“Crazy Central Banker Neuters Growth With Weird Obsession Over Inflation”
“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.
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.
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.
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”:
- There is no evidence monetary policy is incapable of providing more AD even at the ZLB.
- 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.
- 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.
Scott Sumner asked a simple question about the table I posted earlier: why did the GDP deflator spike up in Q1 and Q4 of 2011?
The deflator spike in Q1 clearly looks that the effect of the VAT rise, with the huge difference between NGDP at market prices and NGDP at basic prices.
Q4 is more interesting – and hence this short post.
The upward spike in the Q4 deflator seems to come from… government spending! The breakdown of GDP by expenditure has a big jump in nominal government final consumption spending – but with a much smaller increase in output; the data for general government final consumption are as follows (SAAR, ONS series NMRP, NRMY):
For the one quarter in 2011 where government spending actually rose significantly, it was mostly reflected in price rises, not an increase in output. Ahem.
There is probably a benign explanation for this; most likely it’s a statistical artefact which will get revised away as the ONS get better data. But it accounts for 1.2% of the 3.7% GDP deflator (annualized rates) in that quarter, which is significant.
It’s worse. Q1 had 0.2% NGDP growth, annualized rate, since 2011 Q4. Seasonally Adjusted Annual Rates for the last five quarters:
|Quarter||Nominal GDP||GDP Deflator||Real GDP||NGDP at Basic Prices|
The initial estimate of the 2012 Q1 NGDP data is out. The “month 2″ estimate is very unreliable, but here it is: 0.4% quarter on quarter growth, annualized rate. Bang on the estimate using the qoq CPI rate. I’ll do another post once the data series are published. The deflator looks to be sub-2% annualized.
It is a really really excellent time to try to get the CPI rate down, Mervyn.
The excellent Chris Giles is worth his weight in FT subs:
This week Ed Balls, shadow chancellor, again said: “Cutting spending and raising taxes too far and too fast has backfired, with the resulting slow growth and high unemployment meaning the government is set to borrow an extra £150bn.”
Let’s apply his logic and calculations to an earlier period. In late 2008 Labour cut taxes and raised public spending and this too-far and too-fast “fiscal stimulus” resulted in an unemployment surge, meaning the government had to borrow an extra £273bn. How can you generate such a glaring contradiction as to the effects of fiscal policy? Simple. The calculation is an irrelevance because, guess what, other things affect the economy as well. Blaming changes in deficit forecasts on the pace of austerity alone is not worthy of a serious politician.
There’s more good stuff in there.
The MPC minutes for May are out, along with the forecast data from the 2012 Q2 inflation report.
This confirms that the MPC have deliberately allowed the CPI forecasts from 2 to 3 years out to drift downwards slightly. The reason? The near-term CPI forecasts have moved sharply upwards; in February, the Bank’s median prediction was for a 1.6% CPI rate in the first quarter of 2013, that has now moved up to 2.6%. The burst of QE has “worked”: the probability of a downside CPI miss has been greatly reduced.
The IMF drop the ball and call for more QE, lower rates and/or fiscal spending. Believers in the multiplier fairy become ever more hysterical; having painted themselves into a corner where monetary policy is somehow “impotent”, they now hope to eat (almost) free lunches from doing deficit spending! Extensions of the Bank of England balance sheet will have no effect, but we can borrow and spend to boost AD.
Are you kidding me? Are those guys watching what the Bank of England is actually doing? The short-term CPI forecast has moved up, there are no “supply shock” excuses from VAT or commodity shocks, and the MPC are allowing a passive tightening of policy to get it down again, even at the expense of instability in the medium term forecasts.
Change. The. Damn. Target.
(With apologies for being a bit ranty)
A quick note. David Blanchflower has another excellent article at the Indy today, noting the incomprehensible MPC decision to cease QEasing this month, and adding his voice to those calling for a change to the inflation target:
Targeting inflation hasn’t delivered the promised economic stability, far from it. It is now time for a change. In a new book*, Olivier Blanchard, chief economist at the IMF, puts it well: “Before the economic crisis began in 2008, policymakers had converged on a beautiful construction for monetary policy. We convinced ourselves that there was one target, inflation, and one instrument, the policy [interest] rate. And that was basically enough to get things done. One lesson to be drawn from this crisis is that this construction was not right: beauty is not always synonymous with truth. There are many targets and many instruments … Future monetary policy is likely to be much messier”.
Messy indeed. There have been calls for the MPC to target nominal demand, but I just don’t think that is practical given the frequent data revisions that occur. A simple change, which amounts to much the same thing, would be to first raise the inflation target to 4 per cent. This could be done next year when the CPI changes to include house prices based on rental equivalence. Second, the mandate should be extended to become dual and explicitly include “maximum employment” as of the Fed, which is tasked with maintaining “maximum employment, stable prices, and moderate long-term interest rates”.
Simon Wren-Lewis had also written last week that “Inflation targeting is not working“. Excellent progress! And still some work to be done on the practicalities of NGDP targeting.