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Archive for February, 2015

The Supply Shock is Coming… in 2016(!?)

February 19, 2015 2 comments

Carney has stuck by his line that the falling oil price is “unambiguously positive” for the UK economy, repeating it in the Inflation Report last week   The oil price collapse started in September 2014.  I’ve charted here the latest three median forecasts produced by the Bank in each Inflation Report, for both CPI inflation and real GDP growth:

BoE Median CPI Forecast

BoE Median CPI Forecast

BoE Median Real GDP Forecast

BoE Median Real GDP Forecast

What do we see?  A huge downgrade to the expected path of inflation concentrated on 2015.  You do not see revisions like that very often.  At the same time we have a very slight downgrade to real GDP growth over the year to 2015 Q1, and a rather small upgrade, mostly in 2016.  So, the “unambiguously positive” effect seems a bit ambiguous to me, less a Draghi-esque “with low inflation, you can buy more stuff“, but something more like: “with low inflation, a year later you can buy more stuff.”

Here’s a crazy theory – let’s call it the Bernanke, Gertler, Watson theory.  The effect of the falling oil price has little to do with oil, or even the relative price of oil, but is mostly a reflection of the central bank’s reaction to the effect of the oil price on headline inflation.  Though interest rates are definitely ambiguous, in September 2014 the Bank was expected be raising rates from early 2015.  Today, the MPC is not expected to be raising rates until late 2016.  The Bank’s CPI/RGDP forecasts are based on the market curve, and the forecast model will have “lower rates for longer” cause faster growth.

Alternatively we could look at the “unambiguously negative” effect of the rising price of oil in 2011 on the Eurozone: similarly, very little to do with oil, and everything to do with the ECB’s reaction to the rising oil price: two rate hikes aimed at slowing AD growth and inflation.  They declared that policy a success!

Really, no big surprises here.  An honest Governor could confess: “The falling oil price is a good thing because it means the MPC is less likely to screw up like it did in 2008 and 2011” – although he might look a little foolish.

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Bank of England no longer at the ZLB

February 13, 2015 1 comment

I didn’t expect to be writing this post so soon!   The Governor of the Bank of England announced yesterday that interest rates are no longer at the Zero Lower Bound.  This was a rather under-the-breath “Oh, and by the way” announcement, which is kind of funny given how much some economists have staked on the significance of the ZLB.  From Carney’s letter to Osborne, my emphasis:

There are risks to the outlook in both directions. To the downside, the fall in near-term inflation could be more persistent than the Committee currently expects. Global activity could continue to disappoint, or if low inflation were to depress inflation expectations, it could become self-reinforcing. In that case, the MPC would need to provide more support to return inflation to the target over the appropriate horizon.

Were these downside risks to materialise, market expectations of the future path of interest rates could adjust to reflect an even more gradual and limited path for Bank Rate increases than is currently priced. The Committee could also decide to expand the Asset Purchase Facility or to cut Bank Rate further towards zero from its current level of 0.5%. The scope for prospective downward adjustments in Bank Rate reflects, in part, the fact that the UK’s banking sector is operating with substantially more capital now than it did in the immediate aftermath of the crisis. Reductions in Bank Rate are therefore less likely to have undesirable effects on the supply of credit to the UK economy than previously judged by the MPC.

In choosing to hold rates at 0.5%, the MPC is choosing to set rates above the new, lower, actual ZLB.  The Bank of England is no longer at the ZLB.

The good news is that now the Bank is off the ZLB, reality-based Keynesians will return to talking about UK macro policy in terms of conventional monetary policy and will go quiet about the need to use fiscal policy to control AD.  Right?  No more talk of building schools to create jobs.  We are seeing today the Bank’s preferred path for output and inflation.  It leads to 2% inflation and zero output gap.  We know, that if the Bank wanted a different path for output and inflation they can use the conventional tools of policy.  If you think that path is not optimal, it is either because the Bank has the wrong target, or that you believe they are making a conventional policy error.  Either way, no need to talk about fiscal policy.

Musical Chairs in Britain, Revisited

February 12, 2015 3 comments

Economist writer H.C. has an interesting Free Exchange post discussing Scott’s “musical chairs” model and British unemployment.  Scott also comments.  Here is my curve-fitting exercise:

One of the difficulties in working with the UK macro data is that the ONS don’t produce a good quality high frequency time series for hourly wages.  Of the available data we have low frequency, high accuracy data in the Annual Survey of Hours and Earnings (ASHE) based on very large sample of employers’ payroll data held by HMRC.  At the other end we have high frequency, low accuracy data in the Average Weekly Earnings (AWE) data, produced from a small survey which deliberately excludes a number of workers (notably, I believe, high earners and small employers).  I compared the range of various sources at the beginning of last year.

In this post I’ll use the lower quality AWE data, from which we have time series for both regular (ex bonuses) and total weekly pay, and also for average actual hours worked.  I’ll also assume that bonus pay is not very sticky.  From either pay series we can then calculate average hourly wages by simple division.

The musical chairs model says there is a strong positive correlation between the unemployment rate and the ratio of hourly wages to nominal GDP.  I’ll cheat slightly (I did warn you this was a curve-fitting exercise) and use nominal GVA at basic prices instead of NGDP.  An increase in nominal GDP which is accounted for entirely by an increase in indirect taxes would not be expected to increase the resources available to hire workers; since we’ve had big VAT shocks in the UK I think this is a reasonable “cheat”.

Here’s the first version of the musical chairs graph, using regular wages to derive hourly wages:

Music Chairs in Britain

Music Chairs in Britain. W/NGVA/pop. Source: ONS KAI7, YBUV, MGSX, ABML

I would say this has done quite well since 2008: though the recovery is predicted slightly too fast, and the correlation is absent for the period prior to 2008.

A second interpretation is to use aggregate employee income instead of nominal GDP/GVA, so changes in the labour share of GDP don’t affect the results:

Musical Chairs in Britain

Musical Chairs in Britain. W/Wage Income/pop.  Source: ONS KAI7, YBUV, MGSX, RPCG

This is a better fit.

One thing that either of these models will struggle with, if only because of data limitations, is the shift between employment and self-employment.  There have been two very large swings in UK self-employment in the period covered above: a 9% rise in 2003 and a 10% rise in 2013/4.  We cannot really measure the wages of the self-employed, and as far as I know those workers are entirely excluded from the AWE data – I would not find it surprising that the musical chairs model appears to breaks down for that kind of shock.  If there are studies on self-employment and wage stickiness I’d be interested to hear in the comments.

Categories: Data, Wages