The UK NGDP dog is barking

A James Alexander post

It is always amazing that the UK statistics authority can produce a Real GDP estimate four weeks after the end of the quarter. They do admit that there are often large revisions due to the fact that less than 50% of the data is in the bag, particularly lacking are the third month surveys of business output, ie September for the 3q15 number.

The first Real GDP estimate is based on the first estimate of inflation-adjusted, industry by industry value added, or GVA – and  is always about 90% of RGDP. The statisticians have to add back taxes on production and take off subsidies on production to get to the bigger number.

The Real GVA figure, technically known as the “Chained Volume Measure at Constant Prices” is itself half based on GVA at Current Prices, ie Nominal GVA. This data is a hotpotch, some actual physical output, grossed up to a “Current Prices” value are included as are the actual (ie nominal) turnover numbers from the business surveys, particularly for the service sector where physical output is almost impossible to measure.

Around half of GVA numbers are not from reports of business turnover but physical production numbers (for manufacturing and construction), sales figures (for retailers), imputed rent (for the value of owner-occupied housing) and government expenditure (for bureaucrats, teachers and health workers).

In order to get from the nominal GVA figure to the real GVA and hence to RGDP the statistics people have to use a deflator. The estimate four weeks after period end is clearly not considered good enough to release to the public but it is being used nonetheless. Given that real YoY GDP growth in 3q15 is put at 2.6% and nominal GVA 2.0% then the deflator is around 0.6% YoY. This ultra low figure is not a million miles from the very low YoY (and not very reliable, admittedly) CPI figure of 0% for September released two weeks ago. If you really are targeting inflation things look really grim.

If you are implicitly targeting NGDP, as the Bank of England probably is, then things are equally grim. The nominal GVA figure is very closely followed by the first estimate for Nominal GDP released several weeks later. For the second quarter in a row nominal growth has been horribly low. the last time it was this low was in 3q08 just before Lehman. In 4q08 nominal GVA began to crash and was YoY negative for four quarters. Sure, the Bank of England could wait until the first “proper” NGDP estimate in a month’s time, but in the meantime be very, very careful – remember 4q08. The same goes for the Fed, too.

JA GDP Release

The supposedly strong retail sales figures for September could well be giving us a bad steer. The “strong” number was a quantity figure up by 6.5% YoY. Nominal sales (ie by value) were up just 2.7% YoY as in-store prices collapsed at a record-equalling rate of negative 3.6% YoY. The figures are further messed up by a continuing surge in online sales vs physical sales.

This is a really, really dangerous time for the UK economy. Monetary policy is very tight indeed. Yet what is the Governor of the Bank  of England saying? A barking dog makes more sense. What is the market thinking about UK monetary policy? It has no idea either.

Carney and the Fed are actors and scriptwriters

A James Alexander post

In his recent extended interview with The Daily Mail Mark Carney not only raised the problem of market-deniers, those who deny the validity of rational expectations in the climate change market.

He revealed his own very confused state of mind when it comes to the future path of UK interest rates when he gave this “guidance”:

‘If we think there is a prospect, a possibility – that’s a possibility not a certainty – of rate rises, then that is far, far better to let the British people know so they can prepare,’ he says. ‘If events mean that does not happen and rate rises are not appropriate, then we will do the right thing and we will not adjust rates.’

It reminded me of the famous response from the patrician British Prime Minister Harold Macmillan when asked what could push his government off course: “Events dear boy, events“.

As his government blundered from mistake to mistake he was eventually booted out for his hopeless response to events, but many of the events blowing him off course were caused by his government in the first place.

Central bankers, like Macmillan, seem unable to see themselves as endogenous, only thinking they respond to exogenous impacts. It’s never their fault.

If they are operating with faulty Philips Curve models they will cause a lot of confusion when the economy refuses to move as they expect, as now. They think that they have to raise rates now to keep their predictions of 2% inflation in 2017-18 intact. They’ve modelled it, so it has to be true. First they corral market forecasters to predict rate rises. And then they produce circular reasoning charts like this:

JA Carney_1

As the data comes in worse than they expect they should admit their models are faulty rather than ad hoc blaming new, exogenous, “events”.

In fact, it is the markets’ belief that the UK (and US) central banks are itching to raise rates in line with their faulty inflation scenarios that subdues nominal growth and therefore inflation also. The answer is to target nominal growth, not inflation.

Is Mark Carney a Market-Denier?

A James Alexander post

Mark Carney is feeling a bit under pressure. His entry into various non-monetary policy debates such as “inclusive capitalism”, climate change, and now Brexit has stirred a few feathers, especially amongst Bank of England traditionalists. Progressives and others from the chattering classes seem to be making less fuss as he mostly seems to be one of them.

His spin doctors evidently decided that he needed to try and get back on-side with the more conservative majority in the UK and so allowed a journalist from the right-wing Daily Mail to follow him around for a day and record some of his more informal thoughts.

Climate change denial vs market-denial

On the big question for the Bank of England, climate change, he was giving no quarter.

‘I was in Lima with the International Monetary Fund and G20 last week and the second most talked about issue was climate change. Is it a bad thing that the Bank of England is not only doing its job but leading the way?’ he asks. Crucially, he argues, it is not outside his remit. London is one of the world’s biggest insurance markets. Insurers are having to take account of climate change fears and risk. It is affecting their capital levels and the premiums they levy.

Carney pulls the debate back to his core job – regulating and monitoring the UK’s financial system, saying: ‘If you want to deny climate change, OK. But you can’t deny the market. If you want to deny the market, then I can’t talk to you.’

Unlike Scott Sumner I feel somewhat sceptical about man-made climate change. The physicists I talk to seem unsure. Who knows? Anyway, the far more revealing point to me was when he drew an analogy between climate change deniers and market-deniers.

It is a paradox. Carney is most certainly not a climate change denier. But is he a market-denier? He appears to have no interest in creating an efficient market in UK inflation futures or Nominal GDP. He denies the market a leading role, or at least doesn’t trust it when it comes to monetary policy, instead preferring the models of the PhD’s in the engine room of the Bank of England. Most mainstream economists are like this, all treating rational expectations as too random, and therefore are all more or less market-deniers. It is arrogant beyond belief, but there you have it, and it causes huge market and economic dislocations as a result.

To be somewhat fair, Carney is not like the Fed in denying the market implied US inflation rate. But this is probably because the UK implied inflation curve is frankly unbelievable because of various technical failures.

  • Firstly, it measures an index called RPI that is no longer an “official” UK National Statistic, just calculated as an afterthought because so many index-linked gilts and other long-term contracts rely on it.
  • Secondly, CPI is what the BoE now targets and it runs anywhere between 0.5 and 1.5% below the officially under-resourced RPI measurement  .
  • Lastly, it is widely known that the UK pensions and annuity industry, that provides long-term RPI-indexation guarantees, is starved of supply for index-linked gilts causing an artificial shortage. The lack of supply drives up the price and drives down the inflation adjusted return, causing implied inflation to be shown as much higher than it really is.

JA Carney

(4% implied inflation! must be something screwy, and there is, massive artificial shortage of longer dated index linked gilts)

What a mess! Come on Mark, get a grip, help sort it out and stop denying markets a proper role.

UK inflation expectations are rather unreliable as a result of these technical issues and public confusion. The BoE’s modelled inflation seems very much to underestimate medium term “inflation” versus surveys and market implied RPI numbers given in the BoE’s Inflation Reports.


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.

The Bank of England should stop its monetary tightening now

A James Alexander post

Yesterday the UK inflation data for July came out. Core inflation “surged” from 0.8% to 1.2%. This was not just journalistic hype. Importantly the core inflation rate was 0.3% above market expectations. The market’s response? To push Sterling up against the already strong US Dollar by 1.3%.

Why this crazy, upward, dancing on the top of a tiny inflation pinhead? Because the Bank of England has a strong bias to tighten. Hence, news on core inflation ahead of expectations drives up Sterling and effectively tightens monetary policy. As Market Monetarists say: the market reaction is the policy.

The constant driving up of Sterling to pre-crisis levels should be recognised for the tight money signalling that it represents, and that the insane idea to actually raise rates would badly compound this current monetary tightening.

At the very least the BoE should go back to its policy of implicit flexible inflation targeting as it did when core inflation was consistently above its target. Better still move to targeting Nominal GDP (aka Aggregate Demand) and not something as flaky and little understood as core CPI.