Imagine a policymaker, in whatever area of public policy, who acts in a random and unpredictable fashion. One day they say one thing, the next day they say the complete opposite. Would you expect this kind of policymaking to encourage “stability” in the way people act, in the way people behave in whatever area that policy covers?
Well, welcome to British monetary policy.
Carney gave a speech last night which created an instant swing in financial markets. The FTSE 250 (a good indicator for UK domestic prospects) – is off about 2% this morning, though US markets fell late yesterday so we can’t blame the guvnor for all of that.
Carney and friends think that they can use the tools of macropru to create “financial stability”, whatever that means. They are not even able to formulate and stick to a monetary policy rule which avoids creating “financial instability”.
That should be the simplest thing in the world. 2% IT. 5% NGDPLT. Rules are simple. Automatic. Is the inflation forecast on target? Below, we loosen; above, we tighten. Is NGDP on target? Likewise.
Oh, and the inflation forecast is not on target, by the way. In the May inflation report the mean, median and mode projections of the CPI rate are below the MPC 2% target in every quarter of the forecast based on market interest rate expectations. So it’s “obvious” we need tighter monetary policy, and of course central bank governors should go around giving hawkish messages about rate rises. Governors who know exactly what they are doing, using words which have no doubt been chosen with extreme care, to express the right amount of “nuance”.
And here are four carefully chosen words to strike fear into your heart:
That is why an essential counterpart to our monetary stance is macroprudential vigilance and activism.
“Macroprudential vigilance and activism“? Dear God. Osborne, what monster have you created?
Update: Chris Giles also demonstrates the sharp movements in forward rates. Be in no doubt this was a tightening of policy.
Faisal Islam posted to Twitter some quotes from his book, “The Default Line” (Kindle edition here), which I thought were a fantastic illustration of Nick Rowe’s favourite slogan – I hope Faisal will not mind a transcription here:
It was well known that Greece was running out of cash, in metaphorical terms at least. In June 2011, after months of stalling on its economic reform programme, the foreign Troika that effectively ran the country had run out of patience with the Greek leadership. [...]
But what people did not know was that Greece was literally running out of cash. There were shortages of all denominations apart from the €10 note. Greeks had responded to the uncertainty regarding the Troika’s next move by withdrawing euros from their bank accounts at a record rate. Soon there would be not enough euro notes in the country to cope with the number of Greeks trying to get their hands on their money from cash machines and bank branches. A secret plan was activated. [...]
As it happened, in June 2011 demand for paper currency had nearly trebled. To deal with this crisis, the Greek military cargo planes returned from abroad laden with freshly printed euros. The secret mission was intended not only to preserve Greece’s fracturing social stability, but also to preserve the single currency itself.
I do not think you could ask for a clearer example of a money demand shock. People are literally trying to hoard the monetary base, the physical currency. Of course it is also a nice illustration, perhaps, how financial crises and recessions are intertwined. I think it’s not unreasonable to argue that the chain of causation can go from “banking crisis” to “money demand shock” to “recession”. But monetarists would argue in between those last two steps we have a central bank which refuses to satisfy money demand by printing “enough” money.
I can recommend buying Faisal’s book based on those quotes!
Update: Giles Wilkes has a great post about how money should be central to our macro debates. It’s great that Giles is blogging again!
It’s the boom which isn’t quite a boom. The labour market data today is far more significant than the arbitrary benchmark of a return to the pre-crisis level of output… in aggregate, if not per capita.
The chart above attempts to decompose the loss of UK output versus trend growth into a demand-side and a supply-side component. The demand-side is represented by per capita hours worked. The supply-side is output per hour worked. Both are benchmarked as the deviation from 1997-2008 trend, and on that benchmark the demand-side recovery is now complete. The supply-side, however… not so much.
That is in no way sophisticated; it is fairly primitive. But however you cut the data, the labour market is doing astonishingly well. Which means that the real GDP figures look relatively pathetic – and that has been true since early 2012; the recent weakness of output has been partly or mostly a supply-side not a demand-side phenomenon.
There is really only one hope left for supply-side optimists in my view. Maybe there is still, somewhere, hiding under a bush, some pockets of highly productive but currently idle labour ready to spring into action. Set against that we have seen a massive surge in labour supply from low-skilled workers, which is pulling down average productivity. Maybe that surge is because of welfare reform, migration from the empty deserts which used to be called Spain, Greece, etc; maybe it is because MTRs on low incomes have been slashed and the retirement age hiked. Maybe the data is wrong, and rising numbers of self-employed are lying about their hours in the LFS responses. Then we must also turn a blind eye to the rise in MTRs further up the income scale, and pretend that doesn’t matter. (Check out Figure 2a and 2b in Paul Johnson’s excellent dissection of UK taxation.)
The one data point optimists can cling to is that nominal wage growth is dead dead dead. Completely totally dead. This is growth rate of nominal regular pay divided by average weekly hours, rolling 12m total, used as a proxy for nominal hourly wages (perhaps a poor one):
With a tight labour market and strong nominal GDP growth, we should expect to see nominal wages rising at around the same rate as NGDP, 4-5%, as they did before 2008. That is not happening. Despite amazing Lawson-boom-esque growth rates of hours (or jobs); the labour market is nowhere near tight yet. So we’ll have to wait to see what happens as that slack continues to be used up; only when nominal wages catch up with nominal GDP we will know for sure.
(Also: NO RATE RISES YET, THANKS MPC, KEEP PUMPING, THERE IS NO “INFLATION”.)
A nice reminder that price index data is a work of
fiction statistical genius on which it is perfectly safe to base macroeconomic policy. Reading through the ONS announcements today, this is how they describe the new methodology for determining car prices used in the national accounts:
4.2.2 New approach to be implemented in September 2014
For the new approach the list prices from Glass’s Guide are reduced to take into account discounts negotiated at the point of sale. The percentage discount applied for each model is partly offset by an uplift to account for point of sale accessories/optional extras purchased.
Discussions with industry experts including Glass’s and HM Revenue and Customs (HMRC) established that data on discount prices and amount spent on optional extras isn’t available. As an alternative method, “target price” information from What Car magazine (monthly publication) has been used to estimate a best achievable discount. The target price is a guide to a typical achievable discount based on a team of What Car mystery shoppers (people posing as customers) who haggle with dealers. A discount percentage for each model is calculated using the target price data. Since this represents the best discount available, the discount calculated has been reduced by 30% to take into account not all customers will achieve this price (i.e. not everyone will negotiate the optimum discount).
“We took the figures for discounts out of a magazine and knocked 30% off for good measure.” Why 30%? Don’t ask too many questions.
The discount applied is further reduced to account for point of sale accessories/optional extras purchased. Research suggested metallic paint is the most popular extra added. This option isn’t typically available by moving to an improved model in the range which other optional extras often are. Looking across a range of models the cost of metallic paint typically offset the original What Car discount price by approximately 35%. ONS have therefore further reduced the discount calculated by a further 35%. The What Car best achievable discount price has therefore been reduced by 65% overall.
“Then we knocked off another 35%”. Let’s hope there are no spreadsheet errors.
In fact it’s even worse: this method is used to calculate the deflator used for car sales, which is applied to the survey data on the volume of car sales to produce current price (nominal) spending. The ONS really does produce RGDP first and NGDP second for some (many?) sectors. The more I learn about price index and national accounts methodology, the more attractive nominal wage targeting becomes!
Way waaaaay back in the dark days of 2012, which was, ooh, decades ago, Mervyn King used to complain about uncertainty. “Uncertainty” was King’s “excuse” for really bad stuff happening which wise central bankers can’t do anything about. Like real GDP going the wrong way. This is my favourite collection of Merv quotes from his infamous “black clouds” speech:
… a large black cloud of uncertainty hanging over not only the euro area but our economy too …
… Complete uncertainty means that the risks to prospective investments … are simply impossible to quantify …
… the black cloud of uncertainty and higher bank funding costs …
… The paralysing effect of uncertainty, with consumers and businesses holding back from commitments to spending …
… the black cloud of uncertainty has created extreme private sector risk aversion …
… private sector spending is depressed by extreme uncertainty …
… during the present period of heightened uncertainty …
Fast forward to 2014, and this is the “new normal” for central banking, as expressed by Charlie Bean:
Another reason the exit [from the ZLB] may be bumpy stems from the starting point. Implied volatilities in many financial markets have been at historically low levels for some time now (Chart 7). Together with low safe interest rates in the advanced economies, that has underpinned a renewed search for yield and encouraged carry trades. Taken in isolation, this is eerily reminiscent of what happened in the run-up to the crisis. Episodes like the ‘taper tantrum’, which produced a short-lived bout of volatility but no major disruption may also be contributing to a sense of complacency and an underestimation of market risk by investors.
It is inevitable that at some stage market perceptions of uncertainty will revert to more normal levels. That is likely to be associated with falls in risky asset prices and could be prompted by developments in the Ukraine, the fault lines in the Chinese financial sector, monetary policy exit in the advanced economies, or something else. But it will surely come at some point.
In 2014 wise central bankers are now worried that there is not enough uncertainty – there may be that dreaded “search for yield” – or, as those cheeky capitalists like to call it, “higher investment”. This is a bad thing, because, well, there might be “bubbles” even if we can’t define what a bubble is or identify one until after the fact. And we’ll apply the usual post hoc ergo propter hoc fallacy, because there are things which went up in 2007 which also went down in 2008, ergo those things caused the recession in 2008. Even though central banks’ own models tell us that financial crises and recessions have a single common cause: bad monetary policy.
We can be sure of only one thing: whatever happens, central bankers will be quick to tell us it wasn’t their fault.
Never mind about voting, it’s NGDP day. Usual caveat first: the quarter-on-quarter growth rates for nominal GDP tend to be unreliable in early estimates. That said, the data in the second estimate of GDP for 2014 Q1 has nominal GDP growth slightly slower than in the second half of 2013, but still respectable at a 4.9% growth rate. Here’s the table for q/q growth at annual rates:
2013 Q2 still stands out as particularly weird there, with strong RGDP but massive deflation. It seems possible the ONS has struggled to balance income, spending and output measures in that quarter, with timing of bonuses a distortion due to the higher rate tax cut kicking in.
The chart below shows year-on-year growth, switching to GVA to factor out the impact of indirect tax changes on prices:
Real output continues to track growth of nominal demand very closely; the broadest measure of “inflation” across all of GDP (the implied deflator) continues to run below 2% year-on-year even as demand growth has picked up.
When oil prices went up in 2008 the media blamed the Bank of England’s monetary policy. When VAT rose in 2010 and 2011, the media again blamed the Bank for being too inflationary. When the price of bonds rose in 2012, the media blamed the Bank (QE) for hurting virtuous savers with low interest rates. When the price of equities rose, the media blamed the Bank (again, QE) for making the rich richer – and hence everybody else poorer (yes, British progressives even brought “fairness” into monetary policy). When the price of London houses rose in 2014… well, guess who gets the flak?
So I enjoyed Carney and co sticking two fingers up at the Inflation Report today. At the press conference we again saw a long stream of questions about housing from the hawkish journalists who mostly live in, wait… where is it… let me guess… Aberystwyth? Carney and co did a great job of throwing them off, here is a choice quote from the Guv’nor:
Guy Faulconbridge, Reuters: Perhaps it’s a stupid question, I didn’t quite understand – do you see signs of a bubble in the housing market in London? And another stupid question probably, but you’ve been in your job nearly a year, what have you found most difficult about doing your job? Thank you very much.
Mark Carney: Answering stupid questions Guy, that’s the most difficult thing.
You probably didn’t understand on the first question because at no point in the Report or in the press conference did we talk about housing in a specific city, a specific borough in a city, because we make policy for the United Kingdom.
Quite right. Spencer Dale even debunked “Londonism“:
The other question is – is, independent of that, do increases in house prices have a material impact on economic activity? And in the past one can observe quite a strong correlation between increases in the house price and economic activity.
The question is, is it house prices themselves that are driving that or is it something else? And we published some work in that box which tried to get at that by looking at, as house prices move, do the consumption behaviour of say renters, people who rent houses, change very differently to those who own their house? And if it was house prices themselves, you’d expect to see very different movements.
In fact, in terms of the cross section of data, you don’t see very different movements. So we don’t think house price movements in themselves are a big driver of activity. And so when we’re thinking about the macroeconomic implications it’s the transactions, which is where we think is the main driver.
This is not a post about monetary policy and that’s something we should celebrate. The Riksbank have made household debt a focus of Swedish monetary policy and it is proving a terrible policy failure. The ECB is emulating the Bank of Japan. The MPC has declined the opportunity to screw up UK monetary policy and is rightly ignoring changes in London house prices. Bravo!