BoJ in “Targeting The Forecast” Shock

Every three months the Bank of Japan publishes their forecasts for inflation, including the range and the median of board members’ individual forecasts.  Here is how the median forecast of CPI ex indirect taxes has changed over the last three meetings, looking at the forecast for Fiscal Year 2014:

Forecast date	CPI ex indirect taxes
October 2012	+ 0.8%
January 2013	+ 0.9%
April 2013	+ 1.4%

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“.

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

George Osborne, New Keynesian

Pretend you have been appointed Chancellor of the Exchequer in May 2010, and you want to find out what what “bleeding-edge” macro research says you should do.

What do you find out?

If you’ve read New Keynesian Lars Svensson, you might be sceptical about the efficacy of deficit spending in boosting aggregate demand.  Like Svensson, you’ve watched Japan run large deficits for two decades, and seen that that the level of Japanese nominal GDP is unchanged after that all time, yet public sector debt has soared.  You don’t want to go down that route.  You might like the idea of a “Foolproof Way” to exit the ZLB, a price level target and currency devaluation, but you can see the UK CPI is already above target, and you are worried about the global politics of engaging in “currency wars”.

If you’ve read New Keynesian Ben Bernanke, you would be a strong believer in the unlimited power of the printing press in raising UK aggregate demand.

You would surely listen to New Keynesian Mervyn King, who is one of the UK’s most prestigious macroeconomists, and also happens to run your central bank.  He tells you in no uncertain terms to get the deficit down and let him get on with running  AD policy.  He tells you he tried out his printing press in 2009, and it worked very well indeed.  He’s got your back.

If you’ve read New Keynesian Paul Krugman, you’ll consider raising the inflation target to 3% or 4% as the best policy choice at the ZLB… but you get shot down by Mervyn King who thinks that’s a really bad idea, which might herald a return to the 1970s.

You’ll also believe that under New Keynesian inflation forecast-targeting, the central bank will internalize whatever fiscal policy decisions you make, and steer an appropriate course for UK aggregate demand.  Your new friend Mervyn has promised to print enough money to keep things ticking along nicely.

So maybe you get on with running fiscal policy to cut the deficit, and let the Bank take care of AD policy for a year, or two years, or three years.  Inflation stays well above target, and the jobs market, well, it could be much worse.  The printing press is duly deployed when necessary.

But bizarrely, all this time another bunch of “New Keynesian” economists are baying for your blood, admonishing you for making some kind of policy error.  They don’t seem to believe a word Ben Bernanke wrote.  They don’t believe in inflation forecast-targeting.  They tell you that monetary policy doesn’t work, and you’re an idiot for thinking it ever would.  They have nothing much to say about Japan.  And they have strange ideas about how fiscal policy can be used as a “magic money tree”, with “self-financing” deficits.  They tell you that increasing borrowing will reduce borrowing, yet reducing borrowing will increase borrowing!  They are hard to understand.

You also get advice that tells you maybe the central bank has been screwing up all along.  You find another New Keynesian, Dr. Escape Velocity – he tells you he can fix things if you let him loose with that printing press and give him room to move.  But another bunch of “New Keynesian” economists, the ones who are running the central bank, tell you in no uncertain terms that UK AD policy is working just fine.

Who do you believe?  The Bernanke/Svensson New Keynesians?  The New Crude Keynesians who think fiscal policy is all that matters at the ZLB?  The New Keynesians at the central bank who are screaming at you that everything is just fine?

You bet the farm on Dr. Escape Velocity… and throw in some interventionist fiscal policy for good measure.  Nobody’s very happy with you.

I must say I’d almost feel sorry for you after all that.  It’s a tough job at the top, isn’t it, when all you have is conflicting New Keynesian macro policy advice?