So close and yet so far. This is a comment on safe assets from this month’s MPC minutes:
This improvement in risky asset prices came at a time when the underlying risks to the global economy remained material. Much of the increase could be attributed to lower rates on safe assets, such as some government bonds, which raised the current value of future flows of income from risky assets. These low rates, in turn, reflected both a global mismatch between strong desired savings and weak investment plans, and the policies undertaken by various central banks to underpin nominal demand and meet their inflation targets. At some point, higher prices of risky financial assets would in all probability make investing in the real economy a more attractive proposition, leading to higher aggregate demand. A sustained rise in demand would, in due course, mean a rise in interest rates on safe assets and, potentially, some unwinding of the rise in risky asset prices.
If only some central banks could work a little harder to “boost” nominal demand rather than just “underpinning” it. The doves (King, Fisher, Miles) say ease, noting correctly that easing monetary policy now will mean interest rates rise sooner than otherwise:
Earnings growth had fallen and there was little sign of any de-anchoring of inflation expectations. Further asset purchases now would facilitate an earlier normalisation of the monetary stance when that became appropriate. Against that backdrop, it was appropriate to reduce labour market slack more quickly than was envisaged in the Committee’s central projections. The impact of such a policy on inflation was uncertain. The initial impact of faster demand growth might be to reduce cost pressures by improving productivity.
But the hawks say no, and the hawks win:
Inflation had been above the target for a considerable period and there was tentative evidence that measures of medium-term inflation expectations were becoming more sensitive to short-term news in inflation. Moreover, financial markets were not expecting further asset purchases at this meeting and might, at the margin, reassess the Committee’s tolerance of elevated inflation should additional stimulus be injected.
In other words, the most important thing for UK monetary policy is that everybody believes that the MPC are inflation hawks.
Dr. Martin Weale is concerned about market sector Unit Labour Costs. OK. Here is what happened to market sector Unit Labour Costs going in to Summer 2011:
They have just tipped out of outright deflation. To be fair, this is current data; possibly the Bank had data saying something different back in 2011. But let’s presume that if Dr. Martin Weale was looking at even vaguely similar data, he must have been arguing for looser monetary policy at the time? Here’s what he was saying in June 2011:
I have, of course, been pleasantly surprised that wage settlements in the private sector have remained low and that private sector regular weekly earnings are rising by less than 2 1⁄2 per cent per annum.
(Yes, Dr. Weale! Like you, people all round the country are celebrating their low pay rises! Hooray for low pay rises, they say! Hooray, hooray! He continues…)
But a more general picture of unit domestic costs excluding taxes can be obtained by looking at the gross value added deflator. This rose by 1 per cent in the first quarter of the year and by 2.4 per cent compared with the first quarter of 2010. So it is consistent with the view that, even after excluding import costs and taxes, there are at present substantial cost pressures in the economy.
Can you see what he’s done there? He did not mention unit labour costs! In 2011, the GVA deflator was a good reason to… well, what did Dr. Martin Weale want to do in 2011? Just check the title of the spech: “Why the Bank Rate should increase now“.
Coming back to 2012, Unit Labour Costs have been rising, and what is happening to the GVA deflator? It rose just 1.2% in the four quarters to 2012 Q4 and has been below 2% for most of the last four years. So is that a “substantial” level of cost pressure, Dr. Weale, or a “pathetically weak” level of cost pressure? What would you say? Or do you in fact cherry-pick the statistics which fit your narrative and ignore the rest?
[Update: I meant to note that the GVA deflator reading which Weale mentioned, of 2.4% over the four quarters to 2011Q1, has since been revised down to 1.0%.]
I am honestly disgusted by this. This is not policy. This is not how the UK’s most powerful technocrats should behave, lurching from arbitrary decision to arbitrary decision. We deserve much, much better than this. Re-appointing the hawks to the MPC is looking like a catastrophically bad decision, absent a tighter (less discretionary) policy mandate to keep them on a tight leash.
… get inflation down. He presents the graph of nominal wages. I’ll put the figure here for the annual rate of change in average weekly earnings, looking at private sector regular pay:
0.7% in the year to March 2013
Weale decides instead that private sector unit labour costs are a clear and present threat to the sacred inflation target, and concludes:
So my own judgement is that a further easing of the rate of growth of cost pressures is necessary before I feel we are in danger of undershooting the inflation target.
Do you like that? “easing of the rate of growth of cost pressures”? Nominal wages are rising, let’s say it again ZERO POINT SEVEN PERCENT, and Weale wants to see an “easing of the rate of growth of cost pressures” before he’d consider easing monetary policy.
In the February Inflation Report we saw the Bank forecasting (and hence, targeting) CPI inflation significantly above 2% on the two year horizon for the first time in four years. In this week’s Inflation Report we saw the Bank revising up its real GDP forecasts for what Chris Giles says is the first time since 2007. What a strange co-incidence that is, eh?
Claire Jones has a nice post covering the improvements to the Inflation Report prompted by the Stockton Review. For the first time, I didn’t have to wait a week for the Bank to publish their sacred Excel spreadsheet with the forecast data. Rejoice! This graph shows how the median forecasts of the CPI rate have moved over the last four Inflation Reports:
The median forecasts have shifted down across the entire forecast period, since February, and now perfectly hit 2.0% CPI on the two year horizon (versus 2.3% in February on the same horizon). The obvious response is to castigate the MPC for yet another opportunistic disinflation. In this case I wonder whether the Bank’s models might only have altered the real/inflation split, since the real GDP forecasts have moved in the opposite direction to inflation; Chris’ post has the graph showing the latter. It would be useful to have the forecast for the path of nominal GDP so we could identify such cases.
It is worth noting here that Mervyn King’s hawkish ITV interview in March seems to have “successfully” capped the rise in market inflation expectations seen earlier in the year, and put a floor under Sterling – at least the latter of these feeds in to the Bank’s forecasting model. King declared in that interview that the pound was “close to properly valued” and insisted the Bank was not going soft on inflation. Great work, Merv!
(The sharp movement in market inflation expectations at the start of January is not a data error, it was caused by the outcome of the RPI methodology consultation.)
So the usual conclusions must be drawn… does the MPC want higher inflation? No. Are they constrained from moving inflation expectations? No. Have the MPC been desperately printing money to raise (or keep elevated!) expected growth and inflation since February? No, no, no.
I had been unsure what I could write about King’s legacy at the Bank of England, but the Governor provided a quote which captures it well. In the press conference today, this is how King responded when asked about the new remit, and whether the Bank needed more discretion:
No I don’t think we need more discretion as such, I think the two key features of the remit which I welcome are, one – reaffirming that the central objective of monetary policy, which is the main role of a central bank, is to meet the inflation target of 2% a year; in other words the commitment to price stability. Nothing is more important than that and the Chancellor has moved – well he wasn’t tempted to go down the path of giving up the target, he’s reaffirmed the commitment to price stability.
Mervyn King coined the term “inflation nutter” in 1997 to describe those who embraced stability of inflation above all else. Governor King in 2013, along with an entire generation of central bankers, will still claim “nothing is more important” than price stability. That is the legacy of King and the rest of the modern-day inflation nutters.
I wrote and then lost a whole post about UK monetary policy which was perhaps moderately interesting. There was no need, it turns out, because instead I could give up blogging and direct you to read Chris Giles in the FT:
With the annual growth rate of nominal GDP being so important, it is extremely disappointing that Mark Carney, incoming governor of the BoE, has backed-away from his suggestion that targeting its value would help in a depressed environment. Instead, his new big idea to shake-up the BoE is to introduce “conditional guidance” alongside monetary policy decisions – similar to the Federal Reserve’s commitment to keep the money-printing going until unemployment falls below 6.5 per cent.
Mr Carney’s idea still represents an opportunity. What is important in the Fed’s conditional guidance is that the US central bank uses the most relevant indicator of US economic health – unemployment – as its intermediate threshold in its information to markets. Substitute nominal GDP for unemployment in the UK and monetary policy is again targeting what matters.
A thousand times yes. The only thing I’d want to add is that a flexible inflation target enhanced by short-run “forward guidance” setting out a path for nominal GDP is exactly the policy regime which Michael Woodford is advocating:
As argued above, the inflation target itself does not suffice to determine what near-term policy decisions should be; and yet in the absence of a clear near-term criterion that should generate the desired rate of inflation over the medium run, the way in which the central bank’s decision procedure is supposed to maintain confidence in a particular medium-run rate of inflation remains obscure. And no inflation-targeting central bank would actually maintain that the correct near-term criterion should simply be minimisation of the distance between the actual inflation rate and the target rate, even at short horizons. Hence what is needed is a near-term target criterion, that will not refer simply to inflation, but that can be defended as an intermediate target, the pursuit of which in the near term can be expected to bring about the desired medium-run inflation rate (without an unnecessary degree of volatility of real variables). A nominal GDP-level path is an example of a fairly simple target criterion that satisfies these requirements.
There is little more to say about UK macro policy; this is what we need to do. Dr. Escape Velocity… over to you.
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.
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!