Chris Dillow produces this graph:
…and makes a rather grand claim:
You can read this chart as a refutation of neoliberalism. Neoliberals thought that if only taxes could be cut and labour’s bargaining power weakened, that capital spending would rise and economic growth follow. This has not happened. And it is, surely, unlikely that the corporate tax cuts Osborne announced in the Budget will significantly turn things around.
The graph Chris uses is confusing; it is hard to distinguish between cyclical movements in (private non-financial) corporate income (or retained earnings, gross saving) and movements in corporate capital formation. Here’s a graph of the two series in nominal terms:
I would hesitate to pull out any divergent trend between these series except at around 2002/3. This is curious, because for the UK economy as whole, gross capital formation has stayed roughly at 16-18% of GDP for a while, if we are permitted to count the late 1980′s as a cyclical boom and 2008 onwards as a cyclical slump:
The sectoral breakdown of capital formation does back the case that Business Investment was going sideways since around 2000. But total capital formation keeps growing. This is the graph of the volume of capital formation broken down by sector – sadly the ONS do not have data before 1997:
Housebuilding will contribute to PNFC income but not (greatly) to PNFC capital formation, because new houses are allocated to the household sector’s capital account. The growth in housebuilding might explain to a small extent the divergence between corporate gross saving (retained earnings) and corporate capital formation which Chris is looking for. I have not attempted to analyse that further, but it may well be an insignificant effect, for example if the UK housebuilders were distributing most of their income rather than saving it.
This story does offer up a possible explanation for the lack of PNFC capital formation: the real resources required for capital formation were scarce, and UK housebuilders simply outbid other firms. It wasn’t possible to build a lot of new houses and a lot of new factories, in other words.
This argument could be extended to the concurrent expansion of government investment; a simple “crowding out”, though the scale of expansion in fiscal investment spending is less significant prior to 2007 . Absent the expansion of deficit-funded fiscal spending under the Blair/Brown government, the Bank of England would have cut interest rates to keep nominal spending and inflation in line, a point Mervyn King has made before. Lower (real) interest rates could have encouraged more investment spending, ceteris paribus.
The causation could go the other way, of course, as Chris might claim; a lack of domestic capital investment opportunities freed up resources for housebuilding etc. Food for thought, anyway.
Will Hutton has outed Business Secretary Vince Cable as a supporter of NGDP targeting. The Guardian have Hutton interviewing Cable this weekend. Will Hutton frequently advocates for an NGDP target in his Observer/Guardian columns; it was also known that Cable’s Special Advisor, Giles Wilkes, was a reader of Scott Sumner’s blog and supporter of NGDP targeting. The influence of blogs on policymakers is revealed!
Here’s a transcript of the last four minutes of the video, discussing macro policy:
Hutton: Would you advocate pegging the pound to the Euro, not joining, pegging the pound to the Euro, to kind of lock in the competitive exchange rate we’ve got?
Cable: I don’t think that works. We’ve had all kind of experience of trying to peg exchange rates, not least what happened under Mrs Thatcher and it was a terrible mess you may remember. So I don’t think in practice that can be made to work. But I think you have put your finger on a very very big policy issue that we’ve hardly talked about actually in the last few years. Which is that the biggest consequence of economic policy since the last three years has been a big devaluation of the currency, it’s about 25% and it has provided a big push, “kick” if you like, to British industry.
It has partially worked, it is one of the reasons why the automobile industry is growing quite rapidly. I think it will continue to get us growing, but you quite rightly say it hasn’t had the dramatic effects it did have in the mid 1990′s for example.
The big question you raise about the exchange rate is this. That in the past, I think this has happened now 3 times, whenever the British real economy has started motoring, it’s been crushed by an overvalued exchange rate. In the Tory years it was done deliberately. In the Howe budgets, Howe/Thatcher budgets, 1980s, they used a very high exchange rate to crush inflation. And in the process destroyed quite a lot of manufacturing industry.
It happened again in 1990 and it happened in a less deliberate way through the long period of Labour government where the exchange rate was clearly overvalued, we had a big contraction in manufacturing industry. And under the last government I think it went down from 18% to about 10% of GDP as a result of the fact the exchange rate in real terms was too high.
The challenge you’re posing which I think is exactly the right one, is how we stop that happening again. Because if it happens again all the stuff I’m doing about promoting industry policy and apprenticeships and so on, it could easily be swept away if this experience is repeated.
Hutton: I have the solution. You’re going to give a yes or no answer. If you won’t peg the pound to the euro your other option to keep a competitive exchange rate is this.
That we change, we require, the Bank of England not to target inflation with its inflation target, but instead to target the growth of all goods and services in the economy, so called money…
Cable: Money GDP. I’m very attracted by that.
Hutton: You are in favour of moving from an inflation target to a money GDP target?
Cable: I’m attracted by that.
Hutton: Because that is the way of doing it. If you do that, you do two things. We would guarantee to our banks that their balance sheets would become more manageable over time. And we would also assure with QE that the exchange rate would remain competitive.
So I mean can I tease you, [are you] not just attracted to it Vince, come on – I’m for it, are you for it?
Cable: Well look, one of the boring things about being a Cabinet Minister, is that the following day the Guardian says Minister instructs Governor of the Bank of England to do X or Y, and I’m not going to write your headlines for you. But no, look, the economic logic you’ve set out is impeccable, let’s leave it at that.
Hutton: Vince Cable, thanks very much indeed.
[Errors and omissions in the transcript are my own!]
Cable’s comment about the high exchange rate “crushing” the British economy under Labour seems somewhat odd. Manufacturing output shrunk between 2000 and 2003 but was otherwise growing modestly under Labour up to the beginning of 2008. Other more productive service industries grew faster, notably finance, so manufacturing as a proportion of GDP shrunk. That’s what’s supposed to happen in advanced economies. No big deal.
It’s not clear (to me) exactly why Hutton/Cable think NGDP targeting would benefit manufacturing industry in particular. Perhaps they envisage active pro-industrial fiscal policy being “enabled” by stable NGDP growth? NGDP targeting is surely not going to “stabilise” the real exchange rate, nor necessarily involve devaluation, which is what both Cable and Hutton appear to want.
But it is revealing that Cable knows what is coming; he is willing to take a position on NGDP targeting in an public interview, rather than take the easy road and defend the status quo.
H/T to commenter “anonymous” on Scott’s blog.
Market Monetarists Lars Christensen and Nick Rowe like to talk about invoking the Chuck Norris effect. In Nick’s words:
Central banks run monetary policy not so much by doing things, but by threatening to do things. If their threats are credible, we never observe them carrying out those threats, and we often observe them doing the exact opposite
But does the Bank of England believe in the power of Chuck? There is a hint they still do, but we have to go back to 2009.
The March 2009 minutes of the Monetary Policy Committee are a fascinating read. The MPC faced for the first time the horrific scale of the collapse in nominal GDP growth:
12. UK nominal GDP had fallen by 0.8% in 2008 Q4, and was only 0.5% higher than its level a year earlier. If unrevised, this would be the weakest four-quarter growth in nominal output since quarterly data began in 1956.
What is the response? They focus entirely on boosting nominal GDP by buying assets (mostly gilts) – confirming explicitly that influence over the level of NGDP comes ultimately from their control over the Sterling monetary base, not merely their ability to set (short-term nominal) interest rates:
30. The Committee agreed that such [asset] purchases were necessary in order to increase nominal spending growth to a rate consistent with meeting the inflation target in the medium term. Such operations were a natural extension of the Committee’s usual monetary policy operations. Given the Bank’s role as monopoly supplier of sterling central bank money, the Committee had previously chosen to influence the amount of nominal spending in the economy by varying the price at which it supplied central bank money in exchange for assets held by the private sector. Under the operations now under consideration, the Committee would instead be focusing more directly on the quantity of money it supplied in exchange for assets held by the private sector.
Then follows a lengthy discussion on the magnitude of asset purchases necessary to boost NGDP:
33. There was a high degree of uncertainty over the appropriate scale of purchases necessary to keep inflation at target in the medium term. The Committee noted that their February Inflation Report projections suggested that a significant shortfall in nominal GDP was possible over the forecast period. Nominal GDP had grown by, on average, around 5% since the inception of the MPC – a period over which inflation had been close to the target on average. In contrast the Committee’s February projections implied a small decline in nominal GDP in 2009, with growth remaining below 5% in 2010. Therefore the projections suggested a shortfall in nominal GDP of at least 5%.
This looks like NGDP growth rate targeting rather than the level targeting preferred by the Market Monetarists; the MPC are ignoring the lack of annual NGDP growth over 2008/9, allowing “base drift”.
The decision is to buy assets of a value equal to the expected shortfall in NGDP:
35. These considerations suggested that the increase in the level of money balances should be of a similar magnitude to the required increase in nominal GDP. The Committee agreed that reserves should initially be increased by a figure somewhere in the range of £50 billion to £100 billion.
But after losing the use of their usual toy, Bank Rate, they are flying blind, and incredibly, concerns about doing “too much” remain.
Finally, here comes a little bit of Chuck:
38. In addition, should the first injection prove too small, there was a risk that observers would wrongly infer that such asset purchases were not an effective policy tool. That might dampen the extent to which liquidity premia were reduced, and asset prices boosted, by further purchases. The initial programme of asset purchases needed to be on a scale large enough to demonstrate that the Committee would do whatever was needed to boost nominal spending sufficiently to keep inflation at target in the medium term.
That’s more like it! There’s your credible threat – “we’ll hit the inflation target, come what may”, and they are ready to beat up as many people as they need to get there – they will “do whatever was needed.”
- Who could read that wording, and believe that the Bank of England is likely to waver in its defence of the inflation target if fiscal policy is tightened “too far, too fast“?
- The level of the UK CPI rose 11% between February 2009 and February 2012, an annualized growth rate of 3.6%, well above the 2% target.
- It’s just a tragic shame the CPI rate was the wrong target.
In March 2011, MPC dove-in-chief Adam Posen explained to the Guardian why he was concerned about weak demand, and not concerned about a wage/price spiral:
Consumers, he said, were unlikely to run down their savings in an attempt to maintain spending patterns, while the weakness of trade unions meant it would be hard for wage bargainers to push up pay settlements in response to higher inflation.
“Wages will be the dog that doesn’t bark,” he said.
That was an understatement. The Labour Market Statistics covering the three months to January 2012 show that despite CPI peaking above 5% in September 2011, nominal wage rises were muted through 2011. The growth rate of total pay has fallen to a mere 1.4% for the three months to January 2012 vs the same period a year earlier:
These figures are confused by the reclassification of half the British banking system as part of the Public Sector in late 2008, and distorted somewhat from attempts to smooth out the financial sector bonus season through seasonal adjustment. Those bankers do make things complicated.
With that caveat in mind, here are the levels, using the monthly figures now rather than the three-month average to show the downtick over the last quarter:
(The ONS figures for the public sector “ex financial services” show a smaller disparity with the private sector earnings.)
Looking at these figures, it is really hard to believe the MPC came close to tightening monetary policy in early 2011.
The lobbying by pension funds against QE must qualify as some of the most ill-advised special pleading ever seen. Yet the National Association of Pension Funds insists on adding to the shrill attacks by Ros Altmann, filling the press with stupidity like this time and again:
Quantitative easing has knocked another £90bn off the value of final-salary pension schemes, says the National Association of Pension Funds (NAPF).
The Bank of England should take some blame for this situation by making the argument that monetary easing works primarily by lowering long-term interest rates.
Fortunately the Pension Protection Fund provide us with data on what actually happened to the funding position of UK defined-benefit pension funds during the first round of £200bn QE:
In March 2009, the aggregate balance of DB schemes in the PPF was in deficit by £200bn. By the end of the programme, the schemes were roughly balanced, and then went into surplus. This should be no surprise, as long-term gilt rates went up slightly during this period, and the FTSE soared; reducing liabilities and raising assets respectively.
One silver lining in the latest estimate of the UK Q4 GDP figures is that the quarterly nominal GDP outturns appear to be fairly close to the Office for Budget Responsibility‘s estimates in the November 2011 Economic and Fiscal Outlook. Coupled with the (relatively) positive monthly borrowing data we might hope the OBR will not downgrade the fiscal position again in this month’s update.
Here’s how the OBR forecast has evolved, along with the current ONS data:
With the second estimate of UK 2011 Q4 GDP growth now published, we have the first estimate of nominal growth in that quarter, and of annual nominal GDP in 2011.
Looking at the (seasonally adjusted) annualized quarterly growth rates in Q4, NGDP growth was very weak at 1.9%; with the deflator growth at 2.6% we are left with a 0.7% fall in real GDP.
For the year as a whole we have an estimate of 3.1% NGDP growth against a 2.3% deflator:
Finally, here’s the picture of the “hole” – this projects out the 1997-2006 NGDP trend growth rate of 5.3% – in 2011 Q4 we are now 13% below the trend line:
(It is arguable whether the trend should be chosen to 2007 or 2006 but the results are similar in either case.)