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:
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.
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.
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.
It appears my timing could have been better in calling UK macro boring.
Those are not my ideal measures but the closest for which I have good data. The 2.5 year implied RPI has fallen by 0.5% over the last thirty days, to 2.4% as of yesterday, implying a significant undershoot of the 2% CPI target over the Bank’s forecast period (2-3 years). The FTSE 250 is at the lowest level for a year.
I caught a Newsnight discussion on the UK inflation data which was perfectly introduced by Duncan Weldon, who asked the right question: is the fall in inflation driven by the demand-side or supply-side? The studio debate which followed was a little disjointed from the reality in which the UK CPI rate has been a consistently bad indicator of UK demand-side strength. In fact it’s a contrary indicator, since periods of stronger real growth have been associated with weaker inflation and vice-versa. George Magnus would have us believe that the inflation data is giving us textbook (“Economics 101″) evidence of a “chronic deficiency of aggregate demand”. Chronic deficiency!? If you ignore the fact that CPI inflation has averaged 2.9% over the last eight years, sure, Mr Magnus.
But I’d answer Duncan’s question like this. If we see inflation running below the expected path and real GDP above the expected path, that looks like a positive supply-side shock. If we see both falling short, that’s a negative demand-side shock.
Here for each quarter I take the Bank’s median forecast of the CPI rate and RGDP growth from the Inflation Report four quarters earlier, and compare with the outturn:
The unexpected weakness of inflation and unexpected strength of real GDP growth does look like favourable supply-side news so far this year. That’s a backward-looking analysis.
What matters now is policy today, which is forward-looking. If the fall in UK inflation expectations is evidence of a positive supply-side shock then we should see a symmetric rise in UK real growth expectations. So who has upgraded their forecast of UK growth over the last month? The answer is… nobody has… and the fall in the equity markets (and gilt yields) makes it clear that growth prospects are falling too.
The Bank’s defence of inflation targeting as a policy regime, and their defence of the MPC’s decision-making under that policy regime, has always been consistent: what really matters is ensuring that inflation expectations are firmly anchored.
So… do it! Carney and friends have been making hawkish noises in speech after speech through the summer, trying to prepare the ground for rate rises. Does anybody seriously believe that there is even a single MPC member who believes the Bank is stuck in a “liquidity trap”, desperate for higher inflation but doesn’t know how to get there? No: that is just a convenient fiction.
For the MPC, the facts have changed, and policy needs to aim at raising inflation expectations so they are consistent with the target. Bravo to Andy Haldane for shifting in a dovish direction. As for Martin Weale… what can you say.
UK macro is really quite boring at the moment, and I cannot be happier to report that news. Of course boring events do not get reported as “news”, but that’s why we have blogs. Sure, there is a lot of debate about Scotland and so on which is related to macroeconomics – but UK macro events are not really capturing the headlines. UK GDP updates, labour market news… well, there’s a war on… let’s talk about Putin.
Contrast with the Eurozone. Mario Draghi is exciting! He is doing things. Pulling levers! Fiddling with interest rates. Easing credit conditions, improving financial conditions. Trying to get that CPI rate up… maybe. Oh, and allowing inflation expectations to collapse. That’s news.
Mark Carney expressed a worthy ambition in his statement to the Treasury Select Committee in 2013, that he “would like to achieve an exit in 2018 that is less newsworthy than my entrance”. I think he is well on the way to achieving that. This is how it should be. Central banking should be boring – nominal stability should be boring. If the nominal economy is stable, all the “news” will be “real”, in the sense of being supply-side.
For the first time in years I could not be bothered to watch the Inflation Report live last month, but skipping through the recording, the Broadbent, Carney and Shafik show is delightfully dull. Carney even takes pleasure from his own boringness:
What we’re putting emphasis on, and I know it’s boring and repetitive and it doesn’t clip into a new headline, we’re focusing on the path, the likely path of rates, the limited and gradual adjustment in those rates over the medium term, because of the headwinds that are facing this economy.
First and foremost it’s about the path for rate increases. I know it’s dull, I know it’s repetitive, but that’s the problem with consistency, it’s dull and repetitive.
Bravo Dr. C, bravo. And the annoying cricket metaphors are gone too.
This is what short-term inflation expectations (from gilt yields) looked like when UK macro events were newsworthy:
Quite the roller-coaster. I use the 3.5 year measure because it’s the most complete time series. Note this is RPI not CPI, and RPI at 3% is roughly equivalent to CPI at 2%.
Here is the last year and a bit:
What a dull, dull graph. Carney and the rest of the MPC deserve the highest praise for making macro policy boring.
Imagine a policymaker, in whatever area of public policy, who acts in a random and unpredictable fashion. One day they say one thing, the next day they say the complete opposite. Would you expect this kind of policymaking to encourage “stability” in the way people act, in the way people behave in whatever area that policy covers?
Well, welcome to British monetary policy.
Carney gave a speech last night which created an instant swing in financial markets. The FTSE 250 (a good indicator for UK domestic prospects) – is off about 2% this morning, though US markets fell late yesterday so we can’t blame the guvnor for all of that.
Carney and friends think that they can use the tools of macropru to create “financial stability”, whatever that means. They are not even able to formulate and stick to a monetary policy rule which avoids creating “financial instability”.
That should be the simplest thing in the world. 2% IT. 5% NGDPLT. Rules are simple. Automatic. Is the inflation forecast on target? Below, we loosen; above, we tighten. Is NGDP on target? Likewise.
Oh, and the inflation forecast is not on target, by the way. In the May inflation report the mean, median and mode projections of the CPI rate are below the MPC 2% target in every quarter of the forecast based on market interest rate expectations. So it’s “obvious” we need tighter monetary policy, and of course central bank governors should go around giving hawkish messages about rate rises. Governors who know exactly what they are doing, using words which have no doubt been chosen with extreme care, to express the right amount of “nuance”.
And here are four carefully chosen words to strike fear into your heart:
That is why an essential counterpart to our monetary stance is macroprudential vigilance and activism.
“Macroprudential vigilance and activism“? Dear God. Osborne, what monster have you created?
Update: Chris Giles also demonstrates the sharp movements in forward rates. Be in no doubt this was a tightening of policy.
Way waaaaay back in the dark days of 2012, which was, ooh, decades ago, Mervyn King used to complain about uncertainty. “Uncertainty” was King’s “excuse” for really bad stuff happening which wise central bankers can’t do anything about. Like real GDP going the wrong way. This is my favourite collection of Merv quotes from his infamous “black clouds” speech:
… a large black cloud of uncertainty hanging over not only the euro area but our economy too …
… Complete uncertainty means that the risks to prospective investments … are simply impossible to quantify …
… the black cloud of uncertainty and higher bank funding costs …
… The paralysing effect of uncertainty, with consumers and businesses holding back from commitments to spending …
… the black cloud of uncertainty has created extreme private sector risk aversion …
… private sector spending is depressed by extreme uncertainty …
… during the present period of heightened uncertainty …
Fast forward to 2014, and this is the “new normal” for central banking, as expressed by Charlie Bean:
Another reason the exit [from the ZLB] may be bumpy stems from the starting point. Implied volatilities in many financial markets have been at historically low levels for some time now (Chart 7). Together with low safe interest rates in the advanced economies, that has underpinned a renewed search for yield and encouraged carry trades. Taken in isolation, this is eerily reminiscent of what happened in the run-up to the crisis. Episodes like the ‘taper tantrum’, which produced a short-lived bout of volatility but no major disruption may also be contributing to a sense of complacency and an underestimation of market risk by investors.
It is inevitable that at some stage market perceptions of uncertainty will revert to more normal levels. That is likely to be associated with falls in risky asset prices and could be prompted by developments in the Ukraine, the fault lines in the Chinese financial sector, monetary policy exit in the advanced economies, or something else. But it will surely come at some point.
In 2014 wise central bankers are now worried that there is not enough uncertainty – there may be that dreaded “search for yield” – or, as those cheeky capitalists like to call it, “higher investment”. This is a bad thing, because, well, there might be “bubbles” even if we can’t define what a bubble is or identify one until after the fact. And we’ll apply the usual post hoc ergo propter hoc fallacy, because there are things which went up in 2007 which also went down in 2008, ergo those things caused the recession in 2008. Even though central banks’ own models tell us that financial crises and recessions have a single common cause: bad monetary policy.
We can be sure of only one thing: whatever happens, central bankers will be quick to tell us it wasn’t their fault.