Archive for August, 2012

Dodgy TUC Graphs, GDP by Expenditure Edition

August 17, 2012 Leave a comment

Not satisfied with circulating dodgy graphs about GDP by income, the TUC have produced this little graph:

TUC GDP by Expenditure

TUC on GDP by Expenditure

which they use to make various claims about GDP by expenditure, including this zinger:

There is little evidence that government consumption rose as a share of GDP in the ten years before the crash, and a consistent share of GDP of under 25% is well below that of many other advanced economies.

This is a highly misleading claim, and it’s odd that left-wingers would want to make this claim.  “After thirteen years of New Labour, what did we achieve?  No increase in government spending!”

Here is the trick the TUC are pulling.  Imagine an economy with just consumption spending where we start with nominal GDP of £1000/year.  The first year is like this:

Government consumption spending is £100, which pays for the education of 10 students.

Market sector consumption spending is £900, which pays for 900 apples.

Now fast forward a few years, but presume nominal GDP is held constant:

Government consumption is now £200, which is still educating just 10 students.

Market sector consumption is now £800, but there’s a massive productivity improvement on the farm, so this pays for 2000 apples.

Total output has gone up, and you get to pick your statistic to fit your bias.  As a proportion of total output, government consumption has fallen.  As a proportion of total spending, government consumption has risen.

That is a crude reflection of what happened under New Labour, which raised public sector pay (in education and the NHS particularly) without achieving a commensurate increase in measured public sector productivity.  That’s a perfectly defensible thing to do, if you think, say, public sector pay was too low before.  Plus, measuring public sector output is a particularly meaningless exercise; there have been endless arguments about whether the kids are better educated, how you measure health outcomes, and so on.

This graph shows the change in nominal government consumption as a proportion of nominal GDP, and yes, ignoring everything after 2008 is reasonable because of the erratic nominal GDP growth since then:

UK Government Consumption Spending

UK Government Consumption Spending. Source: ONS Series NMRP, YBHA

The TUC paper also uses the volume series to draw demand-side conclusions about the trend in household consumption and investment, which just does not make much sense as far as I can see.

Categories: Fiscal Policy, UK GDP

MPC Minutes, August 2012

August 15, 2012 6 comments

A quick review of this month’s MPC minutes.  Claire Jones at FT Money Supply notes that there was no discussion of a rate cut, unlike earlier months.

There is – finally – a warning on the strengthening of Sterling:

4.  Sterling had appreciated further, particularly relative to the euro. In trade-weighted terms, sterling had risen by almost 1% since the Committee’s July meeting and was 3.5% higher than at the start of the year. Although sterling remained over 15% lower than it had been five years earlier, it was around 5% higher than its average in 2011. A continuing appreciation could have a material influence on the outlook for growth and inflation in the United Kingdom.

Overall the MPC are stuck in “wait and see” mode again.  This comment scared me:

38.  The Committee discussed whether it was appropriate to expand or continue with the programme of asset purchases it had agreed at its previous meeting. Inflation was still slightly above 2% but likely to remain close to the target in the coming months. The level of underlying activity was perhaps not as weak as the GDP data for the second quarter had suggested and, with the squeeze on real incomes beginning to ease, some recovery in spending was probable. The FLS had the potential to improve funding conditions for banks materially and to encourage lending, thus providing some support to both demand and supply. These effects might be particularly marked if the FLS allowed some households and companies to borrow who had previously been unable to obtain bank credit. Set against that, the FLS might prove less effective if uncertainty and risk aversion among households and businesses were the dominant factors holding back spending in the current environment. These same factors might also limit the effectiveness of additional asset purchases.

My emphasis on the “central bank impotence” view.  There is so much uncertainty that asset purchases might not be effective.

And this beauty from the resident hawks:

For some members the decision [on more QE] was nevertheless more finely balanced, since a good case could be made at this meeting for more asset purchases. For those members [Ben Broadbent and Spencer Dale] who had voted against the expansion of the programme at the previous meeting, there were potentially costs to reversing the previous month’s decision.

What the hell?  Doing more QE this month is “reversing” the decision to do some QE last month?  And that risks what exactly?  That the central bank looks really stupid?  Our central bankers would rather not be seen reacting to “events” and changing course, month by month?

I think somebody should remind Messrs Broadbent and Dale that their comments in the MPC meetings are a matter of public record.  And if they are worried about the central bank looking stupid, it might be better for them to shut up and, preferably, resign their positions.

Inflation Target at 1.5% since 2008

August 15, 2012 1 comment

The forecast data from the August Inflation Report have now been published.

The near-term median CPI forecast has been revised heavily downwards since the May (Q2) Inflation Report, and the forecast looking 2-3 years out is at its lowest this year.  Here is a graph of the forecast curves for all three quarters this year.

BoE Median Inflation Forecasts, 2012 Q1 to Q3

BoE Median Inflation Forecasts, 2012 Q1 to Q3

If we take the two year forecast as the main indicator of the policy stance, then the average (mean) inflation rate which the Bank of England have aimed to hit over the last four years is just 1.5%.

If we take the three year forecast as the indicator instead, the average inflation target over that same period has been 1.8%.

<Cue shock, outrage, resignations, etc. etc.>

Lessons from Japan

August 14, 2012 Leave a comment

Marcus Nunes posted some graphs on Japan a while back, but he missed out my two favourite graphs.

First, the graph showing the Bank of Japan’s fairly successful CPI level targeting regime.  The level target they seem to follow is to keep the CPI at around the level of 1993/1994; allowing only temporary upward deviations due to supply-side shocks.  But certainly none of the “base drift” you see from central banks targeting an inflation rate.

Japan CPI Level

Japan CPI Level.  Source: Timetric/OECD

You can see the 2% hike in the VAT rate in 1997, but the BoJ had deflated back down to the old price level by 2002.  The commodity price spike in 2008 shows up, but never fear: the BoJ were on hand to heroically lower the CPI level, right down to 1993 levels by 2011.  Jean-Claude Trichet, eat your heart out.

Marcus’ commenters did not appreciate my sarcasm on this topic.  But if you listen to (most) Keynesian macroeconomists talking about the UK right now, and apply their advice to Japan, should we not conclude that what Japan needs is some more deficit spending?  They’re stuck at the ZLB, so monetary policy “obviously doesn’t work”, and deficit spending is “obviously expansionary”.

That’s not what Keynesian macroeconomists were saying about Japan a decade ago, of course, but let’s pretend Krugman/Bernanke/Svensson never existed.

The second graph Marcus missed was government net debt/GDP:

Japan General Government Net Debt

Japan General Government Net Debt. Source: IMF WEO

Just a teeny bit more deficit spending.  That’s all we need.  Right?

A Failure of the Economists, not the Economics

August 13, 2012 2 comments

I can read Scott Sumner and he makes sense.  Scott is saying the same things that Lars Svensson was writing about back in 1996, after all.  It can hardly be controversial if the New Keynesians were saying the same thing sixteen years ago.

Back when Svensson was writing that paper on inflation targeting, UK politicians ran UK monetary policy.  When they screwed up, they got fired.  The Thatcher governments – whatever else you think about them – ran pretty decent monetary policy in the 1980s, after a few “minor hiccups”.   They secured repeated electoral success, in part surely on the basis of that success.

In the early 1990s, the politicians screwed up again and tried importing German monetary policy to the UK.  Doh!  The Major government did not get re-elected after that experiment failed.  Maybe that’s just co-incidence; politicians screw up in lots of other ways too and get fired for those failures.

By this point the economists were really pissed off with the politicians.  They convinced the politicians that it would be better if economists ran monetary policy directly.  So one of the first major reforms of the new Blair government in 1997 was to let the economists run monetary policy directly.  I’m pretty sure that reform was supported right across the political spectrum at the time.

So monetary policy was one step removed from direct democratic accountability.  This shouldn’t have been a problem though.  Svensson gave us a simple method by which to judge the performance of the independent central bankers: look at the forecasts.  The economists at the Bank followed Svensson’s methods, and did so exceedingly well for ten years.  Everybody was happy.

Yet in 2008, the economists at the Bank screwed up.  We know they screwed up, because we can apply Svensson’s method for judging whether the Bank are screwing up, and see the glaring error.

And yet.  It is the conventional wisdom for economists – both inside and outside of the Bank – that the economists at the Bank have been doing a pretty good job.

In fact, the economists have now gone even further than that.  They’ve decided that the persistent stagnation of the UK economy is not the fault of economists at the Bank.  It’s the fault of the politicians in Westminster.

This just isn’t cricket.  If economists outside the Bank will not hold the economists inside the Bank to account by their own metrics, why the flippin’ ‘eck should we listen to them about anything else?

UK monetary policy is not “doing fine”.  The Bank of England has been running tight money since late 2008 on conventional New Keynesian metric a la Svensson of 1996.  There is obviously a large output gap.  The Bank should set their instruments to target inflation well above the 2% target.   That’s what Svensson says.   The Bank aren’t doing it.   This is surely what the history books will say; it is a failure of the economists, not a failure of the economics.

Monetary Policy Stance under Inflation Targeting

August 11, 2012 9 comments

I keep seeing people say the Bank of England is “doing the right thing” because it has shown a willingness to tolerate high inflation.  To an extent this is fair – at least the Bank isn’t as bad as the ECB, but it is really not the right way to judge the monetary policy stance.

Lars Svensson, in his paper on Implementing and Monitoring Inflation Targets, says the following on how to hold the central bank accountable:

Adjusting the instrument [interest rate] so the inflation forecast equals the target is the best the central bank can do. Ex post inflation will differ from the target, because of forecast and control errors, for instance due to disturbances that occur within the control lag. If the central bank is competent, the mean forecast errors will be zero, and the variance of the forecast errors minimized. Ideally, if the inflation forecast could be verified, the central bank should be accountable for deviations of the inflation forecast from the target, but not for the unavoidable deviations of realized inflation from the target. This issue is discussed further in section 7.

My emphasis.  What people are doing today is exactly what Svensson says not to do: looking at the deviation of the actual CPI rate from the target, not the deviation of the forecast.from the target.

Here is a plot which shows the Bank’s record under inflation targeting from 2004 to the beginning of 2008.  On the X axis is the observed current CPI rate known at the time of each Inflation Report.  On the Y axis is the Bank’s forecast for the median CPI rate looking two years out, which is generally what the Bank target.

UK Monetary Policy, 2004 to 2008

UK Monetary Policy, 2004 to 2008

That is, I’d say, really good monetary policy.  The Bank has nailed the forecast to around 2%, regardless of what the current CPI rate is.  Svensson would have the Bank incorporate an offset into the target to account for any output gap, shifting the target upwards or downwards if the output gap is negative or positive respectively, but I’m not aware that the Bank ever ever done that.

Here is what happened in 2008-2010:

UK Monetary Policy, 2008 to 2010

UK Monetary Policy, 2008 to 2010

This is really bad monetary policy.  As the CPI rate drifts high in late 2008, the Bank allows the forecast to drift downwards.  In Q1 of 2009, the Bank are saying the monetary policy stance is very very tight; they are expecting inflation to be barely positive looking two years out.  By the last quarter of 2009, they had raised the forecast above 1.5%, but it is still below target, and remains so going into 2010.  (By this stage there is also a massive negative output gap.)

Next, let’s look from 2011 to the current data (only current as of Q2, we don’t have the Q3 forecast data yet):

UK Monetary Policy Policy, 2011 to 2011 Q2

UK Monetary Policy Policy, 2011 to 2012 Q2

The Bank is targeting roughly 2% for the first three quarters of 2011, so, if we ignore the fact that they should bias the target upwards to reduce the output gap, that’s fine.  In Q4 of 2011, they are again saying monetary policy is really tight.  This has been corrected somewhat by Q2 2012, but the Bank is still expecting to significantly undershoot its 2% target.

So where is the inflationary bias of the Bank of England, on the very metric that Svensson (et al) say we should hold the central bank accountable under inflation forecast targeting?

I’d say it is very clear there is none.  In fact, I’d say it is very clear they have a disinflationary bias: every time the current CPI rate shoots too far up (right on my graphs), they “passively” tighten policy by allowing the two year forecast to shift downwards.  And never mind the depression.

A Plea to New Keynesian Economists

August 10, 2012 5 comments

Gavyn Davies, writing in the FT on the dreadful UK GDP data says: “Many economists are arguing that monetary policy is running out of options and that the one remaining hope is to delay the path for fiscal tightening”

This must be the most depressing comment I’ve read in a particularly depressing week.

Can “many economists” please go and re-read Svensson, Bernanke, and Krugman?  Because the idea that monetary policy will “run out of options” at the ZLB is exactly the opposite of what those guys concluded a decade or more ago.

Paul Krugman advised setting a higher inflation target.  Fine.  Simple.  We can do that.  It takes a single letter from HM Treasury to Threadneedle Street to achieve that.  It requires one stamp, not a Budget through Parliament and a thousand civil servants working out how to efficiently allocate capital, and not a penny on the national debt.

(And incidentally, this is the Paul Krugman of 2012 in one of his less partisan moments: “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.”)

Ben Bernanke deployed the killer argument that it must be true that central banks can always print money and devalue their currency, boosting domestic inflation:

…[One] can apply a reductio ad absurdum argument, based on my earlier observation that money issuance must affect prices, else printing money will create infinite purchasing
power. Suppose the Bank of Japan prints yen and uses them to acquire foreign assets. If the yen did not depreciate as a result, and if there were no reciprocal demand for Japanese goods or assets (which would drive up domestic prices), what in principle would prevent the BOJ from acquiring infinite quantities of foreign assets, leaving foreigners nothing to hold but idle yen balances?  Obviously this will not happen in equilibrium.

And Lars Svensson has a “Foolproof Way” to exit the ZLB, using a price level target.  Note that word, foolproof.  That means even Osborne can’t screw it up.  I see no reason why the Bank of England could not deploy a price level target within their existing mandate.

So why, oh why, oh why, have “most economists” decided that monetary policy is “running out of options”, when even the New Keynesian academics who researched monetary policy at the ZLB gave us a plethora of options?  “Self-induced paralysis” is exactly right.

Categories: Japan, Monetary Policy