A Resolution Foundation report on UK monetary policy reminds me of the near absence of discussion about devaluation. The report has a section on policy options to deal with the ZLB, giving five choices: QE, negative rates, higher inflation target, fiscal policy, and structural reform. You could substitute “devaluation” for QE and/or negative rates; the section on the latter only mentions the exchange rate in passing:
Nevertheless, there is much uncertainty over the longer-term consequences of this approach – with exchange rate impacts likely to be a particularly important consideration for an open economy like the UK. And of course, even if the bound can be pushed below zero, at some point a limit must be reached.
The exchange rate does not have that lower bound. In fact, if you really believe the ZLB is a problem, a sensible policy reform would be to stop targeting interest rates (plus “doing QE”) and target a currency basket. The Monetary Authority of Singapore does exactly this. The UK often seems like a small open economy with delusions of being a large closed economy. We should dump the delusions.
I am not sure why there is so little debate about devaluation compared to e.g. fiscal stimulus. This is surely not a monetarist vs Keynesian argument. The theory behind pegging the exchange rate as a way of avoiding the ZLB is arch-Keynesian. Lars Svensson and others have been writing papers on this for decades. Are memories of Harold Wilson still haunting us? I would like to believe it is not because people have supply-side views of inflation, but I suspect that’s large part of it, at least in the media. (Inflation is something that lowers our living standards, and devaluation just causes inflation.)
p.s. The Resolution report is also unreasonably ungenerous toward central bankers’ anticipation of the ZLB, citing as evidence that the BoE Governor had only used the phrase “QE” in one speech prior to 2008. That is a bit silly because the term QE was not widely used prior to 2008. Mervyn King had long discussed the liquidity trap, and persistently rejected ideas of “monetary impotence” at the ZLB. See e.g. King (1999) or his fantastic 2002 paper, “No money, no inflation“. I’d suspect we have Merv to thank for delivering QE to the UK in the face of sceptics both inside and outside the Bank.
I wonder if the best defence of the theory that the imposition of the UK National Minimum Wage didn’t hurt anybody much is that there never really was a youth unemployment “crisis”. After all, it would surely look brave to believe both that the Low Pay Commission was “successful” in setting the minimum wage, and that there was a youth unemployment crisis right after a period of imposing higher and higher minimum wages on young people in the labour market.
One way to claim there was never much of a crisis is looking at the data on NEETs – young people Not in Education, Employment or Training, rather than the standard Labour Force Survey measures of unemployment. The ONS break the NEETs data down into the 16-17 and 18-24 age group, which is helpful because being NEET has become much harder in recent years for 16- and 17-year-olds as the school leaving age has risen to 18 in England (although not the rest of the UK).
The rise in the NEET rate for the 18-24 group during the 2008 recession was much less sharp than the rise in the LFS unemployment rate for the same group. Today’s data update suggests the youth unemployment crisis is perhaps over; at 13.8% for 2015 Q3 the 18-24yrs NEET rate is only a whisker above the all time low of 13.7% in 2004.
When central banks want to shift towards a different policy stance, market expectations are usually carefully and gradually managed through speeches, hints, and off-the-record leaks. The steps required to move the Bank of England from “not doing forward guidance” to “doing forward guidance”, for example, started with the appointment of Mark Carney in November 2012, continued through the various hints and nudges toward MPC remit review, only concluding with the actual guidance announced in August 2013. With forward guidance at best a fine-tuning of the short-run trade-off under the inflation target which the Bank should have been doing anyway, that’s really a tortuously slow process.
Policymakers like to think they maintain “credibility” by not making policy announcements which surprise the market. This makes sense to an extent, but it can go too far. To abuse a nautical metaphor, as is traditional, it’s sometimes too easy to imagine central bankers like the captain of the cruise liner who refuses to make a large course correction after spotting that the ship is going to hit the rocks, because making large course corrections might undermine confidence in the ability of the crew.
The insistence on not making large policy changes creates an environment which is actually very convenient for central bankers who want to hide their mistakes. In particular it lends a lot of credence to the theory that monetary policy has “long and variable lags”. If you only ever make small adjustments to policy it is never going to be very obvious that large changes could affect the economy in near real time. After the fact, you can always blame unexpected shocks, uncertainty, the imprecision of forecasting, etc, if your steering looks questionable.
British central bankers have announced for much of the last six years they expect to “hit the rocks” – undershoot the inflation target, and in private they might admit they could devalue the pound by 10 or 20% at any time, which would raise inflation a lot during the forecast period, i.e. avoid those rocks. But a 20% devaluation is a such crazy, non-serious idea that only an ultra-naive blogger would even suggest it, and surely most people realise that such a policy shock would undermine the credibility of the MPC?
I took a long-winded route to Switzerland. Here is the FT:
On January 15, the Swiss National Bank shocked markets by abandoning a three-year old ceiling on the franc’s value against the euro. In the hours that followed, the currency chart looked like the sheer face of an Alpine mountain as the franc shot up.
Swiss business soon felt the impact, and the economy contracted by 0.2 per cent in the first three months of the year.
Meanwhile, January’s turmoil and persistent, below-zero inflation rates threaten the central bank’s credibility. The SNB forecasts inflation will fall to a low of minus 1.2 per cent in the third quarter of 2015 and turn positive again only in early 2017.
I find it strange that it’s so simple to associate a monetary shock with an almost immediate contraction, but harder for people to imagine how a monetary shock can cause an almost immediate expansion. Could monetary policy possibly be so asymmetric? The FT article discusses four options for the SNB, all of which “entail risks, pushing the traditionally-conservative SNB further into untested policy territory”. Yes, switching from Policy A (the old weak franc policy) to Policy B (new strong franc policy) has caused things to get worse… so… what should they do now? It’s a real head-scratcher.
In case anybody thinks I’m pulling a fast one and weaker Swiss RGDP was just one of those funny co-incidences, the Swiss Federal Government’s official forecast group was very clear about cause and effect when revising their forecasts back in March; they do not expect the the slow down to be particularly severe, but slightly higher unemployment and lower output and inflation has achieved… what, exactly? The FT article contains one suggestion:
The SNB’s concern is financial stability, says Mr Harvey. “It has kind of given up on its price stability mandate, and prioritised balance sheet risk,” he says. “It is a very Swiss approach.”
A quick look at the SNB’s web site appears to confirm the expected: the tight money (strong franc) policy has been associated not only with lower interest rates but also a larger balance sheet, so if there are “risks” from expanding the monetary base, they are not going away with tighter money. It all sounds rather Swedish to me.
Landlords are allowed to deduct a wide range of expenses, on top of mortgage interest costs, before they have to pay tax on their rental income. These allowable expenses include the cost of insurance, maintenance and repairs, utility bills, cleaning and gardening, and legal fees. Ordinary homeowners are not entitled to similar privileges.
The idea that “ordinary homeowners” do not enjoy the “privileges” of landlords in the tax system is wrong; in fact the opposite is true. Owner-occupation is slightly favoured over rental, since the imputed rent of the owner-occupier is tax exempt, whereas the actual rent received by landlords is taxable income. In addition, capital gains are taxed for landlords and tax exempt for owner-occupiers (with some minor caveats). That’s just taxation: the long list of direct government subsidies for residential mortgage lending surely further skew the balance of subsidy towards owner-occupation; an NAO report from March 2014 lists (Figure 2) six different schemes since 2006, and then we could move on to bank regulation, and so on.
The ONS estimates owner-occupiers’ imputed rent at £125bn in 2014, so perhaps a more accurate (though still nonsense) headline would be that homeowners receive a “£125bn subsidy” over landlords? I suppose that wouldn’t fit as neatly into the standard Guardian workers vs capitalists zero-sum narrative. I highly recommend Chapter 16 of the Mirrlees Review for a thorough discussion of land and property taxation.
The “Generation Rent” group (who claim to campaign on behalf of renters) seems to be firmly embedded in the long tradition of completely insane British housing market policy, proposing in their manifesto both rent controls and the extension of a weak form of “Right to Buy” to the entire private rental sector. They are a reliable source of silly quotes in any article about the housing market, this time coming up with:
“The tax system also puts landlords at an advantage over potential owner occupiers when competing for the limited supply of houses and it’s those thwarted first-time buyers who end up paying off the mortgage anyway in rents. “We need to stop subsidising property investment and use that money to build more homes instead.”
We need to stop subsidising investment in property… so we can invest more in property? A cunning plan.
If you compared two periods:
1) Period One, where nominal asset prices fell 15%, nominal incomes fell 4%, the labour market was contracting sharply … oh, and the CPI rate was usually above 3%.
2) Period Two, where nominal asset prices are at all time highs, rising 5-10% p.a., nominal incomes are rising 3-4%, the labour market is expanding rapidly… oh, and the CPI rate was slightly negative.
… which period would you call “deflation”?
To keep my comment section happy, here is some “productivity scepticism”. I like this theory from Paul Donovan of UBS discussed in a Guardian article, here quoting Donovan:
“In 2000, 32% of UK businesses were employers. By 2014, 24% of UK businesses were employers. This raises the obvious question of what on Earth 76% of UK businesses were doing if they were not employing anyone – and the answer of course is that they were single person businesses where the owner was the sole person ‘on payroll’.
This matters for capital spending, because people setting up as self-employed – for example, as a consultant – may well make little or no upfront investment in kit. Says Donovan:
“If you are a self-employed consultant, you probably already have a laptop, have a car, have an office at home. As the boundaries between home and work blur, we are making better use of the capital we have got.”
“What this means is that investors looking for a “capex recovery” may be missing the point. The secret capex story may be that businesses make better use of non-business assets, and that part of the capex cycle … masquerades under a ‘retail sales’ pseudonym.”
One of the puzzling parts of the UK productivity puzzle is the divergence of employment and output during late 2011 through 2012, when output barely grew and employment soared. If output and employment are both growing we can use the “low-skilled labour supply shock plus composition effect” theory to explain slow average productivity growth, but that doesn’t work well for this period.
We can (partially) resolve this problem by revising up 2011-2 real GDP, and Donovan’s theory could help here. 2011-2 saw a self-employment boom; if capital investment by the self-employed shows up only as consumption, or not at all, then measured GDP was too low. The recovery in household consumption of durable goods has been much stronger than total consumption, up 19% from 2008 Q1 to 2014 Q1 versus 2% for the latter. One of the upcoming ONS methodology changes is to remove a £500 lower bound on what counts as capital spending in the business investment survey, perhaps this will help.
File under “grasping at straws” if you prefer. There are good reasons to be sceptical there is any significant bias in measuring GDP, and other survey indicators (PMIs etc) suggest the 2011-2 quasi-depression was roughly that. Stories about the unemployed being pushed into “false” self-employment could make us doubt the jobs data instead, though again it would be surprising if that was sufficient to explain such a large shift in the labour market surveys.
What do you expect to happen with a 2% inflation target, if productivity growth falls from 2% per annum to 0% per annum? You expect tight money. Nominal wage growth must be pushed down from 4% to 2%. If nominal wages are sticky you’ll need a nasty blast of unemployment to achieve this. But the labour market will adjust eventually to the new equilibrium. This is the EARN08 table which tracks one measure of nominal hourly wages, updated today, steadily tracking below 2% average growth since 2009.
Alternative view using nominal weekly wages, with the arrow highlighting that dangerous inflection point in Britain’s inflationary wage/price spiral which prompted Carney and other MPC members to insist last year that Bank Rate would soon rise:
Of course everybody knows that productivity growth will pick up to 2% per annum again, slash return to the pre-crisis trend, and then wages will rise 4% per annum again, slash soar into the heavens, and everything will be just fine. See also, Bank of England productivity forecasts today.
Welcome to Britain, have a nice day!