Koichi [Hamada] cited our late colleague Mike Mussa, who of course in addition to being brilliant, was the master of the quip and he at one point had said, “Putting Alan Greenspan in charge of bank supervision was like putting a conscientious objector in charge of the Marine Corps.”
Governor Shirakawa or Governor Hayami as head of an expansionary monetary policy is the same thing. They both took office and insisted that they could not do anything and that any attempts they made would fail and that when they made attempts that their heart wasn’t in it and it was contrary to their principles and it would only prove that their attempts would fail. Now, monetary policy is not merely a confidence game, but this meant that at every level throughout the BOJ and every time there was an innovation or an attempt at new policy, the governors themselves were undercutting it.
I have edited out a couple of errors in the transcription…. central bankers who insist that they cannot “do anything”, and anyway “doing something” would be a really bad idea? Does that sound familiar?
There’s a presentation from Abe’s adviser Koichi Hamada in there too (slides here), though it is a little hard to follow. He says the stock market rally and Yen devaluation since November disprove the arguments of those who argue “monetary policy doesn’t work” (right on), and also debunks the “currency war” rubbish; what would be really damaging is trying to align Japanese monetary policy with the needs of the American economy, rather than the domestic economy of Japan.
I enjoy looking at the historical data; the annual GDP deflator for 2012 at 1.3% is the fifth lowest on record (after 1954, 1959, 2000 and 2009). Will the hawks celebrate this impressive result?
In the picture of tight money below, fiscal fiddling with the VAT rate shows up as the large divergence between the GDP (market price) and GVA (basic price) deflators between late 2008 and 2012.
The second estimate of GDP for 2012 Q4 is out, and we now have the first estimate of NGDP for that quarter along with annual NGDP data for 2012.
2012 saw the second lowest annual nominal GDP growth on record, after 2009. Here are annual data for the last five years, as usual showing both market prices (GDP) and basic prices (GVA) to highlight the impact of indirect tax changes which push up the former:
Here is the breakdown for the last four quarters, quarterly change at annualized rates:
This is what tight money looks like in pictures:
Finally the updated market monetarist “NGDP gap” chart, the hole gets ever larger:
I had no time to post last week, and there is a lot to write about.
The forecast data from the February Inflation Report is out. The CPI forecasts have been revised upwards right across the forecast period, particularly sharply in the near term. Here’s how the forecasts have developed over the last four quarters:
The Bank is for the first time since 2008 forecasting CPI inflation significantly above 2% on the two year horizon – 2.3% to be exact.
We can split out the forecast on the two and three year horizon for context. Each point on this chart gives the contemporary forecast looking two years (blue line) and three years forward (green line):
This is a sharp move upwards on the two year horizon. Why? Over to the February MPC minutes:
25. Inflation was likely to rise further in the near term and could remain above the 2% target for the next two years, reflecting sterling’s recent depreciation and the persistent contribution from administered and regulated prices. That persistent contribution was likely to be increasingly offset by a gentle moderation in domestic cost growth, aided by a gradual revival in productivity growth, and an easing in external price pressures, such that inflation was likely to fall back to around target by the end of the forecast period. The outlook for inflation over much of the forecast period was higher than in the November Inflation Report, reflecting the impacts of administered prices and the lower exchange
What is more interesting is that no less than three MPC members (King, Fisher, Miles) voted for an extension of QE at the February meeting despite this forecast for CPI above 2%.
This seems like quite a shift in the Bank’s reaction function. It is worth contrasting February 2013 with May 2012 when MPC hawks were on the rampage despite below-target CPI forecasts, or Spring 2011 when the MPC came close to a rate hike with the CPI forecasts were roughly on target.
Or we could go back to early 2010, when the MPC did not try to offset the supply-side price shock when Darling allowed VAT to return to 17.5%, stopping the original QE programme in January that year as this took effect. The MPC could easily have used this same type of “administered and regulated prices” excuse to ensure the VAT rise did not compress net prices below 2%. Instead we got CPI at constant taxes rising just 1.5% in 2010. (Memo to Ed Balls: it is hard to imagine a worse way to try to boost UK aggregate demand than hoping the MPC plays along nicely both after and during a temporary VAT cut.)
It’s welcome that UK monetary policy is becoming less tight, but it should be clear that this is another example of monetary discretion not monetary rules.
JP Irving reports from Sweden:
Since about mid-2011, the Riksbank has turned from the bold imposer of negative interest rates, to the timid, fretting institution we know today. Despite most forecasters expecting a steady if not catastrophic rise in joblessness this year, a flatlined CPI and a strengthening currency, the Riksbank chose to leave rates unchanged today. Note that this does not mean that monetary policy was unchanged. Quite the contrary, Swedish monetary policy was tightened meaningfully.
The Swedish central bank has on their Board one of the smartest monetary theorists in the world, Lars Svensson… and they are still failing.
Over in Japan, the central bank openly spits in the face of democracy, announcing today that they really do have every intention of ignoring the 2% inflation target set by Abe’s government:
For the time being, the year-on-year rate of change in the CPI is expected to turn negative due to the reversal of the previous year’s movements in energy-related and durable consumer goods, and thereafter, it is likely to be around 0 percent again.
Do I even need to mention the Eurozone? Here is Left Outside trying to contain his disgust at the ECB last month:
The Eurozone is blowing up. Unemployment is increasing across Europe and this is in large part because of contractionary policy from the ECB.
What they have not done, in a continent savaged by depression is cut fucking interest rates in the last six months. They have another 0.75% before they reach 0, but they are not willing to do so.
If you’re not outraged, you’ve not been paying attention.
As normal, I felt like ranting and raving after watching Mervyn King speak at the Inflation Report press conference yesterday. But I’ll skip all that, it’s all been said. Yesterday the Bank (reluctantly) eased UK monetary policy, and that should be celebrated. The combined effect of Messrs Draghi, Bernanke, Abe and Carney has probably been more significant for the UK economy, but the Bank put the cherry on top.
All that “happened” yesterday was that the Bank of England held a press conference and published some documents. That’s all they “did”. They didn’t print any money. They didn’t fiddle about with interest rates; no “levers” were pulled. They just communicated. Here’s the WSJ:
Sterling dropped to a six-month low against the dollar Wednesday after Bank of England Governor Mervyn King said the Monetary Policy Committee is prepared to undertake more measures to stimulate the economy at a press conference following the release of the quarterly Inflation Report.
The pound weakened almost 1% against the dollar and traded as low as $1.5535, while it dropped 1.3% against the euro, which jumped to GBP0.8684. The selloff in sterling came after Mr. King said more needs to be done to stimulate external demand in the U.K. economy, hinting that more currency weakness would be helpful.
In the grand scheme of things, the change to the UK monetary policy was tiny – the Bank moved its forecasts of inflation up a few tens of basis points, and the Governor said he wouldn’t tighten policy in response. This tiny change was significant enough to knock 1% off Sterling. Imagine what “regime change” could do!
A monetary policy is not just the central bank doing something right now. A monetary policy is some sort of rule that tells the central bank the different things it should be doing under all sorts of different circumstances in the past, present, and future.
We have to think of monetary policy that way. First, because the effects of the central bank doing something right now, and whether those effects are good or bad, will depend on the circumstances. Second, and more importantly, what the central bank does right now isn’t the only thing that matters. What it did in the past matters too. And what it is expected to do in the future matters even more.
Some eyebrows have been raised after Mark Carney used the phrase “flexible inflation targeting” to describe the current UK monetary policy regime. I don’t think that should be a surprise, and I do think it’s correct to call the current regime “flexible inflation targeting”.
I keep saying it, but I think the source of confusion here is a failure to appreciate that inflation targeting is (and monetary policy generally can only be) forward-looking. Below I’ve quoted from a speech made by Mervyn King back in 1994 when he was merely the Bank of England Chief Economist, explaining this key point (after dismissing the need for an “intermediate” target for money supply growth alongside the formal inflation target):
The use of an inflation target does not mean that there is no intermediate target. Rather, the intermediate target is the expected level of inflation at some future date chosen to allow for the lag between changes in interest rates and the resulting changes in inflation. In practice, we use a forecasting horizon of two years. It is absolutely crucial to understand that the inflation target does not mean that policy is set according to the current rate of inflation. The latest inflation rate is relevant only in so far as it affects the projection for inflation some two years ahead.
My emphasis added. I can only hope that people read and re-read those last two sentences until the impact fully sinks in. To concentrate the mind, imagine that you are on the MPC in the Autumn of 2011, when the CPI rate is nearing 5%, and almost the entire press corps is berating you for printing too much money and being “too flexible” about the 2% target.
The policy regime King was following in 2011 is the same policy regime he was talking about in 1994, and that’s broadly the same regime that the Bank has followed every year since it gained independence in 1998.
King’s speech gives a standard explanation of flexible inflation targeting, or “inflation forecast-targeting”; where the monetary authority is flexible to the point of ambivalence about the current, observed rate of inflation. The Bank’s aim is to set policy such that its own forecast for inflation is at 2% at some point in the future. The Bank tends to use the two year horizon, although the MPC never specifies that precisely.
Flexibility Does Not Imply Discretion
I am rehashing an old post here, but this is where things get interesting. If you accept this interpretation of the current policy regime – be flexible about the current CPI rate, and keep the forecast of the CPI rate on target, we get a simple measure of the Bank’s policy stance: the deviation of forecast inflation from desired inflation.
To simplify a bit, I think it’s correct to say that “flexibility” in this specific sense does not involve the Bank exercising “discretion”; the choices the MPC make should be predictable and derive from the regime itself, plus their forecast model. A “neutral” policy stance should mean that Bank is always targeting 2% inflation.
If the Bank has set policy such that their forecast of inflation is not on target, they are exercising some kind of discretion, following a different policy than prescribed by the regime.
The chart below shows what the Bank’s own published data says about their policy stance over the last nine years under the 2% CPI target, showing the forecast for CPI inflation looking both two and three years forward, at each quarterly Inflation Report:
This shows the significant variation in the median forecast on the two and three year horizon in recent years. Those two downward spikes in late 2008 and late 2011 are exceptional. The Bank was not targeting (i.e. had not set policy such that the forecast equals) 2% inflation on the two or three year horizons at those times. Why not? An obvious correlation is that current observed UK CPI inflation was very high, exceeding 5% in exactly those same time periods; late 2008 and late 2011.
In my opinion this is evidence of a discretionary, disinflationary bias in the MPC. Specifically, monetary policy has been almost continually “too tight” even if you accept that “target 2% inflation on the two year horizon” is the optimal policy regime. There are two obvious counter-arguments:
a) “The Bank is impotent at the ZLB. They can’t raise inflation whatever you say about their forecasts.”
b) “The Bank may be able to affect inflation and demand at the ZLB by printing money, but their forecasting model can’t capture the effects of QE so they are unable to make the forecast dependant on their actions.”
I think (a) is obviously false, but more importantly the Bank think it is false; otherwise they would not have done QE, stopped QE, started QE, etc, etc. This is also no excuse for the November 2008 forecasts being so far off target when interest rates were around or above 3% right across the yield curve, with no zero bound in sight.
(b) might actually be true, I’m not sure. If it is true, this is even stronger evidence of discretionary behaviour; the MPC has no basis on which to choose whether to do £100bn of QE or £50bn if they have no way to model how that money affects inflation and demand outcomes.
Back to the Future
The Inflation Report will be a fun one this week, and I’m looking forward to reading the minutes from this month’s MPC meeting. The unusual statement which accompanied the MPC decision implies their own forecasts have the CPI rate back above 2% on the two year horizon. The last time this happened was Spring of 2011 when the hawks were fighting to raise rates; the wording in the statement implies perhaps that the hawks have declared a cease fire. I’m using the language of discretion, here, of course.
I have to end this rambling post with an irresistible quote from Milton Friedman in 1960 which King used in his 1994 speech:
‘The failure of government to provide a stable monetary framework has thus been a major if not the major factor accounting for our really severe inflations and depressions’.
King gave his future self a get-out-of-jail-free card, insisting that “real shocks” can also have the same effect as bad monetary policy… a position which looks rather convenient for the UK’s top central banker in 2013. I’d bet future historians will go with Friedman.
Was UK government spending “unsustainable” in 2008? Is UK government spending “unsustainable” in 2013? Is fiscal austerity “necessary”?
When I watch the neverending debate about fiscal austerity in the UK there is always something missing. The closest economists come to answering the above questions is usually the dreaded “cyclically-adjusted budget deficit”, and that is little better than pulling numbers out of a hat.
I think you can only answer these questions if you consider the expected path of nominal GDP. (You knew I’d say that, right?)
If you expect that UK nominal GDP is going to rise 8% every year for the next five years, then your answer to whether we “need” austerity right now is probably “no”. Planning for Total Managed Expenditure rising 5% a year should not be too much of a problem at all. In fact, it would be a breeze; the deficit will fall sharply as tax receipts rise in-line with NGDP, as is perfectly normal.
But if you expect that UK nominal GDP will be at the same level in 2018 as it was in 2008 – roughly what happened in Japan post 1991 – you’d want to make very different plans for TME.
The decision between “austerity” or “no austerity” seems like a false dichotomy. We “need” austerity only to the extent that we have really bad monetary policy. I see a simpler choice:
Plan A: We accept the current macro policy framework, and hence accept whatever path of NGDP the Bank of England decides to deliver. Under the inflation target over the last five years, annual NGDP growth has varied between -3% and 5%; 2% on average. The expected path of NGDP is very unclear.
Plan B: We change the macro policy framework to ensure the Bank of England provides growth of NGDP along the desired path. Then set fiscal policy given that forecast path of NGDP.
Darling in his final 2010 Budget, and Osborne since, have both used some variation of “Plan A”; Ed Miliband and Balls offer no alternative. Whether or not you do “fiscal stimulus” is highly unlikely to change the Bank’s desired path of NGDP; that if anything is the lesson of Japan (and I’d argue of 2008-2013 in the UK).
“Real” fiscal conservatives should not be content to stick with any variant of “Plan A”. If you claim “Plan A has failed”, I’d agree with you; but you must realise that “more capital spending, maybe some tax cuts, and don’ t worry, I’m sure the Bank will do the right thing” is merely another variation of “Plan A”. “Plan B” must be “better monetary policy”.
I do not wish to imply that we should change the macro policy framework because it makes fiscal policy “easier”, or because it will cut the deficit faster. That would be a very bad way to set macro policy. But I think it’s important to understand that fiscal policy has been “difficult” for the last few years for the same reason that the labour market has been “difficult”: nominal GDP fell sharply below the path that was expected in 2008, and has remained well below that path.
Those who cry that fiscal policy was “unsustainable” in 2008 are really making an absurd claim based on the presumption that the observed path of NGDP was the only possible path we could have followed. That’s wrong. Brown/Darling fiscal spending plans were neither cause of the crisis, nor the cause of the deficit (at least its unusual magnitude). The pattern in this graph should be familiar:
Every Budget since (and including) March 2010 has accepted an ever-larger “NGDP gap”, a greater deviation from the old trend growth path. Adjusting the fiscal stance to a much lower path of NGDP is always going to be very difficult; you can’t easily knock 15% off your spending if your income happens to come in 15% below expectations. Nominal shocks matter, and wage contracts (among others) are sticky in nominal terms.
Alistair Darling was (rather bravely, I thought) telling people to expect “cuts worse than Thacher” before the 2010 election because he accepted a lower trend path of NGDP (and hence tax receipts), not because he was ideologically opposed to public sector spending. Much the same applies to George Osborne.
If anybody is pleasantly surprised to read such a view of New Labour fiscal policy on this blog, there’s a kicker: everything I’ve said above about the public sector applies equally to the private sector. It will always be possible for aggregate private sector borrowing, hiring, or investment to appear ex post “unsustainable” if nominal GDP falls below well below the expected path.
Had the private sector taken on, in aggregate, “too much debt” in 2007? That question is as misguided as asking whether fiscal austerity is “necessary” in 2013. It all depends on the path of NGDP.
FT Money Supply’s Claire Jones quoted the MPC announcement I referenced in my previous post, and noted the element of “forward guidance”:
The text tells us two things: first, that the MPC is likely to revise up its forecast for inflation, due out next week, to the extent that it shows there is a better chance than that inflation will not remain above the 2 per cent target for most of the forecast horizon. Second, that the MPC is concerned the market will (mis)interpret the forecasts as a signal that the committee will soon tighten policy.
The MPC statement sends a clear signal that policy will remain ultra loose even if inflation remains above for the next couple of years.
Classic forward guidance, then, mixed in with a very “flexible” approach to inflation targeting. The new boss will be pleased.
A reasonable argument, but I’d say two things:
Firstly; repeat after me: when NGDP is growing 10% or 20% a year you have “ultra loose” monetary policy. That is what the 1970s were like. When NGDP is growing 2% per year you have “ultra tight” monetary policy. That is what we have now.
Secondly, when the Bank of England deliberately (or perhaps, accidentally) compresses nominal GDP growth down to 2-3% a year, and it knows it has has done that, and then it says:
The Committee agreed that it stood ready to provide additional monetary stimulus if warranted by the outlook for growth and inflation.
What are the markets going to think the Bank means? Roughly that the Bank of England doesn’t think “additional monetary stimulus is warranted” right now when NGDP is growing at 2-3% a year, but maybe if things get a lot worse, they’ll step in.
Here is an analogy. The Bank has driven the car half-way off the cliff, and it’s now dangling precariously over the edge. The Bank does not admit that driving the car half-way off the cliff was an error; it says everything is just fine, and look at that lovely view! Rather than indicating they will do something to remedy a bad situation, they bravely announce… that if the car tips any further forwards, they might shift their weight backwards a bit to prevent things getting worse.
Are you inspired? I’m not.
James Zuccollo provides a good write-up of Carney at the TSC. Carney was very consensual and was avoiding controversy, as you’d expect. My expectations were slightly too high, so I came out a little disappointed; Carney did provide a decent defence of NGDPLT but made it clear that he was strongly attached to flexible inflation targeting, and if anything was emphasizing the need for more “flexibility”.
The highlight for me was when Carney mentioned almost in passing the correct figure for the UK’s nominal GDP “gap” (the difference from trend) at 15% – I didn’t see him refer to notes, he just knows the data. That is excellent! Scott is surely right that NGDP will never again be forgotten – that’s progress at least.
Meanwhile, back on the farm, the MPC produced an unusually long statement after the conclusion of this month’s MPC meeting today. Key quote:
CPI inflation is likely to rise further in the near term and may remain above the 2% target for the next two years, in part reflecting a persistent inflationary impact both from administered and regulated prices and the recent decline in sterling. But inflation is expected to fall back to around the target thereafter, as a gradual revival in productivity growth dampens increases in domestic costs and external price pressures fade.The Committee discussed the appropriate policy response to the combination of the weakness in the economy and the prospect of a further prolonged period of above-target inflation. It agreed that, as long as domestic cost and price pressures remained consistent with inflation returning to the target in the medium term, it was appropriate to look through the temporary, albeit protracted, period of above-target inflation. Attempting to bring inflation back to target sooner by removing the current policy stimulus more quickly than currently anticipated by financial markets would risk derailing the recovery and undershooting the inflation target in the medium term. The MPC’s remit is to deliver price stability, but to do so in a way that avoids undesirable volatility in output. The Committee judged that its policy stance was fully consistent with that remit. The Committee agreed that it stood ready to provide additional monetary stimulus if warranted by the outlook for growth and inflation.
Is somebody feeling a little bit defensive? Why would they feel the need to emphasize that their policy is “fully consistent with [the] remit”?
It will be interesting to see the new forecast data after the quarterly Inflation Report next week; the claim that inflation “may remain above the 2% target for the next two years” is quite specific; the forecasts from November were much lower. But it’s a good way to make clear how flexible you can be!
Flexible IT had a bad day today. The hot topic in Parliament was the new kid in town with his bright new idea, NGDPLT. The Old Lady of Threadneedle Street is feeling the heat – at last!