Carney helps clear a mess he partly made

A James Alexander post

Mark Carney gave a speech at 4pm today that clearly eased monetary policy and raised NGDP growth expectations. Sterling immediately fell 1%, gilts rose 1% and stocks surged. What had he said that was so good?

Essentially this: The fall in Sterling would push up domestic inflation and not only was he OK with that but he also expected he would have to ease monetary policy even further.

Finally, as expected, sterling has depreciated sharply. For given foreign demand, this will mean support to net trade, though this may well be dampened by uncertainty around future trading relationships. A lower exchange rate will also entail higher prices for imported consumer goods, energy and capital goods, and consequently lower real incomes.

As the MPC said prior to the referendum, the combination of these influences on demand, supply and the exchange rate could lead to a materially lower path for growth and a notably higher path for inflation than set out in the May Inflation Report. In such circumstances, the MPC will face a trade-off between stabilising inflation on the one hand and avoiding undue volatility in output and employment on the other. The implications for monetary policy will depend on the relative magnitudes of these effects.

In my view, and I am not pre-judging the views of the other independent MPC members, the economic outlook has deteriorated and some monetary policy easing will likely be required over the summer. 

We have been consistently critical of Carney due to his instigating a crushing slowdown in NGDP growth during 2015. It has dragged down RGDP growth and made the UK vulnerable to shocks, like Brexit. To be fair, he is only one of many central bankers with the same mindset of inflation-phobia that blinds them to weak NGDP growth – and one shared by most mainstream economists and many financial types.

He didn’t help his credibility by taking sides in the referendum debate warning of potential long term damage to the economy. No one can predict with any confidence what the economic outcome will be given the huge unknown of the future political and trade relationships. These are political issues on which he was badly trespassing. 95% of economists reckoned an 8% loss of RGDP by 2030, roughly what the domestic FTSE 250 index fell. It’s an approximation that will depend on the politics.

The politics quickly became a huge mess, but is gradually being resolved. The FTSE 250 is recovering. A big help has been and will be the devaluation, a natural offset to economic damage from political uncertainty. Carney has now not only blessed the devaluation but vowed to protect it. So credit where credit is due.

That said, the bad old Carney was still evident earlier in the speech when he said this:

In May, the MPC judged that a sustainable return of inflation to the 2% target probably required a gradually rising path for Bank Rate over the next three years as growth picked up, jobs and wages increased and the drags from a stronger currency and lower commodity prices faded. 

To get inflation up he needs to tighten monetary policy? What? It still shows he is badly confused about his role even if he seems to be a good man in a crisis. The sad thing is that he is partly responsible for the crisis – a characteristic of far too many of today’s central bankers.

Mark Carney, “an unreliable boyfriend”? I blame his Dad, George

A James Alexander post

(On the title see here)

Mark Carney is supposedly handsome, but I don’t really feel qualified to comment. One observation I would make is that handsome friends seem to be prone to unreliability. A bit like Hugh Grant, allegedly.

Carney’s lack of commitment was made clear from the day his appointment was announced when it was revealed that the new standard eight-year term for Governors of the Bank of England would, in fact only be five years for him, a special concession he negotiated. Mmm.

At Christmas a puff piece on Carney in the FT was followed two days later by a (related) story indicating he was now willing to make himself available for the full eight years . Mmm. Rather like a Premier League footballer he remains  open to offers. Mmm.

The list goes on

Carney floated the idea of NGDP Targeting back in December 2012 only to never mention it again. Mmm. He has also talked of fairly concrete “thresholds” for monetary tightening over the years, only to ignore them when they are passed through. Mmm. He has talked of “forward guidance” only to see that guidance ripped up as the “forward” time has arrived.

He was reportedly very tetchy at the press conference presenting the February 2016 quarterly inflation report. One tweet from the meeting suggested that he had said all members of the MPC agreed that the next move in rates would be up. I searched for confirmation in the official minutes but could find none. Mmm.

He has now rowed back again, apparently. In regular testimony to the House of Commons Treasury Select Committee he now says that the next rate move could be up or down, that the period to reach the 2% goal could be extended. He has even flirted with negative interest rates, the last refuge of a failed inflation-targeting regime the world over.

Extending the period to reach 2% is not a good idea if the goal is still the Bank of England’s own expectation of 2% inflation two years’ out. The constant threat of tightening every time their medium term range of expectations biases above 2% effectively tightens monetary policy, killing any hope of achieving the objective – thus depressing nominal growth lower and lower.

He is not really fit to be Governor, except that another candidate might be less reactive and more hawkish, like a new Mervyn King, and equally disastrous. An unreliable boyfriend is better than a violent one.

Personally, I blame Carney’s “dad” for this behaviour, Chancellor George Osborne. He needs to set firmer rules of behaviour. Broadening the inflation target regime to one of NGDP growth expectations targeting. A stable path of expected nominal spending, income or output – depending on your school of macro-economics – is all that is required. This stop-start monetary policy of targeting the Bank of England’s own inflation expectations two years out is just self-defeating and ultimately damaging nonsense.

Come on George, stand up for NGDP Targeting

A James Alexander post

It has been noted already by Market Monetarists and others that George Osborne and his UK Treasury team are concerned about the low level of expected Nominal GDP growth in the UK. The latest January 2016 CPI figures showing just 0.3% YoY growth will only worry them more. The correct inflation number for policy should be the GDP Deflator, not CPI, but it is also pitifully low and dragging down both RGDP and NGDP.


But whose responsibility is NGDP growth? It is no good Osborne worrying about it and then doing nothing. The Treasury sets the targets for Bank of England monetary policy.

Monetary Policy Framework: The Bank’s monetary policy objective is to deliver price stability – low inflation – and, subject to that, to support the Government’s economic objectives including those for growth and employment. Price stability is defined by the Government’s inflation target of 2%. The remit recognises the role of price stability in achieving economic stability more generally, and in providing the right conditions for sustainable growth in output and employment. The Government’s inflation target is announced each year by the Chancellor of the Exchequer in the annual Budget statement.

Is Mark Carney concerned by low NGDP growth? Not at all by the sound of it. He is still obsessed by managing to the Bank’s own forecast for CPI two years out, and keeping that forecast below 2%. He has UK the monetary policy set firmly for tightening. The evidence was crystal clear in this exchange  at the February press conference:

 Sam Nussey, Nikkei: Governor, with the BOJ having joined the ECB Switzerland, Sweden, Denmark, and having used negative rates, do you see negative rates as part of the BOE’s arsenal and could you envisage a situation in which they would be used?

 Mark Carney: Well let me start that discussion we had at the MPC was whether now was the right time to raise interest rates. And the judgement, as you’ve seen nine to nil, was that now was not the right time to raise interest rates, but we had a forecast – we have a forecast – which requires some increases in interest rates in order to sustainably achieve the inflation target.

And the markets understand this tightening bias, just look at UK stock markets and UK government bond yields. Sterling has been relatively weak vs the even tighter USD, and on rising trend vs the EUR although weak just recently.

The result is both lower and lower NGDP growth and lower and lower NGDP growth expectations.

Something has to change and it has to be led by Osborne and the Treasury. Central bankers change little once in office.

Osborne wants to follow his instinct and balance the budget by 2018 despite the most vocal mainstream macro-economists urging him not to. It’s sad that most are crypto-Corbynites, but that is social science academia for you, there are no jobs for free-marketers. It’s an increasingly closed shop for anyone not a socialist. Fortunately, students, and more importantly voters, aren’t so dogmatic. Our university social science departments will become like old theology colleges, with the professors just chatting amongst themselves.

Yet when Osborne ordered an inquiry into possible changes to the inflation target mandate he meekly accepted the macroeconomic consensus that there was no need to change, in fact it would be a bad thing. To his credit the crypto-Corbynites are amongst the most sympathetic to NGDP Targeting, but he shouldn’t let that worry him – they much still prefer big deficits over monetary policy.

Osborne needs to show some leadership about NGDP Targeting and not just the deficit. He should keep the CPI target if he has to, but combine the price stability and growth and employment targets into one NGDP Target. It really isn’t that difficult to understand.  He and his advisers can read some of the answers to the very weak mainstream macro criticisms here and here .

The ONS might need to raise its game a bit, but calculating NGDP really should be easier, faster and more reliable than RGDP. They should relegate the very tricky Output method of calculating GDP to the third choice (like in the US) and promote either the easier Expenditure method to first place (like in the US) or Income. The Output method was preferred once upon a time when advanced economies grew, dug or made stuff (i.e. agriculture, mining, manufacturing). The output of the dominant services sector cannot be so easily measured.

UK NGDP growth flashing red

A James Alexander post

Back in late October we highlighted the collapse in growth of UK NGDP as proxied by the release of the 3Q15 Nominal Gross Value Added (GVA) figure. Things have now worsened. Growth has dropped from 2% YoY to less than 1%. Where is the Bank of England? Where are their political masters, the UK Treasury? Are they all asleep at the wheel? Hello? Wakey, wakey!

It is not just the risk of falling revenues leading expense reductions combining with the usual “sticky wages problem” forcing employers to cut staff, although this should be alarming enough on its own. It is the huge hole in tax revenues that will open up that should alarm the UK Treasury. They need nominal growth to reduce the deficit, and slow the growth in national debt. They are happy enough, and possibly right, to attempt to constrain public sector spending, but a recession will mean years of hard work washed away in an instant. NGDP growth should be their top priority, for both issues.

The figures are alarming

In it’s first estimate of RGDP the UK’s Office of National Statistics is unable to give us a figure for Nominal GDP. This situation is highly unsatisfactory for what should be the key measure of monetary policy. They don’t devote a lot for resources to its proxy either as the initial 4Q15 GVA figure contained a bad and obvious error (spotted by yours truly) and had to be withdrawn for a few days before reissue.

The reissued had no bad or obvious error, it just looked bad. UK NGDP growth had been running at a too slow 4%, before crashing down over the last 4 or 5 quarters to 2% and now less than 1%. There is some stuff going on in the wider world, but in common with the US central bank, the Bank of England has been talking the tightening talk for a year, and has now reaped the consequences.


Carney is only chasing the game

Of course, Mark Carney is no Meryvn King or Trichet-like dogmatist and can react to markets, but the damage has been done. Ask any sports team manager and you´ll hear that chasing the game is a lot tougher than leading the game. And Carney is chasing the game.

However interesting, try not to dissect the output data

Nerdily-speaking, GVA is about 90% of the GDP figure, the other 10% is the rather mysterious “Basic Prices Adjustment” (BPA), to add a large slug of taxes on production that are paid by final buyers of that output (less a miniscule amount of subsidies on production). BPA is a very stable number.

More nerdily, GVA is the building block for the output version of GDP, the prime method in the UK for measuring GDP. The other two methods are expenditure and income, but are usually adjusted” to the output result. In contrast, the US gives primacy to the expenditure method, and adjusts the other two to it. It is rather irrelevant as the main issue is speed of deliver. The O, I and E measures should all equal each other. They often use similar fundamental data anyway, just released at different times, and at the micro level are used to check the reliability of each data set.

Even more nerdily, and as an example, wage income and gross profits in the media sector should equal money spent on media products by consumers (films, games and TV etc) and should equal the value-added of output too (calculated, using similar data sets, as all sales less sales to other producers, i.e. intermediate sales).

One can look at the industry breakdown of UK GDP, via the industry-by-industry contributions to GVA. For monetary policy it doesn’t make any difference, tight money is tight money as evidenced by weak NGDP growth – please stop looking at the level of interest rates and the amount of QE, they tell us little about the stance of policy. Indeed, rates are usually high when monetary policy is loose and NGDP is growing fast.

There will still be relative winners and losers in an economy whatever the stance of monetary policy, and analyzing individual industries performance can easily mislead policy makers into thinking it is the fault of the relative losing industry dragging down growth when its monetary policy.

The output data is probably as good as it can be, but still not much use

That said, there appears to be some underlying changes still working through the economy. Manufacturing is in relative decline versus the services sector. But so what. In any case the “service sector” is so huge and poorly understood that it is impossible to really see the drivers of the switch from manufacturing. IT is in services and growing, but should it really be in manufacturing? Consultancies likewise, aren’t they just outsourced management?

The ONS, like most other national statistics authorities, collects agricultural, extraction and manufacturing industry output in minute detail, with around 61 separate categories of data – yet these sectors account for just 20% of national output. There are only 51 data points for the 80% represented by services. The ONS is steadily working to rectify this problem via a number of initiatives, but it is very hard work indeed.

It is highly entertaining to read all the wordy, earnest, discussions about productivity when so little is known about 80% of the economy. Still, discussing the productivity crisis (or miracle) is nice work if you can get it.

One oddity is that while the manufacturing sector is in recession, the extraction sector is apparently growing in real terms but crashing in nominal terms. Mmm.

Disappearing UK NGDP growth: the culprit

A James Alexander post

According to the UK Office for National Statistics (ONS) the reason for the heavy downward revisions to UK NGDP are due to heavy downward revisions to the implied GDP Deflator. The deflator is “inflation” as measured for national income statistics. It broadly follows the unreliable, because never revised,  UK CPI figures that the BoE tries to manage.


The deflator is unreliable too, but at least mistakes are corrected! This time, to be fair, it looks as though the GDP Deflator has been revised down, bringing it into line with the collapsing CPI.


Which is “right”, who knows?  One suspects that there are a lot more resources at the resource-strapped ONS put into the politically sensitive CPI than the GDP Deflator. Over time the two indices broadly follow each other.

What is undeniable is that the UK is flirting dangerously with deflation. Nominal GDP remains around 2% or so, confirmed by today’s UK GDP releases, leaving zero room for monetary policy errors. It seems as if the UK is not making them, unlike the US, but do the policy makers at the BoE really understand how close they are to disaster? It doesn’t seem so. The culprit remains the same at all the big four central banks, asymmetric inflation targets. Despite protestations of symmetry the tightening bias is plain for all to see whenever CPI is expected to rise to 2%.

Where has UK NGDP gone?

A James Alexander post

I need to apologise. On 23rd December I was asleep on the job of monitoring UK NGDP.

Having posted in October on the collapsing proxy for UK NGDP in 3Q15, “Nominal GVA”, and then posted again in November on the first estimate release of actual 3Q15 NGDP, I had not thought to check on the second estimate release for NGDP.

Only today when preparing for the release of the UK’s first estimate of 4Q15 RGDP tomorrow and that NGDP proxy, “Nominal GVA”, did I look at that second estimate of 3Q15 NGDP released just before Christmas.

Well, it was quite a shock. The data, charted here, shows that NGDP growth has been revised down considerably. No wonder the UK has seen steady stream of emollient commentary from the grandees of the Bank of England’s rate-setting Monetary Policy Committee, even our least favourite hawk chimed in this week. No wonder UK tax revenues are disappointing, it’s not just tax dodging Google or inevitable societal reactions to excessively high VAT rates. No wonder nominal wage growth has been disappointing for a few months. A very weakly growing nominal economy is responsible, as we suspected. This is awful.


It is the Bank of England’s responsibility to ease now. All that talk of a rate rise coming into view at the end of 2015 has done enormous damage, motivated by Carney and his friends asymmetrical inflation targets based on ceilings, a new central bank orthodoxy in place at the Fed and the ECB. This inflation-phobic stance needs to be changed as a first step, by moving to properly flexible, symmetrical, ideally level, inflation targets. Better to move to NGDP growth expectations targeting. The perfect illustration of working with problematic historic data is well illustrated here, although we had said that 3% NGDP growth was worryingly low.

Carney achieving his goals, strangling the UK recovery

A James Alexander post

In mid-2015 Mark Carney stated that the next move in UK rates would be up and that it would come into sharper focus at the turn of the year. This was interpreted as monetary tightening by Market Monetarists  and some others.

Market prices moved: Sterling, bond prices, UK domestic stock markets as monetary policy impacted future expectations immediately and precisely (ie not in any long and variable fashion). The playing out of the flight path that Carney set in motion is now being seen in the backward-looking actual data.

NGDP does not get released in the first estimate of GDP, but the second. The trend seen in some low-level aggregates that we highlighted with the first estimate has been confirmed. UK NGDP is way off trend at 3.40%, down a touch from the poor 3.42% recorded in 2Q15. And we already know that this nominal sluggishness is dragging down RGDP. The deflators obviously tell the same story. No inflation here.

JA Deflator

Perhaps just over 2% RGDP is all that the UK can expect but the downside risks due to a 1%, and falling, deflator are heavy – due to downwardly sticky prices as highlighted by a German ECB Board Member recently. And as yet there are not many signs Carney is alert to these dangers, even if he has pulled back a bit from his monetary tightening language, money itself remains tight as NGDP bobbles along below trend.

It’s hard to understand Carney, but by standing pat in the face of this nominal slowing he is ensuring its continuance, that’s the nature of monetary policy – doing nothing is doing something.

Broadbent shows BoE going after the wrong target: the real economy

A James Alexander post

I had some hopes for fresh thinking due to the “outsider appointment” status of the Bank of England’s new’ish Deputy Governor for Monetary Policy Ben Broadbent. He wasn’t part of the clique around Mervyn King and the long-serving staffers like Paul Tucker the previous Deputy Governor who so messed up UK monetary policy in 2007-09.

His latest speech shows him falling into the very messy and confusing place, where central bankers love to be Kings of Discretion rather than Rule Abiding Good Citizens. He is so busy patting himself and his colleagues on the back for ignoring above target CPI in 2011-13 that he can’t see the damage he is causing and about to cause today.

We love teasing you, it makes us feel important

But he starts of by setting himself a pointless problem and then digs an enormous hole as an answer, partially digs himself out but then proves when you are in a hole you should stop digging.

 The previous Governor of the Bank, Mervyn King, once referred to what he called the “rich seam” of MPC communication. Rich or not, it’s certainly a wide seam: MPC members each give several speeches a year; we publish minutes of every meeting, now supplemented with a Monetary Policy Summary; every quarter we publish a 50-page Inflation Report that summarises the MPC’s collective view of the economic outlook and includes our latest forecasts; every Report is followed by a session in front of parliament’s Treasury Committee. Yet, from all this, the outside world seems increasingly interested in only one particular nugget: the MPC’s central inflation forecast two years ahead.

The answer is simple: the Monetary Policy Committee sets monetary policy based on their forecast of inflation two years away. Inflation is always said by the Governor and his colleagues to be on target or off target by this “medium term” forecast. Of course, we all watch the forecast, that’s the world the BoE has created. The idiotic thing is that the forecast depends on the ever-so-slightly-circular market-implied BoE interest rate forecast, as created itself by nods and winks from the BoE.

The problem is that the “data” is very stubborn and near term inflation refuses to rise in line with the forecasts to allow the BoE to follow its desired rate normalisation path.

This is because their simple Philips Curve model of the world is wrong. Some would like to see the model and the results it produces, but for Market Monetarists it wouldn’t tell us much we don’t already know about their “slack theory” of inflation.

Slack being taken up does not lead to wage pressure and so does not lead to price pressure. Aggregate Demand, or rather aggregate nominal spending, drives prices up and that pulls wages up. And aggregate nominal spending is set by NGDP growth expectations. For all Broadbent’s protestations of the BoE having a flexible inflation target, the market is a better prophet.

The market can see the BoE’s obsession with the mid-point of its two-year out inflation forecast. But there really is no need to actually raise rates if the BoE is on target with its target as we said a few weeks ago. The market will anticipate the rises in rates and cool-off its expectations accordingly. This cooling-off acts as a break on nominal spending growth, in turn causing inflation to never rise as expected by the BoE. We are thus stuck in a self-defeating loop.

“Long and variable lags” the standard cop out of  today’s bankrupt monetary economists.

Broadbent sets up three scenarios in the face of a “cost shock” sending inflation up by 2% to 4%. The second question he asks is how to get it down. Quickly. Slowly. Or, weirdly, “Drunkenly”? Actually, methods don’t matter, the fact that it must be brought down is all important. It’s not a flexible target, it’s still a 2% target. It is merely a flexible amount of time to bring it back to 2%. And it is gradually squeezing the life out of the recovery. It’s not too late to react, and the BoE probably will, just in time, but their reaction time is too slow.

Shouldn’t the policy horizon simply be the shortest time delay between changes in interest rates and their impact on consumer prices? Well one problem is that one can’t be entirely sure about what that delay is. As a famous economist once said, monetary policy seems to operate with “long and variable” lags.

It is funny how Milton Friedman is wheeled out repeatedly for this hoary old chestnut. He was really on to scare politicians and policymakers out of trying to fine-tune the economy. Friedman was probably just wrong on this point, as rational expectations theory has shown and the markets demonstrate day in day out by reacting immediately to unexpected changes in monetary policy, and to unexpected inaction in monetary policy to changes in the economic outlook. It is hard to see why it has gained status as a near religious truth.

Interestingly, when Milton Friedman said lots of other things he gets ignored or ridiculed, especially by Keynesians when it comes to his supply-side views on economics. More importantly, he also said that often you can’t tell the stance of monetary policy by the level of interest rates. He also ridiculed the idea of cost-push inflation.

Didn’t they do well?

I think this had real relevance at the time I joined the MPC, in mid-2011. At that time … After a tepid recovery there was still plenty of spare capacity in the economy. Companies said they were operating well below capacity; unemployment was still high. But thanks to a series of cost shocks, including the big depreciation of sterling’s exchange rate 2-3 years earlier, inflation was nonetheless well above target.

In response, the MPC … took a more balanced approach. As I tried to explain in a speech I gave later that year, the MPC had arguably tolerated the (then) high rate of inflation for longer than it might have done because the real side of the economy was so weak.

It signalled this choice more explicitly in early 2013. Following a further depreciation in the currency, rises in administered prices and the prospect of continued weak growth in productivity, inflation was thought “likely to remain above target for much of the forecast period”. But “attempting to bring inflation back to target sooner…would risk derailing the recovery” and it was therefore “judged appropriate to look through the temporary, albeit protracted, period of above-target inflation”.

Was it so difficult in 2011 to look through headline CPI? Look at core inflation back then.

JA Broadbent_1

And the more appropriate measure to steer the economy, the GDP Deflator, was running at or below 2%. Of course, RGDP was certainly weak and falling. And the combination of the two, NGDP, was also weak and falling. In 2013, there was some modest recovery but we know how the BoE is currently squashing that with all its contractionary talk of rate rises sooner rather than later.

JA Broadbent_2

 Quoting Svensson only when it suits, but are they symmetrical?

I don’t think this was so exceptional. There is no inflation-targeting monetary authority that behaves so rigidly as to attempt to offset all shorter-term shocks to inflation, no matter the effects on the variability of interest rates and output. As the economist Lars Svensson puts it, “in practice, inflation targeting is always ‘flexible’, because all inflation-targeting central banks not only aim at stabilizing inflation but also put some weight on stabilizing the real economy”.

While it is great to see the magpie Broadbent quoting Svensson what would Svensson be saying right now about the UK? Is he saying that now the UK is near “full capacity” and there is no need to get inflation back to target? I don’t think so. I think he’d be warning of the dangers of Japanese-style deflation, not fussing about when the next rate rise would be like Carney, or teasing the market, Broadbent-style, about the way to read or not to read the BoE’s intentions.

Broadbent indicates that the BoE is not targeting inflation but real variables

What is the BoE really up to? Well, actually, it appears to be trying to steer the real economy, and I’m not sure that’s their job or that it is possible. In three charts from his speech Broadbent shows the correlation between economic variables and average votes on the MPC to change rates.

JA Broadbent_3

The strongest, in fact the only meaningful, correlation is with real economic variables (Chart 3). But the real economy is a residual between nominal growth and inflation. And that is not a central bank job as all textbooks and mission statements will tell you.

They are not trying to steer inflation (Chart 2). This is good, because that is very tricky trying to steer the residual between real and nominal growth, even though it is what they should be doing according to their mission statement. So, sort of bad, too.

They are also not steering a form of NGDP (Chart 4, I think). This is bad as that is what they can actually steer, aggregate UK demand or nominal spending. And by not looking at NDGP they make big mistakes, causing instability in RGDP. They missed the rapidly declining NGDP in 2Q08 and appeared unconcerned by 3Q08, half-heartedly focusing, instead, on the banking crisis they had caused. Then, they are shamefully guilty of the four successive quarters of negative NGDP from 4q08 onwards with its appalling impact on RGDP, unemployment and lost growth.

They need to pay attention now as NGDP shows a bad trend in the UK, declining to 3.4% in 2Q15 and looking lower again in 3Q15. Broadbent needs to wake up and stop this somewhat smart-alec self-congratulatory lecturing.

Andy Haldane makes a very basic (and conventional) mistake

A James Alexander post

The Chief Economist and Executive Director, Monetary Analysis and Statistics, at the Bank of England and Head of the Economics Department gave a long speech at the Trades Union Conference last week. It was certainly long on statistics but, as usual, with Andy Haldane largely empty of any monetary analysis.

There was a lot of very interesting “on the one hand this/on the other hand that” chat about the relationship between technology and labour, with lots of colourful charts using his statistics department to the utmost. That said, as with most macro-economists he had zero to say about how to meet the enormous challenge of measuring productivity in the huge variety of services sector sub-sectors.

Towards the end of the speech he switched to a more substantive topic:

The UK inflation picture is relatively easy to explain, at least in an accounting sense. The lion’s share of inflation’s weakness is accounted for by external factors – weak world prices and a strong exchange rate. These factors are themselves in part a reflection of weak world demand, pushing down the prices of oil and other commodities. The impact of external disinflationary pressures on UK inflation is thus likely to be persistent. Nonetheless, in time these external pressures should wane. What will then determine UK inflation is the evolution of domestic costs, specifically labour costs.

Inflation is not determined by the evolution of domestic costs. Inflation is not a cost-push phenomenon It seems like that if you are a bottom-up, statistics-obssessed, nerd, but monetary economists know better. It is a monetary phenomenon, driven by changes in nominal demand expectations, in that sense it is “demand-pull”. And those expectations are led by the central bank’s monetary policy stance. This is a pretty basic and worrying schoolboy error for the Chief Economist to make. This might help when Milton Friedman responds to a student’s question (about 7.40 minutes in).

As a result, he and the Bank of England end up lost:

The UK labour market has been hard to read over the past few years. In common with other forecasters, the MPC has consistently been surprised by the weakness of wages, given the strong cyclical bounce in job creation. It has over-predicted the path of wages in recent years. There are a number of possible explanations for this wage weakness.

Chart 30 accompanied this section, and shows just how much ground has been lost through the forecasting errors of the MPC and their fear of incipient wage inflation leading to over-cautious monetary policy targets.

Ja Andy Haldene

Haldane then ran through the usual worn-out excuses of why the MPC has been so consistently wrong (and other forecasters, don’t forget, they are all wrong together so it’s kind of okay to be wrong): more slack than thought; the Philips curve has flattened, maybe due to more technology, maybe due to labour losing bargaining power. He even speculates that labour’s share of the economic pie is not going to mean revert.

He runs with this last notion and actually decides inflation may also not mean revert, if labour’s bargaining power never picks up and just flatlines. He actually thus comes to a sensible conclusion, even if his theory is wrong:

That would put the balance of risks squarely towards a more protracted undershoot of the inflation target, even without any downdraught from external prices and demand.

Uncertainty about demand is, once more, on the rise. Given its source – the third in a triplet of crises, this time afflicting the emerging market economies – I do not expect that rise in uncertainty to be temporary. I expect its impact to be greater in today’s world of post-crisis traumatic stress and could more than offset the cost of capital accelerator, as we have already seen repeatedly since the crisis.

 Against that backdrop, my view is that the case for raising interest rates is still some way from being made. Whatever the reason, the economic aircraft appears to be losing speed on the runway. That is an awkward, indeed risky, time to be contemplating take-off. Meanwhile, inflationary trends do not at present given me sufficient confidence that inflation will be back at target, even two years hence.

For those reasons, I have continued to vote to leave rates unchanged, with a neutral stance on the future direction of monetary policy. Now more than ever in the UK, policy needs to be poised to move off either foot depending on which way the data break.

 This mysterious thing “demand” keeps getting derailed. This time by some sort of EM  shock. It doesn’t seem very clear how an EM downturn can cause a demand shock in the UK, but Haldane is worried. And that’s a good thing because NGDP growth is weakening and NGDP expectations are weak too, so the BoE might do the right thing yet.

Even if he can’t understand the power of a central bank to sustain domestic demand, Haldane is sensitive enough to sniff a problem. But he will remain a lost soul, adrift on a boat tossed about by the breaking data, sorry, by breaking waves. He should turn on the engine and steer the ship to a better target than the 2% inflation ceiling.

What is it about 2% and the Bank of England?

A James Alexander post

The Bank of England published its quarterly Inflation Report for November 2015 last week. The fact that the BoE is missing its 2% inflation target by more than 1% set in train the usual mini-flurry of letters to and from their political masters at the UK finance ministry, aka The Treasury. While reading the Treasury reply I spotted that there had been an “evolution in UK monetary policy”, I was forced to read on.

In fact the gap to the 2% target was back to the largest for some time at a negative 2.12% thanks to the most recent CPI itself coming in at a negative 0.12%. Of course, sophisticates prefer one of the numerous measures of “core” CPI, excluding food and/or energy, and/or housing, etc, etc.

JA Target Misses

Market Monetarists prefer to pay no attention to CPI since it is not a proper macroeconomic statistic, but a political one, since it is never revised. All proper economic statistics have to go through numerous revision processes over time – that is what makes them robust measures of the actual economy. No reliable macro number can be perfect first time. Only faith-based economists look for certainty.

But the Treasury and the BoE are, by statute, stuck with headline CPI as their official target, and the BoE has to explain why it is missing this target by such a wide margin. The correspondence is often quite revealing about what the BoE or the politicians are actually thinking or targeting and the fallacies on which these thoughts are based. All the usual ones were trotted out:

Fallacy 1: The long and variable lags

From the BoE Governor letter to the Treasury 

The peak effect of monetary policy on inflation is generally estimated to occur with a lag of between 18 and 24 months.

There is little recent evidence of 18-24 month lags. US monetary policy immediately crashed the world economy in 2008 after the Lehman bankruptcy. The Bank of England was busy doing the same in 2007 and 2008 with its extremely grudging, and therefore massively confidence-sapping and counter-productive, response to a run on its banks. The ECB immediately crashed the Euro Area in mid-2011 when it raised rates twice.

Monetary policy has supposedly been “highly accommodative” as Janet Yellen constantly reminds us, for nearly seven years. It is actually quite destructive of central bank credibility this refrain, and gets repeated by so many really quite smart people. But this supposedly “ultra loose” monetary policy has only engendered the slowest recovery in the post-war years, showing that: a) it hasn’t been very accommodative and b) that the supposed 18-24 month lag are faith rather than being evidence-based.

Fallacy 2: The “spare capacity” theory of monetary policy

From the BoE Governor letter to the Treasury

The MPC judges it appropriate to set policy in order to ensure that growth is sufficient to absorb the remaining spare capacity to return inflation to the target in a sustainable manner in around two years and to keep it there in the absence of further shocks.

We have already commented on central bankers really targeting the two-year out inflation that their macro models generate, and that these models are based on the false Philips Curve theory: that inflation and unemployment are inversely correlated. These central bankers need to look at the track record of both the Great Moderation and the last seven years, abandon the theory as false, and move back to orthodox monetary economics (that monetary policy determines nominal growth), or better Market Monetarism (that expectations of nominal growth are the monetary policy and thus drive actual nominal growth).

Fallacy 3: Consistently missing the 2% inflation target (on the upside) would court disaster

From the Treasury’s reply

In line with the requirements in the MPC remit, your letter provides a clear assessment of considerations and trade-offs guiding decisions from the MPC when considering the appropriate approach to, and horizon for, bringing inflation back to target, including implications for output volatility and risks of possible financial imbalances. The Government’s commitment to the current regime of flexible inflation targeting, with an operational target of 2% CPI inflation, remains absolute.

Trying to ignore the humour in an absolute commitment to a flexible policy, there is nothing special about 2%. The figure was plucked out of the air one day by central bankers as an ad hoc number around which to organise their weapons to fight much higher inflation. It worked for a while in bringing down inflation from those higher levels, and helped create the space for the Great Moderation. But Inflation Targeting’s time has come to an end as it has become a ceiling and started to interfere with optimal monetary policy. Monetary policy should be set to secure stable nominal income growth along a trend level, not “inflation”. There would be no disaster if we all just stopped talking about “inflation”.

To be fair the Treasury did try to make clear in their letter that the “target is symmetric: deviations below the target are treated the same way as deviations above the target.” I find that a bit hard to believe given the hand-wringing in the commentariat when CPI is above target is only matched by much the same hand-wringing when it is below target but could soon rise above target – according to the false theory in Fallacy 2.

That “evolution”: what is it about 2%?

From the BoE Governor letter to the Treasury

As described in the Inflation Report published today, the MPC’s preference is to use Bank Rate as the active marginal instrument for monetary policy, and expects to maintain the stock of purchased assets at £375 billion until Bank Rate has reached a level from which it can be cut materially. The MPC currently judges that such a level of Bank Rate is around 2%. This is a further evolution of the Committee’s forward guidance framework, which included guidance on the APF, originally announced in August 2013.

We now seem to have two 2%’s in the UK. The flexible inflation target and now some sort of natural 2% rate of interest at which the BoE can “materially” unwind its Asset Purchase Facility (“QE”) and do more than just not reinvesting proceeds from maturing bonds but sell them off too.

Is this really what they talk about at the Monetary Policy Committee? A sort of Fantasy Football League chat about what the future level of interest rates might possibly mean for the economy. Sure, if nominal growth is robust at over 5% and “inflation” bobbing along regularly above 2% then rates might be higher. But why set yourselves up as hostages to fortune and declare that a 2% Bank Rate is the right level to aggressively unwind QE? And why do both the BoE and the Treasury declare this an “evolution” of monetary policy guidance. At the end of the day the rate setters have to talk about something and Fantasy Football League is fairly harmless, I suppose.