The chorus of scepticism about UK NGDP targeting which has surfaced in the press since Carneymania deserves a response, which I’ll attempt at some point in the new year. The Q3 Quarterly National Accounts have also resolved some mysteries in the national accounts, that also deserves a post.
Without the time for any of that, I’ll end the year with a graph I thought was interesting, if probably not in any way significant:
This breaks down real GDP into real gross domestic expenditure (consumption plus investment) and separately real net trade (exports minus imports). I thought the pattern of swings since 2008 was curious; from falling domestic spending plus a positive net trade balance in 2008/9, to the inverse combination in 2010, then flipping back and forth again in 2011 and 2012.
And with that I’m done for the year… Merry Christmas!
There is a neat symmetry between 1981 and 2012 in the UK macro policy debate.
1) In both cases we have a Tory (ish) government which has been in power for two years, having replaced a Labour government which presided over disastrous macro policy failure. (There’s an interesting argument about whether the 1970s were more or less disastrous than 2008-2010; that’s not the point of this post.)
2) In both cases the new government has spent its first two years – despite protestations to the contrary – more or less in continuation of the failing demand policy it inherited. In 2012, that means 2% inflation targeting plus desperately low, unstable NGDP growth; in 1981 that means uncontrolled inflation and desperately high, unstable NGDP growth. (The Keynesians would argue the Coalition has changed macro policy by tightening the fiscal stance, but that is only a matter of degree: “tightening fiscal stance, 2% inflation target” really was the Coalition’s inherited macro policy.)
3) In both cases we have a monetarist vs Keynesian divide. UK academics famously thought Howe’s 1981 Budget tightened fiscal policy, um, “too far, too fast”; 364 of them writing to The Times. Ramesh Ponnuru and David Beckworth pick up this theme in their recent article for The Atlantic:
The Bank of England vividly demonstrated the power of central banks to offset fiscal policy at the dawn of the Thatcher era. In 1981 her government introduced a budget that would sharply reduce the deficit in the midst of a recession. Most economists opposed it on Keynesian grounds, with 364 of them signing a now-famous letter arguing there was “no basis in economic theory or supporting evidence” for it. Yet the Thatcher government implemented its plan and by late 1981 the economy was recovering. The Bank of England at the same time had begun a cycle of monetary policy easing, and the economists had underestimated its effects.
This slightly overstates the role of the BoE. HM Treasury was wholly in control of monetary policy in the 1980s, and set the Bank target ranges for broad money growth. If you’re new to this debate it is worth reading the IEA paper from 2006, “Were 364 Economists All Wrong?“, if only for monetarist hero Tim Congdon’s epic contribution which tears chunks of flesh out of the British academic establishment, with regression analysis to boot.
I don’t want to stretch the analogy too far. But when I see comments like this, from Duncan Weldon:
The renewed debate on the UK’s monetary policy regime is a welcome development (and it probably matters a great deal in the long run) but it shouldn’t breed a false complacency – I struggle to think of any monetary regime that could restore decent growth alongside the government’s current fiscal policy.
… it does seem like the UK macro policy debate is still stuck in 1981.
A slightly cheeky question: how many Keynesians believed that the Bank would fail to hit (as in undershoot) its nominal target (the 2% CPI rate) in the presence of the Coalition’s fiscal consolidation? I guess Danny Blanchflower counts as one, he has been consistent in warning about deflation. But whilst I do remember reading lots of dire warnings about low growth from tight fiscal policy, I don’t remember many about sub-target inflation.
Here’s the thing. Anybody who thought we’d undershoot the CPI target was wrong. Not just a little bit wrong. The Bank not only hit but has consistently overshot its nominal target for every single month of the Coalition’s fiscal consolidation. You can make good excuses (as I do) about why the overshoot was so bad, but that’s the evidence.
So why is there even a debate? We’ve had a fiscal consolidation. The Bank has done more than enough (provided sufficient nominal GDP growth) to continue hitting its nominal target in every single month of this fiscal consolidation. Fiscal tightening has therefore been more than offset by monetary policy. End of argument?
Perhaps not; that’s an unsophisticated way to think about either monetary or fiscal policy. But I think the basic point is sound (as does Scott Sumner). The last thing we should worry about is the Bank’s ability to hit their nominal targets. We just need to give them the right nominal target.
In 1981 Geoffrey Howe welcomed the first monetarist counter-revolution to Britain. George Osborne has the opportunity to introduce the second monetarist counter-revolution. Will he take it?
It’s slightly depressing to see push-back on NGDP level targeting from British Conservatives, who should know better. See for example what Mr Redwood had to say (HT Duncan Brown) – a horrible confusion of the demand-side and supply-side, cause and effect.
The Tories were demand-side revolutionaries when we needed a demand-side revolution – after the 1970s. Not just supply-side reformers. Here (again) is Nigel Lawson in 1985, “money demand” means nominal demand, nominal GDP:
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.
Or here is a view of 1980s UK macro policy articulated by a Treasury civil servant (name censored!) in 1989, discussing the appropriate choice of nominal anchor:
45. In recent versions of the MTFS the aim has been to use money GDP to provide this anchor. This is the best measure we have of the total activity in the economy in the prices of the day – and it has become the centre piece of our nominal framework.
46. The implicit view of how the world works is the same as in the price-output approach. The essential principal is that over the medium term, output growth is determined by the supply potential of the economy and any persistent growth of money GDP above this rate will be reflected in faster inflation. In the short term it is likely to be reflected in a faster growth of real output but subsequently inflation will rise and output will revert to trend.
Even so in my view it is a useful framework. It enables Government to concentrate on the financial framework and take a ‘hands-off’ approach to the division between real output and inflation. In principle it is easier to relate to the behaviour of monetary aggregates; it is consistent with the approach followed throughout the 1980s; and involves getting tangled up in the web of fine tuning output and inflation.
(Transcription errors my own.) The “MTFS” referred to was the Medium Term Financial Statement, a multi-year macro policy framework.
This is what nominal GDP looked in the years following the famous 1981 budget decried by 364 Keynesians who wanted looser fiscal policy:
Lawson may have been shooting for circa 8% NGDP growth rate; over the period the UK fairly closely followed a level path of 9% annual growth, up to 1988 where that Chancellor’s eponymous boom pushed demand growth well above trend. Between 1981 and 1991 annual RPI inflation averaged 6%, real GDP growth averaged 3%. And Redwood is worried about inflation today? UK nominal GDP has grown a little over 9% in total since 2008. An average annual growth rate of 2.3% over four years.
After the ERM debacle we then switched to a inflation-targeting regime under Ken Clarke in 1992. Again, the results very closely approximated a nominal GDP level target – this time a lower circa 5.4% growth path.
We’re about 15% below the old trend. We can’t fill all that gap, but shooting for a new 5% level path starting from the depth of the 2009 recession would seem reasonable; that’d be a couple of years of 7% NGDP growth and then 5% forever.
Brooks Newmark, a Conservative, is asking the questions now.
Q: You were thinking “out of the box” when you hired Carney? Isn’t it time for the Treasury to think “out of the box” on inflation targeting?
Osborne says there has been plenty of creative thinking on monetary policy in the UK in recent years.
He won’t give a running commenting on Treasury thinking, he says.
But if you want to change the regime, you need to make a strong case for it, he says.
Q: But you must have an opinion on replacing the inflation target with a GDP target?
Osborne says he does not think it is sensible for him to openly speculate about the macro-economic framework.
• Osborne does not rule out replacing the Bank of England’s inflation target.
Osborne says it would be a good thing for academia to lead the debate on the value of having an inflation target, and for governments to follow.
You can blog for months about UK nominal GDP targeting at a leisurely pace… and then suddenly it’s hard to keep up with the news cycle. This just in from the Daily Telegraph:
The Daily Telegraph understands that senior Government figures are privately pressing the George Osborne, Chancellor to consider giving the Bank a new target of increasing the size of the economy.
“When you look at the state of the economy, [changing the Bank’s target] is certainly something we should be looking at,” one senior minister said.
Mr Osborne “is a pragmatist” who is willing to consider the arguments for and against changing the target, the minister added.
Mr Osborne is understood to have discussed Mr Carney’s views about inflation targeting with the Canadian before appointing him earlier this month. However, Treasury sources said the Chancellor has “no plans” to change the Bank’s instructions at the moment.
There’s specific use of the plural – “figures”, “ministers” in that article. Vince Cable and who else? Osborne’s second-in-command at HM Treasury is Vince’s fellow Liberal Democrat Danny Alexander, he’d be a likely candidate. We need more quotes on the record, please!
This post is purely for posterity; a round-up of the media storm which Mark Carney kicked off with his innocent little speech.
The BBC lower the tone by getting confused: “Mark Carney suggests targeting economic output“
Sky News Editor Ed Conway: “Why we all need to know about NGDP“
Jeremy Warner at the Daily Telegraph: “It’s time the Old Lady was given more obvious growth objectives“
Larry Elliot at the Guardian: “New Bank of England governor Mark Carney mulls end of inflation targets“
Gavyn Davies at the FT: “Carney differs from Bank of England orthodoxy“
Chris Giles and George Parker at the FT: “Treasury open to Carney radicalism“
FT Editorial: “New broom clears way for Old Lady“
Chris Giles again: “Osborne should heed Carney’s message“
Faisal Islam, Channel 4: “Carney’s recent musing on UK jobs and housing bubbles“
Let me know if I’ve missed any.
The Treasury opened the door to a more aggressive monetary policy on Wednesday, as aides to the chancellor welcomed the next Bank of England governor’s radical views on stimulus measure for flagging economies.
In a speech on Monday, Mark Carney suggested setting targets for the overall size of the economy, or nominal gross domestic product, rather than inflation. While Treasury officials said there were currently “no plans” to ditch the BoE’s 2 per cent inflation target, a spokesman for George Osborne added that “there’s quite a lot of interest in what he has to say … It reaffirms the fact that he is the central banker of his generation.”
Mr Osborne’s aides added that the chancellor was well aware of Mr Carney’s views on inflation targeting when he was appointed.
This is a gem:
Alistair Darling, former Labour chancellor, said on Wednesday he had considered changing the 2 per cent inflation target while at the Treasury, but was overwhelmed by other aspects of the financial crisis.
Darling didn’t find time to stop and deal with UK demand policy during the biggest UK demand crisis since the 1930s? Never mind eh, what’s the worst that could happen? Oh, wait.
A brief review of developments in UK monetary policy over the last six months:
1. Members of the Bank of England Monetary Policy Committee make clear in speech after speech that they are very happy to reside over neverending stagnation in the UK economy; price stability will be maintained above all else.
2. We have a UK cabinet minister speaking openly about support for nominal GDP targeting.
4. Osborne refuses to appoint any Bank insider as Mervyn King’s successor, instead headhunting Mr Mark Carney from the Bank of Canada.
5. Mark Carney yesterday delivered his first speech since his appointment to the BoE was announced. And here’s a funny thing. The speech just happens to explain why nominal GDP level targeting might be a good alternative to inflation targeting:
From our perspective, thresholds [for unemployment and inflation] exhaust the guidance options available to a central bank operating under flexible inflation targeting.
If yet further stimulus were required, the policy framework itself would likely have to be changed.  For example, adopting a nominal GDP (NGDP)-level target could in many respects be more powerful than employing thresholds under flexible inflation targeting. This is because doing so would add “history dependence” to monetary policy. Under NGDP targeting, bygones are not bygones and the central bank is compelled to make up for past misses on the path of nominal GDP (Chart 4).
Bank of Canada research shows that, under normal circumstances, the gains from better exploiting the expectations channel through a history-dependent framework are likely to be modest, and may be further diluted if key conditions are not met. Most notably, people must generally understand what the central bank is doing—an admittedly high bar. 
However, when policy rates are stuck at the zero lower bound, there could be a more favourable case for NGDP targeting. The exceptional nature of the situation, and the magnitude of the gaps involved, could make such a policy more credible and easier to understand. 
Of course, the benefits of such a regime change would have to be weighed carefully against the effectiveness of other unconventional monetary policy measures under the proven, flexible inflation-targeting framework.
We have the central banker about to make the leap to Governor of the Bank of England talking casually about “regime change”? Really? Without wishing to elevate my “cautious optimism” much higher, I’d say the UK has moved another inch down the road to targeting NGDP with that speech.
Chart 4 in Carney’s speech is the “fill the hole” NGDP level chart beloved of market monetarists the world over. Footnote 19 in Carney’s speech is a little hint to George Osborne:
 In most jurisdictions, including Canada, a change in the policy framework would require the approval of the political authority. In some others, it would require a change in the constitution.
The OBR’s latest forecasts show they have given up hope of an eventual return to robust growth in nominal GDP. The reason is two-fold: partly a downgrade to expected real GDP growth, and partly a downgrade to the deflator forecast:
3.98. Nominal GDP growth is weaker throughout the forecast than in March, reflecting both weaker real GDP growth and the downward adjustment to the growth of the GDP deflator. These changes to the forecast reduce the level of nominal GDP in 2016 by 5.1 per cent relative to our March forecast.27 Of this, 3.2 percentage points is accounted for by the downward adjustment to our forecast for real GDP growth, with the remainder due to lower GDP deflator growth.
Failure to hit the government’s fiscal target of falling debt/GDP by 2015 can be attributed to this change. It both reduces the level of that ratio’s denominator (nominal GDP) in 2015, and the expected growth rate of nominal GDP in any given year, and hence lower tax revenues and higher debt, ceteris paribus.
This is no way to run a country. If the Bank of England is instructed to target the path of nominal GDP, the OBR could hold that fixed in their forecasts (rather than CPI inflation as they do now), as they should.