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.
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.