Groupthink at the BoE As UK Monetary Policy Remains Too Tight

A James Alexander post

We have recently discussed groupthink amongst the elite academic macroeconomists in the UK. The same groupthink was visible in the Minutes of the latest Monetary Policy Committee meeting of the Bank of England released today. Aggregate demand growth, aka NGDP, turned down quite badly in YoY in 2Q but was there a word about that from any one of the nine present, of course not.

They all agree things are just right, apart from the Ian McCafferty. He is the BoE’s equivalent of the “always wrong” clique of inflation-scaremonger regional governors like Plosser and Fisher on the Fed’s MPC, aka the FOMC. There are some welcome signs of a pushback from UK macroeconomists but it’s a poor show compared to the US where there is an incredibly active debate across the blogsphere about a September rate rise, with even the 2nd choice for Yellen’s Chair now blogging.

Only here do you read regular news of what is really going on in the UK relevant to best practice monetary policy.

There was the usual fussing over the least important inflation number, headline CPI. It’s 0.1%, 190bps below the target, but will soon,or rather soon’ish rise back towards the target.

Yeah, right. That’s not what markets are saying, they think CPI will average just 1.3% for the next 10 years. Yes, 10 years! But who cares about markets when the MPC Minutes say that “in the third year of [the BoE’s own] projection, inflation was forecast to move slightly above the target as sustained growth led to a margin of excess demand.”

To be fair the MPC had noticed things weren’t going swimmingly in 2Q but on the economist’s other hand some things were going well. They don’t really know. They should look at market-derived NGDP forecasts, but we don’t have those for the UK or anywhere, just for inflation. And they don’t like those numbers anyway as they don’t agree with the BoE’s own projections. They prefer models over markets. Better nine geniuses than the sum total knowledge of thousands of market participants.

The muddled thinking was well demonstrated by the section on wage growth in the Minutes:

“28. Wage growth had picked up over the past year, reflecting the past tightening in the labour market. However, the recent slowing in employment alongside steady output growth implied that productivity had risen, offsetting the effect of higher wage growth on unit wage costs. Annual unit wage cost growth of around 1% in Q2 was some way short of what was likely to be needed to return CPI inflation sustainably to the 2% target.

On one view, the slowing employment data might imply that labour demand had plateaued, and that this would keep pay growth muted. Further improvements in productivity might also limit growth in unit wage costs. On another view, however, the slowdown in employment might reflect greater hiring difficulties, consistent with survey evidence of skill shortages, with the likely consequence of more rapid growth in pay.”

You can see them still clinging, like many elite macroeconomists, to the equally discredited Philips Curve. What is funny about that theory is that we are constantly told that macroeconomics is not like the economics of the household. We shouldn’t worry about national debt, fiscal deficits, etc. But when unemployment drops to a low point wage demand must pick up because labour markets will be tight and aggregate wages must rise. The economics, if not of the household, of the firm.

Aggregate nominal wage growth is a function of aggregate demand not labour market slackness or tightness. The rate of unemployment is irrelevant. And aggregate demand, or nominal GDP, is entirely in the power of monetary policy. Aggregate nominal wage growth can’t escape out of control if monetary policy is prudently targeting NGDP forecast growth of 5% or so.

What 1% unit wage cost growth is telling us is that monetary policy is too tight! Just as, in a messy, mixed up way, is the message from 2.5% nominal wage growth; from 0.1% CPI; or the falling growth of the GDP deflator now below 1% YoY; or the falling growth rate in NGDP.

Never mind, in a July speech Governor Carney made clear:

“In my view, the decision as to when to start such a process of adjustment will likely come into sharper relief around the turn of this year [2015].”

So be warned. And thus Carney put a cap on growth in the UK in the 2nd half of 2015. Thanks for that.

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