Shameless Hypocrisy and UK Monetary Policy

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:

Market Sector Unit Labour Costs. Source: ONS Sectional Productivity Bulletin

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.

May 2013 Inflation Report: Two Point Oh Not Again?

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:

Bank of England Median Forecasts for the CPI Rate

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!

Sterling Exchange Rate Index and Market RPI Expectations in 2013.
Source: BoE, Sterling Broad ERI , 5 Year RPI Implied Forward

(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.

There is still room for a little hope; Carney might, just might, bring some improvement to policy.   Lars has some excellent suggestions.  In the mean time, well… things could be worse.

“To Understand Inflation We Must Understand Money”

Christina Romer’s paper links to this brilliant “infomercial” video from the US in 1933, which explains the power of monetary policy – which, by the way, is all about expectations:

Absolutely wonderful!

UK Macro Policy, A Short Story

A short story for Jonathan Portes and Prateek Buch.  Is the use of deficit-funded capital spending a sensible way to fine-tune UK demand policy?  Opinions welcome.  (What would Krugman say?)

George Osborne writes to the Bank of England:

Dear Bank of England, please target 2% inflation!  Thanks!

The Bank of England meets and prepares its reply:

Dear George.  Here’s the path we’ve set out for the nominal economy.  You’re going to get above-target inflation and poor real GDP growth over the next two years, with the CPI rate hitting 2% after that.  Is that OK?

George replies:

Dear Bankers, thanks!  That’s really great.  I actually want a bit more inflation and faster nominal GDP growth.  But instead of telling you to provide a bit more inflation and/or NGDP, I am going to do a £30bn capital spending package over two years.  I have told my voters this will raise NGDP!  So take it as a subtle hint.

Bank of England to George Osborne:

Erm, really?  Do you want us to target 2% inflation or not?  We could just target higher NGDP growth, but we’ll probably get even higher inflation too.  Shall we do that?

George Osborne to Bank of England:

WOAH.  STOP RIGHT THERE.  What are you thinking?  Please target 2% inflation.  Gosh darnit guys, aren’t I making this clear?  Can you imagine what Ed Balls would say if I asked for more inflation?  I’d be crucified!   2%, 2%, 2%.  Got it?

One month passes.  Stuff happens… let’s say for the sake of argument that one of our major trading partners tips into recession.   The Bank meets to set monetary policy again.

Bank of England to George Osborne:

Well George, we’re going to target 2% inflation like you said.  Here’s the path we’ve set out for the nominal economy.   Exports are looking a lot worse than last month, but government spending is up!  So you’re getting an above-target CPI rate and poor real GDP growth over the next two years.  We’ll hit the 2% after two years – is that OK?

p.s. By the way George, the national debt is looking pretty ugly.  You might want to think about getting the deficit down.

George Osborne Correctly Rejects Fiscal Stimulus

George Osborne explained the Sumner Critique to the CBI tonight:

What’s more, without allowing inflation to climb even further above target, a fiscal stimulus three years ago would simply have been offset by less supportive monetary policy, with no net impact on demand.

With the independent MPC judging that the risks to inflation and output are evenly balanced, the same is true today.

So, just as the argument for fiscal stimulus three years ago was mistaken, so is the suggestion for a discretionary fiscal loosening now. Because we have sensibly allowed the automatic stabilisers to operate, our deficit is only just falling in nominal terms.

This is an improved version of the wording Osborne used last time.  Pedantically correct wording, noting the forward-looking nature of monetary policy.

Paul Krugman, Deficit Hawk

Forgive me for some cheap sniping at the great Professor, but I couldn’t resist.  Via Travis Allison here is Paul Krugman writing in 2000 about Japan:

Japan has the dubious distinction of being the first major nation since the 1930′s to experience a ”liquidity trap,” in which even cutting the interest rate all the way to zero doesn’t induce enough business investment to restore full employment. The result is an economy that has been depressed since the early 90′s, and that in 1998 seemed to be on the verge of a catastrophic deflationary spiral.

The government’s answer has been to prop up demand with deficit spending; over the past few years Japan has been frantically building bridges to nowhere and roads it doesn’t need. In the short run this policy works: in the first half of 1999, powered by a burst of public works spending, the Japanese economy grew fairly rapidly. But deficit spending on such a scale cannot go on much longer.

What is Paul Krugman’s 2000 policy recommendation for Japan?  The BoJ should set an inflation target and then do QE.

Here is Paul Krugman in a 2012 interview with Martin Wolf:

“The question is, what did [Ben Bernanke] do as we started to look more and more like Japan? At that point the logic says you have to find a way to get some traction. Fiscal policy might be great. But if you’re not getting it you should be doing something on the Fed side and I think that logic becomes stronger and stronger as the years go by. And it’s sad to see that the Fed has largely washed its hands of responsibility for getting us out of the slump.”

To complete the picture here is Paul Krugman writing in 2010 about how new UK Chancellor George Osborne should give up on the deficit-funded capital spending splurge, and should instead set an inflation target and print lots of money:

…

Oh, no, sorry, I couldn’t find that quote.

Just Read Chris Giles

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.

“The Price Index is Never Revised”, RPIJ and CPIH Edition

The “revisions” critique of nominal GDP targeting seems ever more absurd as time passes.  The argument pushed by some is that it’s hard for monetary policy to target something which gets revised, like the nominal GDP statistics, but we can target the CPI because that does not get revised.

So here is brief a look at this year’s two new ONS series.  First is the CPIH, which is a revised version of the CPI now including owner-occupier housing costs.  Second is the RPIJ, which is a revised version of the RPI, switched to use the Jevons formula.  The UK’s inflation target between 1993 and 2004 was a variant of the RPI which excluded mortgage payments, the RPIX series.  The ONS now lack confidence in both RPI and RPIX to such a degree that the series are no longer designated as “national statistics”.

Given these revisions to the price index methodology, is there any change of heart from the inflation-targeters?  We spent ten years targeting a price index which is now considered to be of a poor quality!  Was that not a bad thing?  Was not UK monetary policy “wrong”, ex post, because we now have a different – better – way to calculate inflation?  Or doesn’t it matter?

The answer is surely that it doesn’t matter.  We already dumped the 2.5% RPIX target in favour of a new target using a “better” methodology, 2% on the CPI, and I don’t recall anybody making hysterical arguments about how badly misguided UK monetary policy had been under the RPIX target.  Methodology changes, and policy adapts.

Here is a graph of the cumulative “error” in the RPI and CPI methodology, compared to RPIJ and CPIH respectively:

Revised UK Price Indices.  Source: ONS: RPI, RPIJ, CPI, CPIH

Both the RPI and CPI “overestimated” inflation in comparison with the new indices.  The total change in prices over fifteen years measured by the RPIJ was 6% smaller than the change in prices measured by the RPI.   The change in prices over eight years measured by the CPIH was nearly 2% smaller than the change measured by the CPI.

The latter is particularly interesting; for all the talk of the Bank of England “blowing bubbles” by ignoring soaring housing prices, the inclusion of owner-occupier housing has pulled down the price index since 2005.  Targeting such a price index would, if anything, have allowed slightly easier – not tighter monetary policy over the last eight years.

UK Labour Income & Unemployment

This is a belated follow-up to Scott Sumner’s post last month on the puzzles in the UK macro data.

I tested Scott’s “musical chairs” model of the business cycle on the labour compensation data from GDP by income in the national accounts.  Define “Labour Income” as the sum of total wage and salary compensation paid to employees (excluding employer social security contribution), plus household “mixed income”.  The latter should be a good proxy for the income of those in self-employment, but is not perfect, I believe it also includes things like owner-occupiers’ imputed rents.  (A topic for another post.)

Then we can find the ratio of mean hourly wages to per capita “labour income”.  This shows the outcome of Scott’s “game of musical chairs”, which he explained here and also in his EconTalk podcast.  (Briefly, the intuition is that when total income available to pay salaries falls below the expected trend path, total hours worked falls and unemployment rises, because hourly wages are sticky in nominal terms.)

Caveats:

1) per my previous post, the ONS data for mean hourly wages is not an official “national statistic”.  The series was also incomplete, missing a single data point in 2001 Q1.

2) There appeared to be some seasonality in one of the series used for “Hourly Wage / Per Capita Labour Income”; all inputs except the population count are seasonally adjusted.  I applied a 4 quarter moving average to smooth it.

The ONS series used here are RPCG (Wages & Salaries), ROYH (Household Mixed Income), and MGSL (LFS Population aged 16+); the hourly wage data is table “EARN07″ from the Labour Market bulletin.

Mean Hourly Wages / Per Capita Labour Income, versus Unemployment.

Update: Ritwik Priya rightly took me to task on twitter for omitting the unit on the RHS, which is “£/hour / £000s/quarter/capita”.

Update 2: I very much appreciate Ritwik checking my data here.  He noticed the RHS scale was still out by a factor of four in my original chart.  I had carelessly used a 4Q moving total rather than a moving average to smooth the data.  I have replaced the chart above with one which really does use a moving average.  The original chart used in this post is here, for purposes of full disclosure; there is no difference apart from the scale on the RHS.

That seems like a remarkably good fit; perhaps (level) targeting per capita “labour income” on something like the definition above would be a good monetary policy for the UK.

As I’ve noted previously, when HMRC starts collecting real-time payroll data it should be easy for the government to estimate total current wage income; though income to the self-employed would still rely on surveys.  A worthwhile initiative in “open government” would be for HMRC to publish aggregates of their payroll data in real-time.

Broad Monetarism and UK NGDP

There’s long tradition of “broad monetarism” in the UK, a theory which holds that a) central banks should aim to stabilise some measure of the broad money supply, and b) such measures of money are both predictive and “lead” the nominal economy with some lag.

Steve Hanke has a series of blog posts (for example here and here) showing a collapse in the Bank of England’s “M4″ measure of UK.  Active UK-based broad monetarists include Tim Congdon and Simon Ward, and many members of the IEA’s Shadow Monetary HawksPolicy Committee have a broad monetarist leaning.  (A few on the SMPC such as Anthony Evans and Jamie Dannhausert do also look at NGDP.)

In recent years, as in the 1980s, broad money has not been strongly correlated with nominal GDP growth, because the velocity of circulation has not been constant.  It also remains hard to pick a “useful” measure of broad money.  The Bank of England itself dropped the focus on the M4 series which Steve Hanke referenced, in favour of a new series, “M4ex“, which excludes deposits in certain financial intermediaries – think the “shadow banking” sector.

Here is a graph of M4ex growth and nominal GDP growth:

UK Nominal GDP and M4ex.  Source: ONS (YBHA), Bank of England Series RPQB53Q

And here’s the graph of M4ex velocity:

M4ex Velocity. Source: ONS, BoE, as above