This is what Resolution’s Matthew Whittaker had to say about inflation in a piece for the Independent earlier this month, titled “Why the Bank of England should target wages as well as unemployment“:
Nothing at all. There is no mention of the word “inflation”, nor of the “CPI”, nor even “prices” in a piece purportedly about UK macroeconomic policy – about UK monetary policy. I’m sure Matthew is a good guy, and I’m not trying to pick on him specifically, but that is a beautiful illustration of how I see centre-left/progressive economists addressing UK inflation over the last five years. The motto is “Don’t mention the
Yet at the same time the centre-left political movement has been obsessing about inflation – that is literally what the “cost of living crisis” means. Yes, you can come up with a different translation of that phrase, but the CPI really is how we measure “the cost of living”. It is going up, and that is a “crisis”. In fact it is even worse: progressives love to exaggerate the extent to which the “cost of living” has risen, by deflating nominal wages by the RPI (rather than the CPI) to show just how badly real wages are suffering.
This is all both depressing and frustrating to watch. I’d roughly agree with Mr. Whittaker’s eventual conclusion, that targeting nominal wages (or nominal incomes) is a good idea. But he gets there from talking first about real wages, and then median wages (which is almost as bad), without use of the word “nominal”, so it is not totally clear he even wants a nominal target, but let’s assume he does. And so does Mr. Whittaker want the Bank to continue targeting the CPI… and unemployment… and add nominal wages as well? Really? All of those things at once?
I have a relatively simple narrative about what the BoE has been doing for the last five years: roughly what they’ve always done, keeping the “risks to inflation broadly balanced”… around the 2% target. I construct that narrative based on what the MPC have been saying for the last five years, month after month after month. What that means in practice is that the Bank steer a course for nominal demand (NGDP) which is sufficient to keep the CPI on target.
And so the Bank defend their policy stance based on those damn CPI numbers. Is that wrong? Why should it be – hitting the CPI is their legal mandate! How can anybody possibly argue that UK macro policy was too tight ex post, at the same as attacking the government because “the CPI is too damn high”. That would be utterly ludicrous… and it is the critique of Coalition macro repeated endlessly for the last three years.
There are more complicated narratives too. Maybe that unexpected shocks to nominal demand have resulted somehow more in lower measured productivity and output, less in lower prices/inflation. OK, maybe that is a bit true, and I hope it is a bit true. But if that is even a little bit true, then inflation targeting is the worst possible monetary policy you can have, and you need to be openly screaming about that fact. ”Inflation targeting is not working“, you might write.
Instead the best and brightest on the centre-left have been producing critiques of UK macro policy along the lines of:
a) Monetary policy is not a panacea. (Well, thanks so much. Jens Weidmann totally agrees with you.)
b) We need more infrastructure spending. (Brilliant. And what about macro policy?)
c) No really, we need more infrastructure spending. (Yeah, but that’s not a macro policy, is it?)
d) I insist there is a big output gap because X, Y, Z. (Fantastic! The Bank are still targeting the CPI.)
e) Infrastructure spending? (Please stop.)
f) How about we target a real variable like unemployment? (Yeah, the 1970s were brilliant.)
All of that serves only to duck the real question… the nominal question. The nominal question appears to me to be remarkably simple:
What is more important: (1) output/consumer price stability, or (2) nominal wage/income stability?
If you want “price stability” then you can’t have nominal income stability. We’ve tried that. Productivity shocks are horrible, and inflation-targeting seems to make them much worse. And if you want nominal wage/income stability then you can’t have “price stability”. We need to be open about that, with the politicians and the public; “price stability” was a good idea which failed. Can we do better?
Now, please, get off the fence and decide what you really, really want.
Egon Spengler: There’s something very important I forgot to tell you.
Peter Venkman: What?
Spengler: Don’t cross the streams.
Spengler: It would be bad.
Venkman: I’m fuzzy on the whole good/bad thing. What do you mean, “bad”?
The Bank’s forecasts for real GDP growth over the next two years. 2014: 2.8%, 2015: 2.3%. WHAT A BOOM. What an explosion of growth! In the Inflation Report press conference today, the press first asked lots of sensible questions about forward guidance and monetary policy – you know, the things the MPC are actually responsible for. But there was an elephant in the room, something was weighing on the minds of assembled hacks… see if you can spot it.
Richard Barley, Wall Street Journal: … Because I guess the concern is that so far we’ve seen perhaps some worrying signs of returning to the old normal and greater lending, reliance on house prices.
Guy Faulconbridge, Reuters: Just a follow on on the housing, I see you have a section on property. Do you see any signs of a bubble in any regions of the British housing market, because overall it’s fine to say that perhaps prices are still below the 2007 peak, but in London dinner parties the prices that you pay for prime real estate in London is kind of the main topic of discussion.
Tim Wallace, City AM: Governor, another one on housing.
Maybe hold the press conference up North somewhere next time?
Chris Giles’ post on demand vs supply made me very gloomy – look at the comparison with US productivity, the “cost of living crisis” is right there in that data. Here is a slightly different take based on today’s labour market figures.
You could say based on that, the UK demand-side recovery is basically complete. Hours worked is back on trend. The demand-side debate is dead. The stagnation of UK output is, and always has been, purely supply-side.
The fact that supply-side optimists find excitement in one month of a still-above-target CPI rate is even more depressing. Has nobody learned anything at all? If the CPI rate is irrelevant when it tells an “inconvenient story” about the aggregate supply/demand balance, it does not suddenly become relevant because one data point confirms your biases. Recognize that oh-so-wise policymakers might not share your rose-tinted view of the UK inflation data, and what implications that has for macro policy when the CPI rate is above target (see also 2008, 2010, 2011, 2012). Yes, the MPC really are steering us towards price stability.
And Dr. Carney… great job, really, great job.
There’s been some discussion of UK productivity recently, Simon Wren-Lewis here, Martin Wolf here, and Scott Sumner indirectly too. What I find interesting is that UK productivity exhibits such a strong positive correlation with nominal demand growth. I’ve graphed here the growth rates of nominal GVA, and market sector output per hour.
Why do we see that procyclical movement of productivity? I’ll offer three views:
1. Firstly, this is simply what we should expect to see under an inflation-targeting central bank. The inflation-targeting CB is trying to control the gap between (growth of) aggregate demand and aggregate supply. When we have a negative productivity shock (2008, 2012) the CB must drive down nominal demand growth to prevent high inflation. That’s all this data shows; Mervyn King and the supply-side pessimists will settle for something like this view. There is no AD problem per se, it’s supply, supply, supply.
That story is muddied only a little by the difference between CPI inflation (the actual BoE target) and output price/GVA inflation. GVA inflation, averaging 1.8% over the last four years, has been stabilised by the BoE arguably more effectively than the headline CPI.
2. Another view is that the GDP data is wrong, at least post-2009. The 2012 productivity collapse is genuinely weird. The fall in market sector output/hour masks the fact that hours worked soared upward, up 2.6% over the four quarters to 2012 Q4, while market sector output contracted by -0.3% over the same period. (The GDP data still show a market sector ”double-dip” in 2012, offset by the positive contribution from the
savage fiscal austerity rise in the volume measure of government consumption). There are a few theories here:
a) The idea that the GDP data is wrong is neatly supported by work on measuring intangible investment (see Goodridge, Haskel et al). I find this quite compelling because it matches an anecdotal view of what is happening in some sectors, e.g. retail. With the shift towards on-line shopping; that sector is investing in intangible assets (web sites, software etc), and there is less demand for new tangible capital (shops).
b) Markit’s Chris Williamson made the argument recently that the official labour market data which is wrong. The ONS disagreed, needless to say. Given that the change in unemployment has roughly tracked the movement in the claimant count, I’m not sure how much weight to put on this idea.
c) The nominal GDP data is right, but the inflation data, and hence output and output/hour, is wrong. A pet theory of this inflation-sceptic blogger. Under five years of 1920s-style NGDP growth we have seen widespread discounting and substitution. For the latter, think about the success of UK budget hotels, airlines, and supermarkets; this is substitution between goods/services of different quality. I strongly suspect such changes are near-impossible for the ONS to capture “correctly” in the price indices, and hence measured inflation is far too high. This makes measured productivity appear to be more procyclical than it should be if we “correctly” measured inflation and output.
3) A third view… it’s demand, demand, demand. The slow growth of NGDP was simply a mistake, it was bad macro policy. Labour hoarding and hand-waving are used to explain away the productivity data. The correlation in the graph really is a causal relation, but it goes from demand to productivity; we’ll see a recovery in productivity with a recovery in AD. So jump to it Mr. Carney/Mr. Osborne.
In optimistic moments I can subscribe mostly to (3), and 2013′s apparent recovery in output along with a recovery in demand supports that argument, in my view. Martin Wolf argues the Bank can “correct… highly visible errors” on inflation later on, after “gambling on growth”. But what is a “highly visible error” if not the last five years of UK inflation?
Supply-side optimists cannot sit on the fence and pretend the 2008-201X CPI trainwreck never happened. It’s surely more convincing to argue we should take productivity – and inflation – out of macro policy altogether. Set a stable path for nominal incomes and let the supply-side puzzle itself out.
… that is the opposition front bench. Soon, we might be able to “celebrate” that even Japan has a higher inflation rate than most of the EU, thanks to Shinzo Abe and the ECB.
There’s always “good news” from the European periphery where the cost of living is falling, falling, falling – every British politician’s dream (and they don’t even need price controls).
Looking at Eurozone macro data still feels a little like “rubbernecking”… but I’ve mastered Eurostat now, so here goes. Charts here show the headline HICP, the HICP at constant taxes (HICP-CT) and the HICP ex administered prices.
All three of the above have large “VAT wedges” since 2009.
In fact even the aggregate Eurozone HICP has a noticeable “VAT wedge” of its own, which I had not realised.
A little poetic license there… but I think there is an important point here.
In the long run all that matters is productivity. Yes, it would be fantastic if Britain can turn into Switzerland. But Keynesians have a nice turn of phrase about the long run… let’s forget about the long run for a minute.
In the short run, coming out of recession, the biggest difference the government (and I mean you, Carney et al) can make to British “living standards” is to deal with the problem of unemployment and under-employment. In that short run, the growth of real hourly wages is inversely correlated with rising employment and hours worked. Hence I think it is reasonable to argue that falling real wages are a good sign that British living standards are rising because it will be a good sign that employment and hours are rising.
And note again that real wages are not real incomes. Consider a part-timer who goes from 10hrs/week to 20hrs/week at the same time their real hourly wage drops 2%; their real income rises 96%. And then consider the unemployed person who goes from the dole queue to a job. The “real hourly wages” data does not capture a change in either person’s “standard of living”.
This inverse correlation is obviously not generally true. Outside of recessions any supply-side issue which lowers real wages (because productivity falls) is unambiguously bad. But recessions are special.
I couldn’t find a source for historic UK hourly wages, but I did find a couple of studies which imputed hourly wages from the compensation of employees data in the national accounts divided by total hours worked in the labour market stats. Here is the 1990s recession; hourly wages are deflated by the GVA deflator, the best measure of whole-economy inflation:
Now where do you want to argue that British “living standards” were rising? When real hourly wages were soaring in 1991, or when real hourly wages were stagnating in 1994/5?
Maybe this argument is uncontroversial. But if so then why the focus on falling real hourly wages from opponents of current UK macro policy? That is exactly the wrong focus from the perspective of macro policy. If the (political) focus is now purely on the supply-side, on productivity, then Osborne is surely right to claim he has won the argument on macro policy, merely because his opponents have abandoned the debate at the first whiff of positive real GDP growth. Oh, and forget about the unemployed, forget about the labour market… that is the ultimate victory of the inflation hawks.
[Inspired by, and see also: old Sumner posts on real wages in the Great Depression.]
A follow-up on a post from last month; I managed to replicate the data on House of Commons research on changes in real hourly wages across Europe. What I wanted to check is whether the UK is an outlier in terms of hours worked.
The research commissioned by Labour looks at changes between 2010Q2 and 2012Q4, so I’ve done the same. The Eurostat data I’m using has had one quarter of revisions since the HoC report was written, so the results have minor differences; Germany has real wages growing +2% over this period rather than the cited +2.7%.
Real hourly wages are found using nominal hourly labour costs from the Labour Cost Index series, and deflated using the all-items HICP. This isn’t necessarily the best definition of real hourly wages; using the GDP deflator might be more interesting, but I’ve stuck with the HICP.
The table below compares the change in real hourly wages and the change in actual hours worked from the quarterly national accounts, between 2010Q2 and 2012Q4. It is sorted by the change in real wages, and I’ve included only countries with population >1m, sorry Malta et al, you are just not that interesting. The averages for the EU27 and Eurozone are also included. All figures non-annualized.
|Country||Change in real
|Change in total
|European Union (27 countries)||-1.9||-0.3|
|Euro area (17 countries)||-1.5||-0.7|
What does this say? The most astonishing aspect is surely the collapse of hours worked in Greece, Portugal and Spain. Remember this data looks at just an 18 month period, and yet hours worked fell nearly 17% in Greece.
Against all that, the UK does look like something of an outlier. In this group, of countries with falling real hourly wages, only the UK and the Netherlands had rising hours worked. The UK in fact has the fourth highest rise in total hours worked of the group, after Estonia, Germany and Hungary.
One more thing. The Channel 4 “Fact Check” blog misses a very basic but important point in analysing Labour’s “cost of living crisis” claims:
Real Income = Real Hourly Wages * HOURS WORKED
Labour are citing real hourly wage data and some survey evidence as an “attack” on Osborne’s “out of touch” (Labour’s claim) “controversial comment” (C4′s words) on real household income. In C4′s view it is “controversial” to correctly cite ONS data? Maybe it would be better if Osborne ignored the official statistics and went with his gut feelings? More seriously, survey evidence on household perceptions of inflation is known to be unreliable.
The truly remarkable data point in the 2012 statistics is the change in hours worked, which rose 2%. The changes to hours worked is the key data point in the “productivity puzzle” so people should be well aware of this. And falling real hourly wages plus rising hours worked is consistent with rising real incomes.
If anybody can find a European country which has similar real GDP numbers to the UK and hours worked & employment data which look like the graph below, I promise to do a post being extremely nice about Ed Balls:
Total hours worked and total in employment both hit record highs again in today’s data.
(By the way if anybody has a copy of the HoC Library research which Cathy Jamieson is citing, I’d love to see it, please mail me. I could not find Eurostat series which precisely matched the cited results.)