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Inflation Variations

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.

UK Price Indices

UK Price Indices

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.

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Categories: Inflation
  1. asdasdasd
    January 31, 2013 at 18:09

    Some papers for Britmouse’s Journal club, NGDP targeting has had some formidable advocates:

    You can’t help but feel that the MPC’s response to this crisis would have been far better if we still had vintage King, Weale, Bean and Goodhart circa 1983-1994 around.

    I wonder why Goodhart wasn’t imploring Besley to ignore the oil price shock in 2008, and Weale, Dale, and Sentance to ignore the price increases due to taxes in 2010-11?

    Doyle and Weale (1994):

    “An alternative approach is to target a nominal aggregate which is some function of both output and the price level. Higher prices may be a mechanism which allows an economy to recover from a recession: it is sensible to adopt a target which makes this possible.”

    “It is then difficult to see why inflation is a more sensible target than money GDP.”

    King (1994):

    “Of the alternative intermediate targets that have been suggested, the most serious candidate is a nominal income or GDP target. This has an impeccable pedigree with support from James Meade, Sir Samuel Brittan and Charles Bean in the UK, and Robert Hall and Greg Mankiw in the US. Nominal income rules were proposed to reduce the volatility of real output in the face of shocks to the economy.”

    Goodhart (1994):

    “There are several reasons for advocating a nominal income, rather than a price inflation target (Meade, 1994). The former gives some weight to deviations of output from its ‘equilibrium’. Also, policy makers should not react to an adverse supply shock (e.g. the oil shocks of 1973 and 1979) by further deflating the economy. In practice, the latter point is largely met in the small print, or qualifications, to the inflation targets, whereby indirect tax increases, severe terms of trade shocks, energy and food price increases, and the own effects of interest rate increases on the RPI may be disregarded for the purpose of such targetry.”

    Bean (1983):

    “a policy of targeting nominal income produces an optimal response to demand shocks and to productivity shocks if labour supply is inelastic. Even if labour supply is elastic nominal income targets will still produce a better response to productivity shocks than monetary targets if the price elasticity of aggregate demand is less than unity. Growth rules are less attractive than targets for the level of nominal income”

    References:

    Doyle C, Weale M. Do We Really Want an Independent Central Bank? Oxford Review of Economic Policy. 1994;10(3):61–77.

    King M. Monetary Policy in the UK. Fiscal Studies. 1994;15(3):109–28.

    Goodhart CAE. What should central banks do? What should be their macroeconomic objectives and operations? The Economic Journal. 1994;1424–36.

    Bean CR. Targeting nominal income: an appraisal. The Economic Journal. 1983;806–19.

    • January 31, 2013 at 20:27

      Thanks asd! Yes, isn’t it fun. I’ve read King & Bean before, not sure about Weale, do you have a PDF of that? So there’s a cute conspiracy:

      1) Charlie Bean was Chief Economist until June 2008. We know Bean has an NGDP focus from his 1983 paper.
      2) Every single Inflation Report has a section on “Demand” which increasingly clearly speaks about NGDP and how the MPC can control inflation *via* its control over NGDP (I did a post on that way back). Up until sometime in… 2008.
      3) MPC perfectly hit an NGDP level target up until Q2 of 2008. Absolutely perfect.
      4) Spencer Dale replaced Bean as BoE Chief Economist in July 2008.
      5) Inflation report section on “demand” loses the NGDP focus.
      6) 2008 Q2 onwards, UK NGDP is left for dead, pure inflation focus at the MPC.
      7) Spencer Dale turns out to be a rabid inflation hawk, c.f. May 2012

      Can we join the dots?

      And now to the future: Bean is staying on as Dep. Gov for monetary policy under Carney. Dale’s term is up in July, and Osborne can ditch him and put someone sane in, somebody with an NGDP focus. Carney is an expectations guy like King was, which Bean lacks. Carney/Bean/XXX dream team at the Bank? Even without an NGDPLT they can do much better.

  2. asdasdasd
    January 31, 2013 at 21:32

    Weale’s paper is here:

    http://oxrep.oxfordjournals.org/content/10/3/61.full.pdf

    or I can email a copy?

    There’s also a Economic Journal special issue on QE, although I’ve not read any of it as yet:

    http://onlinelibrary.wiley.com/doi/10.1111/ecoj.2012.122.issue-564/issuetoc

    Any idea about the potential (sane) candidates for chief economist at the BoE?

    • January 31, 2013 at 21:48

      Yes please, could you? the.britmouse@gmail.com

      Candidates? One of the market monetarists, or somebody like Simon Wren-Lewis from UK academia who actually understands modern macro. I’ve no idea if any of them would want it though. Frankly, who *would* want to sit on the MPC with a bunch of crazy hawks? It’d be the most frustrating job in the country.

  3. January 31, 2013 at 22:17

    Does the GVA deflator data go back any further? What’s almost as interesting as observing how various inflation indices have behaved post-crisis is looking at what they were doing pre-crisis. For example, the GDP deflator ran way ahead of CPI during the boom years, and has been way under since – suggesting tighter money was needed before 2007, and easier money since. Might have been a smarter thing to target.

    Changing the targeted measure of inflation to a measure that runs lower, and is less distorted, would presumably be much more politically and institutionally acceptable than adopting NGDPLT.

    • January 31, 2013 at 22:56

      Theo – yes it goes back to the 50s. You are right about about the deflators pre and post ’08, it’s an interesting story. The government consumption spending boom 2000-2007 made a significant impact on the deflator, pushing it up 1%. That has now reversed and govt consumption is a negative contribution to the deflator. It would be very obvious and clear that monetary policy would be offsetting fiscal policy if you target the deflator!

    • January 31, 2013 at 22:58

      I should also say on trends: if you did price level targeting on the GVA deflator, we are slightly below the 2000-2007 trend now. But that trend was not long established and is basically a distortion because of the government contribution.

  4. sk
    February 1, 2013 at 11:02

    What inflation hawks? This must be a joke right?

    BoE MPC has been doing NGDP targeting for the last 4 years and inflation has reached 5%!

    In reality NGDP targeting has already been implemented and has already failed, so Carney will not offer anything new…

    • February 1, 2013 at 12:11

      sk, you must be new around here! No, the MPC is not doing NGDP targeting, they are doing inflation targeting. If they were doing NGDP targeting they wouldn’t be up in arms at the suggestion that we adopt an NGDP target, would they. When Spencer Dale talks about “getting inflation down” (May 2012) because our problems are supply-side, he being is an inflation hawk. Plain and simple.

  1. April 5, 2013 at 22:09

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