Newsflash for Jonathan Portes: The MPC Are Targeting Inflation
There is at least some economic theory behind [using monetary policy first for demand management]; indeed, I used to believe it myself, as I set out here. But this is a purist approach, which simply hasn’t survived contact with reality, as Chris’ own articles show. If monetary policy alone was indeed enough in practice, we wouldn’t be where we are now, with unemployment in the UK a million higher than the official estimate of the natural rate, and no prospect of it coming down in the immediate future. Any demand management policy that delivers that outcome is not one that policymakers should regard as remotely adequate.
Why have things turned out this way? Well, economists will be arguing about this for some time. As Milton Friedman famously said, monetary policy has long and variable lags; and he was talking about conventional monetary policy operated through interest rates, not the present extraordinary measures. It is clear the Monetary Policy Committee, let alone the rest of us, has no idea of the impact, of any, of their monetary policy actions; in these circumstances, it is absurd to argue that all the weight of demand management should axiomatically fall on those actions.
I think this is an odd claim to be making, particularly in a post about “evidence-based analysis”, and the logic of the argument defeats me.
The MPC are targeting the CPI inflation rate. How should we judge the impact of their actions? Well, we could look at the CPI inflation rate. Inflation has been above target for most of the last seven years. The AD management policy which we legally require the MPC to follow has been saying that – in effect – AD has been growing too fast.
Has this AD policy delivered a remotely adequate AD outcome? Nope. But here’s the rub: if you try more deficit spending, the MPC will keep on targeting inflation. That same AD management policy which is producing dreadful AD outcomes will stay in place; it won’t suddenly disappear. (See also Nick Rowe on the macroeconomics of “doing nothing”).
And there’s a huge implication from that little aside – that “the rest of us” don’t know what the impact of the MPC’s actions are either. We are (apparently) clueless about the impact of current monetary policy at the ZLB – and we don’t like AD outcomes with current monetary policy at the ZLB… therefore we should ignore monetary policy? Really? Surely the opposite? Surely we should think harder about monetary policy; at least consider whether a new target for monetary policy would be appropriate? Especially when we are directing our arguments at HM Treasury, which itself has great discretion over monetary policy.
Let’s apply the Sumner Critique, and presume that the MPC will prevent the CPI rate raising much faster or much slower than 2%, though they will try to ignore (short-run) supply shocks. This is roughly what they actually do. What difference will more – or less – deficit spending have on AD? Answer: probably not much; if the MPC see demand growing much faster or much slower than is consistent with a 2% CPI forecast, they will offset it.
(Scott has also made the more subtle point that deficit-funded fiscal policy aimed at pulling down the CPI rate, such as an NI or VAT cut, might elicit a positive offsetting response from the MPC. That could be true, but it is inconsistent with the MPC’s behaviour in 2011 where they allowed a short-run upward deviation of the CPI rate under the inverse condition; inflation targeting is supposed to be symmetric, after all. I’m not saying that would definitely happen – just that we can’t predict what the MPC will do.)
I submit for “evidence-based analysis”:
- There is no evidence monetary policy is incapable of providing more AD even at the ZLB.
- The MPC are currently unwilling to allow faster AD growth because they are constrained by the inflation target. Inaction at the May MPC meeting is good evidence of this claim.
- Therefore, we must change the monetary policy target if we want more AD.
Requiring the MPC to target the desired path of nominal demand, level targeting, is a policy which seems to be vastly preferable; eliminating all the uncertainty and discretion over current UK AD management, not to mention the disastrous economic outcomes and instability.