Archive for August, 2013

It’s Still Price Stability All the Way to Tokyo

August 8, 2013 1 comment

Left Outside has another great post explaining what was announced yesterday by the MPC in detail, and read his first here.

The simplest way to tell that there was no massive change in the BoE’s policy stance yesterday is to look at the forecasts.  The forecasts for inflation are basically unchanged since the May inflation report.

Bank of England Median CPI Forecasts

Bank of England Median CPI Forecasts

The Bank is still expecting to hit its 2% target at around the two year horizon, and then slightly undershoot from mid-2015 onwards.

Categories: Bank of England, Inflation

Nominal Recovery Does Not Happen “Naturally”

August 8, 2013 Leave a comment

I’ve seen quite a bit of discussion recently from various quarters about how a return to UK growth was inevitable regardless of what Osborne did with UK macro policy.

The benchmark here is Japan.  Japan did see a recovery in real GDP after 1991 as prices and wages adjusted to slower nominal GDP growth.  But they have never seen a recovery in nominal GDP – Japan’s nominal GDP in 2013 is lower than in 1991.  That is basically the critique Bernanke and others applied, to show that Japan’s macro policy was a failure; slow nominal wage growth, slow nominal GDP growth, slow or negative price inflation.

So I think it is still absolutely vital to distinguish between real and nominal GDP growth today in the UK.  What we saw in the July PMIs was one month of particularly good growth in a real indicator.  If the real indicators continue to indicate fast output growth and we continue to get moderate levels of price inflation I think that is a reasonable sign that we have a nominal GDP recovery.  Such a recovery does not happen “naturally”; it must be attributed to a change in macro policy.

(One note of caution here is that measures of output price inflation have been well below consumer price inflation, and the CPI is distorted by things like tuition fees, so it is hard to know exactly what is happening with the nominal economy.)

Market monetarists will point to the “long and variable leads” associated with an anticipated change in UK monetary policy since Carney’s speech on NGDPLT last December.  Evidence of a significant easing in monetary conditions since last year is the rise in inflation expectations, fall in Sterling, and rise in UK equity and other Sterling asset prices (yes, house prices too.)  It is also reasonable to say that changes in Japanese or US monetary policy have eased UK monetary conditions.

Fiscalists might want to offer a different explanation.  Did George Osborne end the “balance sheet recession” by goosing up the housing market, thereby providing a massive helicopter drop of net wealth to the credit-constrained private sector?  (I’ve seen estimates that Help 2 Buy will boost house prices by 30%.)  Somebody should make that argument, if so.  The path of UK private sector balance sheets is completely different to that seen in Japan since 1991, where nominal asset prices have collapsed by 50% or more over twenty plus years.

But either way I think it is important we must judge the success of macro policy in short-run stabilisation by looking at nominal outcomes not by concentrating on real indicators.

Reaction Roundup #2

August 8, 2013 1 comment

Left Outside has a very good post explaining exactly what was announced yesterday.

City A.M. have a trio of reports: Lars Christensen says the Bank falls short though it made a small step forward (I reluctantly agree), Allister Heath says it will backfire, and Andrew Sentance says we risk steep rises later.

Simon Nixon’s write up for the WSJ is on the whole very reasonable, but give up with the “housing bubble”!

Carney on TV: Faisal Islam has the C4 interview. with Ed Conway for Sky News, Richard Edgar for ITV, and Hugh Pym for the BBC.

Carney was on Radio 4 Today this morning, he said exactly the right things about Japan when Evan Davis asked him about low rates punishing “savers”.

Categories: Monetary Policy

IR Reaction, Roundup

August 7, 2013 5 comments

The ASI’s Ben Southwood says Carney bottled it – dead right.

Simon Wren-Lewis is not inspired.

Duncan Brown says it was a “Storm in a teacup“.

Scott Sumner is very disappointed by the BoE’s justification for rejecting NGDPLT.

Marcus Nunes says Carney’s bubble has popped.

Philip Booth of the IEA wants everybody to know he’s an inflation hawk.  Anthony Evans is much more measured and rightly critical over the lack of real reform.

Stephanie Flanders nails the confusion from Carney about whether this was a change in the Bank’s reaction function.

Editorials from the Guardian and the FT, neither seem particularly impressed.

The Evening Standard think low nominal rates are always and everywhere good for homeowners (HT James).  Wrong, see Japan, where house prices have crashed by 50% over two decades.

Meanwhile the Daily Telegraph insist low nominal rates are always and everywhere bad for “savers”.  Wrong, again see Japan, where cash and bank deposits have been a relatively good investment over the last twenty years, I believe with a positive real return.

Categories: Monetary Policy

The 2.5% Inflation “Knockout” is an Epic Disaster

August 7, 2013 6 comments

This is how the MPC describe the inflation “knockout” – this is one of the  conditions under which the current stance of monetary policy would be considered to be too expansionary:

On the basis of these considerations, the MPC has chosen to set its knockout at 2.5% at the 18 to 24-month horizon. While there is a range of views as to whether the knockout horizon should extend out to two years, the MPC’s best collective judgement is that an 18 to 24-month horizon strikes an appropriate balance between not bringing inflation back to the target so quickly as to threaten the recovery, while demonstrating the MPC’s determination to bring inflation back to the target over the medium term. The knockout is framed in probabilistic terms, such that it would be breached if, on average, it is more likely than not that the Committee’s projection for inflation 18 to 24 months ahead is half a percentage point or more above the 2% target.

The Bank publish all the data we need to assess past policy against this “knockout”, so I’ve produced a crude graph.

For each quarter (one IR forecast), we get three data points, looking forward 18, 21 and 24 months.  Each data point is a probability representing “% chance that inflation will be above 2.5% in this quarter”.  If any point goes above 50% that triggers the “more likely than not” clause in the knockout and a (possible) tightening of policy.  Those data points are on the red, green and blue lines in the chart.  Against that I’ve plotted annual nominal GDP growth, yellow line, on the right hand scale.

2.5% Inflation "Knockout" Analysis

2.5% Inflation “Knockout” Analysis. Source: BoE

This is a particularly confusing graph, for which I apologise.  What it says is that the indicators for the inflation “knockouts” have spectacularly bad timing.  They spike up in mid/late 2008 when nominal GDP was crashing downward.  They spike up again in mid-2011 when nominal GDP growth has slowed from 5% to 3%.   And they spike up again in early 2013, when NGDP growth is still very slow at 2-3%.

The “knockout” actually triggers exactly once, in the February 2013 forecast, when the probability of the CPI rate being above 2.5% on the 18 month horizon is 51%.  In fact Mervyn King eased policy in that meeting.  Good thing he didn’t have a “knockout”!

This analysis is really telling us something we already knew: the MPC doesn’t like setting policy which produces forecasts of above-target inflation near the 2 year horizon.  You could argue that the MPC would not have tightened policy on this basis in mid-late 2008, because the “knockout” does not actually trigger (go above 50%).  But the salient point is that the MPC need an indicator which tells them they should have been dramatically easing policy by the middle of 2008; instead they will remain tightly focussed on the inflation forecasts.

Categories: Monetary Policy

Bank of England Targeting High Unemployment

August 7, 2013 5 comments

Simon Wren-Lewis is right to claim that the Bank isn’t targeting 2% inflation on the two year horizon.  At two decimal places, the Bank’s median forecast for the CPI rate is 1.96% on the two year horizon.  That’s what you meant, Simon, right?

Please, everybody, apply more Svensson.  The Bank’s forecasts are what the Bank is targeting.  There is no difference between the two.  The forecasts tell us exactly what the Bank expects to happen to the UK economy.

Carney made it 100% clear that the MPC will adjust the “tools” of policy if they do not think the economy is on an acceptable course.  He made it 100% clear that the MPC do think the economy is currently on an acceptable course; that is why they did not adjust QE/talk down rates/extend FLS/or whatever at the August MPC meeting.

It is 100% clear that the course the MPC currently expects the economy to follow is most likely to involve unemployment staying above 7% for the next three years.  We now have the fan charts to prove it.

Ergo, the Bank of England is now targeting high unemployment.

It cannot get any clearer, or more transparent than that.  It is a welcome improvement in transparency!  The Bank have made it 100% clear that “price stability” remains dominant over all other concerns.  No wonder the hawks signed up.

IR & press conference roundup:

1. Carney gave an impressively scary “steely eyed hawk” look to the WSJ’s Simon Nixon (who is a hawk, duh, like all WSJ employees) when pressed on whether the Bank cared if house prices rose 15% next year.  “No, Mr. Bond, we expect you to die.” – uh sorry, no, he said they were going to target 2% inflation (HT Marcus).

2. There was no addition to the BoE’s current levels of creditism. Celebration!

3. Scott rightly points out that UK monetary policy is still significantly looser than it was this time last year (market inflation expectations and equities up), even though the MPC undershot expectations.  True.  It is worth noting that the MPC has now undershot expectations with three consecutive announcements: the July MPC minutes, the August MPC decision, and now the IR.

4. Bill Keegan (Observer) asks the obligatory “but what about the tight, tight fiscal policy?” question.  Carney, paraphrased: “Good one Bill, very funny.  We don’t give a damn about fiscal policy, we only care about the CPI.  Have you seen the CPI figures, Bill?  They’re shocking.”

5. David Smith (Sunday Times) tries to trip up the new kid in town, quoting the RPI-based market inflation expectations.  Carney is not at all amused.  Don’t expect any exclusive interviews with the Guv’nor any time soon, Mr. Smith.

Any fiscalist who thinks this is a worthwhile improvement in UK monetary policy can take their plans to “do public works and create jobs”, get in their time machines, and bugger off back to the 1970s.  The hawks were totally victorious today.

I must end with a special mention for one Mr. Ed Balls MP, whose response to the IR provides us this with this priceless quote:

Given the high inflation we have seen over the last couple of years it will be very important that the MPC stays vigilant to inflationary risks.

Thanks so much for that one, Mr. Balls.  Apparently, those who failed to learn from Japan are indeed doomed to emulate it.

Welcome to the Lost Decade(s)

August 7, 2013 12 comments


The Committee intends at a minimum to maintain the current highly stimulative stance of monetary policy until economic slack has been substantially reduced, provided this does not entail material risks to either price stability or financial stability.

In particular, the MPC intends not to raise Bank Rate from its current level of 0.5% at least until the Labour Force Survey headline measure of the unemployment rate has fallen to a threshold of 7%, subject to the conditions below.

Very, very weak.  From the press conference intro:

Today’s Inflation Report contains for the first time, in Chart 5.10 on page 47, the MPC’s projection for unemployment. It shows that, with Bank Rate remaining constant at 0.5% throughout the 3-year forecast period, the MPC’s best collective judgement is that the median unemployment rate at the end of the projection period is 7.3%. Chart 5.11 on page 48, also new in this Report, shows that unemployment is judged by the MPC to be as likely to reach the 7% threshold beyond the three year forecast horizon as before.

The MPC expects to fail.  As with the Fed, we could have unemployment at 8% for the next century and the MPC cannot be judged to have deviated from its guidance.

Markets dropped on this announcement, so this is an effective tightening of policy versus what was expected.  Osborne’s gamble failed.