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.

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.

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.

Absolutely wonderful!

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.

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.

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.

And as of today’s meeting in April 2013, the median of the board members’ forecasts for CPI ex indirect taxes looking two years forward to fiscal year 2015 is… drumroll…
 

+ 1.9%

I’d call that targeting the forecast, so great job so far, Kuroda and Abe.  Now hold that forecast steady and do not hesitate to print, print, and print some more, until even Richard Koo “believes the lies“.

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.

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.