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“Paper Money Men and Bullion Men”

October 14, 2013 1 comment

I enjoy reading the Hansard achives from the 1930s… what an amazing resource.  It is not hard to find parallels to modern-day debates about macro policy.  The following quote is from David Mason MP speaking in Parliament in July 1934 during a debate which appears to be mostly about monetary policy:

It is rather interesting to see how complete is the analogy in many respects between that period of history after the Napoleonic Wars and the period through which we are now passing. Of course, there is the difference of time, and increases of population and so forth, but there were inflationists and deflationists, paper money men and bullion men just as there are now, and it is curious and interesting to find, if one will take the trouble to read up the Debates in this House, comments and statements made almost similar to those that are being made to-day.

It is a cliché, but history keeps repeating itself.  A contribution from a Pierse Loftus MP contains many gems:

I believe that, if His Majesty’s Government would announce in due course that they were prepared to set up an inquiry into the monetary system and into monetary policy, they would be astonished at the flame of enthusiasm that they would arouse throughout the country, especially among the younger people. They are not satisfied with world conditions as they are to-day; they are not satisfied with any policy of going back to 1924 or 1914; they feel that the productive capacity of the world is immense, but that it is not being utilised owing to the defects in the monetary system, which should facilitate the exchange of goods and services all over the world.

I love that clarity.  So many today talk about monetary policy only in terms of borrowing and lending or banks or interest rates… how about sticking with “facilitating the exchange of goods and services”?  A little later from Loftus, here is that history we’re repeating:

We know the effect which, as my hon. Friend the Member for East Aberdeen has pointed out, deflation has had upon our people; and we know also that to-day the economic problem is linked with the political problem. In Yugoslavia you have revolutionary discontent. Why? There is deflation. In Italy under the surface there is revolutionary discontent, Why? Deflation. In France, riots and revolutionary discontent. Why? Deflation. What was that bloody business in Germany the other day caused by but the pressure of deflation constantly driving down the standard of living? That was the main cause.

The loci of the riots and deflation only a little different this time around.

Categories: History, Monetary Policy

We Need Better Policy, Not Better Central Bankers

January 28, 2013 4 comments

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 principlesIf 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.

UK Nominal and Real GDP Growth, Annualized % Change over Five Years

UK Nominal and Real GDP Growth, Annualized % Change over Five Years

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.

Categories: History, Monetary Policy

Tories and Supply-Side Reform

September 13, 2012 2 comments

It seems the righter-wing end of the Conservative party has had a think about their party’s 2015 electoral prospects, looked at the GDP figures, and gone into a little bit of a panic.  Not necessarily a bad thing.  What is their plan?

Liam Fox today gifted a stream of nasty party” quotes to the Guardian sub-editors, allowing them to concoct headlines with the words “slash” and “welfare” carefully arranged to maximize the righteous indignation of their readers.  David Davis last week made a speech calling for a government “growth strategy” – and the growth strategy that he and Fox have in mind is no more and no less than “radical” supply-side reform.

Davis and Fox remember that Thatcher won elections, and Thatcher loved supply-side reform.  So they revert to this primitive ideal of Thatcherism which says “supply-side reform wins elections”.

But they have forgotten that a good part of Thatcherism was demand-side, with the adoption of monetarist targets for the broad money supply aimed at providing lower, and stable inflation.  Cobham’s book on UK monetary policy makes the point that this was more an evolutionary change than a revolution; monetary targets had been used but completely ignored in the 1970s; after the targets were made more explicit in the 1980s, they were still ignored or revised when policymakers found that convenient.

Regardless, the demand-side policies under Thatcher brought down nominal GDP growth from an average annual rate of 16% in the 1970s to 9% in the 1980s.  Some volatility remained with inflation and NGDP soaring in the first years of the decade and another (less severe) spike at the end during the “Lawson Boom”.  The intervening period saw marked stability in nominal GDP, real GDP and inflation.  Lawson’s abortive ERM experiment was another unnecessary screwup, but the subsequent adoption of inflation targeting in 1992 set the stage for 16 years of stable growth.

My point is not to elevate the record of demand management under the Tory governments of the 1980s, a record which is certainly not above criticism.  But it was generally a lot better than what came before.  Davis’ idea of a “growth policy” is simply to pretend the demand side does not exist, or in his words:

when I talk about a growth policy, be clear that I am not talking about an exercise in Keynesian demand management.

He is similarly dismissive of Japan’s experience with “suppressing interest rates to zero”.  Milton Friedman keeps on turning in his grave.

Davis does come out in favour of government-funded infrastructure spending, but purely for its benefits in improving the supply-side and long run growth.  This support is conditional; it must only be infrastructure spending on things David Davis thinks are really good.  Which apparently means that high speed rail is out, and gigabit broadband is in, because South Korea has gigabit broadband and therefore, um, handwaving here.  I’m not sure Davis has fully grasped the Hayekian critique of central planning embraced by Thatcher.

The (short) list of supply-side reforms which Davis deems necessary for growth may well (or may not) be sensible ideas.  Jonathan Portes is surely correct to point out that an “easy win” from supply-side reform would be to relax the immigration rules tightened under the Coalition, a subject which the likes of Davis and Fox are curiously silent on.  But supply-side reform will not help escape from the demand-deficient slump we are in.  UK nominal demand growth has been weaker over the last four years than any other period on record, and there is no obvious recovery imminent.

For these politicians to abandon any consideration of demand policy right now not only contributes to their party’s electoral suicide, but is a repudiation of the Thatcherism they claim to admire.  Monetarism’s “second counter-revolution” offers an escape from what might be considered “Keynesian” demand management, but the Tories have little time to embrace it.

Recurring Failure

July 20, 2012 Leave a comment

Here is the graph of the headline UK CPI rate, and the Bank of England’s median forecast for the CPI rate looking 3 years out.  The latter is a roughly what the MPC aim to adjust when setting the monetary policy stance, as per Lars Svensson’s “target the forecast” methodology.  If the forecast is nailed to 2%, go and watch the tennis.  Otherwise, adjust the monetary policy stance until the forecast is at 2%.

The last recession, and the ongoing double-dip are shaded.

UK CPI Rate, Current and Forecast

UK CPI Rate, Current and Forecast

Is it chance that the failure to hold the forecast at 2% was preceded both times by a spike up to 5% on the current CPI rate?

And then.. is it chance that both episodes of failure are associated with a recession? Correlation, but no causation?  Admittedly it would better to look at some measure of nominal demand growth here, not just falling real GDP.

Bring Back Nigel Lawson

April 27, 2012 3 comments

How often do we see a discussion of nominal GDP in modern British politics?  Hands up everybody who thinks George Osborne could explain the difference between the nominal and the real?  What, no hands?

This is Nigel Lawson presenting the 1985 Budget – “money demand” being the traditional parlance for “nominal demand” (my emphasis throughout):

In my Budget speech I emphasised the undertaking that I gave to the National Economic Development Council, last month, that the medium term financial strategy is as firm a guarantee against inadequate money demand as it is against excessive money demand. I hope that Opposition Members fully understand the implications of those remarks and will now unreservedly endorse the benefits that will flow from wage moderation.

In other words, Lawson wanted to stabilise the growth rate of NGDP.  He continues later:

The Government are pursuing a responsible path for the growth of money demand.  During the past few years it has grown by 8 per cent. a year. That is more than adequate for any reasonable increase in demand in the economy. It provides ample scope for both inflation and unemployment to fall. There might be an inadequate real demand, but the notion that the solution is an increase in money demand is a profound fallacy. Money demand is the only instrument on the demand side that the Government can manipulate.

That is why it is so important to deal with the problems on the supply side. One of the main problems that we have seen there has been the failure of pay and prices in the economy to adjust to the growth of money demand, leaving more room for output and employment to rise. The tragedy is that too much of this growth of demand has gone in higher living standards for those in work at the expense of those without jobs. I repeat my claim that there is no shortage of demand.

That is in the Budget speech. 

A few years of 8% NGDP growth, Mr Lawson?  Yes please.  And some supply-side reform?  Sure, why not.

Categories: History, Monetary Policy

UK GDP by Income

April 23, 2012 8 comments

For Tim Worstall and Richard Murphy, who discuss the breakdown of GDP by income, here are the figures, current as of the 2011 Q4 Economic Accounts.

First, for the breakdown of GDP by category of income, we have ONS data going all the way back to 1955:

UK GDP by category of income

UK GDP by category of income

The relevant series used here are CGBZ, DTWM, CGBX, CMVL and YBHA.   I think Tim is correct to note the (slight) rise in other income (which includes income from self-employment, so-called “mixed income”) and VAT are the significant secular trend.

For the split of “compensation of employees” between employers’ National Insurance contributions and wages, we only have data from 1987:

Wage Share of GDP

Wage Share of UK GDP

The relevant series are RPCG, RPCH and again YBHA for nominal GDP.

Categories: History

Chuck Norris in Threadneedle Street

March 22, 2012 4 comments

Market Monetarists Lars Christensen and Nick Rowe like to talk about invoking the Chuck Norris effect.  In Nick’s words:

Central banks run monetary policy not so much by doing things, but by threatening to do things. If their threats are credible, we never observe them carrying out those threats, and we often observe them doing the exact opposite

But does the Bank of England believe in the power of Chuck?  There is a hint they still do, but we have to go back to 2009.

The March 2009 minutes of the Monetary Policy Committee are a fascinating read.  The MPC faced for the first time the horrific scale of the collapse in nominal GDP growth:

12.  UK nominal GDP had fallen by 0.8% in 2008 Q4, and was only 0.5% higher than its level a year earlier. If unrevised, this would be the weakest four-quarter growth in nominal output since quarterly data began in 1956.

What is the response?  They focus entirely on boosting nominal GDP by buying assets (mostly gilts) – confirming explicitly that influence over the level of NGDP comes ultimately from their control over the Sterling monetary base, not merely their ability to set (short-term nominal) interest rates:

30.  The Committee agreed that such [asset] purchases were necessary in order to increase nominal spending growth to a rate consistent with meeting the inflation target in the medium term. Such operations were a natural extension of the Committee’s usual monetary policy operations. Given the Bank’s role as monopoly supplier of sterling central bank money, the Committee had previously chosen to influence the amount of nominal spending in the economy by varying the price at which it supplied central bank money in exchange for assets held by the private sector. Under the operations now under consideration, the Committee would instead be focusing more directly on the quantity of money it supplied in exchange for assets held by the private sector.

Then follows a lengthy discussion on the magnitude of asset purchases necessary to boost NGDP:

33.  There was a high degree of uncertainty over the appropriate scale of purchases necessary to keep inflation at target in the medium term. The Committee noted that their February Inflation Report projections suggested that a significant shortfall in nominal GDP was possible over the forecast period. Nominal GDP had grown by, on average, around 5% since the inception of the MPC – a period over which inflation had been close to the target on average. In contrast the Committee’s February projections implied a small decline in nominal GDP in 2009, with growth remaining below 5% in 2010. Therefore the projections suggested a shortfall in nominal GDP of at least 5%.

This looks like NGDP growth rate targeting rather than the level targeting preferred by the Market Monetarists; the MPC are ignoring the lack of annual NGDP growth over 2008/9, allowing “base drift”.

The decision is to buy assets of a value equal to the expected shortfall in NGDP:

35.  These considerations suggested that the increase in the level of money balances should be of a similar magnitude to the required increase in nominal GDP. The Committee agreed that reserves should initially be increased by a figure somewhere in the range of £50 billion to £100 billion.

But after losing the use of their usual toy, Bank Rate, they are flying blind, and incredibly, concerns about doing “too much” remain.

Finally, here comes a little bit of Chuck:

38.  In addition, should the first injection prove too small, there was a risk that observers would wrongly infer that such asset purchases were not an effective policy tool. That might dampen the extent to which liquidity premia were reduced, and asset prices boosted, by further purchases. The initial programme of asset purchases needed to be on a scale large enough to demonstrate that the Committee would do whatever was needed to boost nominal spending sufficiently to keep inflation at target in the medium term.

That’s more like it!  There’s your credible threat – “we’ll hit the inflation target, come what may”, and they are ready to beat up as many people as they need to get there – they will “do whatever was needed.”

Final notes:

  1. Who could read that wording, and believe that the Bank of England is likely to waver in its defence of the inflation target if fiscal policy is tightened “too far, too fast“?
  2. The level of the UK CPI rose 11% between February 2009 and February 2012, an annualized growth rate of 3.6%, well above the 2% target.
  3. It’s just a tragic shame the CPI rate was the wrong target.
Categories: History, Monetary Policy

UK NGDP Targeting, circa 1989

February 14, 2012 Leave a comment

After the UK left the ERM in 1992, HM Treasury had to adopt a new nominal anchor for monetary policy fairly quickly.  Before entering the ERM the Government had ostensibly used money supply growth rate targets as the framework for monetary policy, though they were not good at hitting the targets.

One anonymous civil servant discusses alternative frameworks in internal Treasury correspondence from 1992; an inflation target was ultimately picked.  Included are sections of something called “the December 1989 Chevening paper”, covering the relative merits of inflation targeting, a “price/output” framework, and an NGDP framework.

Below is a transcription of the section on using an NGDP target (growth rate presumably):

45. In recent versions of the MTFS the aim has been to use money GDP to provide this [nominal] anchor.  This is the best measure we have of the total activity in the economy in the prices of the day – and it has become the centre piece of our nominal framework.

46. The implicit view of how the world works is the same as in the price-output approach.  The essential principle is that over the medium term, output growth is determined by the supply potential of the economy and any persistent growth of money GDP above this rate will be reflected in faster inflation.  In the short term it is likely to be reflected in a faster growth of real output but subsequently inflation will rise and output revert to trend.

47. Bringing down inflation means bringing down the growth of money GDP closer to the underlying rate of output growth.  In the short-run this is likely to mean a period when real output growth falls below its underlying rate but in time we would expect output growth to return to trend and inflation to stabilise at a lower rate.

48. Of course these are only tendencies; in practice there are no hard and fast rules because changes in money GDP can be brought about by a number of factors, both internal and external, which directly affect prices.

49. Again we can interpret recent events in this framework (see Chart 10).  Money GDP growth accelerated to almost 10 per cent in 1997 and 11 per cent in 1988 before appearing to decline slightly this year (1989).  Not suprisingly, in both 1987 and 1988 real GDP growth was significantly in access [sic] of supply potential (say 3 per cent).  Inflation picked up in 1988 and rose further in 1989.

50. If the underlying rate of growth is 3 per cent, reducing inflation from its current rate of 6 per cent plus requires bringing the growth of money GDP below 9 per cent on a sustained basis.  The extent of the reduction of inflation will depend on how far money GDP growth is reduced.

51. There are also problems with this approach:

  • the initial data is poor and money GDP growth can only be controlled in a rough and ready way taking one year with another; if it departs significantly from its desired path it takes time to bring it back into line;
  • we have a record in recent years of underestimating the growth of money GDP which has affected the credibility of this approach;
  • presentationally it has unattractive features.  A frequent criticism is that it is a curious magnitude to target, being the addition of inflation, which is bad, and output, which is good.

Even so in my view it is a useful framework.  It enables Government to concentrate on the financial framework and take a ‘hands-off’ approach to the division between real output and inflation.  In principle it is easier to relate to the behaviour of monetary aggregates; it is consistent with the approach followed throughout the 1980s; and avoids getting tangled up in the web of fine tuning output and inflation.  In theory it is entirely consistent with the price-output approach.  Being from the same stable they are complementary – different ways of looking at the same problem; one is easier to understand intuitively, and throws light on short-term movements; the other is probably a better control procedure from a medium term perspective.  It also possesses presentational advantages.

The “MTFS” is the “Medium Term Financial Strategy” published by the Treasury in the 1980s.

Other hints at the use of NGDP as a not-quite-explicit target in the 1980s can be found in Hansard:

The Government are pursuing a responsible path for the growth of money demand. During the past few years it has grown by 8 per cent. a year. That is more than adequate for any reasonable increase in demand in the economy. It provides ample scope for both inflation and unemployment to fall. There might be an inadequate real demand, but the notion that the solution is an increase in money demand is a profound fallacy. Money demand is the only instrument on the demand side that the Government can manipulate.

That was Nigel Lawson, then Chancellor of the Exchequer, speaking in the House of Commons after the 1985 Budget.

Categories: History, Monetary Policy
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