The great Brexit devaluation mystery

A James Alexander post

Simon Wren-Lewis has an interesting post, Brexit harm denial and the exchange rate, where he discusses some popular notions about the great British devaluation after the Brexit vote.

I have already discussed it here and explained that part is a pessimistic reading of the future trade deals that the UK might strike. If you are pessimistic then fair enough. But this is not really about economics but futurology.

For a more optimistic, but very realistic understanding of the issues involved in trade deals Dr Richard North and his colleagues at EUReferendum have an excellent blog and series of monographs on Brexit, or Flexcit as they call it.

Wren-Lewis who, as far as I can tell, has never written a blog post on the economics of wealth creation out of the hundreds that he has posted, is not a great guide to the workings of the market – even if, to his credit, he is occasionally sympathetic to NGDP Targeting. Wealth creation is mysterious to him, a grubby business at best, full of overpaid CEOs, neoliberalism at worst. Perhaps it just happens by chance? According to him “99% of economics is about market failure” [in a reply on his blog to a comment of mine]: the modern dismal science epitomised, and his flirtations with Corbyn explained.

What caused the price change?

While it is utterly wrong to argue from a price change, it is very right to try and understand what caused the price change. Why did holders of Sterling sell? Political uncertainty was a factor, but that was relatively quickly sorted out and Sterling remains at the lows. Have other factors like US Dollar strength taken over, preventing a Sterling rally. Maybe.

Perhaps it was expectations that Mark Carney would dramatically ease monetary policy? In which case, the devaluation was not caused by Brexit but by the BoE’s expected stance. Although Carney had campaigned for Remain he made it clear he was ready to act if Remain lost. And he did act decisively, both on the day with interviews and somewhat grudgingly followed up with actions.

A relaxed monetary policy is quite a big step for a BoE that had been tightening all through 2015, if not quite a much as the US. In that sense, Brexit got Carney off the hook of having to make a more obvious u-turn. Carney had heavily overestimated UK economic strength during 2015 and early 2016 and was going to have ease in 2016 anyway.

Perhaps Sterling fell because market participants expected the UK economy to be smaller years ahead. Maybe, but it’s hard to see, practically speaking why they sold Sterling now on such an uncertain outcome, years ahead. Safe-haven buying of UK government bonds pushed down yields, which rather goes against this argument.

At the end of the day, the depreciation was only 10%, not that big in longer run historical contexts. Sterling fell 25% vs the US Dollar during both the 2008 financial crisis and after the ERM exit. It often moves on unexpected political news. The mild shock of a Tory victory in May 2015 drove it up 4%.

On Wren-Lewis’ specific four points:

  1. 1. “Depreciation has a good side, because it gives a boost to our exporters”

Well, he admits this is true. There will be a short term boost to exports thanks to the depreciation. And this will be good for the economy as the costs of Brexit, when it happens, will only come later. He says that “we are poorer because of Brexit”, but only because the markets expect us to be poorer and hence drove down the currency. He may be right in his interpretation, but those markets could turn out to be wrong about that piece of futurology. It is still very encouraging that Wren-Lewis recognises that market expectations can have real effects, just like market expectations about nominal growth.

He also claims that “markets believe Brexit will cause an economic downturn in the UK, implying lower levels of UK interest rates. (In this they have been proved correct).” One hates to disagree with such an eminent economist in his interpretations of market moves, but the Bank of England was very confident that Brexit would cause a rise in gilt yields due to fear about the UK economy and its credit rating. Remainers like Wren-Lewis and the BoE seem like they want to be right about the negative consequences of Brexit whatever gilt yields did.

What Wren-Lewis specifically fails to mention is the benefit to domestic demand of a depreciation, nicely expressed by Britmouse at Uneconomical back in January this year. Currency devaluation is a way of boosting AD, by forcing consumers to switch from overseas goods and services to domestic goods and services. This is the classic benefit of devaluation, not that it is good for exporters. The overall impact on the balance of trade is hard to tell given the inelasticity of much import demand. What tends to happen on a devaluation is that the value (in the devaluing currency) of both exports and imports rises, thus raising AD. If the devaluation was due to Carney’s expected reaction, then good.

  1. “Sterling was overvalued anyway”

While it is “ludicrous” to suggest that the problem of overvaluation, if it existed, was overcome by the Brexit devaluation, it isn’t ludicrous to suggest that devaluation will offset some of the pain. See 1.

3. “Sterling is only back to where it was …”

Wren-Lewis makes an obscure argument by analogy, something about having your basic pay cut but the boss promises it won’t be that bad as bonuses will be higher. The UK may be 10% poorer in $ terms but is it really relevant when Britons are paid in Sterling and wages in Sterling didn’t move at all. The UK is a massive holder of overseas investments, was the UK richer after the devaluation also?

And, yes, Sterling in Euro terms (the purple line) really only was “back to where it was”. In US Dollar terms (the blue line) it has been falling for a long while, mostly due to much more US monetary tightening versus the UK. To be fair, it does depend where one starts to draw the line, but then an argument about that issue doesn’t really lead very far as more and more “noise” enters the discussion.

JA Brexit Devaluation

  1. It is just a temporary problem before things become clearer”

Wren-Lewis now lays his cards on the table (I think) and assumes there will be a short term economic downturn until the UK accepts the single market and free movement, at which point “the economy then recovers, interest rates rise, and sterling appreciates”. Brexiteers can then be blamed “for all this uncertainty and the temporary damage”.

Again, Wren-Lewis engages in a lot of futurology. Who knows if there will be much of a significant economic downturn from Brexit. Were we due one anyway given the weak NGDP growth over the last 15 months? A fact that Wren-Lewis and other macro-economists have been awfully silent over.

Who is to say what “free movement” means once it is up for negotiation? Does it mean exactly what we have now, with full access to UK welfare benefits for all and any EU citizens who move to the UK? Once we have agreed the trade deal with the EU will the EU prevent us negotiating deals with third party countries and blocs that the EU has so signally failed to do itself? Would this be bad for the UK?

The answers to these questions and many more will inevitably colour the macro-economic outcome, but these are political questions and macro-economists (and the Bank of England) would do well to make clear their political judgements on these issues before sounding off with such certainty about the economic outcomes.

UK NGDP picks up ever so slightly

A James Alexander post

UK RGDP in 2Q 2016 surprised on the upside today with 2.2% annual growth. NGDP also picked up a bit to 2.9%, but is still well below trend.

The numbers are only a first estimates, and there has been some funny business with a usually strong April following a very weak March. In any case no-one is that interested in 2Q as it is all pre-Brexit. No-one will be that interested in 3Q probably either as it will be influenced by the shock of the Brexit vote.


We are also not that interested in RGDP as it is such a low quality number, based on the neglected numbers that go to make up NGDP and the low quality GDP deflator figure that, like CPI, struggles to cope with qualitative and structural change.

NGDP in the UK has been horribly weak for the prior four quarters. The proxy number for NGDP, Nominal GVA, has been even weaker at a less than 2% average over the last four quarters. While the 2Q 2016 figure of 2.9% is better than the recent past it is still far below a healthy level. Only NGDP growth and hence wage growth of around 5% will allow real incomes to show a good diversity of outcomes and thus promote flexibility and productivity growth. Real wages are still squashed down into a narrow range of growth by this nominal sluggishness.

A top priority for the new Chancellor of the Exchequer is to give the Bank of England nominal growth targets for the good of the economy overall and for healthy tax receipts in particular.

Higher nominal growth will also enable the UK labour market to cope with (potential) shocks from things like Brexit, allowing aggregate negative real wage growth without having to go through job and wealth destroying process of aggregate negative nominal wage growth.

Three ideas for new UK Chancellor Hammond

A James Alexander post

The UK has a new Chancellor of the Exchequer this weekend, Philip Hammond. Encouragingly he has studied at least some economics having read the infamous PPE course at Oxford, more than could be said for George Osborne who just read Modern History. Although Hammond was awarded a 1st we don’t know (yet) whether he specialised in the Politics bit (hopefully, little), the Philosophy bit (OK’ish) or the Economics bit (hopefully a lot).

The fact that he has been in business and especially property development is reasonably encouraging. He should recognise the need for nominal growth across the economy, as economic actors live in the (real) nominal world and not in artificial constructs like inflation and Real GDP.

Here are three ideas he should be considering this weekend:

  1. Commission his UK Treasury to update the 2013 Review of the monetary policy framework. The strict inflation targeting was more or less reaffirmed but has failed to get inflation up to, let alone averaging, 2%. The grand line-up of public and private sector economists who criticised NGDP targeting should all be asked back to justify the failure of IT to deliver.

2. Downgrade the essentially arbitrary inflation target of 2% as secondary to a target of 5% growth in underlying          nominal GDP. This growth rate of 5% is about right for nominal wage or income growth such that an economy has flexibility to cope with shocks and not lead to involuntary unemployment and recessions. This level will also allow much greater relative real wage and income flexibility, which in turn will allow for relatively more productive individuals and firms to be rewarded by real rises in wages and incomes, and for less productive ones to be let down gently in real terms but still grow (more or less) in nominal terms. Productivity will rise, people will be happier and you will be more popular.

2.1. If this is  too much change in one step, move to a properly assessed dual target of inflation in a range of 1-3% with the flexibility coming from reference to real growth in GDP. It is imperative to stop the 2% target becoming, as it may already have done, a 2% ceiling to projections two years out.

3. Issue some government bonds tied to a 24 month moving average of NGDP or, better still, sponsor an NGDP Growth Futures market and target NGDP growth one or two years ahead. Do not target current or historic NGDP as there is always noise in that data that needs to settle down as estimates become actuals and errors corrected. CPI is an unwise target as it is an economic and politically-sensitive index that cannot be corrected for its inevitable errors – except when the whole framework is revised like with the switch from RPI.


Where were 99% of UK economists in August 2015?

James Alexander post 

It is reported that 90% of UK economists are in favour of the UK remaining in the EU. They have carefully considered the costs and benefits of the UK leaving and mostly decided the economic loss is great, up to 8% of RGDP by 2030 – or around 0.5% per year for the next 14 years.

Yet right here, right now the UK is currently losing 1% of RGDP per year from tight monetary policy pressuring NGDP growth to below 3%. But there are no round-robin letters from these economists, no blog campaigns, no nothing.

In August 2015 we warned that UK NGDP had fallen to below 3% in 2Q15 driven by a rapidly shrinking growth in the GDP Deflator, indicative of near deflationary conditions.

Back then the Governor of the Bank of England was clearly warning that tight money was ahead. It had the effect of reducing NGDP growth further. There was virtual silence from these 90% of economists, except for one or two notable, mostly overseas macro-economists, like Danny Blanchflower.

The weak trend in RGDP fuels concern about the management of the economy and adds fuel to the Brexit flames. Similar trends occur in other countries: weak NGDP, weak RGDP, protest movements.

Market Monetarists are clear, below trend growth in NGDP will drag down RGDP. We would like to measure expectations for NGDP growth but that is tough. Longer term government bond yields are not a bad proxy and they are low and going lower in the UK despite Brexit fears about potential credit downgrades caused by Brexit. Of course, global slowdown fears could be trumping UK credit rating fears, but this would still put those latter fears into perspective, i.e. no big deal for the UK’s credit rating or at least for the consequences of downgrades.

Since the 2Q15 slowdown in NGDP the situation has mostly worsened and dragged down RGDP. Trend growth in NGDP was 5.3% in the UK 1992-2007 and trend growth in RGDP nearly 3%. Since 2010 NGDP and RGDP growth have averaged 3.8% and 1.8% respectively.  Every time RGDP has moved it appears to have been dragged up or down by NGDP. With NGDP growth averaging 2.4% over the last four quarters we would expect RGDP to be dragged down from its below 2% current level to closer to 1%.

JA 99%_1

The charts below give a more striking view of the depression caused by misguided monetary policy. The same outcome can be seen in the US and Eurozone, indicating that even monetary policy mistakes have become “sinchronized and globalized”!

JA 99%_2

Because of the neglect of NGDP growth by the Bank of England under the targets set by the UK Government, RGDP growth is running perhaps 1% or more below trend. This figure compares with the 0.5% below trend that could result if the worst fears of 90% of UK economists are realised.

Yet there is a deafening silence on this current disaster and a very loud campaign about Brexit. These UK economists and their claque in the press and social media should be ashamed of themselves.

UK NGDP growth not playing to Osborne/Carney tune

A James Alexander post

UK NGDP growth was released today together with the second estimate of RGDP figures. NGDP picked up slightly to 2.5% YoY. We had earlier shown a similar trend using Nominal GVA data. The very messy and subsequently revised figures from 3Q and 4Q last year now show two quarters of a very low 2.2% YoY growth.

NGDP growth was very poor before Brexit concerns and has, if anything, now picked up slightly as those concerns have increased. Rather ironic given all the scaremongering – perhaps the GBP weakness helped ease the concerns.

Carney solemnly swore that there had been no government interference forcing the Bank of England to take its strong anti-Brexit stance. We believe him. All the ruling elites of both the UK and the Rest of the World are taking the same view. They are not at the sharp end of the woeful nominal growth that constantly drags down real growth. Above everything they prefer governments to be remote from the public and in the hands of self-selected technocrats who should be trusted to do the right thing.

The evidence from the UK is that Carney is failing badly. “Remain” economists remain surprised by the strength of the Brexit support despite all their best efforts. Well, they should look at nominal growth and not be so surprised. Mainstream macro-economists fail in so many ways, but none more so in their relaxed attitude to low Aggregate Demand (aka NGDP) growth. The Brexit debate is a sideshow compared to this abdication of responsibility.

Carney and his political master George Osborne should have been alarmed at the trend of nominal growth in the UK. Even if Brexit concerns are not preventing a small rise in nominal growth the rate is still far too low.


Carney still believes that the next move is up in interest rates, so cementing a policy of passive monetary tightening. When he strongly repeated his view this week, Sterling rose strongly. Just great. It’s not clear if all his Monetary Policy Committee agree with him but they don’t seem brave enough to speak out much.

In recent exchanges over Brexit Carney looks like a very hard man to cross. His responses to Jacob Rees Mogg in Parliamentary questions over the BoE’s anti-Brexit stance were a cross between Tony Blair and Bill Clinton. About right as he has passed from wannabe Canadian politician to global stage-trotter. He has become the model of a very modern hawkish central banker more concerned about fighting non-existent inflation threats than doing his upmost to help create prosperity. This is a shame.

We had high hopes back in the day he openly talked about NGDP Targeting. If he had to face an electorate worried about prosperity perhaps he would change his tune. It probably wouldn’t have much effect given the little impact it seems to have on his boss, Osborne.

UK NGDP turns up a little but still dragging down RGDP

A James Alexander post

First release of UK RGDP for 1Q16 today was in line with expectations. This is not saying much at it is just 2.1% up on the year ago quarter and trending down.

Much worse news was that Nominal Gross Value Added (or “GVA at Current Prices”, a close proxy of the not-released-for-another-4 -weeks NGDP) is still limping along below 2% per annum and will continue to depress real growth. Households will continue to feel there is no growth while the economy appears so lacklustre. Real growth (RGDP) will continue to be dragged down by weak nominal growth (NGDP).


The crucial point missed by mainstream macro is that economies need micro-flexibility to promote efficient allocation of labour amongst different companies and sectors without some companies hitting downwardly sticky wages and thus forcing mass lay-offs. With 5% nominal growth gentle reallocations can occur via money illusion, as some employees in relatively declining industries or companies can lose real income but not lose their jobs. With 2% or less nominal growth nominal weakness in revenues forces nominal cuts in expenses and thus real job losses – and lost real GDP.

There has to be a huge caveat on these first release nominal GVA/GDP figures given large errors in the series seen in recent quarters on top of the inevitably large adjustments made as more data on the quarter is collected. To be fair, the trend NGDP had looked worse even  but the really bad figures have now been revised up a little.

Although Nominal GVA was reported at 1.9% and thus a small increase on the 1.4%  in 4Q15 the figure implies the official implied deflator, and the best measure of inflation we have, is still negative. That is, you have to inflate Nominal GDP to get Real GDP, rather than the usual deflating of Nominal to get Real. Confusing? Well, that is the actual deflationary world we live in these days for you.

NGDP not less reliable than RGDP (or inflation), but it’s not relevant anyway

A James Alexander post

There is growing debate about the potential introduction of NGDP targeting or, rather, a debate that had quietened down seems to building up steam again in Europe  and in the press.

Back in 2012 it was discussed in central bank circles. This was probably due to the recovery seemingly stalling in many countries and central banks were reluctant to do more QE and cast about for alternatives.

As the global recovery began to pick up in 2013 the NGDP train itself thus stalled. In the UK semi-secret discussions led nowhere and some semi-public inquiries opted for the status quo. The cloak and dagger nature of the debates was because of the sensitivity of the subject, evidenced by the wonderfully positive response to Mark Carney raising the issue when he was still head of the Bank of Canada, but on his way to the Bank of England.

The major confusion about the actual target of monetary policy and the direction of US and UK interest rates has brought NGDP targeting back on the agenda. Headline inflation, core inflation and the central bankers’ preferred measure of the GDP deflator, are all flat on their backs. Long term market-implied inflation, or as the Fed likes to belittle it “inflation compensation” (ie the US TIPS spread) is also very low. Why not look at NGDP expectations instead?

The weakest criticism of NGDP Targeting

A lot of the smart set like to dismiss NGDP because they think it gets revised a lot more than RGDP or inflation. This is simply false for the US as I showed here.

In any case it is theoretically impossible for NGDP to be revised more than RGDP, given equal resources to the production of the data. RGDP is merely a derivative of NGDP deflated by inflation, another set of data that is prone to revision, as shown for the US by Mark Sadowski here.

Yesterday’s revisions to UK GDP by the Office for National Statistics provided an opportunity to do a similar test of RGDP vs NGDP revisions. It’s a bit hard to compare apples with apples as UK RGDP estimates bizarrely come out in what the ONS calls Month 1 (M1), 3-4 weeks after the quarter end, while NGDP only comes out in Month 2 (M2) with the first revisions of RGDP. There is then a Month 3 final release. However, there are also at least three further reviews “Blue Book 1” (BB1) after a year and “BB2” after two years, plus a more final review after a period of 3 years (Y3). Yesterday’s revisions showed some very large changes to the history of RGDP,  in particular for the 2012 quarters.

Looking over a long period the quarterly YoY revisions for the UK come out like this:

JA NGDP Revisions_1

The revisions more or less cancel themselves out over long periods. The UK RGDP and NGDP has been shown to be much worse than first feared during the Great Recession, but the recovery has been shown to be more robust too.

The average revision excluding the direction of the revision is somewhat greater for NGDP than for RGDP, although the Standard Deviations aren’t that different.

So much for NGDP being far worse than RGDP for revisions, and with equal work they will be smaller revisions.

Inflation: CPI, RPI or the GDP Deflator?

Some have pointed out that inflation in the UK never gets revised, but this is just the Consumer Price Index and its predecessor, the Retal Prices Index. The “no revision” stance is a political one, not a statistical one. And something so political should not be an object of serious monetary policy, or even serious economic research. The ONS themselves more or less admit this:

Consumer price inflation statistics are important indicators of how the UK economy is performing. They are used in many ways by individuals, government, businesses, and academics. Inflation statistics impact on everyone in some way as they affect interest rates, tax allowances, benefits, pensions, savings rates, maintenance contracts and many other payments.

 “The uses to which consumer price inflation statistics are put (notably indexation) means that it is imperative that every effort is made to ensure all data are included in the first release of any month’s figures. This is reflected in the revisions policies below.

“CPI indices are revisable although the only time the CPI all items index has been revised was when the index was re-referenced to 2005=100, which took place with the publication of the January 2006 indices.

And the Retail Prices Index before it:

The policy for the RPI is that once the indices are published they are never revised. This was re-affirmed in the 1986 RPI Advisory Committee report (Command 9848 p86, para 183) which states:

“it has always been the practice not to revise the RPI once it has been published, as doing so would create serious problems for some users, particularly in connection with index-linking, and we have no wish to see this practice changed.”

There are no perfect macro indices. The notion that it is a political stable index is shown by the number and size of revisions to the GDP deflator, the professional central bankers measure of choice.

The ONS also helpfully released its “revision triangles” for the GDP deflator this week which make a colourful chart that reveals some incredibly wild revisions to the GDP deflator from any particular quarter. Many are revised by quite substantial amounts several years after the initial releases.

The lines in the chart show the “life” of each YoY quarterly deflator, from birth a few weeks after the period end to the current day. The most ill-behaved child is the 3q12 deflator, going negative at one point in its 3 year life to date. Not coincidentally, the quarterly RGDP numbers have been ill-behaved too.

The volatile lives of YoY quarterly deflators

JA NGDP Revisions_2

The average revisions for the quarters from 1q00 to 1q06 are 0.1 including the sign, 0.9 excluding the sign with a standard deviation of 0.6. The latter two quite a bit worse than either RGDP or NGDP. So much for NGDP being less reliable than a reliable inflation index.

It is slightly comical, but also deadly serious. Historic data cannot be relied upon. Medium term expectations are what really matters as they drive actual behaviour. People do not drive by looking in the rear view mirror. Steering current and future behaviour is what will avoid recessions and excessive booms.

Osborne needs to learn some Market Monetarism

A James Alexander post

Keynesians, especially left-wing ones, are hyper-quick to attack George Osborne, the U.K. Chancellor of the Exchequer (aka the Finance Minister or Treasury Secretary) for the smallest attempts at controlling the budget deficit and howl him down whenever he is so economically illiterate to think there is the smallest problem with Britain’s 80% debt to GDP ratio.

Perhaps on the day when Osborne’s deficit reduction plans went a bit astray they were all too busy cracking open the prosecco that they failed to spot significantly worrying remarks about monetary policy.

The Times reported thus , while Osborne was tripping through ChIna:

Mr Osborne hinted earlier yesterday that interest rates were going to rise, clearly siding with Mark Carney, the Bank of England governor, against Andy Haldane, its chief economist, who recently suggested that rates might have to stay low for longer because of problems in the Chinese economy, or may even need to fall.

Mr Osborne appeared to play down last week’s decision by the US Federal Reserve to hold rates rather than put them up, saying it had been dictated by the circumstances at the time.

Then he added, in what was close to a departure from the traditional reluctance of chancellors to interfere with the independence of the Bank, that the signals of rate rises in recent weeks reflected the growth in the American and British economies and that the “general signal coming from the Bank and the Federal Reserve is that the exit from very loose monetary policy is going to come”.

For starters, I thought this might trigger a debate about Central Bank Independence. (CBI) which has been filling then UK macro blogs like here and here since the Corbynomics debate exploded. Personally, I am CBA about CBI, the policy is the key, and often central bankers can’t be trusted to make good policy, but governments can, eg Japan. Of course, we see things often the other way around, too, but it is a sterile debate about means rather than ends.

The bigger issue is why Osborne thinks monetary policy is very loose. To be fair mainstream macro and “mediamacro” (HT Simon Wren-Lewis for the term) make the common mistake all the time of confusing interest rate levels and the amount of QE with the stance of monetary policy. The stance of monetary policy can only be measured by looking at whether demand for money is outstripping supply of money, and that can only be seen by looking at where nominal growth (aka Aggregate Demand) is headed. If on a downward trend money is tight, if on an upward trend money is loose. If in trend monetary policy is just right.

The recent historical economic evidence is that UK NGDP is slowing down, 2Q15 was quite poor. The relevant inflation rate for macro policy, the GDP Deflator was worse than poor. Tax revenue growth on incomes is still not great, just like the more difficult to measure wage growth itself. Looking forward, implied UK NGDP growth forecasts are weakening too, judging by market indicators like Sterling strength, long term bond yields, commodity prices and the stock market.

Despite some interestingly radical thoughts from the BoE Chief Economist Andy Haldane, Governor Carney seems squarely in the Janet Yellen/Philips Curve camp of warning rates must rise soon.

Hopefully, Osborne’s Treasury advisers will get him to see sense, if not things won’t turn out well. They won’t turn out disastrously as markets will force more delays in further monetary tightening. But the guidance on policy from Carney and his boss Osborne (and Yellen) will remain a mess. And the mess will, of itself, crimp NGDP growth.

One small step for supply-siders, a giant leap for Wren-Lewis?

A James Alexander post

Market Monetarists have often been a bit frustrated with Simon Wren-Lewis’ Keynesian over-concern with the obstacle of the Zero Lower Bound. Having flirted  with NGDP Targeting a few years ago he went off the idea. It is great to see him both attacking  the idea of raising rates, in fact suggesting a cut in rates, and also returning to support NGDP Targeting:

“Good policy should not just look at the most likely outcome, but also at risks. At the moment there is a significant risk that we may be losing a huge amount of resources because of a tepid recovery. To cover that risk, we should cut rates now. The worst that can happen if this is done is that rates might have to rise a little more rapidly than otherwise in the future, and inflation might slightly overshoot the 2 per cent target. Inconvenient, but not very costly.

If we fail to cover that risk, there is a non-trivial probability that in three years’ time inflation will still be well below target and we will all be asking why on earth everyone in 2015 was talking about an interest rate increase.”

“If the Bank of England had adopted a NGDP target, as many have recommended, the MPC would be tearing their collective hair out right now trying to stimulate the economy. There would be zero talk of interest rate increases. So there seem to be just two possibilities. Either NGDP targeting is nuts, or monetary policy has slowly gone off the rails by focusing on CPI inflation alone.”

Unfortunately, there is still little room for the UK to cut rates as they are obviously very close to the the ZLB, unless the MPC goes down the negative rate road. Perhaps Wren-Lewis is just paving the way for a reopening of his campaign for more big government fiscal policy – he has never proposed tax cuts as a form of fiscal policy as far as I have read. Is this because his anti-market, anti-supply side, bias blinds him? I don’t know. But this bias needs to be overcome for NGDP Targeting to be really effective.

At or around the ZLB central banks have to be very clear just how far they will go with unconventional monetary policy in order to achieve their targets. But the key issue is how the markets, and thus the wider economy, understand what the central bank is really targeting.

Actual NGDP is a tricky thing to target as the numbers inevitably come out after the event, and accurately many months after the event. It could be too little, too late if central banks only look at incoming data. They must look forward, to set the flight path they want to be on.

Better to work with the market and target the market’s expectations for future NGDP. At the moment these expectations can only be seen indirectly through market implied inflation rates, longer term bond yields, equity markets and exchange rates. Consensus macro forecasts are almost worthless with their constant reversion to mean, usually using the same discredited macro models used by the central bank’s themselves. Market prices are far more reliable as a guide to the future as real money is at stake rather than just the reputations of a lot of rent-a-mouths.

It would be best for central banks to help launch an NGDP Futures market as Scott Sumner has argued. This small but imaginative step by a supply-side macroeconomist brought together Friedman’s classic monetarism with the new insights of rational expectations.

It would be even greater if Wren-Lewis too could make this step and work with rational expectations to achieve successful monetary policy and growth, rather than being so skeptical about the market all the time. For a Keynesian like Wren-Lewis this would be a giant leap, but it is a necessary one.

When your mind´s made up…there´s no point trying to change it!

From The Telegraph:

Turmoil in China and slower UK growth will not blow the Bank of England’s plans to raise interest rates off course, policymakers are expected to signal this week.

While economists said there was “little doubt” that rates would be kept at a record low of 0.5pc for a 78th consecutive month, minutes of the September meeting, which will be published alongside the Monetary Policy Commitee’s (MPC’s) rate decision, are expected to highlight the strength of the domestic economy, even as the nine member panel remains split over the timing and path of rate rises.


Michael Saunders, chief UK economist at Citi, said even a sharp slowdown in China would only exert a “modest” drag on UK growth and inflation, while stronger pay growth meant increases in real income were on course to reach 3.5pc this year, a level that has not been seen over the past decade.

“The UK suffered several mini-slowdowns during the long pre-crisis expansion from 1993-2007. But, when one looks back at the period as a whole, what stands out is the economy’s resilience and the expansion’s ability to shrug off minor setbacks. Unless global conditions or UK credit availability worsen markedly, we suspect the same will apply in coming years,” he said.

Exactly, but why? Is a repeat performance guaranteed as he suspects?

The charts indicate the reason for the UK´s economy “resilience” from 1993 to 2007. That´s because NGDP growth was kept “right on top” of a trend level growth path of 5.4%. With that, RGDP was also kept stable, “shrugging off minor setbacks”!

When your minds made up_1

The growth chart shows the result of the lost NGDP stability. Given that NGDP growth has remained substantially below the previous trend path and has been somewhat volatile, I believe Michael´s “suspicion” is not warranted!

When your minds made up_2

Title song