CPI rate at 0.5%! It appears we are well clear of the “boring period” for UK macro. Shame. I am impressed by the media commentary around inflation. Go read our good friends at the FT, and Allister Heath at the Daily Telegraph.
A quick reminder of the modus operandi of inflation hawks witnessing above-target inflation:
1. Acknowledge that inflation can be driven away from target by supply-side shocks as well as demand-side shocks.
2. Identify an alternative inflation measure which attempts to strip out those supply-side effects and supports a demand-side interpretation of high inflation.
3. Remind the world that there are serious consequences of allowing inflation to deviate from target (unanchored inflation expectations, a wage/price spiral, the 1970s, civil unrest, meteor strikes, etc), ergo we need tighter monetary policy.
I exaggerate only slightly there. Now here is Simon Wren-Lewis:
This is also why looking at some measure of core inflation is important. If below target inflation is just due to lower oil prices, say, which in turn are just lower because of increased supply, say,  then this is no reason to think resources are being wasted. Just as inflation targeting central banks should largely see through any inflation caused by higher oil prices, they should also do the opposite. However in the UK, US and Eurozone core inflation is significantly below target, suggesting resources are being wasted everywhere.
I groaned all the way through Simon’s post. There is no official measure of “core inflation” in the UK, and the MPC rarely makes any reference to such an index. The ONS variant of the CPI which strips out energy, food, alcohol and tobacco is probably closest to what would be a textbook “core inflation” index. Here is the chart of that series:
As you can see, “core inflation” was above 2% all the way from 2010 through late 2013. I’ll predict the response: “Look at 2010 and 2011. Obviously we should strip out VAT too, you idiot!” OK, that’s sensible, I agree, but there is no ONS index which does that. The ONS produces literally hundreds of different price index series, and you want to argue that the one which really matters when setting monetary policy… doesn’t actually exist. Really?
Regardless, even with stripping out VAT in 2010/11, we are left with above-target “core inflation” in 2012 and and most of 2013. So, who was citing that data and arguing that we obviously had a too-expansionary monetary policy, and clearly there was little or no output gap with inflation pushed safely above target? I don’t remember Simon doing so. Yes, we can qualify the inflation data even further. Let’s strip out train fares, water prices, tuition fees, other administered prices, all prices which went up, etc. Those are (ahem, mostly) reasonable arguments. But recognize that this is basically the same logic followed by the hawks.
I could make a fence-sitting argument where I say the hawks might have been “correct” to take a demand-side view of high inflation in 2011, just as Simon might be “correct” to take a demand-side view of low inflation in 2015. But I don’t believe that. I think the hawks were mostly wrong before and I think Simon is mostly wrong now in taking a demand-side view of supply-side shocks. From my previous post, the recent downward revision to forecasts of inflation for 2015 happened at the same time as downward revisions to forecasts of unemployment. That is simply not what a negative demand-side shock looks like.
The “balance of risks” argument is reasonable, and it might be true that a slightly looser monetary policy will do little harm now – hey, after all, there is a risk house prices in London stopped going up*. In fact, sterling fell in response to the inflation data surprise, indicating precisely that money got slightly easier, so a “dovish” reaction to low inflation surprises is already embedded in current policy. In the long run I think we’ll have a more stable economy if monetary (and fiscal) policy makers can be encouraged into looking at “inflation” in a way which doesn’t require sharp swings in aggregate demand in response to supply shocks.
* This is a joke. Also it’s not a joke. Having UK monetary policy target the oil price with too high a weight would be likely to create excessive volatility in nominal demand and hence other nominal asset prices, so I think we’d expect to see more boom-bust housing cycles.
Good retail figures today from the ONS, with another decade high:
• Year-on-year estimates of the quantity bought in the retail industry continued to show growth for the 20th consecutive month. In November 2014, the quantity bought increased by 6.4% compared with November 2013. This was the highest year-on-year increase since May 2004 when it grew by 6.9%.
This is always my favourite series:
There have been quite a number of papers over recent years (e.g. Cheshire et al, 2012) documenting how UK land use regulation has damaged retail productivity, for instance by restricting store size. I wonder to what extent the shift to on-line shopping is both a response to – and ultimately a route around – those regulatory restrictions. On a per capita basis, Amazon appears to have more warehouses in the UK than any other country; it would be fascinating to know how their productivity compares across countries.
The 2008 Pre-Budget Report was a response to a combined demand-side and supply-side shock. The major discretionary changes were a temporary deficit-funded VAT cut (demand-side or supply-side stimulus, take your pick), bringing forward some planned capital spending (ditto), “efficiency saving”-type cuts planned for 2010 onwards, plus:
1. introducing a new 45% marginal tax band for high earners,
2. introducing two new 60% marginal tax bands for high earners (“for no obvious economic rationale” – Robert Chote),
3. raising employee and employer-side national insurance rates from 2011,
4. raising alcohol, tobacco and fuel duty.
Pop quiz. Would you expect those policy changes to (a) increase or (b) reduce potential aggregate supply? If you don’t like the framing of this obvious right-wing trap, let’s ask another question. In that PBR document the Treasury described the situation as follows (p161):
[…] the global credit shock has significantly increased the uncertainties surrounding trend productivity and it is therefore difficult to assess to what extent lower rates of productivity growth over the course of 2007 and 2008 are likely to reflect cyclical or structural developments. Challenges in decomposing recent developments into cyclical and structural elements are likely to persist for some time.
From the perspective of 2014, the last sentence in that quote is certainly astute; the challenge of decomposing cyclical and structural issues has arguably only got harder since 2008. My (slightly) less loaded question, then: would the aforementioned tax hikes reduce or increase your uncertainty around the future path of productivity?
I had a depressing conversation with a friend recently, a high-skilled high-ish-earner with two growing-up children and a partner looking to return to part-time work after a few years providing full-time childcare. The family had calculated that due to the insane schedule of child benefit withdrawal, they could raise their net household income by having the high-skilled parent take a day off per week, and have the lower-skilled parent take a part-time job working that day. (This happens because the increasingly generous personal allowance applies a 0% marginal rate to the lower hourly wage and the benefit withdrawal schedule imposes a 60+% reduction on the higher gross hourly wage.)
That’s only a dumb anecdote, and I hate policy-by-anecdote debates, but it seemed like a good reflection of what has happened to the UK labour market. Since 2007 the government has introduced policy after policy aimed at reducing labour supply from high-skilled workers, just a sample here:
- The top tax band, now back at 45%, remains higher than in 2007.
- Marginal tax rates due to various withdrawals have risen at 60% and above for some.
- “Fiscal drag” means an increasing proportion of the workforce is hit by higher marginal rates; the IEA claim that in 2013, one in six income tax payers face a 40% tax rate, up from one in sixteen in 1990.
- Immigration reform aimed at reducing the number of (future) high-skilled workers entering the country.
For many of the policies above, I would think we would see the “long run” effects pretty quickly. At the same time, we have benefit reform and a large increase in the personal allowance aimed at increasing labour supply from low-skilled workers. If you discourage labour supply from high-skilled workers at the same time as encouraging supply from low-skilled workers, what’s the expected effect on average productivity? I don’t want to overstate the case, but surely at least some of the reduction in productivity which we’ve seen is just not that hard to explain. (Post title stolen shamelessly from Sumner/Lucas.)
PS. Since I know some progressives believe raising tax rates causes people to work harder, I asked the Guardian’s personal finance writers for their advice to those facing higher marginal tax rates:
Taking an extra week’s unpaid holiday,
The first six words were enough.
Carney on supply shocks at the Financial Stability Report yesterday when asked a question about “oil price risk and deflation risk”:
Mark Carney: Yeah. The – in terms of oil, I mean, this is a net positive development. I went through some of the channels of risk in my remarks – geopolitical, uncertain high yield issuers and then this deflation point, which I’ll expand on.
But I think we should be clear that the 40% plus drop in the oil price will flow quite quickly through to consumers; it will increase real disposable income; it’s a net positive for the UK economy. And the relative exposure – the relative exposure – of the UK financial system to the energy complex is manageable. And so unambiguously – net positive.
I asked this before but I’ll ask it again. Who is upgrading their forecast for UK real GDP growth in the light of falling oil prices? The Treasury’s helpful comparison of independent forecasts came out today, and that upgrade is not showing up yet.
A quick post on this, this data deserves wider attention. You might expect that UK inflation expectations would have fallen recently, given the collapse in oil prices. You’d be wrong. This is the BoE data for this year for implied RPI from the gilt market.
UPDATE, January 2015: This data is wrong. See subsequent post.
(Reminder for non-Brits, expect the RPI rate to be roughly 1% above the CPI rate, 2% on the latter being the Bank’s actual target.)
That’s actually a very dovish (as in “high”) inflation forecast, when many forecasters are busy revising down their short-term inflation forecasts as the oil price falls. What are the markets seeing that the City scribblers have missed?
If we take the data as given… I could argue this one either way. On the one hand, an inflation-targeting central bank really should be judged on its success in stabilising the expected path of inflation. MPC members should be crowing about this data. On the other hand, we know that inflation-targeting central banks which try too hard to hit their targets in the face of large supply shocks tend to screw up time and time again.
So, let’s cheer a little, but perhaps quietly. I don’t see any reason to be concerned about near-term demand-side weakness as long as the the MPC continues to keep short-term inflation expectations steady in the face of a large supply-side disinflation.
The headlines scream twelve-year low for inflation. Meanwhile, UK inflation is at a nine year high. Confused? Tough luck, “inflation” means whatever I want. When Paul Krugman uses the word “inflation” he really means something like “aggregate demand” 99% of the time. When you read Krugman saying “inflation”, imagine Sumner saying “nominal GDP growth”. Same idea, same model. This is Krugman attacking Jürgen Stark making a “low inflation means we can buy more stuff” argument, back in April this year:
So, Stark begins by asserting that low inflation boosts real disposable income. That’s a zero-credit answer on any undergraduate exam: yes, low inflation makes income gains higher for any given rate of increase in nominal income, but low inflation reduces the rate of nominal income growth one for one. The notion that an influential former monetary official doesn’t understand this is breathtaking.
Like the Stark claim that “low inflation boosts real incomes”, Krugman’s argument that “low inflation reduces the rate of nominal income growth one for one” is either wrong or trivial. Stark is saying “positive supply-side shocks increase real income”. Krugman is saying “negative demand-side shocks reduce nominal income”. Well, yes. Both are correct, so let’s take the word “inflation” out of it completely.
In the UK’s “high inflation” period (2008-2013) we also had “low inflation”. We had a high CPI rate, and slow nominal income growth. Which “really mattered”?
Today we have “low inflation” – and also “high inflation”. We have a low CPI rate, and fast nominal income growth. Growth of nominal gross value added over the two quarters to 2014 Q3 is at the highest rate (7.7% annualized) since 2005. Four-quarter NGVA growth at 5.3% is the highest rate since the four quarters to 2008 Q1.
Does the CPI rate going 1% below target “really matter” in a way that going 3% above target “didn’t matter” in 2008 or 2011? You can make that argument, but I say we’re in no bad position right now.
I see some fuss over the wage data (again)… but I’m not convinced, especially since this happened earlier in the year and it was a false “dawn”. Declaring my bias: I want to believe there is still a massive hole in labour supply, either in the form of unemployed workers, or workers not getting enough hours. Hence, we still have a significant output gap, and we can expect to see unemployment fall to somewhere near 5%. Fast wage growth now would be a disconfirmation of labour market slack, so in a sense it is not what I “want” to see. (I also prefer that we’d had a macro policy since 2008 which had aimed for 4% wage growth and avoided large shocks to unemployment.)
Martin Weale and others are citing survey measures of pay settlements. I don’t see any reason to trust that over the ONS data. But the ONS labour market update for 2014 Q3 gave us a spike in the 6m growth rate:
That measure is clearly quite volatile.
The annoying thing here really is the “policy-based evidence-making” by Weale (et al), who has spent the last four years cherry-picking whatever data best supports his preferred policy of higher interest rates. In 2011 Weale told us to look at the GVA deflator, in 2013 the excuse was unit labour costs, and in 2014 the excuse is that he spoke to some business owners who said wages were rising. And by the way in 2014 the GVA deflator is running below 2% y/y and unit labour cost growth is around 0%.
Anyway, here are trends and levels for private sector regular weekly wages:
That tiny spike is enough to warrant rate rises? Really, that’s the best argument there is? We also have the quarterly estimates of hourly earnings, with the update to the “EARN08″ table, although this survey measure excludes very high earners:
Again… there is no “inflation”.