This is a belated follow-up to Scott Sumner’s post last month on the puzzles in the UK macro data.
I tested Scott’s “musical chairs” model of the business cycle on the labour compensation data from GDP by income in the national accounts. Define “Labour Income” as the sum of total wage and salary compensation paid to employees (excluding employer social security contribution), plus household “mixed income”. The latter should be a good proxy for the income of those in self-employment, but is not perfect, I believe it also includes things like owner-occupiers’ imputed rents. (A topic for another post.)
Then we can find the ratio of mean hourly wages to per capita “labour income”. This shows the outcome of Scott’s “game of musical chairs”, which he explained here and also in his EconTalk podcast. (Briefly, the intuition is that when total income available to pay salaries falls below the expected trend path, total hours worked falls and unemployment rises, because hourly wages are sticky in nominal terms.)
1) per my previous post, the ONS data for mean hourly wages is not an official “national statistic”. The series was also incomplete, missing a single data point in 2001 Q1.
2) There appeared to be some seasonality in one of the series used for “Hourly Wage / Per Capita Labour Income”; all inputs except the population count are seasonally adjusted. I applied a 4 quarter moving average to smooth it.
Update: Ritwik Priya rightly took me to task on twitter for omitting the unit on the RHS, which is “£/hour / £000s/quarter/capita”.
Update 2: I very much appreciate Ritwik checking my data here. He noticed the RHS scale was still out by a factor of four in my original chart. I had carelessly used a 4Q moving total rather than a moving average to smooth the data. I have replaced the chart above with one which really does use a moving average. The original chart used in this post is here, for purposes of full disclosure; there is no difference apart from the scale on the RHS.
That seems like a remarkably good fit; perhaps (level) targeting per capita “labour income” on something like the definition above would be a good monetary policy for the UK.
As I’ve noted previously, when HMRC starts collecting real-time payroll data it should be easy for the government to estimate total current wage income; though income to the self-employed would still rely on surveys. A worthwhile initiative in “open government” would be for HMRC to publish aggregates of their payroll data in real-time.
There’s long tradition of “broad monetarism” in the UK, a theory which holds that a) central banks should aim to stabilise some measure of the broad money supply, and b) such measures of money are both predictive and “lead” the nominal economy with some lag.
Steve Hanke has a series of blog posts (for example here and here) showing a collapse in the Bank of England’s “M4” measure of UK. Active UK-based broad monetarists include Tim Congdon and Simon Ward, and many members of the IEA’s Shadow Monetary
HawksPolicy Committee have a broad monetarist leaning. (A few on the SMPC such as Anthony Evans and Jamie Dannhausert do also look at NGDP.)
In recent years, as in the 1980s, broad money has not been strongly correlated with nominal GDP growth, because the velocity of circulation has not been constant. It also remains hard to pick a “useful” measure of broad money. The Bank of England itself dropped the focus on the M4 series which Steve Hanke referenced, in favour of a new series, “M4ex“, which excludes deposits in certain financial intermediaries – think the “shadow banking” sector.
Here is a graph of M4ex growth and nominal GDP growth:
And here’s the graph of M4ex velocity:
Pretend you have been appointed Chancellor of the Exchequer in May 2010, and you want to find out what what “bleeding-edge” macro research says you should do.
What do you find out?
If you’ve read New Keynesian Lars Svensson, you might be sceptical about the efficacy of deficit spending in boosting aggregate demand. Like Svensson, you’ve watched Japan run large deficits for two decades, and seen that that the level of Japanese nominal GDP is unchanged after that all time, yet public sector debt has soared. You don’t want to go down that route. You might like the idea of a “Foolproof Way” to exit the ZLB, a price level target and currency devaluation, but you can see the UK CPI is already above target, and you are worried about the global politics of engaging in “currency wars”.
If you’ve read New Keynesian Ben Bernanke, you would be a strong believer in the unlimited power of the printing press in raising UK aggregate demand.
You would surely listen to New Keynesian Mervyn King, who is one of the UK’s most prestigious macroeconomists, and also happens to run your central bank. He tells you in no uncertain terms to get the deficit down and let him get on with running AD policy. He tells you he tried out his printing press in 2009, and it worked very well indeed. He’s got your back.
If you’ve read New Keynesian Paul Krugman, you’ll consider raising the inflation target to 3% or 4% as the best policy choice at the ZLB… but you get shot down by Mervyn King who thinks that’s a really bad idea, which might herald a return to the 1970s.
You’ll also believe that under New Keynesian inflation forecast-targeting, the central bank will internalize whatever fiscal policy decisions you make, and steer an appropriate course for UK aggregate demand. Your new friend Mervyn has promised to print enough money to keep things ticking along nicely.
So maybe you get on with running fiscal policy to cut the deficit, and let the Bank take care of AD policy for a year, or two years, or three years. Inflation stays well above target, and the jobs market, well, it could be much worse. The printing press is duly deployed when necessary.
But bizarrely, all this time another bunch of “New Keynesian” economists are baying for your blood, admonishing you for making some kind of policy error. They don’t seem to believe a word Ben Bernanke wrote. They don’t believe in inflation forecast-targeting. They tell you that monetary policy doesn’t work, and you’re an idiot for thinking it ever would. They have nothing much to say about Japan. And they have strange ideas about how fiscal policy can be used as a “magic money tree”, with “self-financing” deficits. They tell you that increasing borrowing will reduce borrowing, yet reducing borrowing will increase borrowing! They are hard to understand.
You also get advice that tells you maybe the central bank has been screwing up all along. You find another New Keynesian, Dr. Escape Velocity – he tells you he can fix things if you let him loose with that printing press and give him room to move. But another bunch of “New Keynesian” economists, the ones who are running the central bank, tell you in no uncertain terms that UK AD policy is working just fine.
Who do you believe? The Bernanke/Svensson New Keynesians? The
New Crude Keynesians who think fiscal policy is all that matters at the ZLB? The New Keynesians at the central bank who are screaming at you that everything is just fine?
You bet the farm on Dr. Escape Velocity… and throw in some interventionist fiscal policy for good measure. Nobody’s very happy with you.
I must say I’d almost feel sorry for you after all that. It’s a tough job at the top, isn’t it, when all you have is conflicting New Keynesian macro policy advice?
First, Paul Krugman’s definition of a liquidity trap:
In a liquidity trap the problem is that the markets believe that the central bank will target price stability, given the chance – and hence that any current monetary expansion is merely transitory. The traditional view that monetary policy is ineffective in a liquidity trap, and that fiscal expansion is the only way out, must therefore be qualified: monetary policy will be effective after all if the central bank can credibly promise to be irresponsible, to seek a higher future price level.
(I’ll pause here while we wait for the inflation hawks to stop laughing about the BoE’s credibility in seeking a “higher future price level”. Have you all finished? Good, let’s continue.)
Guy Johnson: Ed Balls, you do have your economics GCSE, we all know that. Do you think the change in the [BoE] mandate will lead to higher inflation?
Balls: No, because I think the Bank of England will do its job, and it’s got a very clear remit to meet a symmetric target of 2% and that’s not changed.
My emphasis. Yes, I omitted transcribing the previous question in the interview where Balls talked about a liquidity trap and how monetary policy was “pushing on a string”… so shoot me. I also omitted the hilarious joke, where Balls says he has “not seen any sign of reluctance” from the BoE to “support growth”. Mr. Balls, that’s a good one.
Does Ed Balls really believe the “liquidity trap” is a problem, if he thinks the Bank of England “will do its job”? Answers on a postcard to No. 11 Downing Street.
For all the talk of “monetary activism”, what is striking from reading the monetary policy remit review is that HM Treasury is very, very conservative; small-C conservative. They fear a return to the 1970s. They fear loss of “credibility”. They fear the untried, the untested. Setting aside the relevance of those fears, we should perhaps recognize the value of such “institutional conservatism” at a time when the governance structures elsewhere in Europe are proving barely adequate in preventing the state stealing from its own citizens.
Can I find any positives in the Bank’s new remit? There is a lot of fudge and a lot of nudge. I hoped for a “regime change” which avoided both, but here’s a look at what we did get:
1. A “dual mandate” nudge: a slight de-emphasis of the “strictness” of the 2% target; and a slightly greater emphasis on short-run output stabilisation. Ed Conway discusses this point. The relevant paragraph from the review document follows:
2.17 The remit for the MPC set at Budget 2013 has been updated to clarify the trade-offs that are involved in setting monetary policy to meet a forward-looking inflation target. For clarity, the target “applies at all times”, as distinct from a requirement to be met at all times, because the latter could be mis-interpreted as strict inflation targeting with zero weight on the secondary objective, contradicting the flexibility to respond efficiently to shocks and disturbances that move inflation away from target. The MPC’s forward-looking policy decisions must be consistent with ensuring price stability in the medium term. The appropriate policy horizon is subject to the operational independence of the MPC.
This is also a fudge. It reads like the government wants a dual mandate without saying they actually want a dual mandate. Say what you mean, George.
2. A nudge towards a Bernanke-Evans rule – use of “forward guidance” and “thresholds” as an “unconventional policy instrument”. I think this is the most significant part of the remit change. There is a long and favourable discussion of forward guidance and managing expectations in the review document. This is very welcome, it implies the Treasury recognize the MPC’s abject failure to manage expectations over the last five years, and see that as a key problem.
The MPC are required to review the “forward guidance” idea and report back in the August Inflation Report. The review gives this hint:
3.30 Potential indicators that might function as thresholds for state-contingent guidance, aside from the unemployment rate used by the Federal Reserve, include the output gap, real GDP and nominal GDP. To be efficient, any indicator would need to have some relation to the objectives of monetary policy. To be credible and accountable, a threshold would need to be understood and verifiable. As such there is likely to be a trade-off in any choice of indicator for a threshold.
We will have to wait and see what Carney goes for. And so again, this is a fudge. Osborne is betting on Carney coming in and persuading the MPC to adopt a Bernanke-Evans-like rule, rather than requiring the MPC to run better policy starting tomorrow.
Carney could go further than Bernanke-Evans and set expectations around NGDP; the above text at least allows the MPC to explore that idea. That would not be a bad route to trialling a “back-door NGDP target” if the government wanted to avoid the complexity (and risks?) of changing away from the 2% inflation target. If you want to “keep the flame [of NGDP] alive”, run with that idea. It seems pretty remote to me.
3. An attempt at improved accountability around deviations of inflation from target, and the trade-offs required; from the review (emphasis from the original):
The remit goes further by clarifying that in exceptional circumstances, where shocks are particularly large and with persistent effects, the MPC is likely to be faced with more significant trade-offs between the speed with which it aims to bring inflation back to target and the consideration that should be placed on the variability of output. This therefore allows for a balanced approach to the objectives set out in the remit, while retaining the primacy of price stability and the inflation target. The remit requires that in forming and communicating its judgements the MPC should promote understanding of the trade-offs inherent in setting monetary policy to meet a forward-looking inflation target while giving due consideration to output volatility.
I’m not sure how much difference this will make. The MPC can easily claim they do this already.
Budget 2013, key paragraph:
Monetary policy has a critical role to play in supporting the economy as the Government delivers on its commitment to necessary fiscal consolidation. To ensure that it can continue to play that role fully, the Government has reviewed the monetary policy framework in international and historical context and the Review of the monetary policy framework is published alongside this Budget. As a result, the Government has: retained a flexible inflation targeting framework and reaffirmed the 2 per cent inflation target, which applies at all times; updated the remit to clarify the trade-offs that are involved in setting monetary policy to meet a forward-looking inflation target; and has requested that the MPC provides in its August 2013 Inflation Report an assessment of the merits of using intermediate thresholds in the operation and communication of monetary policy.
I read this as “self-induced paralysis” at the highest level of government. Osborne is betting the farm on Dr. Escape Velocity (aka Mark Carney) being able to convince the MPC to do something like the “Bernanke/Evans rule” adopted by the Fed; from the new remit:
The Committee may also judge it to be appropriate to deploy explicit forward guidance including intermediate thresholds in order to influence expectations and thereby meet its objectives more effectively. This is likely to be most pertinent should the Committee judge spare capacity is likely to persist for a considerable period.
There is considerable discussion of “forward guidance” in the review of the monetary policy remit. That document discusses but specifically rules out NGDP level targeting… mainly because… can you guess it… inflation is bad! Plus some of the usual excuses, revisions, nobody understands what “NGDP” means, etc.
I see nothing at all in the new remit text which compels the MPC to do anything different to current policy. It is all about judgement. Neither did the old remit prevent the MPC from giving “forward guidance” if they so desired. (The March 2009 QE announcement remains the clearest example of forward guidance to me, the MPC said they’d do “whatever was needed” to raise nominal GDP and hit the inflation target.)
OBR forecasts for nominal GDP got another downgrade:
As suspected, it is game over. It could have been worse. But it could have been so much better.
George Parker and Chris Giles report that Osborne’s economic adviser Rupert Harrison has failed to find enlightenment:
During his tour of Boston, New York and Washington, Mr Harrison is understood to have ruled out the radical option of changing the BoE’s remit to include a growth target based on nominal GDP – cash spending in the economy.
[The Treasury is] considering whether the existing 2 per cent inflation target gives sufficient flexibility or whether the Treasury could tell the Bank to target that rate over a longer horizon to help growth.
Game over? It looks that way. “Sufficient flexibility“? Give me a break. The cult of the central banker lives on, our chosen experts carefully seeking the right path to nominal salvation. In other FT news:
BoE governor says currency is now ‘properly valued’
Good luck, everybody. Blogging will be light for a while.