This is what Resolution’s Matthew Whittaker had to say about inflation in a piece for the Independent earlier this month, titled “Why the Bank of England should target wages as well as unemployment“:
Nothing at all. There is no mention of the word “inflation”, nor of the “CPI”, nor even “prices” in a piece purportedly about UK macroeconomic policy – about UK monetary policy. I’m sure Matthew is a good guy, and I’m not trying to pick on him specifically, but that is a beautiful illustration of how I see centre-left/progressive economists addressing UK inflation over the last five years. The motto is “Don’t mention the
Yet at the same time the centre-left political movement has been obsessing about inflation – that is literally what the “cost of living crisis” means. Yes, you can come up with a different translation of that phrase, but the CPI really is how we measure “the cost of living”. It is going up, and that is a “crisis”. In fact it is even worse: progressives love to exaggerate the extent to which the “cost of living” has risen, by deflating nominal wages by the RPI (rather than the CPI) to show just how badly real wages are suffering.
This is all both depressing and frustrating to watch. I’d roughly agree with Mr. Whittaker’s eventual conclusion, that targeting nominal wages (or nominal incomes) is a good idea. But he gets there from talking first about real wages, and then median wages (which is almost as bad), without use of the word “nominal”, so it is not totally clear he even wants a nominal target, but let’s assume he does. And so does Mr. Whittaker want the Bank to continue targeting the CPI… and unemployment… and add nominal wages as well? Really? All of those things at once?
I have a relatively simple narrative about what the BoE has been doing for the last five years: roughly what they’ve always done, keeping the “risks to inflation broadly balanced”… around the 2% target. I construct that narrative based on what the MPC have been saying for the last five years, month after month after month. What that means in practice is that the Bank steer a course for nominal demand (NGDP) which is sufficient to keep the CPI on target.
And so the Bank defend their policy stance based on those damn CPI numbers. Is that wrong? Why should it be – hitting the CPI is their legal mandate! How can anybody possibly argue that UK macro policy was too tight ex post, at the same as attacking the government because “the CPI is too damn high”. That would be utterly ludicrous… and it is the critique of Coalition macro repeated endlessly for the last three years.
There are more complicated narratives too. Maybe that unexpected shocks to nominal demand have resulted somehow more in lower measured productivity and output, less in lower prices/inflation. OK, maybe that is a bit true, and I hope it is a bit true. But if that is even a little bit true, then inflation targeting is the worst possible monetary policy you can have, and you need to be openly screaming about that fact. “Inflation targeting is not working“, you might write.
Instead the best and brightest on the centre-left have been producing critiques of UK macro policy along the lines of:
a) Monetary policy is not a panacea. (Well, thanks so much. Jens Weidmann totally agrees with you.)
b) We need more infrastructure spending. (Brilliant. And what about macro policy?)
c) No really, we need more infrastructure spending. (Yeah, but that’s not a macro policy, is it?)
d) I insist there is a big output gap because X, Y, Z. (Fantastic! The Bank are still targeting the CPI.)
e) Infrastructure spending? (Please stop.)
f) How about we target a real variable like unemployment? (Yeah, the 1970s were brilliant.)
All of that serves only to duck the real question… the nominal question. The nominal question appears to me to be remarkably simple:
What is more important: (1) output/consumer price stability, or (2) nominal wage/income stability?
If you want “price stability” then you can’t have nominal income stability. We’ve tried that. Productivity shocks are horrible, and inflation-targeting seems to make them much worse. And if you want nominal wage/income stability then you can’t have “price stability”. We need to be open about that, with the politicians and the public; “price stability” was a good idea which failed. Can we do better?
Now, please, get off the fence and decide what you really, really want.
Egon Spengler: There’s something very important I forgot to tell you.
Peter Venkman: What?
Spengler: Don’t cross the streams.
Spengler: It would be bad.
Venkman: I’m fuzzy on the whole good/bad thing. What do you mean, “bad”?
There are few things I hate more than reading headlines saying “GDP growth driven by X” – especially where X is usually something deemed “bad” like “consumer spending”, or “household debt”, or “rising house prices”. There is much fallacious thinking packed into these headlines, and it usually plays out in the articles. “Rising spending leads to rising incomes”, “rising incomes lead to rising spending”, “rising employment leads to rising demand”, “consumers can’t spend more with real wages falling”, and so on, and so on.
All these phrases want to take the macro out of macro; incomes rise then spending rises, or vice versa. In aggregate, spending and incomes are always equal by definition at every point in time because “spending” and “income” are just two different ways to record the exchange of goods and services for money.
What really “causes” rising aggregate spending (income)? Well, of course, the expectation that aggregate spending (income) will rise. Expectations above all else… house rules.
Anyway, my point is, Larry Elliot is very confused:
Fears that Britain’s consumer-led recovery is losing momentum are increasing amid signs that the rising cost of living is hitting confidence and high-street spending.
There is no more a “consumer-led recovery” than there is an “household income-led recovery”. Expectations of income (spending) went up and hence income (spending) went up. Forget about the grossly deceptive partitioning. And do you think the falling cost of living is raising confidence in Spain or Greece, Larry? Maybe UK macro policy is just not tight enough for the Guardian econ editor, who is still addicted to the opium marketed as “price stability”?
So here is some “cheerleader for growth blogging” as a counterpoint to media doom and gloom: the EC’s Economic Sentiment Indicator update for November was published today, and it is says UK “confidence” is up slightly on October and still up in “boom” territory.
The Q3 nominal GDP figures are out. I cannot be too unhappy with NGDP growing at nearly a 7% quarterly rate. If this rate of nominal growth can continue consistently for a couple of years that is close enough to what I’d hoped we’d see.
Here is the quarterly growth profile, at seasonally adjusted annual rates:
On the annual view, I’ve used GVA not GDP to factor out the VAT changes as usual; real and nominal GVA continue to move in lock step, with the GVA deflator still stuck around 1-2% since the beginning of 2010:
And for the all-important fiscal arithmetic, for a change nominal GDP is growing faster than OBR forecasts, hence debt/GDP and deficit/GDP should come in a little better than expected.
The Bank’s forecasts for real GDP growth over the next two years. 2014: 2.8%, 2015: 2.3%. WHAT A BOOM. What an explosion of growth! In the Inflation Report press conference today, the press first asked lots of sensible questions about forward guidance and monetary policy – you know, the things the MPC are actually responsible for. But there was an elephant in the room, something was weighing on the minds of assembled hacks… see if you can spot it.
Richard Barley, Wall Street Journal: … Because I guess the concern is that so far we’ve seen perhaps some worrying signs of returning to the old normal and greater lending, reliance on house prices.
Guy Faulconbridge, Reuters: Just a follow on on the housing, I see you have a section on property. Do you see any signs of a bubble in any regions of the British housing market, because overall it’s fine to say that perhaps prices are still below the 2007 peak, but in London dinner parties the prices that you pay for prime real estate in London is kind of the main topic of discussion.
Tim Wallace, City AM: Governor, another one on housing.
Maybe hold the press conference up North somewhere next time?
Chris Giles’ post on demand vs supply made me very gloomy – look at the comparison with US productivity, the “cost of living crisis” is right there in that data. Here is a slightly different take based on today’s labour market figures.
You could say based on that, the UK demand-side recovery is basically complete. Hours worked is back on trend. The demand-side debate is dead. The stagnation of UK output is, and always has been, purely supply-side.
The fact that supply-side optimists find excitement in one month of a still-above-target CPI rate is even more depressing. Has nobody learned anything at all? If the CPI rate is irrelevant when it tells an “inconvenient story” about the aggregate supply/demand balance, it does not suddenly become relevant because one data point confirms your biases. Recognize that oh-so-wise policymakers might not share your rose-tinted view of the UK inflation data, and what implications that has for macro policy when the CPI rate is above target (see also 2008, 2010, 2011, 2012). Yes, the MPC really are steering us towards price stability.
And Dr. Carney… great job, really, great job.
There’s been some discussion of UK productivity recently, Simon Wren-Lewis here, Martin Wolf here, and Scott Sumner indirectly too. What I find interesting is that UK productivity exhibits such a strong positive correlation with nominal demand growth. I’ve graphed here the growth rates of nominal GVA, and market sector output per hour.
Why do we see that procyclical movement of productivity? I’ll offer three views:
1. Firstly, this is simply what we should expect to see under an inflation-targeting central bank. The inflation-targeting CB is trying to control the gap between (growth of) aggregate demand and aggregate supply. When we have a negative productivity shock (2008, 2012) the CB must drive down nominal demand growth to prevent high inflation. That’s all this data shows; Mervyn King and the supply-side pessimists will settle for something like this view. There is no AD problem per se, it’s supply, supply, supply.
That story is muddied only a little by the difference between CPI inflation (the actual BoE target) and output price/GVA inflation. GVA inflation, averaging 1.8% over the last four years, has been stabilised by the BoE arguably more effectively than the headline CPI.
2. Another view is that the GDP data is wrong, at least post-2009. The 2012 productivity collapse is genuinely weird. The fall in market sector output/hour masks the fact that hours worked soared upward, up 2.6% over the four quarters to 2012 Q4, while market sector output contracted by -0.3% over the same period. (The GDP data still show a market sector “double-dip” in 2012, offset by the positive contribution from the
savage fiscal austerity rise in the volume measure of government consumption). There are a few theories here:
a) The idea that the GDP data is wrong is neatly supported by work on measuring intangible investment (see Goodridge, Haskel et al). I find this quite compelling because it matches an anecdotal view of what is happening in some sectors, e.g. retail. With the shift towards on-line shopping; that sector is investing in intangible assets (web sites, software etc), and there is less demand for new tangible capital (shops).
b) Markit’s Chris Williamson made the argument recently that the official labour market data which is wrong. The ONS disagreed, needless to say. Given that the change in unemployment has roughly tracked the movement in the claimant count, I’m not sure how much weight to put on this idea.
c) The nominal GDP data is right, but the inflation data, and hence output and output/hour, is wrong. A pet theory of this inflation-sceptic blogger. Under five years of 1920s-style NGDP growth we have seen widespread discounting and substitution. For the latter, think about the success of UK budget hotels, airlines, and supermarkets; this is substitution between goods/services of different quality. I strongly suspect such changes are near-impossible for the ONS to capture “correctly” in the price indices, and hence measured inflation is far too high. This makes measured productivity appear to be more procyclical than it should be if we “correctly” measured inflation and output.
3) A third view… it’s demand, demand, demand. The slow growth of NGDP was simply a mistake, it was bad macro policy. Labour hoarding and hand-waving are used to explain away the productivity data. The correlation in the graph really is a causal relation, but it goes from demand to productivity; we’ll see a recovery in productivity with a recovery in AD. So jump to it Mr. Carney/Mr. Osborne.
In optimistic moments I can subscribe mostly to (3), and 2013’s apparent recovery in output along with a recovery in demand supports that argument, in my view. Martin Wolf argues the Bank can “correct… highly visible errors” on inflation later on, after “gambling on growth”. But what is a “highly visible error” if not the last five years of UK inflation?
Supply-side optimists cannot sit on the fence and pretend the 2008-201X CPI trainwreck never happened. It’s surely more convincing to argue we should take productivity – and inflation – out of macro policy altogether. Set a stable path for nominal incomes and let the supply-side puzzle itself out.