UK Aggregate Demand Policy and Air France Flight 447
I hope readers will excuse this wildly inappropriate and unnecessarily tasteless analogy, but discussion of UK demand policy increasingly reminds me of the Air France 447 disaster, a tragic plane crash back in 2009. The investigators found that the pilots ignored stall warnings and not only allowed the plane to fall out of the sky, but acted in precisely the wrong way to correct the fall:
… the jet continued to respond to the commands until impact. Those commands, however, were consistently inappropriate for a plane approaching a stall at high altitude. Instead of pointing the nose down in order to regain speed, the pilot at the controls drove it higher, worsening the loss of forward momentum and depriving the plane of lift.
In the UK, the nominal economy remains under the control of monetary policy. The monetary policy stance, however, is consistently inappropriate for an economy with a deficiency of aggregate demand. Instead of steering the economy towards faster growth, our central bankers keep aiming to drive inflation lower, depriving the economy of demand.
Over to Gavyn Davies, with an interesting discussion on “gilt cancellation” earlier this month, continued this week. This latest policy innovation comes courtesy of Adair Turner (candidate to be the next BoE Governor) who had floated, but quickly retracted, the idea of “cancelling” some of the government bonds which have accumulated on the Bank’s balance sheet through QE. Mr Davies concluded that doing so would boost aggregate demand (nominal GDP):
Now consider what would happen if the bonds held by the central bank were cancelled, instead of being one day sold back into the private sector. Under this approach, the long-run restraining effect of bond sales would also be cancelled, so there should be an immediate stimulatory effect on nominal demand in the economy. If done without amending the path for the budget deficit itself, this would increase the expansionary effects of past deficits on nominal demand, and would also reduce the outstanding burden of public debt associated with such deficits.
The argument Davies is making here is a familiar one about the effectiveness of a permanent versus temporary expansion of the monetary base. It is thus based entirely around expectations; that destroying a portion of the Bank’s assets boosts nominal GDP exactly because it is a way to signal that (some of) the monetary base expansion will be permanent, and will not (can not) be soon reversed by selling those assets again.
There is an implicit assumption that this plan would be useful because the Bank are not satisfied with the current growth rate, or level of, nominal GDP produced by QE to date. But as documented ad nauseum, this is neither their expressed view nor their revealed preference. The Bank has set expectations around the permanence (and continuation) of QE which are clearly anchored to the 2% inflation target (or more accurately, the inflation forecast). And the Bank has been successful in keeping nominal GDP growing at a rate which is more than sufficient to hit the inflation target; witness years of an above-target CPI rate.
Like the poor Air France pilots, in discussion of appropriate policy we scramble around desperately seeking to avert a crash. The government isn’t spending enough – let’s flip that switch! Banks aren’t lending enough, let’s pull that lever! We must have “structural issues”, the cause must be supply-side! And all the while there is no consideration of the one thing that really matters: the nose is pointing the wrong direction.
If the Bank (and/or HM Treasury) wants faster nominal GDP growth it is neither necessary nor sufficient to start cancelling gilts. I’m not sure that policy tool would be particularly useful; it is possible for the Bank to contract the monetary base by issuing bills or similar non-monetary liabilities. So I cannot see that the inflation target would automatically lose credibility as a nominal anchor.
What is necessary to avoid another crash is to simply point the nose in the right direction: abandon the inflation target and tell us you want faster nominal GDP growth. Set expectations around a clear nominal target, a level target, and print enough money to get expectations pointing the right way.