First, Mark Carney! The most interesting thing about Mark Carney is that he is not Paul Tucker. If Osborne wanted more of the same from the Bank of England he would have picked Tucker. But Osborne apparently went to some effort to hook Carney instead. Significant? Maybe not, maybe Carney is just the better candidate and there’s no more to it than that. Plus Osborne got to score points over Ed Balls, who looked dazed and confused in Parliament yesterday as he tried to work out what to say. “George did something right? Now what do I say?”
And on to the GDP figures. Everything you’ve read about a “bounce back” in Q3 after a holiday-ridden Q2 is still totally wrong. We have two measures of demand growth to choose from: nominal GDP at market prices and nominal GVA at basic prices. I prefer the latter for the UK; it measures spending (and hence revenue available for production) net of indirect taxes, so is not distorted by the VAT changes. On the basic prices measure, Q2 demand growth was stronger than Q3. And distortions between basic and current prices persist. Quarter-on-quarter growth at annualized rates, seasonally adjusted:
So, good news: we had another quarter of reasonable demand growth (insofar as c.4% is “reasonable”) and the GVA deflator was negative. Bad news, the Q2 deflator shock has not been revised away.
Taking a slightly wider view, the GDP statistics are looking awful from both a demand and a supply-side perspective. There has been a slight recovery in demand growth, but no output growth to go with it.
That is not a pretty picture.
Here is the development of the median forecast curves over the last four quarters:
Similar to the change between February (dark blue) and May (Green), there has been a sharp upward movement to the near-term forecasts but the medium term forecasts remain firmly below 2%.
The above forecasts are based on the market forecast for Bank Rate. I’m not sure if this has happened before, but interestingly, the forecasts based on Bank Rate held constant at 0.5% have lower expected inflation. I presume this is because the market yield curve expects rates to fall to around 0.2% over the next year. In failing to cut the rate the Bank is effectively producing tighter monetary policy than the market expects, and on the Bank’s own forecast model, they are less likely to hit their legal mandate in two years time.
I’m pretty sure the MPC are aware of this, because they keep discussing it and ruling it out – the November MPC meeting minutes:
The Committee also discussed the likely effectiveness of reducing Bank Rate to below 0.5%. Over the past few months, Bank staff had consulted with the FSA and the Building Societies Association on the possible consequences. In the light of that, the Committee had re-examined in detail the desirability of such an option. While it would be beneficial for some existing borrowers, there were concerns that a cut in Bank Rate might prove counterproductive for aggregate demand as a whole. Staff analysis had concluded that a further cut in Bank Rate would be likely to cause a reduction in the profitability of some lenders, especially building societies, because of the prevalence of loans with interest terms contractually or closely linked to Bank Rate. That would weaken their balance sheets and they might have to respond by increasing other loan rates or restricting lending.
Viewed against the backdrop of the Funding for Lending Scheme (FLS), and the potential for building societies to play a material role in increasing lending, the Committee judged that it was unlikely to wish to reduce Bank Rate in the foreseeable future.
There you go: cutting interest rates is bad for aggregate demand because banks might lend less. You couldn’t make it up.
Chris Giles has doubled down on his previous position, and has an excellent plan to reflate the UK economy by printing money and buying gilts, though he doesn’t phrase it quite that way:
All George Osborne has to do is tweak the Bank of England Asset Purchase Facility Fund, the special purpose vehicle set up to manage QE. I am sure the good people at the Bank would be happy.
All I am proposing is a small tweak to the operations of the BEAPFF that would extend its scope a little. On top of the £375bn of money printing for gilts purchased, it would, under my plan, have a second purpose of making more efficient use of government cash.
The first thing it would do is buy the rest of the gilts market. That way, according to the Office for Budget Responsibility it would receive total gross interest payments of £46bn in 2013-2014, when new tweaks would would be ready to roll.
So, what is the up shot? A simple extension to QE operations and coupons on debt can wipe out borrowing. Magic! Deficit problem? Problem solved.
Obviously, at maturity, the BEAPFF would be insolvent and would need to make use of the indemnity the Treasury would offer. But that is an issue for the future. Not now.
Mr Giles is being a tiny bit sarcastic. But this plan is exactly what we need, with one minor tweak. There are two possibilities for this plan if announced exactly as described:
a) it has zero difference to inflation expectations or any other forward-looking macro indicator such as the stock market, or the value of Sterling.
b) it massively raises inflation expectations, the stock market soars, Sterling plummets.
In the last few years, relatively small unexpected shifts in UK monetary policy have had significant influence on the markets. Sterling has often moved sharply when the MPC minutes say something the markets didn’t expect, for example.
So I’d say that the announcement of a plan to buy up the remainder of the £1000bn gilt market would very much fall under (b), and would trigger what David Beckworth calls the “mother-of-all portfolio adjustments” as people race to dump their “safe assets”. Sterling would plunge, inflation expectations would soar. What would be the effect on the domestic economy? It would boost spending. Which is fortuitously exactly what the UK needs! Over to Professor Bernanke:
A nonstandard open-market operation without a fiscal component, in contrast, is the purchase of some asset by the central bank (long-term government bonds, for example) at fair market value. The object of such purchases would be to raise asset prices, which in turn would stimulate spending (for example, by raising collateral values). I think there is little doubt that such operations, if aggressively pursued, would indeed have the desired effect, for essentially the same reasons that purchases of foreign-currency assets would cause the yen to depreciate. To claim that nonstandard open-market purchases would have no effect is to claim that the central bank could acquire all of the real and financial assets in the economy with no effect on prices or yields. Of course, long before that would happen, imperfect substitutability between assets would assert itself, and the prices of assets being acquired would rise.
I can’t think of a better definition of “aggressive” bond purchases than promising to monetize the £1tn gilt market.
There is one question: if the 2% inflation target remained credible people might expect the monetary injections to quickly be reversed, though I doubt that the 2% target would remain credible for long with such a large shift in policy.
If it did, then Chris is exactly right: this is a free lunch and we should do it straight away. We can go much further: why issue zero coupon gilts when we could be paying negative interest on central bank reserves? If people really want to hoard £1tn of money which loses 2% real value per year, why not pay negative interest on reserves and charge them even more for that privilege? What’s not to like?
So the minor tweak needed to Chris’ plan is to dump the 2% inflation target and announce a nominal GDP level target; and have the government signal that they will keep printing money, buying stuff, and eating free lunches, until we hit that target. This would make the plan much more credible.
Fast rising nominal GDP will of course provide all the tax revenue the government needs to recapitalise the BoE in the future if that ever proves necessary. If monetizing the entire gilt market is not sufficient to move nominal GDP we should definitely promise to buy up the Spanish bond market too, I’m still up for that plan since the despicable ECB are intent on prolonging the suffering across Europe.
Abe advocates increased monetary easing to reverse more than a decade of falling prices and said he would consider revising a law guaranteeing the independence of the Bank of Japan. (8301). In an economic policy plan issued yesterday, the LDP said it would pursue policies to attain 3 percent nominal growth. The party governed Japan for more than half a century until ousted by the DPJ in 2009.
Excellent news from the BBC:
Yen dips as Yoshihiko Noda proposes snap elections
Japan’s yen has fallen after Prime Minister Yoshihiko Noda said he was set to dissolve parliament and hold a snap election.
There is no guarantee the government would win an election, and the opposition has called for aggressive monetary easing by the central bank.
Its leader, Shinzo Abe, has said the bank should print “unlimited yen” to help fight deflation.
Analysts said such a move would weaken the yen even further.
Mr Abe, the leader of the Liberal Democratic Party (LDP), has said that the bank of Japan (BOJ) needed to set an inflation target of 3% instead of its current 1% goal to help revive growth in the economy.
“If we take power, we’d like to do our utmost to beat deflation,” Mr Abe said. “In doing so, monetary policy would be key.”
He indicated that if elected, he would review the BOJ law that guarantees its independence from the government.
Higher inflation target? Check.
Print unlimited amounts of money and devalue the currency? Check.
Put the world’s most inept central bank on a tight leash? Check.
It’s all there. Japan, vote LDP! (I know nothing about Japanese politics, mind.)
Memo to the Dangerous Voices: remember Japan. Stop fretting about fiscal policy, fix the demand problem at source: bad monetary policy. Japan is still fighting to get their central bankers to do the right thing, twenty years after the BoJ drove the Japanese economy off a cliff. I don’t want to still be blogging about UK monetary policy when I’m old and grey.
“This sobering report shows why David Cameron and George Osborne’s deeply complacent approach to the economy is so misplaced,” said Ed Balls, the shadow chancellor. “Their failing policies have seen two years of almost no growth and the Bank of England is now forecasting lower growth and higher inflation than just a few months ago.
Ah, Mr Balls. You see, Ed, the Bank wasn’t just forecasting lower growth and higher inflation, it was telling us that it was only going to provide lower growth because inflation was higher. Can you remind us who gave the
sociopaths inflation-targeting central bankers control and discretion over UK demand policy? Oh, Mr Balls, you’re blushing!
The divorce between the Bank and the macro policy debate in the rest of the country continues. Mervyn King made his position crystal clear in the press conference:
What is limiting our ability to do more is not on the monetary side, it’s on the real side that the economy has to adjust to a new equilibrium. That is what I think is going to pose the constraint.
What we need now – it’s very clear if you look at the numbers – what the UK economy needs is more demand in the rest of the world to buy goods from the United Kingdom. And that is the key bit that’s missing from our attempt to rebalance and that’s why the challenge is so great.
King says the Bank could provide more demand stimulus, repeatedly insisting that printing money and buying gilts is still an effective policy tool. But they will not do it, because the expected path for demand has inflation above target in the short term and roughly on target in the medium term.
After reading the depressing Inflation Report transcript, to cheer myself up I re-read Bernanke’s classic 1999 paper on the “self-induced paralysis” of Japanese monetary policy. Amongst many obvious parallels, here’s one I enjoyed. Bernanke’s paper is based in large part around debunking this phrase from a Bank of Japan policymaker, which he quotes twice:
“BOJ’s historically unprecedented accommodative monetary policy”
This is King yesterday:
We have an enormous degree of stimulus. I mean I think all central banks in the major industrialised countries are pursuing very similar policies. All of them have their policy rates at very close to zero, this is historically unprecedented.
Straight out of the text book. To be fair, on the metric King is asked to target, the CPI rate, he is doing far better than the BoJ. Bernanke also uses nominal GDP, the GDP deflator, and nominal wages as empirical evidence for deficient aggregate demand in Japan; those indicators send the same signal for the UK data over the last four years.
The cash management ministers have in mind is to reduce the government deficit now by raiding the surplus accumulating at the Bank of England under its quantitative easing programme. Lower borrowing now comes with the sure knowledge that a future chancellor will have to borrow more to cover the losses that will build up as QE is unwound and bonds bought above their par value lose money on redemption. This is no contingent liability. It is also large, with an initial cash grab of £37bn, more than 2 per cent of national income.
If future borrowing was likely to be cheaper than current borrowing, this would be sensible, but the likelihood is that QE will be unwound when economic prospects are better and government bond yields higher than their current historic lows. If we assume that QE breaks even in a profit and loss sense – an optimistic assumption – the Treasury is proposing expensive borrowing in the future instead of cheap borrowing now. It is bad cash management and will harm Britain.
I still think this argument is wrong-headed.
Chris makes the assumption that it is is desirable for HM Treasury to attempt to hedge against a future capital loss on the QE portfolio. In fact, he goes further, arguing that is desirable that HM Treasury borrows money and hoards it, so as to hedge against future losses on the QE portfolio.
If the government borrows money and hoards it, that is the exact reverse of QE; it reduces the private sector’s holding of central bank money and increases the private sector’s holding of gilts.
The reductio ad absurdum is that it is undesirable per se to conduct monetary policy at the ZLB by printing money and buying gilts, because it risks a loss of capital. But if the Bank is going to conduct monetary policy by varying the size of the base it has to buy something, and gilts are least risky option.
The assumption that it is desirable to hedge against losses from QE by hoarding cash must be false. Then we are back to the macro argument: what matters above all to the public sector finances is the level of nominal GDP, because that determines tax revenues. If the government was really concerned about reducing the public debt burden they could simply raise the inflation target or set a (higher) target for nominal GDP. Everything else is noise.
Chris is also concerned about economic credibility:
So far, the reaction to Mr Osborne’s ruse has been indulgent eyebrow-raising. People appear to feel that ripping off future taxpayers, polluting statistics and undermining independent monetary policy is benign. Unless the policy is reversed or some independent authorities put a spanner in the works, Britain’s economic credibility has died. Financial markets and credit rating agencies have not noticed yet. They should and I fear they will.
Though I have no love for the fudging of national statistics (I’m also surprised the ONS will allow any impact on the main fiscal deficit measure), Chris’ attachment to the “independence” of UK monetary policy seems misplaced. The highly discretionary operation of UK monetary policy since 2008 is the reason we are in this mess, and absent a monetary superhero to replace Mervyn King, government interference in monetary policy is long overdue.
… not the other way round. How did central banks get elevated to this position of ultimate authority, rather than being seen in their true role as an executive agency of elected governments? The BBC wrote:
The Bank of England has said it will give the Treasury the interest it earns on certain government debts it holds.
Oh, how very kind of the Bank! Over to The Guardian:
Bank of England to hand over gilts interest payments to slash national debt
Such a generous move! We must send them a card. Next, the Daily Telegraph:
The Governor of the [B]ank*, Sir Mervyn King, has approved the arrangement.
King “approved” it? Do you mean to imply he had a choice? The Bank, and its Governor, they work for Her Majesty’s Treasury. They work for Osborne, the elected Chancellor of the Exchequer, appointed by the elected Government which in turn was appointed by the we, the voters. However much you dislike our man George, he’s the raw product of democracy, not some autocrat.
End this tyranny by inept central bankers now.
I still do not follow the argument that this move is a short term benefit for long term costs; back to the Guardian article:
The Treasury and the Bank anticipate the cash position of the scheme will deteriorate when Threadneedle Street starts to sell gilts, leading to higher debt levels in the long term, as future losses could not be offset against the coupon payments
The idea that we should be trying to hedge against “future losses” on the QE portfolio is totally crazy. The only case where the Bank makes losses on QE is when gilt prices fall significantly, and long term interest rates rise. The only case where long term interest rates rise is when nominal GDP is growing fast. When nominal GDP is growing fast, tax revenues will be growing fast. Getting to that point is (or should be) the sole aim of UK demand management policy.
You don’t hedge against winning. You hedge against losing. The government is already hedged against losing, having bought back a third of its own long term debt with zero-maturity liabilities, a.k.a printing money. So we don’t need to hedge against winning by issuing more gilts than necessary and hoarding the cash. We should instead instruct the Bank to try much harder to make massive losses on its investments; until they do, we’ll remain stuck with low growth.
* Telegraph sub-editing is worse than the Grauniad’s. What’s the nickname, the Dilay Tegrelpah?
Osborne has eaten a free lunch. As long advocated by Simon Ward, the Bank of England will start returning to HM Treasury the interest income on the large portfolio of UK government bonds accumulated under the QE programme.
The status quo ante saw the government simultaneously (on a consolidated view of the public sector balance sheet):
a) printing money and buying back its own long term debt to stimulate nominal spending
b) issuing long term debt and hoarding part of the money received
These are effectively bets in opposite directions; (b) only profits if (a) loses, and vice versa. If the government thought the expected losses from (a) were genuinely a problem it could simply do less QE. But that would be silly, because the effect on government income (tax revenue) from higher nominal spending dwarfs potential losses.
Meanwhile, the reduction in the government’s interest burden from doing (a) is a free lunch. So the Chancellor should eat it. If you think that’s wrong, try telling Barack Obama that he should be borrowing more money and hoarding the cash, just in case the US economy has a huge boom, interest rates have to go up faster than expected, and he needs to recapitalise the Fed. Good luck with that!
The most interesting part of all this is the exchange of letters between the Chancellor and the Governor (here and here); it seems to be the case that this decision had a material impact on the MPC’s November decision, when they decided not to extend the QE program:
During its meeting of 7-8 November I briefed the MPC on the agreement we have reached. The Committee was content that its ability to set the appropriate stance of monetary policy would not be affected by this action. But the Committee noted that its policy setting would need to take account of the effect of this action, which amounts to a small loosening of monetary conditions. This is because, as the Committee noted, your intention is to use any funds transferred to the Exchequer to reduce the stock of outstanding government debt. As a result the private sector will hold fewer gilts and more money than otherwise. That implies an easing in monetary conditions relative to the present position in which the coupon payments are held on deposit by the APF. The Committee therefore views the use of coupon income to reduce the stock of outstanding gilts as having an effect similar to the MPC purchasing gilts of the same value.
HM Treasury announced they would be doing some QE today. The MPC decided not to extend their QE programme in the policy meeting this week in full knowledge of HM Treasury’s announcement. There is a test of the Sumner Critique here. It would be fascinating to see if there is any hint in the MPC minutes – absent this decision by HMT would the Bank have extended QE?
Bank of England Deputy Governor Charlie Bean has endorsed both Chief Economist Spencer Dale’s liquidationist stance, and the Mervyn King/Masaaki Shirakawa view on how monetary policy “brings forward” spending from the future. What better team to run UK demand policy could we possibly hope for?
Bean’s speech this week says that because households “need” to deleverage, and we “need” to rebalance to export rather than domestic demand:
… considerable real adjustments are called for. These real adjustments – balance sheet repair and the sectoral reallocation of resources – inevitably take time. It is against this background that monetary policy needs to be set. On the one hand, a highly stimulatory policy stance can encourage households and businesses to bring forward expenditure, boosting demand and mitigating the destruction of the economy’s supply capacity that can result from a prolonged period of weak demand as firms are driven out of business and the skills of unemployed workers atrophy. On the other hand, such policy can also delay the transition to a new growth path if it slows the process of balance sheet repair and inhibits the process of ‘creative destruction’ as unprofitable firms are closed and the liberated resources shifted to the expanding sectors.
My emphasis. Note the “bring forward expenditure” phrase used by King and Shirikawa.
But the big point here: Bean is saying that weak demand growth is a good thing, because we need more liquidation of capital! Not too weak, mind – that might really do some harm. But fast(er) demand growth would be risky, because we need to force the correct number of firms into liquidation, heralding the sunlit uplands of sustainable growth. Will a big light start flashing above Threadneedle Street when we reach that point, I wonder?
Bean also blames the dreaded “uncertainty” for the weakness of demand:
Looser monetary policy works in large part by encouraging households and businesses to bring forward future spending to the present. It is plausible, however, that such intertemporal substitution will be weaker when uncertainty is elevated and when banks and some households are concentrating on repairing their balance sheets. For instance, a modest fall in the cost of capital may do little to boost investment spending when the environment is so dominated by uncertainty about the outlook for demand.
Yet later on, he jumps into the “gilt cancellation” debate, and says:
Cancelling the gilts would deprive the Bank of the assets it needs to sell back to the market in order to suck the bank reserves out when the time comes to unwind the policy. It would also deprive the Bank of the wherewithal to pay the interest on the reserves in the mean time, so we would need either to keep Bank Rate perpetually at zero or else be willing to continue issuing additional reserves indefinitely in order to meet our obligations. One can easily see how this would eventually lead to inflation taking off.
How can you reconcile those views? “One can easily see”? This is Bean laughing away the proposition that the central bank would be unable to raise inflation (and logically hence nominal spending) by holding down interest rates and printing too much money. That’s a view which has a role for money in the conduct of monetary policy. Yet if you can only “bring forward” spending with monetary policy, it is hard to see how inflation can “take off”.
In any case, it is not really clear why one would want to go down the route of cancelling the gilts. In undertaking quantitative easing, we are, for a period, replacing part of the government gilt stock with a monetary liability paying Bank Rate; cancelling the gilts is tantamount to making that period indefinite. In contrast, under present arrangements, how long that period lasts will depend on macroeconomic conditions. The inflation target dictates that we should continue to buy gilts (or other assets), including reinvesting maturing gilts, so long as inflation is more likely than not to undershoot the inflation target in the medium term. And it also dictates that we should sell them when inflation is more likely than not to overshoot the target. Making gilt sales/purchases contingent on the economic environment must surely be the right way to set policy.
I roughly agree, except with the choice of nominal target. But another clear signal from our central bankers: yes, we really are targeting 2% inflation; no, the zero bound isn’t an impediment to hitting our nominal target; and no, we really don’t much care about growth, unemployment or other such trivialities.