Some graphs updated for 2012 Q2. UK nominal GDP is now 15% below the circa 5% trend growth path followed in the decade to 2007:
The instability of nominal income growth since 2010 has not produced a significant downturn in the labour market, as it did in 2008/9. I’ve used the LFS “claimant count” here, but the unemployment rate shows a similar picture of high but not rising unemployment.
Lastly here is the development of nominal gross domestic expenditure (consumption plus investment), the impact of net trade, nominal and real GDP, by quarter. Quarterly growth at annualized rates, seasonally adjusted figures.
|Qtr||Nominal GDE||Net Trade Impact||Nominal GDP||Real GDP|
The Guardian’s economics editor, Larry Elliott, produced an interesting column over the weekend, “Why George Osborne believes everything is going to plan“, which ends with a discussion of nominal GDP targeting.
Assumption No5, therefore, is that the Bank of England will do the heavy lifting when it comes to stimulating the economy. Even though Threadneedle Street has already bought up a third of UK gilts (government bonds) through its quantitative easing programme, Osborne does not think monetary policy is now “pushing on a piece of string”. The mix of policy will continue to be fiscal conservatism and monetary activism, which raises the question of whether the Treasury will grant the Bank powers to buy up a wider range of assets, including corporate bonds.
Sir Mervyn King has always said that this is a political decision since it would involve deciding which companies should benefit from actions designed to drive down borrowing costs, but that if Osborne wants to sanction such a move the Bank would act as the Treasury’s agent.
Would the chancellor be prepared to take this step? Well, attention is being paid to the debate raging in the economics profession about the merits of replacing inflation targets with nominal GDP targets. This sounds esoteric but actually has big implications for the conduct of monetary policy, with its supporters saying it provides a way of recovering the output lost since the start of the crisis and its opponents warning that it will lead to inflation raging unchecked.
That choice of words in the last paragraph is very specific, “attention is being paid”, in the passive voice. Surely, that can only be journalist-code for “I happen to know the Treasury is paying attention but they won’t put it on the record”? We have already heard noise from the top of the Coalition (particularly recently) about needing loose monetary policy to offset tight fiscal policy, but there has been nothing public from the Treasury about NGDP targeting. Even if this is only a trial balloon, it would be encouraging to know that the Treasury is at least thinking about it.
Elliott’s analysis seems plausible. Osborne is supposed to be the “master tactician” of the Tory party, his every move calculated to secure a majority in 2015. Right now that looks like a pipe dream. A robust economic recovery without being seen to accept the necessity for a “Plan B” is the only way forward for Osborne, and NGDP targeting is the obvious answer. (Lars Svensson’s Foolproof Way would work fine too, but that is perhaps politically even harder since it invokes the false image of “competitive devaluation”).
I am left wondering:
a) Can it really be true?
b) How could Osborne achieve a switch to an NGDP target without making it obvious “Plan A” has failed?
c) What could be the method of introducing the target?
For (a), maybe (and most probably) I am over-analysing with a large dollop of wishful thinking. Why would the Treasury be dropping hints to Larry Elliot at the Guardian in particular? Elliott is hardly Osborne’s strongest supporter.
For (b), an “event” from Europe could give an “excuse” for a major policy change. But waiting for such an event would be unwise, since it might never happen. Waiting for the new Bank Governor after Mervyn King’s term expires in 2013 may be too late. So can Osborne switch course without appearing to switch course? Any bright ideas? Maybe he’ll just rely on voters having short memories and/or the “blame Gordon Brown” strategy.
For (c), as Left Outside has shown [edit: fixed link], the Treasury already has the legal flexibility to introduce an NGDP target by clarifying the definition of “price stability” which the Bank of England must follow. If the Treasury intends to allow the Bank much wider flexibility over the range of assets it can buy, that could be done at the same time, or even used as motivation for the change. “Buy whatever you like to keep NGDP rising at a 5% rate”.
Vince Cable, and now, possibly, HM Treasury. Are we inching towards a UK NGDP target? I’m cautiously optimistic.
The largest contributors to the high deflator in the 2012 Q2 GDP figures are imports and government consumption.
Imports fell into a sharp deflation in Q2; import spending was flat but volume of imports rose at a 5.7% annualized rate. That’s some deflation. I find it hard not to connect the dots between the the Bank’s hawkish, disinflationary stance, the strengthening of Sterling, and the impact on the trade figures. Even the most ardent Keynesian will surely agree that the Bank can neuter fiscal stimulus by allowing currency appreciation, removing export demand and increasing “import leakage”.
So even the most ardent Keynesian should be watching what the Bank is doing with Sterling. In 2011 net trade was a positive contributor to real GDP growth, offsetting falling real domestic expenditure. That position has now reversed, with real domestic expenditure growth (albeit weak growth) being offset by a collapse in the trade position. Real domestic expenditure grew at 0.5% (quarter-on-quarter, not annualized) in Q2, against a fall in real GDP by 0.5%.
This graph shows the correlation between the deflator on import spending and the Bank’s “Broad Sterling” effective exchange rate. I’ve inverted the Sterling exchange rate, so positive growth means Sterling devaluation.
Government consumption spending is an equally sorry tale, with nominal spending going up at a 4.2% rate (did somebody forget about the austerity?!), yet being fractionally lower on the chained volume measure. As in Q1, the deflator is hurting.
Those numbers are so bad it’s almost tempting to believe the demand-deniers’ unfounded belief that the numbers must be wrong. But absent revisions, the data are the best we’ve got.
It’s NGDP day, the month 2 estimates for 2012 Q2 are out. Here’s the headline number: UK nominal GDP grew by 1.7% (annualized rate) in Q2 since Q1.
Nominal GDP at basic prices (which ignores indirect taxes), is slightly stronger again at 2.0%.
The deflator is really high again, like Q1. Really, really, bad. Obviously the nominal demand figures are awful too, and the main source of concern. Quarter on quarter growth, seasonally adjusted annualized rates:
|Qtr||Nominal GDP||Real GDP||Deflator|
If we look at Gross Value Added at basic prices, which attempts to avoid the distortion from the VAT rise in 2011, here are the numbers:
|Qtr||Nominal GVA||Real GVA||Implied Deflator|
The deflator growth in 2012 Q2 seems to be bad in both the household consumption and government consumption sectors, I will try to do a post on the numbers over the weekend.
It’s hard not to feel a little sorry for the Bank of England today. First, a sustained attack from the rabid right-wingers, with Ros Altmann’s shrill attacks and the Daily Telegraph pandering to the
liquidationists “virtuous” savers demanding higher interest rates and screw the consequences.
The Bank then publish a defence of the distributional effect of QE, only to suffer a broadside from the left, with the Indy splashing “Bank’s stimulus plan ‘has lined pockets of the rich‘”, and the Guardian run with “Britain’s richest 5% gained most from quantitative easing“.
Sometimes you just can’t win!
I think Chris Dillow has this about right – don’t blame the Bank for inequality, but I’d go a bit further.
If QE has effects in the real economy it must be through its effect on actual spending on goods and services, on the level of nominal demand. If rising stock prices are not matched by an actual rise in corporate earnings, it would be a false wealth effect, not a real one.
Therefore, the mechanism by which you boost demand is surely irrelevant to the particular effects on assets. If you think you can raise demand with fiscal policy, that must have roughly the same effect in boosting asset values, as faster spending growth means faster growth in corporate earnings.
In the end isn’t this all a distraction? Bad AD policy hurts everybody, but surely has most severe outcomes for those at the vulnerable end of the labour market. And if QE is a necessary part of better AD policy, it seems perverse not to embrace it merely because that policy also makes some rich people richer.
I’ve got a new theory to try out. Here it is:
If households accumulate too much wealth, an aggregate demand crisis must inevitably follow. There is a simple causation: when households become very rich, they slow down their spending. Because one household’s spending is another’s income, aggregate spending (income) will then subsequently fall.
My theory is perfectly consistent with the UK data, in which the 2008 recession directly followed an unprecedented rise in total household net wealth to £6.8tn in 2007 (Source: ONS Blue Book), a doubling of wealth in just ten years. If you owned £6.8tn would you carry on working? No, you’re not stupid. And UK householders are not stupid either – you don’t get to own £6.8tn of wealth by being stupid.
The recession was not good for UK households, with their total wealth falling by a cool £1tn in 2008. UK householders were not happy. By 2009, they had resolved to step up and get back to spending more money so they could build up their wealth again.
By 2011, the recession was long gone, and UK households had built up their total wealth to a staggering £7tn. Can you guess what happened next? Yup, that’s right. Boom. Another recession. The data are clear. If aggregate UK household wealth rises to around £7tn, the people of the UK kick back and stop spending as much.
Yes, that is a pretty silly theory. But this type of theory is what got me interested in macro. If you replace “assets” with “debt” in my story… does it make more sense? Or is it a confusion of correlation with causation? And if debt in the UK (and US) caused an AD crisis, why is Australia different? What if debt merely correlates with the level of nominal spending, and does not cause it?
This post is a roundabout way of saying that Nick Rowe’s post on who controls the size of the Sun is one of the most enlightening things I’ve read this year. If you’ve not read it, I recommend it to you very highly indeed.
The only criticism she can find for UK monetary policy is that the MPC failed to tighten policy earlier, and prick the developing credit boom.
Policy content is arguably more important than institutions, however. As far as monetary policy is concerned, it is curious that no reform at all has been suggested. The failure of the MPC, of which I was then a member, to appreciate the financial problems building up in the economy and take any pre-emptive policy actions points to the conclusion that the two year horizon for bringing inflation back to target can distract the MPC from looking hard at longer-term underlying imbalances in the economy.
This is an utterly ludicrous analysis. The MPC have persistently failed to set policy such as to hit the 2% target on a two year horizon since 2008. Their failure to do so has been associated with one of the worst demand management disasters in UK history. And Ms Barker’s policy recommendation is that they should concentrate less on the two year horizon and more on the “longer-term underlying imbalances”. Maybe what we really need is someone running the Bank who has an obsession about “longer-term underlying imbalances” and cares little for actually setting good Svenssonian monetary policy. OH WAIT.
The specific change to the Bank’s mandate which Ms Barker desires is as follows:
In addition to taking a longer-term view of risks to inflation, a more strategic approach to monetary policy would also be enabled if the point CPI inflation target were changed to a range, perhaps of 1-3%. In present circumstances, the MPC declaring its intention to aim towards the top of that range would reassure that there will not be a premature tightening of policy as the economy recovers.
This made me scream at my computer. What was Ms Barker doing in all those MPC meetings? She thinks they need more discretion? Like in February 2009, when the Bank had set policy such that they expected to achieve a CPI rate of just 0.4% looking two years out?
Again we see this assumption that the Bank are “happy inflationists”, who really want to “aim towards the top of the range”. If that were true, why have the Bank set policy which they’ve expected to produce an inflation rate of just 1.5% on average since 2008, on the two year horizon? The assumption is patently false.
That this document includes a commendable discussion of democratic accountability when delegating macro policy to technocratic bodies is a final insult. The MPC have spoken, and they have declared: the MPC are blameless!
which they use to make various claims about GDP by expenditure, including this zinger:
There is little evidence that government consumption rose as a share of GDP in the ten years before the crash, and a consistent share of GDP of under 25% is well below that of many other advanced economies.
This is a highly misleading claim, and it’s odd that left-wingers would want to make this claim. “After thirteen years of New Labour, what did we achieve? No increase in government spending!”
Here is the trick the TUC are pulling. Imagine an economy with just consumption spending where we start with nominal GDP of £1000/year. The first year is like this:
Government consumption spending is £100, which pays for the education of 10 students.
Market sector consumption spending is £900, which pays for 900 apples.
Now fast forward a few years, but presume nominal GDP is held constant:
Government consumption is now £200, which is still educating just 10 students.
Market sector consumption is now £800, but there’s a massive productivity improvement on the farm, so this pays for 2000 apples.
Total output has gone up, and you get to pick your statistic to fit your bias. As a proportion of total output, government consumption has fallen. As a proportion of total spending, government consumption has risen.
That is a crude reflection of what happened under New Labour, which raised public sector pay (in education and the NHS particularly) without achieving a commensurate increase in measured public sector productivity. That’s a perfectly defensible thing to do, if you think, say, public sector pay was too low before. Plus, measuring public sector output is a particularly meaningless exercise; there have been endless arguments about whether the kids are better educated, how you measure health outcomes, and so on.
This graph shows the change in nominal government consumption as a proportion of nominal GDP, and yes, ignoring everything after 2008 is reasonable because of the erratic nominal GDP growth since then:
The TUC paper also uses the volume series to draw demand-side conclusions about the trend in household consumption and investment, which just does not make much sense as far as I can see.
There is – finally – a warning on the strengthening of Sterling:
4. Sterling had appreciated further, particularly relative to the euro. In trade-weighted terms, sterling had risen by almost 1% since the Committee’s July meeting and was 3.5% higher than at the start of the year. Although sterling remained over 15% lower than it had been five years earlier, it was around 5% higher than its average in 2011. A continuing appreciation could have a material influence on the outlook for growth and inflation in the United Kingdom.
Overall the MPC are stuck in “wait and see” mode again. This comment scared me:
38. The Committee discussed whether it was appropriate to expand or continue with the programme of asset purchases it had agreed at its previous meeting. Inflation was still slightly above 2% but likely to remain close to the target in the coming months. The level of underlying activity was perhaps not as weak as the GDP data for the second quarter had suggested and, with the squeeze on real incomes beginning to ease, some recovery in spending was probable. The FLS had the potential to improve funding conditions for banks materially and to encourage lending, thus providing some support to both demand and supply. These effects might be particularly marked if the FLS allowed some households and companies to borrow who had previously been unable to obtain bank credit. Set against that, the FLS might prove less effective if uncertainty and risk aversion among households and businesses were the dominant factors holding back spending in the current environment. These same factors might also limit the effectiveness of additional asset purchases.
My emphasis on the “central bank impotence” view. There is so much uncertainty that asset purchases might not be effective.
And this beauty from the resident hawks:
For some members the decision [on more QE] was nevertheless more finely balanced, since a good case could be made at this meeting for more asset purchases. For those members [Ben Broadbent and Spencer Dale] who had voted against the expansion of the programme at the previous meeting, there were potentially costs to reversing the previous month’s decision.
What the hell? Doing more QE this month is “reversing” the decision to do some QE last month? And that risks what exactly? That the central bank looks really stupid? Our central bankers would rather not be seen reacting to “events” and changing course, month by month?
I think somebody should remind Messrs Broadbent and Dale that their comments in the MPC meetings are a matter of public record. And if they are worried about the central bank looking stupid, it might be better for them to shut up and, preferably, resign their positions.
The forecast data from the August Inflation Report have now been published.
The near-term median CPI forecast has been revised heavily downwards since the May (Q2) Inflation Report, and the forecast looking 2-3 years out is at its lowest this year. Here is a graph of the forecast curves for all three quarters this year.
If we take the two year forecast as the main indicator of the policy stance, then the average (mean) inflation rate which the Bank of England have aimed to hit over the last four years is just 1.5%.
If we take the three year forecast as the indicator instead, the average inflation target over that same period has been 1.8%.
<Cue shock, outrage, resignations, etc. etc.>