Archive for July, 2012

Demand Accountability

July 25, 2012 Leave a comment

The Brown Government

Prime Minister: Gordon “Saved The World” Brown
Chancellor: Alistair “Bailout” Darling
Annual growth rate of nominal demand over term in office: 1.3%
Unemployment rate, start of term: 5.2%
Unemployment rate, end of term: 7.8%
Electoral Success: Removed from office
Popular Support: “high point of British economic policymaking” (Chris Giles, no less!)

The Cameron Government

Prime Minister: David “The Toff” Cameron
Chancellor: George “U-Turn” Osborne
Supporting Cast: Nick “Kingmaker” Clegg, and friends
Annual growth rate of nominal demand over term, to date: 2.8%
Unemployment rate, start of term: 7.8%
Unemployment rate, current: 7.9%
Electoral Prospects: Bad to awful
Popular Derision: “Major Macro Policy Error” (Simon Wren-Lewis)

The Economists Empowered To Steer the Path of UK Aggregate Demand

The Governor: Mervyn “Uncertainty” King
Deputies: Paul “Don’t Mention The Libor” Tucker, Charlie Bean
Chief Economist: Spencer “Crazy Loon” Dale
Supporting Cast: Ben “Current Stance of Policy Looks Broadly Right” Broadbent, Martin “5% All the Way” Weale, Adam “The Dove” Posen, David Miles, Paul Fisher
Democratic Accountability: None

Categories: Bank of England, UK GDP

George and Mervyn: The Secret Letters

July 20, 2012 1 comment

Thanks to my moles in Whitehall, I can exclusively reveal the secret letters exchanged between Mervyn King and George Osborne over the last few months.

Dear Chancellor,

Bad news.  Everything I said about cutting the deficit was wrong.

Confidence is evaporating.  Uncertainty is everywhere.  The black clouds, George!  It just won’t stop raining.

Sterling is appreciating.   Obviously there is nothing we can do about this over here at the Bank.   It’s not like the value of Sterling is anything do with us, George!

Anyway, the reason for my letter is this: we expect to undershoot our inflation target by 0.5% by September.  I don’t know what to do about it.  I thought about printing some money, but really, what’s the point?  People just complain about it “sitting in the banks”, and I get so much abuse in the Daily Telegraph, I’m worried about my reputation.

George, help us!  We need you to borrow and spend some money and get that inflation rate up.  We think about £20bn of infrastructure spending will work.  Spencer and Ben wanted me to mention that they really like trains.

Yours etc,

Sir Mervyn King.

Here is George’s reply:

Dear Governor,

Thank you for your letter regarding the expected inflation undershoot

I get the hint.  I have scheduled the building of some trains, to the value of £20bn, as requested.  They should get started as soon as we’ve completed the project evaluation, tendering, etc.

By the way I had a phone call from a Mr Gnome in Zurich – he said something about currency devaluation, but I couldn’t understand exactly what he was saying because he was laughing so hard. Maybe you could look into it?

Yours etc,

George Osborne

p.s.  I read in the papers that it might be better if we did £150bn of extra spending.  Would that help, or is it too much?

There’s a rather terse e-mail reply the next day:

George – we don’t need £150bn – we only need 2% inflation not 5%.  Dear God man, have you gone mad?  Just do the £20bn of trains, OK?  Thanks, Mervyn

So George sets the civil servants to work on buying some trains.  A month passes.  But the eurocrisis keeps getting worse, and Sterling just keeps going up.  Another letter arrives at 11 Downing Street:

Dear Chancellor,

I am sorry to hear about your political troubles.  I gather the Conservative party is not doing too well in the polls after having to completely reverse its economic policy, which I hear you based on my old advice about cutting the deficit.  Don’t worry too much old chap.  Such things pass.  I’ll get you some tickets for Wimbledon next year by way of apology, and I have some friends in the City who could throw the odd directorship your way.  At least, I think they’re still my friends.  They don’t call much any more.

Anyway, I’m writing about those trains.  Sterling went up some more.  Spencer and his crack team of economists ran the numbers and we’re still going to miss the inflation target.  The £20bn of trains aren’t going to be enough.  Can you bung in £30bn of new roads too?

I don’t know what your Swiss friend was talking about, sorry.

Yours etc,

King Mervyn

George isn’t getting any lucky breaks, is he?

Dear Mervyn,

Are you serious?  You want me to do another U-turn?  I am going to go down in history as the most useless Chancellor ever – though I’m not sure how that Darling guy gets a break.  This ship went down on his watch!  What’s up with that?

Look – OK, I’ll get £30bn of roads done as well.  But this is the last time.  No more U-turns, alright?  I don’t care what happens to Sterling, we’ll have to stick with what we’ve got.

By the way some Swedish guy called Lars called saying he’s willing to take over once you retire.  Have you heard of him?  He was talking about levels, targets, and forecasts.  Does he mean level crossings?  Does fiscal stimulus work better if we combine roads and trainsLike in Ghostbusters – “crossing the beams”?  No?  Merv?  Help me out with this macro stuff, it’s pretty complicated.

Yours etc,

George Osborne (soon to be ex-Chancellor)

To be honest, I’m not sure if these letters are genuine – it seems like an odd way to run a country.

Recurring Failure

July 20, 2012 Leave a comment

Here is the graph of the headline UK CPI rate, and the Bank of England’s median forecast for the CPI rate looking 3 years out.  The latter is a roughly what the MPC aim to adjust when setting the monetary policy stance, as per Lars Svensson’s “target the forecast” methodology.  If the forecast is nailed to 2%, go and watch the tennis.  Otherwise, adjust the monetary policy stance until the forecast is at 2%.

The last recession, and the ongoing double-dip are shaded.

UK CPI Rate, Current and Forecast

UK CPI Rate, Current and Forecast

Is it chance that the failure to hold the forecast at 2% was preceded both times by a spike up to 5% on the current CPI rate?

And then.. is it chance that both episodes of failure are associated with a recession? Correlation, but no causation?  Admittedly it would better to look at some measure of nominal demand growth here, not just falling real GDP.

Levels, Rates, and a Bump in the Road

July 19, 2012 2 comments

The path of the UK CPI level was quite strange in 2011.  It jumped up between January and April, then went flat; jumped up again between July and September, then flattened off again.

This means that the CPI rate in 2012 will be hard to interpret.  Even if the CPI level followed a perfect log-linear path every month of 2012, up a 2% gradient, the annual CPI rate would bounce about because of the variation in the 2011 levels.

To illustrate this point, here is a graph showing how the CPI level moved through 2011, how it has moved so far in 2012, the MPC’s forecast from May, and also what a 2% rate would look like.

UK CPI Level

UK CPI Level

The July to September “ramp” in the 2011 CPI level was similar to what happened in the same period of 2008, but is otherwise an unsual pattern: the common factor in those years being an oil price spike.

Absent such a supply-side spike this year – or aggressive demand-side measures from the MPC, there might finally be a “downside surprise” on the inflation target.  As in “surprise, demand growth really is weak”.

Categories: Inflation, Monetary Policy

UK Disinflation: Mission Accomplished?

July 17, 2012 3 comments

The UK CPI rate is crashing downwards much faster than the Bank expected.

The annual CPI rate of 2.4% for June hides the fact that the CPI level has now been falling for two successive months.  Over the last six months the CPI has risen only 0.5% (not annualized).  The energy supply price shock which showed up in Autumn 2011 is still keeping the current annual rate high.

All this will doubtless be reported as a “welcome break for Britain’s savers”, that “downward pressure on real incomes is easing” and so on.  The last time we saw the six month CPI rate this low was May 2009.  Savers and workers were having such a fantastic time back then, weren’t they?

Anyway, it’s just another month’s data.  Back in sunny May, the Bank put a 10% probability on the CPI rate being below 2% in 2012 Q3.  That doesn’t look so improbable right now.  Here is the chart of the Bank’s median forecast for the CPI rate from the May Inflation Report, when the disinflation cycle began, against the current CPI rate up to June:

MPC UK Median CPI Forecast, May 2012

MPC UK Median CPI Forecast, May 2012


The New Normal, Bank of England Edition

July 6, 2012 Leave a comment

Is this the “new normal” for the MPC?

1. Do just enough QE and expectations management to keep the CPI rising somewhere around (or above?) a 2% rate.

2. If the CPI rate is too far above 2%, and no supply-side excuses can be found, stop QE, start actively lowering inflation expectations.

3. Once inflation expectations are low enough, everybody is sufficiently uncertain about the future, and the CPI rate starts heading downwards, heroically step up and save the day by returning to 1.

The FT get this backwards, at least:

When the BoE announced its £50bn programme at noon on Thursday, the yield on 10-year government bonds rose rather than falling, indicating investors had already priced in a larger move by the central bank

Repeat after me: falling gilt yields are that investors are pessimistic about the future. Higher gilt yields are a good sign (for sovereigns which borrow in their own currency).

Lars Svensson for Bank of England Governor

July 4, 2012 3 comments

David Cameron loves everything about SwedenLars E.O. Svensson is Swedish.  Therefore David Cameron loves everything about Lars Svensson.  Do not attempt to find fault in this impeccable logic.

Lars Svensson (co-)wrote the book on the “target the forecast” methodology for inflation targeting adopted by the Bank of England.

Lars Svensson is an expert in the so-called “liquidity trap” and inventor of the “Foolproof Way“, using currency depreciation and a CPI level target.  We’d like a practical demonstration, please.

Lars Svensson is a Deputy Governor at Sweden’s Riksbank.  A step up to Governor of the Bank of England would be a natural career progression for such an eminent economist.

Sweden’s economy is small and doing well.  Britain’s is large and doing badly.  The skills of Lars Svensson have not been optimally allocated.

Lars Svensson is perpetually constrained by the Riksbank hawks who prefer low inflation over high employment.  As Governor he would be less constrained.

Lars Svensson will demolish the crazy loons who keep trying to target current headline CPI and ignore the forecast.

George Osborne wants easier monetary policy to keep his fiscal plans on track, but is unwilling (or too stupid) to force the Bank of England to provide it.  Svensson would provide it in spades.  Sterling would depreciate if there was even a rumour of Svensson being seriously considered for Governor.

Osborne could easily be accused of appointing a Government patsy if he appointed some (ex-) Treasury economist or an Establishment insider like Gus O’Donnell.  No such charge could be levelled against the appointment of an independent-minded Swede with such a strong record, both academic and professional.

Appointing an outsider to shake up the Bank would be an appropriate way to challenge the supply-side pessimism embedded in the Bank’s forecasting, which provides a key contribution to our current malaise (by restraining looser monetary policy and faster demand growth).

Appointing a foreigner to run the Bank would be a fantastic advert that Britain remains an open and meritocratic country, not one which is obsessed with small-minded xenophobia.

In an ideal world, Osborne would announce a nominal GDP level target and we wouldn’t need to rely on smart people to run monetary policy.  We don’t live in that world (yet), and I can’t see us getting to that world before Mervyn King’s term as Governor expires in 2013.  In the real world, Lars E.O. Svensson is the ideal choice for the next Governor of the Bank of England.