The Telegraph continues to shamelessly lobby for tight money:
The figures lay bare the extent to which repeated rounds of central bank quantitative easing (QE) has distorted the pensions blackhole. A growing number of business leaders are arguing companies should pump spare cash into business growth and job creation rather than plug “artificially depressed” deficits.
What does it say? It says that the funding position collapsed BEFORE the second QE programme started, and has been roughly stable since. Quelle surprise.
How often do we see a discussion of nominal GDP in modern British politics? Hands up everybody who thinks George Osborne could explain the difference between the nominal and the real? What, no hands?
This is Nigel Lawson presenting the 1985 Budget – “money demand” being the traditional parlance for “nominal demand” (my emphasis throughout):
In my Budget speech I emphasised the undertaking that I gave to the National Economic Development Council, last month, that the medium term financial strategy is as firm a guarantee against inadequate money demand as it is against excessive money demand. I hope that Opposition Members fully understand the implications of those remarks and will now unreservedly endorse the benefits that will flow from wage moderation.
In other words, Lawson wanted to stabilise the growth rate of NGDP. He continues later:
The Government are pursuing a responsible path for the growth of money demand. During the past few years it has grown by 8 per cent. a year. That is more than adequate for any reasonable increase in demand in the economy. It provides ample scope for both inflation and unemployment to fall. There might be an inadequate real demand, but the notion that the solution is an increase in money demand is a profound fallacy. Money demand is the only instrument on the demand side that the Government can manipulate.
That is why it is so important to deal with the problems on the supply side. One of the main problems that we have seen there has been the failure of pay and prices in the economy to adjust to the growth of money demand, leaving more room for output and employment to rise. The tragedy is that too much of this growth of demand has gone in higher living standards for those in work at the expense of those without jobs. I repeat my claim that there is no shortage of demand.
That is in the Budget speech.
A few years of 8% NGDP growth, Mr Lawson? Yes please. And some supply-side reform? Sure, why not.
It didn’t take long for the hand-wringing about the limits of monetary policy to resurface. Chris Dillow wonders whether we are “approaching the limit of what QE can do“, and concludes that QE is “not enough” to raise real GDP.
Let’s consider the question of QE.
The Bank of England has a legal mandate to operate monetary policy such as to hit a 2% CPI rate. Have they been unable to hit it? In a sense. They have overshot it for the best part of seven years, three of those with interest rates firmly at the “zero bound”, one (and a half?) of those where fiscal policy was tightened – apparently – “too far, too fast”. So is monetary policy itself approaching a “limit”?
Did we suffer below-2% CPI inflation after hitting the zero bound? Yes, briefly during 2009, but the CPI rebounded after that.
Did we enter a deflationary slump after fiscal policy was tightened? Not obviously; the level of CPI grew 3.3% in 2010 as a whole, and 4.4% in 2011.
The only limit I see is on the number of different excuses the MPC can conjure up for the “temporarily” high CPI rate.
Various counterarguments to the above are often thrown around: the main one being that the VAT rate change “artificially” boosted the CPI rate in 2011, so that somehow “doesn’t count”. But the CPI rate is the Bank of England’s target, not CPI-CT or any other price index which ignores indirect tax changes. You could just as well blame them for failing to stabilize the price paid for Premier League footballers. They weren’t trying to do that, so don’t pretend that their behaviour would be exactly the same in a counterfactual where they had a different mandate.
The empirical evidence hardly falsifies the claim that QE is “enough” to keep CPI growing at around 2%, meeting the Bank’s legal mandate – even at the zero bound and in the face of fiscal tightening. Quite the opposite; doesn’t CPI growth of 4.4% in 2011 suggest the Bank were doing “too much”?
The real question is whether a 2% CPI target is sufficient to get the desirable rate of demand growth. To that we can say: no, evidently not. It is not QE which is providing deeply unsatisfactory macro outcomes, it is the inflation target itself – combined with a healthy dose of supply shocks.
Chris Giles writes that the Bank “must unleash more QE“. That is all very well, but expecting to get good outcomes from monetary policy like this surely requires a huge leap of faith. We are asking the Bank to do one thing (target 2% CPI inflation) and hoping they’ll do something completely different (ignore inflation and provide “enough” demand growth) – if we ask them loudly enough. What if they don’t listen to Mr Giles, and instead, say, the shrill voices of the liquidationists?
If we want really really really want faster nominal demand growth, then why do we not simply change the Bank of England mandate to target the desired path of nominal demand? And empower them to use whatever tools they see fit to hit the level: interest rates, QE, currency devaluation, whatever.
If the professional pundits are correct there is a decent chance the ONS will report tomorrow morning that the UK has entered the dreaded “double dip” recession. This would not particularly surprise our monetary policy makers, as explained in the minutes of the MPC meeting at the beginning of April:
In the absence of revisions to the latest vintage of data, the contraction in measured construction output was likely to depress measured GDP growth significantly in the first quarter. Indeed, it was possible that the ONS’s preliminary estimate for GDP could record a fall in aggregate output. In the second quarter, some activity was likely to be lost because of the extra bank holiday associated with the Queen’s Diamond Jubilee celebrations. With output having already contracted in the fourth quarter of last year, the Committee could not rule out the publication of official data showing GDP falling for three successive quarters. Nevertheless, the Committee’s judgement was that, abstracting from both the puzzling weakness in measured construction output and the impact of one-off factors, the economy appeared likely to be expanding, albeit only modestly, in the first half of the year.
Note the repetitive use of the word “measured”. The MPC think that the ONS may say we are in a recession, but the ONS will be wrong. So that’s OK then! In the MPC’s defence, the new monthly ONS construction survey series has proven rather controversial since its introduction at the beginning of 2010.
Regardless of whether the “measured” recession does materialise, the UK economy has been remarkably effective at demonstrating the validity of the Mainstream Media Macro Model. This model says, roughly:
- fiscal policy determines real output
- monetary policy determines the inflation rate
The media discussion of tomorrow figures will doubtless continue in this light. The Bank of England has printed lots of money, and hence inflation has been above high. Fiscal “austerity” (deficit reduction) implies slow/falling output.
So do not expect any discussion of how a central bank targeting a 2% CPI inflation rate should respond to the CPI rate stubbornly remaining well above 2% all the way through the first quarter of 2012.
Welcome to the UK’s inflationary fiscal contraction: prices, not output, just keep going up:
Of course, that graph looks as you’d expect if monetary policy is aimed at keeping the rate of nominal demand growth roughly fixed (ignoring the “minor hiccup” in 2008/9), with low output growth being the necessary flip-side of high inflation.
Update: And it happened. Cue endless discussion about the impact of fiscal austerity on spending after we get figures for output. The excellent Linda Yueh also has a good interview with David Miles on Bloomberg TV, with MPC member Miles saying roughly that we do need more expansionary monetary policy but, y’know, inflation is pretty high so maybe not too much.
First, for the breakdown of GDP by category of income, we have ONS data going all the way back to 1955:
The relevant series used here are CGBZ, DTWM, CGBX, CMVL and YBHA. I think Tim is correct to note the (slight) rise in other income (which includes income from self-employment, so-called “mixed income”) and VAT are the significant secular trend.
For the split of “compensation of employees” between employers’ National Insurance contributions and wages, we only have data from 1987:
The relevant series are RPCG, RPCH and again YBHA for nominal GDP.
… but only for postage stamps.
The UK government has engaged in a series of unconventional demand-side polices aimed at increasing output without requiring deficit spending:
- A scheduled 13% rise in the cost of postage stamps produced exactly the effect you’d expect from adopting a price level target: demand has soared ahead of the price rise.
- Putting Francis Maude on the radio and convincing people there will be a negative supply shock (from a tanker driver strike) any day now produced a surge in demand for fuel.
- Increasing the VAT on pasties has produced a production boom in Cornish pasties as people stock their freezers ahead of the rate change.
Alright, I’m not too sure about the Cornish pasty data, the fuel effect is probably all consumption moved between periods, the oil is mostly imported anyway, and the government happens to be the monopoly supplier of postage stamps. Plus the effect on aggregate demand from any of these things is probably limited.
But the retail numbers showed an impressive 5.7% rise on nominal retail spending in the yoy comparison for the month of March, and 4.9% ex fuel on the same measure, which is a good number. (It is also quite possible the ONS have screwed up the seasonable adjustment due to the timing of Easter. Who knows.)
Simplest fiscal solution for deficient demand for newly produced goods and services? Whip people up into a frenzy of panic buying.
Chris Giles at the FT has been looking at possible candidates to replace Mervyn King as Governor of the Bank of England after King’s term expires in 2013. Obviously, my first through was to find out whether any of them are hiding an inner market monetarist.
Adair Turner gave a speech about debt and deleveraging in November 2011. He considered the Richard Koo view, but some guy called Ben Bernanke won the day for him:
Well what is certainly the case is that previous major periods of deleveraging have often been accompanied by inflation above current typical target levels, and by buoyant growth in nominal GDP (Slide 24). Post-war Britain did not achieve a dramatic fall in the public debt ratio from 1950 to 70 by paying down nominal debt, but rather by achieving 7% growth in nominal demand, with 2.7% real growth combined with 4.3% average inflation.
And what is certainly also the case is that determined central banks can increase aggregate nominal demand, and create inflation or indeed hyper-inflation, if they buy government debt in sufficient quantity, and/or if they are willing to fund new public deficits with central bank money. That fact should not be in doubt, as Ben Bernanke has persuasively argued. Rather the pertinent questions are whether it is desirable to do so, and whether it is possible to select just the optimal level of inflation, or whether inflation is a somewhat binary phenomenon, either very low and stable, or potentially accelerating and very high.
Boom! Turner then discusses briefly the problems with tolerating higher inflation, going on to conclude:
The case for higher inflation targets or for price level targets is not therefore clearly compelling. But that conclusion is completely compatible with the belief that amid a deleveraging cycle it is vitally important to ensure that inflation targets are symmetric, that positive inflation is actually achieved and that, as a result, nominal aggregate demand and nominal GDP maintain a reasonable growth path. Japan’s path of nominal demand growth over the last 20 years, continued over the last four, has made aggregate economy level deleveraging (public and private combined) close to impossible (Slide 25). And the deleveraging challenge in the UK, US and Eurozone will become far more difficult, and potentially impossible, if aggregate nominal demand growth is not maintained at a reasonable pace.
Achieving that nominal demand growth, and hitting symmetric inflation targets of, let us say, 2%, may well in turn only be possible if central banks are free to use the full range of possible levers, including those of quantitative easing – i.e., temporary debt monetisation – which have been deployed by the Bank of England and the Federal Reserve.
Turner is focused totally on the importance of nominal GDP growth throughout the whole speech. Mr Osborne, here is your candidate for Governor – get this guy into Threedneedle Street pronto, and don’t wait until 2013.