First, Mark Carney! The most interesting thing about Mark Carney is that he is not Paul Tucker. If Osborne wanted more of the same from the Bank of England he would have picked Tucker. But Osborne apparently went to some effort to hook Carney instead. Significant? Maybe not, maybe Carney is just the better candidate and there’s no more to it than that. Plus Osborne got to score points over Ed Balls, who looked dazed and confused in Parliament yesterday as he tried to work out what to say. “George did something right? Now what do I say?”
And on to the GDP figures. Everything you’ve read about a “bounce back” in Q3 after a holiday-ridden Q2 is still totally wrong. We have two measures of demand growth to choose from: nominal GDP at market prices and nominal GVA at basic prices. I prefer the latter for the UK; it measures spending (and hence revenue available for production) net of indirect taxes, so is not distorted by the VAT changes. On the basic prices measure, Q2 demand growth was stronger than Q3. And distortions between basic and current prices persist. Quarter-on-quarter growth at annualized rates, seasonally adjusted:
So, good news: we had another quarter of reasonable demand growth (insofar as c.4% is “reasonable”) and the GVA deflator was negative. Bad news, the Q2 deflator shock has not been revised away.
Taking a slightly wider view, the GDP statistics are looking awful from both a demand and a supply-side perspective. There has been a slight recovery in demand growth, but no output growth to go with it.
That is not a pretty picture.
Here is the development of the median forecast curves over the last four quarters:
Similar to the change between February (dark blue) and May (Green), there has been a sharp upward movement to the near-term forecasts but the medium term forecasts remain firmly below 2%.
The above forecasts are based on the market forecast for Bank Rate. I’m not sure if this has happened before, but interestingly, the forecasts based on Bank Rate held constant at 0.5% have lower expected inflation. I presume this is because the market yield curve expects rates to fall to around 0.2% over the next year. In failing to cut the rate the Bank is effectively producing tighter monetary policy than the market expects, and on the Bank’s own forecast model, they are less likely to hit their legal mandate in two years time.
I’m pretty sure the MPC are aware of this, because they keep discussing it and ruling it out – the November MPC meeting minutes:
The Committee also discussed the likely effectiveness of reducing Bank Rate to below 0.5%. Over the past few months, Bank staff had consulted with the FSA and the Building Societies Association on the possible consequences. In the light of that, the Committee had re-examined in detail the desirability of such an option. While it would be beneficial for some existing borrowers, there were concerns that a cut in Bank Rate might prove counterproductive for aggregate demand as a whole. Staff analysis had concluded that a further cut in Bank Rate would be likely to cause a reduction in the profitability of some lenders, especially building societies, because of the prevalence of loans with interest terms contractually or closely linked to Bank Rate. That would weaken their balance sheets and they might have to respond by increasing other loan rates or restricting lending.
Viewed against the backdrop of the Funding for Lending Scheme (FLS), and the potential for building societies to play a material role in increasing lending, the Committee judged that it was unlikely to wish to reduce Bank Rate in the foreseeable future.
There you go: cutting interest rates is bad for aggregate demand because banks might lend less. You couldn’t make it up.
Chris Giles has doubled down on his previous position, and has an excellent plan to reflate the UK economy by printing money and buying gilts, though he doesn’t phrase it quite that way:
All George Osborne has to do is tweak the Bank of England Asset Purchase Facility Fund, the special purpose vehicle set up to manage QE. I am sure the good people at the Bank would be happy.
All I am proposing is a small tweak to the operations of the BEAPFF that would extend its scope a little. On top of the £375bn of money printing for gilts purchased, it would, under my plan, have a second purpose of making more efficient use of government cash.
The first thing it would do is buy the rest of the gilts market. That way, according to the Office for Budget Responsibility it would receive total gross interest payments of £46bn in 2013-2014, when new tweaks would would be ready to roll.
So, what is the up shot? A simple extension to QE operations and coupons on debt can wipe out borrowing. Magic! Deficit problem? Problem solved.
Obviously, at maturity, the BEAPFF would be insolvent and would need to make use of the indemnity the Treasury would offer. But that is an issue for the future. Not now.
Mr Giles is being a tiny bit sarcastic. But this plan is exactly what we need, with one minor tweak. There are two possibilities for this plan if announced exactly as described:
a) it has zero difference to inflation expectations or any other forward-looking macro indicator such as the stock market, or the value of Sterling.
b) it massively raises inflation expectations, the stock market soars, Sterling plummets.
In the last few years, relatively small unexpected shifts in UK monetary policy have had significant influence on the markets. Sterling has often moved sharply when the MPC minutes say something the markets didn’t expect, for example.
So I’d say that the announcement of a plan to buy up the remainder of the £1000bn gilt market would very much fall under (b), and would trigger what David Beckworth calls the “mother-of-all portfolio adjustments” as people race to dump their “safe assets”. Sterling would plunge, inflation expectations would soar. What would be the effect on the domestic economy? It would boost spending. Which is fortuitously exactly what the UK needs! Over to Professor Bernanke:
A nonstandard open-market operation without a fiscal component, in contrast, is the purchase of some asset by the central bank (long-term government bonds, for example) at fair market value. The object of such purchases would be to raise asset prices, which in turn would stimulate spending (for example, by raising collateral values). I think there is little doubt that such operations, if aggressively pursued, would indeed have the desired effect, for essentially the same reasons that purchases of foreign-currency assets would cause the yen to depreciate. To claim that nonstandard open-market purchases would have no effect is to claim that the central bank could acquire all of the real and financial assets in the economy with no effect on prices or yields. Of course, long before that would happen, imperfect substitutability between assets would assert itself, and the prices of assets being acquired would rise.
I can’t think of a better definition of “aggressive” bond purchases than promising to monetize the £1tn gilt market.
There is one question: if the 2% inflation target remained credible people might expect the monetary injections to quickly be reversed, though I doubt that the 2% target would remain credible for long with such a large shift in policy.
If it did, then Chris is exactly right: this is a free lunch and we should do it straight away. We can go much further: why issue zero coupon gilts when we could be paying negative interest on central bank reserves? If people really want to hoard £1tn of money which loses 2% real value per year, why not pay negative interest on reserves and charge them even more for that privilege? What’s not to like?
So the minor tweak needed to Chris’ plan is to dump the 2% inflation target and announce a nominal GDP level target; and have the government signal that they will keep printing money, buying stuff, and eating free lunches, until we hit that target. This would make the plan much more credible.
Fast rising nominal GDP will of course provide all the tax revenue the government needs to recapitalise the BoE in the future if that ever proves necessary. If monetizing the entire gilt market is not sufficient to move nominal GDP we should definitely promise to buy up the Spanish bond market too, I’m still up for that plan since the despicable ECB are intent on prolonging the suffering across Europe.
Abe advocates increased monetary easing to reverse more than a decade of falling prices and said he would consider revising a law guaranteeing the independence of the Bank of Japan. (8301). In an economic policy plan issued yesterday, the LDP said it would pursue policies to attain 3 percent nominal growth. The party governed Japan for more than half a century until ousted by the DPJ in 2009.
Excellent news from the BBC:
Yen dips as Yoshihiko Noda proposes snap elections
Japan’s yen has fallen after Prime Minister Yoshihiko Noda said he was set to dissolve parliament and hold a snap election.
There is no guarantee the government would win an election, and the opposition has called for aggressive monetary easing by the central bank.
Its leader, Shinzo Abe, has said the bank should print “unlimited yen” to help fight deflation.
Analysts said such a move would weaken the yen even further.
Mr Abe, the leader of the Liberal Democratic Party (LDP), has said that the bank of Japan (BOJ) needed to set an inflation target of 3% instead of its current 1% goal to help revive growth in the economy.
“If we take power, we’d like to do our utmost to beat deflation,” Mr Abe said. “In doing so, monetary policy would be key.”
He indicated that if elected, he would review the BOJ law that guarantees its independence from the government.
Higher inflation target? Check.
Print unlimited amounts of money and devalue the currency? Check.
Put the world’s most inept central bank on a tight leash? Check.
It’s all there. Japan, vote LDP! (I know nothing about Japanese politics, mind.)
Memo to the Dangerous Voices: remember Japan. Stop fretting about fiscal policy, fix the demand problem at source: bad monetary policy. Japan is still fighting to get their central bankers to do the right thing, twenty years after the BoJ drove the Japanese economy off a cliff. I don’t want to still be blogging about UK monetary policy when I’m old and grey.
“This sobering report shows why David Cameron and George Osborne’s deeply complacent approach to the economy is so misplaced,” said Ed Balls, the shadow chancellor. “Their failing policies have seen two years of almost no growth and the Bank of England is now forecasting lower growth and higher inflation than just a few months ago.
Ah, Mr Balls. You see, Ed, the Bank wasn’t just forecasting lower growth and higher inflation, it was telling us that it was only going to provide lower growth because inflation was higher. Can you remind us who gave the
sociopaths inflation-targeting central bankers control and discretion over UK demand policy? Oh, Mr Balls, you’re blushing!
The divorce between the Bank and the macro policy debate in the rest of the country continues. Mervyn King made his position crystal clear in the press conference:
What is limiting our ability to do more is not on the monetary side, it’s on the real side that the economy has to adjust to a new equilibrium. That is what I think is going to pose the constraint.
What we need now – it’s very clear if you look at the numbers – what the UK economy needs is more demand in the rest of the world to buy goods from the United Kingdom. And that is the key bit that’s missing from our attempt to rebalance and that’s why the challenge is so great.
King says the Bank could provide more demand stimulus, repeatedly insisting that printing money and buying gilts is still an effective policy tool. But they will not do it, because the expected path for demand has inflation above target in the short term and roughly on target in the medium term.
After reading the depressing Inflation Report transcript, to cheer myself up I re-read Bernanke’s classic 1999 paper on the “self-induced paralysis” of Japanese monetary policy. Amongst many obvious parallels, here’s one I enjoyed. Bernanke’s paper is based in large part around debunking this phrase from a Bank of Japan policymaker, which he quotes twice:
“BOJ’s historically unprecedented accommodative monetary policy”
This is King yesterday:
We have an enormous degree of stimulus. I mean I think all central banks in the major industrialised countries are pursuing very similar policies. All of them have their policy rates at very close to zero, this is historically unprecedented.
Straight out of the text book. To be fair, on the metric King is asked to target, the CPI rate, he is doing far better than the BoJ. Bernanke also uses nominal GDP, the GDP deflator, and nominal wages as empirical evidence for deficient aggregate demand in Japan; those indicators send the same signal for the UK data over the last four years.
The cash management ministers have in mind is to reduce the government deficit now by raiding the surplus accumulating at the Bank of England under its quantitative easing programme. Lower borrowing now comes with the sure knowledge that a future chancellor will have to borrow more to cover the losses that will build up as QE is unwound and bonds bought above their par value lose money on redemption. This is no contingent liability. It is also large, with an initial cash grab of £37bn, more than 2 per cent of national income.
If future borrowing was likely to be cheaper than current borrowing, this would be sensible, but the likelihood is that QE will be unwound when economic prospects are better and government bond yields higher than their current historic lows. If we assume that QE breaks even in a profit and loss sense – an optimistic assumption – the Treasury is proposing expensive borrowing in the future instead of cheap borrowing now. It is bad cash management and will harm Britain.
I still think this argument is wrong-headed.
Chris makes the assumption that it is is desirable for HM Treasury to attempt to hedge against a future capital loss on the QE portfolio. In fact, he goes further, arguing that is desirable that HM Treasury borrows money and hoards it, so as to hedge against future losses on the QE portfolio.
If the government borrows money and hoards it, that is the exact reverse of QE; it reduces the private sector’s holding of central bank money and increases the private sector’s holding of gilts.
The reductio ad absurdum is that it is undesirable per se to conduct monetary policy at the ZLB by printing money and buying gilts, because it risks a loss of capital. But if the Bank is going to conduct monetary policy by varying the size of the base it has to buy something, and gilts are least risky option.
The assumption that it is desirable to hedge against losses from QE by hoarding cash must be false. Then we are back to the macro argument: what matters above all to the public sector finances is the level of nominal GDP, because that determines tax revenues. If the government was really concerned about reducing the public debt burden they could simply raise the inflation target or set a (higher) target for nominal GDP. Everything else is noise.
Chris is also concerned about economic credibility:
So far, the reaction to Mr Osborne’s ruse has been indulgent eyebrow-raising. People appear to feel that ripping off future taxpayers, polluting statistics and undermining independent monetary policy is benign. Unless the policy is reversed or some independent authorities put a spanner in the works, Britain’s economic credibility has died. Financial markets and credit rating agencies have not noticed yet. They should and I fear they will.
Though I have no love for the fudging of national statistics (I’m also surprised the ONS will allow any impact on the main fiscal deficit measure), Chris’ attachment to the “independence” of UK monetary policy seems misplaced. The highly discretionary operation of UK monetary policy since 2008 is the reason we are in this mess, and absent a monetary superhero to replace Mervyn King, government interference in monetary policy is long overdue.