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Inflationary Fiscal Contraction

If the professional pundits are correct there is a decent chance the ONS will report tomorrow morning that the UK has entered the dreaded “double dip” recession. This would not particularly surprise our monetary policy makers, as explained in the minutes of the MPC meeting at the beginning of April:

In the absence of revisions to the latest vintage of data, the contraction in measured construction output was likely to depress measured GDP growth significantly in the first quarter. Indeed, it was possible that the ONS’s preliminary estimate for GDP could record a fall in aggregate output. In the second quarter, some activity was likely to be lost because of the extra bank holiday associated with the Queen’s Diamond Jubilee celebrations. With output having already contracted in the fourth quarter of last year, the Committee could not rule out the publication of official data showing GDP falling for three successive quarters. Nevertheless, the Committee’s judgement was that, abstracting from both the puzzling weakness in measured construction output and the impact of one-off factors, the economy appeared likely to be expanding, albeit only modestly, in the first half of the year.

Note the repetitive use of the word “measured”.  The MPC think that the ONS may say we are in a recession, but the ONS will be wrong.  So that’s OK then!   In the MPC’s defence, the new monthly ONS construction survey series has proven rather controversial since its introduction at the beginning of 2010.

Regardless of whether the “measured” recession does materialise, the UK economy has been remarkably effective at demonstrating the validity of the Mainstream Media Macro Model.  This model says, roughly:

  1. fiscal policy determines real output
  2. monetary policy determines the inflation rate

The media discussion of tomorrow figures will doubtless continue in this light. The Bank of England has printed lots of money, and hence inflation has been above high. Fiscal “austerity” (deficit reduction) implies slow/falling output.

So do not expect any discussion of how a central bank targeting a 2% CPI inflation rate should respond to the CPI rate stubbornly remaining well above 2% all the way through the first quarter of 2012.

Welcome to the UK’s inflationary fiscal contraction: prices, not output, just keep going up:

Annual Growth Rate of UK CPI, Real GDP

Annual Growth Rate of UK CPI, Real GDP

Of course, that graph looks as you’d expect if monetary policy is aimed at keeping the rate of nominal demand growth roughly fixed (ignoring the “minor hiccup” in 2008/9), with low output growth being the necessary flip-side of high inflation.

Update: And it happened.  Cue endless discussion about the impact of fiscal austerity on spending after we get figures for output.  The excellent Linda Yueh also has a good interview with David Miles on Bloomberg TV, with MPC member Miles saying roughly that we do need more expansionary monetary policy but, y’know, inflation is pretty high so maybe not too much.

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  1. April 26, 2012 at 20:25

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