (headline: “UK Economy on the Mend”) with the Bank of England Chief Inflation Nutter Economist may seriously damage your health.

Fiscal stimulus?  Good luck with that.  A high and stable level of employment?  Good luck with that.  The lunatics are running the asylum.

Mervyn King and the Fiscal Multiplier

Lars Christensen stated recently that for Europe “the fiscal multiplier is zero if Mario says so“.  The debate about the impact of fiscal stimulus in the UK is similarly predicated on the central bank’s response.   It’s rather insane that we must be forced to have this debate about that hypothetical situation.

If the MPC wanted – or would tolerate – faster demand growth, but feel they were unable to provide it using monetary policy, why don’t they just come out and say that?  The government has picked a bunch of the best economists available to run our AD policy.  They are just civil servants; the ultimate technocrats.  If they think fiscal policy could be used to provide better outcomes for the macroeconomy people they serve, why are they not shouting it from the rooftops?

So I was glad to see that Ben Chu came out and hit Mervyn King with the question du jour in the Inflation Report press conference earlier this month.  What’s the impact of fiscal tightening on demand, Merv?  My emphasis here:

Ben Chu, The Independent: Governor, in your opening remarks you said that there were two major factors behind the fact that the recovery has been less healthy than we hoped for – the credit squeeze and high commodity prices. But what you didn’t mention was the fiscal tightening that’s been put in place. I was wondering what your view is on the effect of that fiscal tightening on the pace of the recovery? And also if you could give us an insight into the view of the MPC as a whole on what impact the level of tightening has?  I’m thinking particularly of the infrastructure cuts which were quite high last year.

Mervyn King: Well I don’t think the Committee has formed detailed views about particular aspects of public spending. Of course the fiscal consolidation is a dampening effect on demand; that’s clear. And that’s why we need a rebalancing where you’ve got expansionary monetary policy and a weaker exchange rate boosting exports, offsetting the dampening effect on demand of the fiscal consolidation. But the point I was making was that we knew that two years ago, and there hasn’t been any significant news since then.

“Offsetting” – the Sumner Critique reduced to a single verb.  (MPC Kremlinologists might pick up on the use of the word “need”, implying that King thinks we “need” expansionary monetary policy but haven’t got it.  That would be not be consistent with anything else he says, so let’s presume he is using it in the less formal sense.)

Indeed, Mervyn King has been consistently hawkish on fiscal policy; cautioning against more deficit spending in March 2009, and was subsequently widely criticised when calling for a “clear and credible” plan to reduce the deficit during 2010 and beyond.   Obviously, the Governor does not represent opinion of the whole MPC – and Adam Posen is surely a deficit dove.

It remains very hard to find a strong indication that the MPC want faster demand growth right now.  Any time they do see the need for faster demand growth, they QEase.  Who really believes they work any other way?   And Spencer Dale seems to be setting himself up as the resident hawk:

“Monetary policy at the moment is very stimulatory,” Mr Dale told BBC Radio Scotland. “We have undertaken a large amount of quantitative easing and that will continue to flow through the economy.”
…
Mr Dale said: “We expect to see a gradual recovery in growth this year. We have seen inflation drop from 5pc to 3pc, but we need to get it down further. The case for QE going forward will be affected by the balance of those two risks.”

Never mind the economy – let’s disinflate!  Fiscal stimulus?  Good luck with that.

Market Monetarists, This Country Needs You

There’s a vacancy at the MPC.  Who can fill Adam Posen’s shoes?

The Bank of England is the central bank of the United Kingdom. Standing at the centre of the UK’s financial system, the Bank is committed to promoting and maintaining monetary and financial stability. The Monetary Policy Committee (MPC) of the Bank of England has responsibility for formulating monetary policy.

The MPC comprises the Governor and the two Deputy Governors of the Bank, two of the Bank’s executive directors, and four external members appointed by the Chancellor of the Exchequer.

Candidates are sought for the role of External Member of the MPC. The closing date for applications is Friday 15th June 2012. Please read the candidate brief below for information on the role and application process.

The pay is not quite two trillion dollars, I’m afraid to say:

External MPC members are appointed on a part time basis averaging three days a week.  Appointments are for a term of three years, and members may serve up to two terms. Total compensation will be £131,771 plus healthcare benefits. External MPC members are not required to hold UK nationality, but to fulfil duties are expected to be resident in the UK.

Apply now.

Newsflash for Jonathan Portes: The MPC Are Targeting Inflation

Jonathan Portes has written up a criticism of Chris Giles’ article supporting the IMF’s argument that monetary policy should be the first port of call for demand management:

There is at least some economic theory behind [using monetary policy first for demand management]; indeed, I used to believe it myself, as I set out here.  But this is a purist approach, which simply hasn’t survived contact with reality, as Chris’ own articles show. If monetary policy alone was indeed enough in practice, we wouldn’t be where we are now, with unemployment in the UK a million higher than the official estimate of the natural rate, and no prospect of it coming down in the immediate future. Any demand management policy that delivers that outcome is not one that policymakers should regard as remotely adequate.

Why have things turned out this way? Well, economists will be arguing about this for some time. As Milton Friedman famously said, monetary policy has long and variable lags; and he was talking about conventional monetary policy operated through interest rates, not the present extraordinary measures.  It is clear the Monetary Policy Committee, let alone the rest of us, has no idea of the impact, of any, of their monetary policy actions; in these circumstances, it is absurd to argue that all the weight of demand management should axiomatically fall on those actions.

I think this is an odd claim to be making, particularly in a post about “evidence-based analysis”, and the logic of the argument defeats me.

The MPC are targeting the CPI inflation rate.  How should we judge the impact of their actions?   Well, we could look at the CPI inflation rate.  Inflation has been above target for most of the last seven years.  The AD management policy which we legally require the MPC to follow has been saying that – in effect – AD has been growing too fast.

Has this AD policy delivered a remotely adequate AD outcome?  Nope.  But here’s the rub: if you try more deficit spending, the MPC will keep on targeting inflation.   That same AD management policy which is producing dreadful AD outcomes will stay in place; it won’t suddenly disappear.   (See also Nick Rowe on the macroeconomics of “doing nothing”).

And there’s a huge implication from that little aside – that “the rest of us” don’t know what the impact of the MPC’s actions are either.  We are (apparently) clueless about the impact of current monetary policy at the ZLB – and we don’t like AD outcomes with current monetary policy at the ZLB… therefore we should ignore monetary policy?   Really?  Surely the opposite?   Surely we should think harder about monetary policy; at least consider whether a new target for monetary policy would be appropriate?  Especially when we are directing our arguments at HM Treasury, which itself has great discretion over monetary policy.

Let’s apply the Sumner Critique, and presume that the MPC will prevent the CPI rate raising much faster or much slower than 2%, though they will try to ignore (short-run) supply shocks.  This is roughly what they actually do.  What difference will more – or less – deficit spending have on AD?  Answer: probably not much; if the MPC see demand growing much faster or much slower than is consistent with a 2% CPI forecast, they will offset it.

(Scott has also made the more subtle point that deficit-funded fiscal policy aimed at pulling down the CPI rate, such as an NI or VAT cut, might elicit a positive offsetting response from the MPC.  That could be true, but it is inconsistent with the MPC’s behaviour in 2011 where they allowed a short-run upward deviation of the CPI rate under the inverse condition; inflation targeting is supposed to be symmetric, after all.  I’m not saying that would definitely happen – just that we can’t predict what the MPC will do.)

I submit for “evidence-based analysis”:

1. There is no evidence monetary policy is incapable of providing more AD even at the ZLB.
2. The MPC are currently unwilling to allow faster AD growth because they are constrained by the inflation target.  Inaction at the May MPC meeting is good evidence of this claim.
3. Therefore, we must change the monetary policy target if we want more AD.

Requiring the MPC to target the desired path of nominal demand, level targeting, is a policy which seems to be vastly preferable; eliminating all the uncertainty and discretion over current UK AD management, not to mention the disastrous economic outcomes and instability.