There is an interesting asymmetry in how people read the macro data.
For a given increase in aggregate nominal spending (income) I think it would be generally agreed that “what we want to see” is a higher volume of output and not much inflation. Does anybody disagree? Anybody out there who would prefer the trade-off shifts towards higher inflation and lower output growth? No?
OK. For a given increase in aggregate nominal income (spending) we can consider the same trade-off between employment and wages. I had taken it as given that we had a depressed labour market and so “what we want to see” is that increases in aggregate income will translate primarily into higher employment.
What we have seen over the last year looks quite amazing. Over the year to the March-May 2014 period, hours worked has risen 3.7%. We only have nominal data for Q1, but that showed a 4.1% rise in nominal aggregate labour income. In other words, the increase in aggregate income has translated almost entirely into a higher volume of labour employed and there is no inflation – nominal wage growth is maybe just positive.
Yet this is seen somehow as a bad thing, see, for example the Guardian here, which puzzles me. Do you have a sticky wage model of the labour market, in which AD shocks can raise/lower employment, or not? Is higher employment in 2014 a good thing, or not? These questions have simple answers for this simpleton blogger.
6.5% is a good news story, and let’s hope they keep coming.
A quick note, file under “Relentless Attack on Inflation”. Thanks to some kind soul on twitter (whose name I’ve forgotten), I discovered that Eurostat have time series which split “administered prices” out of the HICP (= UK CPI).
I have discussed the effect of “administered prices” on the CPI here before, and I don’t have much to add. When energy prices go up because of increasing regulatory costs is that an “administered price” shock which should be ignored, or not? There are no “right” answers, it depends on your views on the appropriate goals for macro policy.
(It would be interesting to drill down into the divergence of the HICP from the HICP ex AP between 2004 and 2008. Tuition fees again?)
I want to clarify since I always feel a bit dirty after doing pessimistic posts about the supply-side:
1) I have very low confidence in any views about “potential output” and whether the productivity data is “correct”. That is doubly true for my own half-baked views.
2) I think the productivity data should have a 0% weight in setting monetary policy. Zero, zip, nada, zilch. And I think nominal wages
and/or incomes should have a 100% weight.
It is this second point which made me particularly angry at Carney’s (latest) hawkish move: the new data this year is telling us that nominal wage inflation is at record lows. Hence we need tighter monetary policy because…? Well, it’s not clear.
It is half true that the UK is looking more like Japan in 2014 than ever before. The CPI rate is below target and now looking kind of “low“. Nominal wage growth is dead. Tax revenues are sluggish; there is a gigantic fiscal deficit and public sector debt is heading up to the moon. The currency is looking pretty strong – something which plagued pre-Abe Japan regularly. Almost everybody is a supply-side pessimist. Our central bankers are hawkish. And even Her Majesty’s Loyal Opposition has been campaigning on the basis that “prices are too high”. (Maybe Ed Balls read all the Japan ZLB literature sitting on his head?)
But that is not the whole picture. I still don’t see any convincing sign that nominal GDP growth is slowing from around 4-5% y/y, a rate which should normally be consistent with the Bank’s mandate. The “low CPI rate” today is as useless a demand-side indicator as the 5.2% CPI rate was in September of 2008 or 2011. Inflation expectations are very stable and consistent with hitting that 2%. Confidence indicators are at multi-decade highs. I think “steady as she goes” would be a pretty reasonable monetary policy if you do want to take the inflation target seriously.
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!
We are going to have to watch these guys. This is MPC member Jon Cunliffe:
The self-reinforcing link between property prices, the financial system and the broader economy that operate within the stress test have been key to dynamics in previous UK downturns. As well as lowering homeowners’ wealth, falls in house prices reduce their collateral and so their access to credit. This tends to drag on consumption. Preliminary Bank analysis suggests the most highly mortgaged households have tended to cut their consumption very materially in times of economic stress. And investment in the construction of homes and other property has had a tendency to fall sharply in downturns, with this component of spending accounting for around half of the peak to trough variation in GDP growth across the 2008-9 recession. This combination of lower property prices and a fall in spending across the economy, can, through a rise in defaults, damage banks and contribute to a tightening in credit conditions, creating a further drag on economic activity.
It is Kafkaesque, this world of monetary policy. On Tuesday the Bank of England describes clearly how the Bank of England can, by running a tight monetary policy, cause a recession and falls in nominal asset prices. On Thursday the Bank of England is worried about how the economy might unavoidably fall into a recession when there is an unexpected fall in nominal asset prices.
I was half-joking when I suggested that we drop the CPI target in favour of a house price target. But I am half-serious. If the MPC thinks that stability of house price inflation is a necessary condition for stability of the real economy then they should clearly lay out the model in which that is true. Then HM Treasury should consider whether the MPC should target the CPIH, or whatever, so that there is an appropriate focus on stabilising nominal house price growth. Haldane is apparently going to push for a CPIH target.
Here is a really funny thing. If the UK had applied a 2% CPIH target for the last five years we would have needed an easier monetary policy, because the CPIH rate has been around 0.2-0.3% below the CPI rate. And an easier monetary policy would mean higher nominal asset prices. Thus, if the MPC had been targeting house prices, it’s easy to end up with the conclusion that house price inflation has been too low.
(Because the CPI and CPIH and not equivalent this is really an arbitrary counter-factual; maybe a 1.5% CPIH target should replace the 2% CPI target… or maybe we should stop targeting “inflation” altogether.)
This chart from FT Money supply is neat:
… if you want an illustration of how useless the CPI is.
The graph is a little hard to read, but it says that the real price of “telephones” has flatlined since 2008. (That means the price of telephones relative to the price of entire CPI basket.) The full name of the CPI division which the FT used here is “Telephone and telefax equipment and services”. We touched on this in the comment section recently. The ONS think the actual (not relative) price of “telephone and telefax equipment and services” rose by 18.8% between January 2009 and March 2014. Which seems like an absurd claim, given the improvements in e.g. smartphone quality over this period, never mind the rising popularity of free services like Skype. OFCOM have more stats than you can poke a stick at for those interested. I suspect the ONS simply can’t keep up with the high rate of substitution in this area.
The area which stands out in the graph is the cost of education. Again, this is merely a statistical illusion. This is what the IFS said about education in the CPI:
Education saw the fastest price increase of all CPI categories, increasing by 67% since 2008. The price change for this category was largely driven by increases in fees for higher education from October 2012. The impact of these fee increases was to push up the measured price of the education CPI category by 19% between October 2011 and October 2012, and by a further 10% between October 2012 and 2013. That said, the increase in the price of education as measured by the CPI arguably does not reflect the change in the total cost of education faced by individual students completely accurately. The ONS takes the price of education to be the cost of fees less any grants (but not less student loans).
However, in some ways, the loan system became more generous to students at the same time as the changes to fees were introduced, meaning that for many students the total lifetime costs of education are now actually lower than they were before.
Got that? Total lifetime costs of education have fallen, and the measured cost of education went up 67%.
The UK CPI rate is now down to 1.7% over the twelve months to February 2014, a rambling post follows. It would be easy to point to the falling CPI rate in the UK and the rising CPI rate in Japan, then point and laugh at idiotic UK politicians celebrating falling inflation… my usual cheap gags, in other words.
It’s never that simple, because we still have to care about supply and demand. There is little evidence saying that UK aggregate demand growth has slowed over the last twelve months. There is a lot of evidence that UK aggregate demand is growing faster. Therefore it is something of a challenge that the inflation rate has fallen.
It is possible to argue that holding aggregate demand growth constant the falling inflation rate is mildly positive supply-side news, and we should grasp such news with both hands. This is how 99% of newspaper commentators interpret the inflation data anyway. Keynesians will find some vindication in their view that the inflation rate is related more to the “output gap” than to AD growth, although it comes after six years of UK macro data which generally did the opposite.
Despite some crowing from Tories in the press about the imminent rise of real wages, I see absolutely no indication that hourly wage growth has picked up at all. If anything, wage growth slowed through 2013. It remains hard to get reliable high frequency nominal hourly wage data (see previous post) but I can torture the data to give you this little graph:
The data really is tortured to produce that; I take the series for Average Weekly Earnings Regular Pay and divide by average weekly hours, and then apply a 3-month moving average; using the total pay measure inclusive of bonuses produces an extremely volatile result for hourly wages. Take all this with a pinch of salt. (What do erratic City bonuses imply for stickiness of hourly wages – arguments in the comment section?)
The other supply-side indicator giving me a little doubt about demand-side revival is a slight fall in total hours worked in recent labour market updates. I have said it before, but it is hard to overstate how strong the expansion in the UK labour market has been since 2012. Over the 24 months to October 2013, total hours worked grew 5%. There is no period of employment growth this strong since the Lawson boom in the late 80s. The survey evidence for UK employment this year is looking good so there is hopefully no reason to have doubts about the labour market.