This is a post attempting to illustrate how seriously we should take the idea that there’s a thing called “the price level”, and that it’s the one thing we can measure so accurately that it should be used as the nominal anchor.
I’ve graphed the change in the level of all the broad price indices for which the ONS have a data series. (I couldn’t find a series for the old “Tax and Prices Index” which Andrew Sentance mentioned.)
Has the UK “price level” gone up 20% over the last five years or less than 10%? You tell me.
GDE = Gross Domestic Expenditure, so the deflator is for everything counted as “Consumption” or “Investment” in the national accounts. GDP is measured at market prices; GVA is the “basic price” deflator, so ignores changes in indirect taxes which do affect market prices.
I should have put this in my previous post. Martin Weale professed his concern for gilt yields:
But if we were to have faster inflation in the way you describe we would be hearing quite a lot from people on fixed incomes and we would probably also see the market drive up yields on government debt which could be something that would pose a burden for the taxpayer even if inflation did eventually come down.
Scott Sumner addressed this specific point in his post on Charles Goodhart:
[...] Goodhart is assuming debt markets care about inflation. They don’t. They care about NGDP growth. As long as NGDP growth is around 4%, long term nominal rates will remain relatively low. That’s the case regardless of whether the 4% NGDP growth is associated with o% RGDP growth and 4% inflation, 2% RGDP growth and 2% inflation, or 4% RGDP growth and 0% inflation.
The point about bond yields following NGDP not inflation seems reasonably clear in the data. Here’s the chart for the UK:
This is a fantastic interview; Ben has asked all the right questions. I think it’s really important that we have this kind of discussion from the MPC on the public record; MPC members deserve credit for openly engaging in the debate, and the British press corps deserves credit for holding their feet to the fire. I like to imagine a future Friedman and Schwartz writing the account of UK monetary policy 2008-20xx and finding this kind of transcript invaluable for insights into what policymakers are thinking.
This interview covers a lot of ground; what I think what is most illuminating is what Weale doesn’t say. What he doesn’t say – and certainly not for lack of prompting – is this:
Yes, the UK obviously has insufficient aggregate demand. Yes, we want to be doing more to boost UK aggregate demand. But we can’t because of the damned inflation target! Please, somebody change the target so we can do more.
You might reasonably argue that central bankers never say anything so explicit; certainly correct. But they are masters of nuance. And the “nuance” that MPC members choose to express rarely comes anywhere close to the above sentiment.
Since Carney’s speech, we’ve had views on the record about UK monetary policy from five serving MPC members – Mervyn King, David Miles, Spencer Dale, Ian McCafferty and now Martin Weale. The reception to the idea of targeting NGDP – or even the idea that targeting 2% inflation is not optimal policy – is distinctly lukewarm. Miles – the only remaining MPC “dove” by voting intent – is the only one who is positive on balance about targeting NGDP.
Back to the Weale interview. When asked specifically about targeting NGDP, the responses are as following:
a) Measurement is a problem.
b) It might raise inflation expectations, which would be bad – we should remember the 1970s!
c) If the MPC did provide faster demand growth it might just mean higher inflation anyway.
Again, measurement is a problem for “inflation” too. We know that because we have umpteen different UK price indices and they are all saying different things. And we know that methodology changes happen with the CPI, and they are not retrospectively applied to existing indices. So this is a bad argument. Weale is on the CPAC so he surely knows the CPI is fallible.
I find the 1970s references from King and now Weale little better than puerile scaremongering. NGDP level targeting is not going to create inflation outcomes like the 1970s. This is a straw man. Nobody is arguing for ten years of 10-30% annual NGDP growth like the 1970s. Nobody at all. Get over it.
Finally, Weale is worried that faster demand growth might mean higher inflation. This is rehashing an old theme; the central bank should not care about the inflation/output split, that is a matter for the supply side, and for supply-side reform if necessary.
Ben Chu nails him on exactly this point, and Weale’s response is totally pathetic. He first says productivity growth may never return to previous rates. Sometimes you have got to laugh at these guys. It’s like they heard about “self-induced paralysis” but thought it was good advice. Even if he’s correct about productivity, you then must argue why a 4% inflation/1% output split is worse (see also David Glasner on Goodhart) than what we have now; 2-3% NGDP and maybe output bumping along 0% at best. Obviously it’s not.
Then Martin Weale takes up the loaded shotgun which Ben Chu has conveniently handed him, points it directly at his own feet, and fires both barrels:
As with any other form of monetary policy it [NGDP target] does have distributive effects, it does transfer resources from one part of the population to another part. The traditional argument with monetary policy is that it’s cyclical so you do get swings and roundabout. But if we were to have faster inflation in the way you describe we would be hearing quite a lot from people on fixed incomes and we would probably also see the market drive up yields on government debt which could be something that would pose a burden for the taxpayer even if inflation did eventually come down.
This is pathetically weak. “Optimal” monetary policy is not designed to protect special interest[s in some part] of society over others. It should be “neutral” for the whole economy.
And the idea that steady growth of NGDP would “pose a burden for the taxpayer”… it beggars belief that serious professional macroeconomists can say stuff like this. What “burden” is posed on the taxpayer when the MPC sends NGDP 15% below trend, Mr Weale? Oh, that’s right, we’ve taken public sector net debt from 35% to 70% of GDP – and rising fast. In just four years. Give me a break.
There is much more of interest in the interview but I’m out of time. Weale refuses to put a number on the “output gap” (very convenient!); he says the fiscal multiplier debate is wrong to presume monetary policy is impotent; and he attempts a feeble justification for calling for interest rate hikes in early 2011.
I must close by saying again what a superb interview that was; fantastic journalism from Ben Chu. The questions are much smarter than the answers.
This post is just another round-up of NGDP discussion in the UK media and/or blogosphere. Back in the old days when we had one discussion of NGDP in the UK media per month it was easy to keep up! No longer. In no particular order:
- The bond vigilantes over at fund manager M&G were not terribly impressed with the idea, worrying about how to pick the right level target, inflation expectations and supply-side capacity.
- Posen’s replacement on the MPC, Ian McCafferty, had an interview with Bloomberg, written up here. First question? You guessed it. McCafferty is basically a hawk and is worried about wages rising.
- David Blanchflower has expanded his argument against targeting NGDP in the Indy. Blanchflower is a forceful critic and makes good arguments, so this deserves more time. The revision data he present are to the quarterly growth rate of NGDP (which doesn’t matter) not the level (which does). He could make a stronger argument if he presented the revisions to the level. I want to do another post on this topic.
- Mark Carney got a tonne of coverage during the WEF which was well trailed; see Chris Giles here for example.
- Philip Booth at the IEA wonders whether the Bank is already targeting NGDP. The short answer is “not really”, but inflation forecast-targeting will always look a bit like NGDP rate targeting if you scratch beneath the surface.
- BBC Newsnight political editor Allegra Stratton asks “Could ‘hot potato economics’ trigger an economic recovery?” – new insights mainly into UK politics, but any article on macro policy which uses both the words “potato” and “thermostat” is worth a read.
- Sticking with Auntie, Stephanie Flanders discusses “The Bank of England, the chancellor, and the target“.
- Simon Wren-Lewis follows up on Ms Flanders, with “When formal monetary policy targets are useful“.
On the last two points, Scott Sumner addressed the argument about credibility and time-inconsistency last year; to me it seems utterly bizarre to have this discussion in 2013, doubting whether the Bank, the government, or voters will tolerate tight money. They are. We are. We have been for four damn years. And now it’s time for a change. Can’t it be that simple?
The argument seems to reduce to “We can’t leave the depression in case we have a boom!” Would that be acceptable to voters if they knew it was the choice on the table?
(As an aside, I think the little people, the voters, are vastly underrated. When I was travelling around visiting friends over Christmas there were a couple of times when people compared the current state of the UK economy with the Depression. What’s the phrase they use? “Money is tight”. Yet Mervyn King says money is easy. King is wrong and my friends were right… this time at least. I’m too young to remember, but it made me wonder, was that also true in the 1970s, did people think “money was tight” back then too?)
This is how Richard Koo explained his “balance sheet recession” theory in December 2011:
More importantly, when the private sector deleverages in spite of zero interest rates, the economy enters a deflationary spiral because, in the absence of people borrowing and spending money, the economy continuously loses demand equal to the sum of savings and net debt repayments. This process will continue until either private sector balance sheets are repaired or the private sector has become too poor to save (i.e., the economy enters a depression).
To see this, consider a world where a household has an income of $1,000 and a savings rate of 10 percent. This household would then spend $900 and save $100. In the usual or textbook world, the saved $100 will be taken up by the financial sector and lent to a borrower who can best use the money. When that borrower spends the $100, aggregate expenditure totals $1,000 ($900 plus $100) against original income of $1,000, and the economy moves on. When demand for the $100 in savings is insufficient, interest rates are lowered, which usually prompts a borrower to take up the remaining sum. When demand is excessive, interest rates are raised, prompting some borrowers to drop out.
When an economy is in this “balance sheet recession” state, Koo says fiscal deficits are required to take up the slack. Koo presents the flow-of-funds data for the UK and the US, and berates these countries for not running expansionary fiscal policy:
Yet policymakers in both countries, spooked by the events in Greece, have pushed strongly to cut budget deficits, with the U.K. pushing harder than the U.S. Although shunning fiscal profligacy is the right approach when the private sector is healthy and is maximizing profits, nothing is worse than fiscal consolidation when a sick private sector is minimizing debt. Removing government support in the midst of private sector deleveraging is equivalent to removing the aforementioned $100 from the economy’s income stream, and that will trigger a deflationary spiral as the economy shrinks from $1,000 to $900 to $810.
This seems like a clear and testable claim – fiscal consolidation will “trigger a deflationary spiral”, which Koo explains in terms of a falling “income stream” or “aggregate expenditure” – phrases synonymous with nominal GDP. If you’d looked only at the Japan NGDP data, that is not a surprising conclusion to make - Japan’s nominal GDP has not risen over the last twenty years. It looks like Japan hit a “hard stop”.
Let’s look at the “deflationary spiral” induced by the “balance sheet recession plus ZLB plus fiscal austerity” policy combination in the UK, for those who are slow in etching the UK NGDP data to their retinas. Here’s the path of UK nominal GDP since it’s pre-recession peak in Q1 of 2008; you can date “fiscal austerity” to 2010 or 2011 as you please, tax rises (VAT) began in January 2010:
The UK economy’s “income stream” – nominal GDP – hit a record high in the second quarter of 2010. Then another all-time high in the third quarter. And another in the four quarter. And again in the first quarter of 2011. You get the picture. It went up not down, as predicted by Koo’s theory.
An alternative theory is this: by virtue of its monopoly control over the value of money, the Bank of England has been perfectly able to keep the UK “income stream” rising in a manner which has been more than sufficient to hit – and overshoot – its nominal target, the CPI rate. Neither the ZLB nor “fiscal austerity” have been a major obstacle in this exercise, except in that printing money and indirect tax rises both present a crisis of faith for conservative central bankers stuck fighting the battles of the wrong generation.
Which theory is more consistent with the UK macro data? It seems pretty obvious from here. Defenders of Koo might soften his argument, and claim that “fiscal austerity” has merely slowed the growth rate of nominal GDP – an argument at least worth engaging in. But this puts Koo’s “Crude Keynesians” at odds with the real Keynesians, who argue that UK fiscal policy is unambiguously contractionary – I’ll be better off staying clear of that debate.
For Scott: I thought I’d done a post on this before but I had only prepared the graphs. The ONS does not have an “official statistic” for nominal hourly wages, but they do publish some data in a spreadsheet in the Labour Market stats, which is updated quarterly. The latest data available is from November 2012 [Excel spreadsheet], and comes with this caveat:
IMPORTANT NOTE REGARDING LFS EARNINGS ESTIMATES
Gross weekly and hourly earnings data are known to be underestimated in the LFS. This is principally because of proxy responses.
Also, respondents whose hourly pay is £100 or over are excluded from the estimates.
Graphing Scott’s preferred metric of tight money, mean nominal hourly wages to per capita NGDP works out as follows:
For that graph, I used the mean hourly wages from the above spreadsheet, the
NGDP nominal GVA data from ONS series ABML [edit: note this is Nominal GVA at basic prices] and a population count from ONS series MGSL, which is 16+ population. This is not ideal since both MGSL and the hourly wage data are not seasonally adjusted, whereas YBHA is. If there is better data available please let me know!
The above is not a perfect fit for the unemployment rate, but it’s not bad.
Chris Giles reports that the Chancellor is wavering:
George Osborne is cooling on the idea of changing the Bank of England’s inflation target to one aimed at the amount of spending, top Treasury officials have told the FT. The chancellor now thinks there is sufficient leeway in a “flexible” inflation target for the central bank to boost growth.
The chancellor, who met Mark Carney, the BoE governor designate, for a drink on the sidelines of the World Economic Forum in Davos on Thursday night, is worried that Mr Carney accidentally set up unrealistic expectations of a revolution in monetary policy in a December speech.
The chancellor still wants the new BoE governor to be more active in ending economic stagnation, but does not believe that the bank needs to target nominal gross domestic product to ensure such a change.
Aides to the chancellor say he thinks a move to make the inflation target more flexible is likely to be sufficient, even if that might require a change in the annual remit given to the BoE.
That is depressing. Here is how the OED on-line dictionary defines the word “policy”:
a course or principle of action adopted or proposed by an organization or individual
The monetary policy regime we’ve had in the UK since 2008 has been highly discretionary. It has not been based on principles. If Osborne thinks the Bank of England needs a more “flexible” target – more discretion – he has the analysis completely backwards.
Back in 2007 if you thought about which people you wanted running central banks, you’d come up with guys like Mervyn King, Ben Bernanke and Lars Svensson. Uber-smart macroeconomists with impeccable academic credentials. If all that results from the current debate about monetary policy is that we appoint central bankers we think are really smart, and give them discretion to “do the right thing”, market monetarists have mostly failed.
Some say we need tight money to get inflation down. Some say money is already easy and we need loose fiscal policy. I say, if it walks like a duck and quacks like a duck, it’s probably a duck. The above chart looks like a severe failure of demand-side policy in the United Kingdom over the last five years. Severe failures like this happen when we have the wrong monetary policy. Not because fiscal spending was a couple of % of GDP too low, or taxes were a couple of % of GDP too high.
The failure of 1970s is also obvious in that chart; pushing demand up faster and faster for ever-decreasing returns. But does 2008-2013 look anything like the 1970s? No; quite the contrary. It looks like we have compressed demand tighter and tighter. Yet here is Mervyn King last week:
In assessing the current [monetary policy] framework, however, there are two factors that should not be ignored. First, the primary responsibility of any central bank is to ensure stability of the price level in the long run. To drop the objective of low inflation would be to forget a lesson from our post-war history. In the 1960s, Britain stood out from much of the rest of the industrialised world in trying to target an unrealistic growth rate for the economy as a whole, while pretending that its pursuit was consistent with stable inflation. The painful experience of the 1970s showed that this illusion on the part of policy-makers came at a terrible price for working men and women in this country. The battle to bring inflation expectations down was long and hard, and involved persistently high levels of unemployment. Wishful thinking can be indulged if the costs fall on the dreamers; when the costs fall on others, it is unacceptable.
Look at the words he chooses to use: “unrealistic”, “painful experience”, “illusion”, “terrible price”, “wishful thinking”, “the dreamers”. This is an unrepentant defence not just of the 2% inflation target as the optimal policy regime, but of UK demand management on his watch. He’s saying “this is as good as it can get, buckle down and take your medicine”. It is this or the 1970s!
On the basis which theory says we should judge the stance of monetary policy under “flexible IT” – the deviation of forecast inflation from desired inflation, the Bank of England has found the “discretion” to fail abysmally – and yet the Governor insists everything is just fine.
The “discretion” of central bankers is a problem which echoes around the world. The ECB – which has never even hit the ZLB – uses tight money to depress Eurozone AD and force sovereign governments to do supply-side reform. The Bank of England throws multi-billion-pound bungs at the banking sector (aka the “Funding for Lending Scheme”) in the name of “creditism”. The Bank of Japan refuses to even try hitting the inflation target set by the newly elected government. Lacking any sense of irony, the Riksbank has set out to “prove” that household debt “causes” an AD collapse, by explicitly running tight monetary policy in response to the growth of household debt – to Svensson’s evident disgust.
None of this should be an acceptable state of affairs in a modern democracy. Institutions run by unelected technocrats should not have free reign to depress the economy as they see fit. The “flexible” inflation target offers them that freedom. We cannot and should not rely on finding “heroic” Central Bankers riding in from the West to bravely rescue us when the current round of “heroic” Central Bankers has thrown the economy off the cliff.
Here’s a story about politics, economics and personalities. Feel free to disagree with my characterisations…
In 1997 Gordon Brown gave the Bank of England independent control over UK monetary policy. This, finally, freed UK demand management from the interference of meddling politicians, who could
neveralways be trusted to inflate a little bit too much if there was an election on the horizon. Brown’s economic adviser at the time was Ed Balls, and they set the Bank a simple nominal target: the inflation rate, inspired by the success of the Reserve Bank of New Zealand.
Everything goes well for ten years. But fast-forward to February 2009, and the UK is in a deep demand-deficient slump. The Bank of England forecast the inflation rate falling to fall below 1% by the end of the year and staying around there for the rest of three year forecast period. Their 2% target is not in sight.
In March 2009 Mervyn King cranked up his printing press to full speed, and promised to print and keep printing until nominal GDP was growing at a speed consistent with hitting the Bank’s 2% target. It was probably the clearest form of “forward guidance” the Bank has ever given. It was the closest the Bank has come to using NGDP as an “intermediate” target. Most importantly, it worked. Over the rest of that year, equity markets soared, gilt yields rose, the CPI rate recovered back up towards 2% much faster than expected back in February.
By the end of 2009, King was on top of the world. He’d avoided the Japan trap, the dreaded deflation. The CPI rate was firmly in his control. Controlling the size of the monetary base worked just as well when short-term interest rates were at zero. Q.E.D.
Then politics came along. The UK government was running a large fiscal deficit – this was King’s fault too, but that’s another story. Having awarded the Bank independent control over UK aggregate demand, the interfering politicians were busy arguing about how much and how fast they should cut the deficit, in fear of hurting aggregate demand.
This was a blatant challenge to the Bank’s independence. King would not sit idly by in that debate. He called for a tighter fiscal stance. He made it absolutely clear that the Bank would offset whatever was happening with fiscal policy to maintain an appropriate path of AD – i.e. to keep hitting the inflation target.
An election came and went, and lo, the deficit stance was tightened (in fact, it was tightening regardless). By the start of 2011 the GDP figures were looking weaker and the CPI rate was drifting upwards, heading well above 4%. When pressed on the deficit policy King re-iterated his support for tightening the fiscal stance.
This was an outrage to Ed Balls. Mervyn King – a mere civil servant – was interfering with government policy, and even had the cheek to claim he had control over UK aggregate demand! Where did he get that idea from? No lesser figure than Paul Krugman himself also expressed his disdain at King’s position, a disdain widely expressed by Keynesians since 2010.
Fast forward to 2013. Mervyn King “successfully” navigates through three years of “tight” fiscal policy, continually missing his CPI target on the up-side and allowing real GDP to stagnate.
He then calls for… supply-side reform. After all, his demand-side policy has been damn near perfect. He’s never undershot the nominal target given to him by the elected government. He allowed “base drift” in the face of supply shocks as a proper flexible inflation-targeter should. He tolerated above-target CPI when growth was weak. What more can you ask of him? Clearly our problems are not demand-side!
So what say the Keynesians? Is it the proper role for a Central Bank governor to call for supply-side reform, even though he may not speak of fiscal deficits or their impact on his ability to perform demand-side stabilisation?
I am waiting to hear the shock and outrage from Ed Balls and other Keynesians, on the unnecessary interference in government policy made by the Bank of England Governor this week.
(I’d also love to hear more about how the UK’s chosen path of demand stabilisation – a 2% inflation forecast-targeting “independent” central bank, has been such as success that so few economists seem interested in changing it.)
Congratulations to Marcus Nunes and Benjamin Cole* for publishing their new Kindle book – “Market Monetarism – Roadmap to Economic Prosperity” – available from the Amazon UK Kindle store and from the US Kindle store.
I only started reading this last night so cannot give a full review; so far it is a fantastic introduction to market monetarism, looking at the history of monetary policy through an MM lens, and giving a great explanation of how market monetarists think about macroeconomics.
At only £4.54 inc VAT, what’s not to like? Buy now!
Update: The paperback version of Market Monetarism is now also available from the UK Kindle store.* Where’s your blog, Ben?
Mervyn King phoned tonight’s speech in from his alternate universe, telling us in no uncertain terms that UK demand policy is just fine, and therefore our problems must be purely supply-side.
Maybe he took the hint from the nice Canadian chap that UK demand policy is totally wrong?
Maybe he can see the way the wind is blowing, that his best friend, the “flexible inflation target”, is being left for dead? And his legacy, the “independent” Bank of England, will be stripped of discretionary control over demand policy, after it abused this power and caused such great harm?
“It must be supply-side!”… is this Merv-the-swerve’s final swerve? Roll the speech:
Second, the inflation target is not an impediment to achieving recovery today. It has not prevented the MPC from taking measures to combat the downward momentum in the economy following the shock of 2008. It is precisely because inflation expectations have so far remained firmly anchored that the MPC has been able to respond flexibly to weak demand. So the challenge we face is not the inadequacy of the framework, but the fact that there is no easy route to recovery after a major banking crisis. Recovery is inevitably slow and protracted. The healing process will take time, and patience is not a quality associated with our political debate.
Patience and a sense of realism are sometimes mistaken for fatalism. Our economy is recovering, more slowly than we might wish, but we are moving in the right direction. The Bank has not been, and will not be, inactive. Low interest rates will not be withdrawn prematurely, but we should not rely solely on general stimulus to aggregate demand. If we embark on the type of [supply-side reform] programme I have outlined tonight, I believe we can roll back the black cloud of uncertainty darkening the outlook for demand, allow the rays of supply optimism to peer through, and sustain a recovery based on a successful rebalancing of the UK economy.
When you keep saying things like “our economy is recovering”, “we are moving in the right direction”, it is best if they are least vaguely true.
It is best if you do not say things like when the economy is probably going through a “triple-dip”, a minor event you predict yet choose to ignore.
It is best if you do not say things like that after you advise Her Majesty’s Government to tighten the fiscal stance on the promise of an offsetting loose monetary policy which you fail to provide.
It is best if you do not say things like that when you are the Governor of the Bank of England who has presided over five years of the slowest nominal demand growth on record.