A UK case against NGDP Targeting turns mostly on the alleged quality of the data

A James Alexander post

We have already posted 0n the growing debate in the Euro Area on NGDP Targeting. The first of three papers was leaked in September and Scott Sumner commented  on its positive case for NGDP Targeting. The other two papers presented to the European Parliament argued against. The first was from a French team that we have already dealt with, the second is by Andrew Hughes Hallet (AHH) of the University of St Andrews.

The case for NGDP Targeting

AHH first sets out some weak arguments for NGDP Targeting and then criticises each one in turn. It may just be me but I got the feeling Hughes Hallett’s heart was not in the game. It seemed to consist mostly of arguing that Inflation Targeting or a revised version of the Taylor Rule was superior. So the case “for” starts with this not so open-minded assumption:

“It is undeniable that nominal income targets will deliver worse inflation outcomes on average than a single (inflation) target regime or an inflation focussed Taylor rule.”

It is unclear why this should be so when you consider the actual, even if unintended, consequences of IT or an IT-focused Taylor Rule. Theory may be one thing, but practice delivers something else. IT targets have become rigid ceilings delivering very poor outcomes for inflation, on the low side. Where has Hughes Hallett been for the last few years?

More from the case “for”:

“So, to say that nominal income targeting is suitable is not to say that better rules cannot be found, especially when some flexibility is needed.”

Well, you could adopt flexible NGDP Targeting too. All he is really saying is that flexible rules are flexible, and this may be a good thing.

But what exactly is a flexible rule? Flexibility risks huge discretionary mistakes, as when “inflation nutters” (arguably Trichet) or “macropru nutters” (arguably Mervyn King, or even Ben Bernanke’s Fed) are at the monetary controls. The phrase actually comes from a (gated) Meryvn King paper arguing most central banks weren’t “inflation nutters” quoted favourably by the French team.

Hughes Hallett is a classic example of the strange and strong desire of the mainstream macroeconomics profession to not even consider the possibility of gross errors by central banks in recent times. I suppose it is still much more than their jobs are worth to challenge openly central bank authority.

“A positive demand shock for example will raise both incomes and prices. Higher interest rates, the response of inflation targeting, is the right response for both problems. A nominal income targeting rule will react the same way, although possibly more vigorously because it is acting against both excess prices and greater output. This raises the possibility of overcompensation and induced instability.”

But what is this “positive demand shock”? It’s hard to think of one except perhaps a fiscal policy expansion, but these need to be seen as permanent and not likely to be offset by monetary policy tightening as usually happens. In any case it’s unclear why higher (presumably real) income is seen as a “problem”. It’s a good thing, isn’t it?

It’s hard to bring about a permanent overshoot in nominal income that needs correcting that is not caused by some previously easy monetary policy. Real events don’t cause permanent inflation or excessive nominal growth, only monetary authorities can achieve this outcome.

“Nominal income targeting can be expected to help limit asset price bubbles.”

I’ve never heard this claim made by advocates of NGDP Targeting. However, this is a good thing for Hughes Hallett.

The case against NGDP Targeting

Having turned a weak case “for” NGDP Targeting into the case against and thus not really given a fair hearing to NGDP Targeting Hughes Hallett moved to its drawbacks. There seems to be only one as far as I can judge:

[paraphrasing] Real output data is late and subject to heavy revision versus CPI data that comes out up to one year earlier and is not subject to revision. The output gap is equally hard to measure.

Well, this is just a bit silly, as we have shown before, CPI data is not proper macro data precisely because it is not revised. It is simply not credible to use these figures for steering an economy, real time or looking forward. The GDP deflator is a high quality number and is, obviously, revised, like all quality macro data. CPI is not revised due to politics and other factors related to linkages to financial contracts, pensions etc.

In any case, NGDP Targeters favour targeting the forecast, expectations, just like most mainstream Inflation Targeters including, supposedly, the Bank of England. The question of data reliability of NGDP Targeting misses this really important point.

NGDP Targeting is about ensuring nominal stability, it claims nothing about the “output gap”. This is a concept that can happily be left to economic historians. If NGDP turns out to have been 5% inflation and 0% real no great harm is done, if it turns out to be 5% real and 0% inflation, then whoopee! What is seriously dangerous is too low NGDP growth because of the risks of negative demand shocks causing horrific recessions and unemployment.

The weakness of Hughes Hallett’s argument is shown by his sympathetic summing up of the case against:

… it is not difficult to agree that nominal income targeting makes a great deal of sense as a policy regime. It is simple and intuitive. But the practical difficulties involved in measuring the output term in real time, defining the output target accurately, explaining the necessary revisions, make it a difficult and risky rule to maintain in practice.

The next major section (3.1) of Hughes Hallett’s report is hard to follow. He seems to claim that NGDP Targeting is optimal when labour supply is totally inelastic, and most effective when it is highly inelastic. Then he also claims that it becomes progressively less effective “as the elasticity of labour supply responses diminishes”. Perhaps there are some typos here.

Section 3.2 acknowledges the role of markets in targeting, but says the Bank of England already does this by targeting inflation two years out. One of the current Deputy Governors of the Bank of England has recently shown that the BoE in its actual interest rate decisions  targets real output and not inflation. This is a confusing situation at the very least.

Hughes Hallet then dismisses level targeting as an objective by quoting a 2013 ex-BoE MPC member Charles Bean speech that argued there would have to have been a 15% extra growth in 2008-12 to make up for losses in the recession. Maybe. But the real argument is that a clearly signalled level target in place from before the recession would probably have meant no recession, or at least a very quick recovery. And Bean was a key member of the now discredited team at the BoE operating under the “marcopru nutter” Meryvn King.

Section 3.3 appears to take issue with a claim that NGDP Targeting would promote more discipline. It is a rather obscure discussion and not a claim with which I am familiar. Discipline, to what end?

Section 3.4 frets about dual mandates and how to prioritise them. NGDP Targeters urge monetary policymakers not to fret and just target NGDP and let the long run and/or markets and/or governments sort out the balance. It is not the role of central banks to be the arbiter in this debate about the shares of inflation and real growth in nominal growth. Central banks should merely maintain nominal stability to prevent low nominal income (or GDP) expectations, given sticky wages, being the problem they so often are. All else is noise.

Section 4 sets up a model that shows how precisely executed inflation targeting or a modified Taylor rule work, not only well, but perfectly. Just like the French contribution to the debate that we have already highlighted, but they are far from being precisely executed. Discretion ruins the theory in practice.

NGDP expectations targeting is far more likely to work well and not get hijacked by inflation or macropru “nutters”, using their discretion to follow their own, unintentionally anti-prosperity, ends.

The summary is fairly balanced:

From the ECB’s point of view, nominal income targeting is a feasible regime, but probably with as many drawbacks as advantages. On the positive side: it is easily understood, it accommodates beneficial supply shocks, provides stronger responses in bad times, and is a more efficient rule when supply responses are limited or structural reform is needed.

The “on the other hand” bit that follows is quite weak, as we have just shown.

The drawbacks are: inflexibility, problematic policy responses when prices and output react at different speeds, it may overreact or destabilise, and is robust to real time measurement errors. In addition, it appears to be less effective than the flexible form of Taylor rule that the ECB now uses. Nominal income targeting may be feasible, but probably not desirable.

The idea that “it appears to be less effective than the flexible form of Taylor rule that the ECB now uses” is just so remarkably optimistic, idealistic even. The evidence is primarily in the appalling track record of the ECB with its two bouts of disastrous rate rises in 2008 and 2011. Further evidence is the potential tragedy being played out in real time due to the ECB being so trapped by its rigid, and completely inflexible, ceiling of its “close to, but not above, 2%” inflation target. Draghi struggles heroically to offset the trap with huge amounts of QE and we and the markets watch with dread fascination how it will play out.

While it is really welcome to see the French team and Hughes Hallett taking an interest in NGDP Targeting, even if a somewhat critical one, these issues are just too important to be left to ivory tower academics alone.

Central bankers on target with their targets

A James Alexander post

There has been an illuminating exchange between Scott Sumner and Nick Rowe with John Handley who has been defending bravely New Keynesian models. New Keynesians wonder why QE at the ZLB hasn’t been effective in raising inflation. To me the best the reply is: central banks don’t want to raise inflation.

The central banks seem to define inflation as inflation two years out, that is expected inflation, based on their own “official” expectations. And, therefore, central bankers are on target with their own targets.

The evidence is clear in the charts and tables below, unanimously modelling a return of inflation.

So they just patiently, or often impatiently, wait for near term inflation to behave as their models predict so they can move rates as they plan: up in the US and the UK, hold flat in Japan and the EuroZone.  And the central bankers are slaves to these models.

The markets understand all this: that it is the two-year out inflation outlooks that drive monetary policy. For the Fed and the BoE monetary policy may even be a little too loose, certainly if they don’t raise rates in line with their guidance. The Bank of Japan seems to think it can just stand pat. And that maybe the EZ is a little worried that its two year out projection is a bit too low, and so is muttering about using some more tools.

All four central banks use mainstream New Keynesian models. So what is wrong? Inflation never seems to rise to the two-year out expectations. We have been there many times over the last several years as “inflation” keeps disappointing these determinedly mainstream models. So the market is really asking: at what point will the mainstream economics realise there is something wrong with their models? While the markets wait to find out, nominal growth will continue stalling, fearing that these New Keynesian slaves wont’ change their models but find a reason to raise rates – see our very last chart from the Bank of England desperately searching for an inflation pickup.

Market Monetarists understand that it is the two year out inflation targets that keep depressing near term inflation, and depressing nominal and real growth as a result. The answer is to target nominal growth expectations not strict inflation targets.

Flexible inflation targets would be better, but inflation is a poor economic measure. No one really knows when overall prices rise or fall, it is too difficult to observe. And there is total confusion about individual or particular baskets of goods and services price changes being due to quality changes or not, to mix changes or not.

Just target total nominal incomes, spending or output and forget about inflation. Five percent nominal growth will give enough flexibility for economies to ride the real economy cycles and not cause real economy mayhem due to downwardly sticky wages.

The Federal Reserve Board of Governors forecast in September 2015: PCE “inflation” will be at 2% in late 2016, assuming it raises rates in line with its guidance.


Federal Reserve “guidance” on rates from the same report


The ECB staff projection in September 2015 forecast  HICP “inflation” will be at 2% in late 2016, assuming it raises rates in line with its guidance.


ECB “guidance” on rates from the same report.


The Bank of Japan’s macroeconomic model in October 2015 forecast  (All Items Less Fresh Food) “inflation” will be at 2% in late 2016, assuming it raises rates in line with its guidance.


The Bank of England’s macroeconomic model in August 2015 forecast CPI “inflation” will be at 2% in late 2016, assuming it raises rates in line with its guidance.


Bank of England interest rate “guidance” from the same report.


Evidence of just how watchful central banks are about inflationary pressures coming up on the blind side and biting in the back is the chart from the same BoE August 2015 inflation report. The chart heading reveals a lot about the thinking at the BoE. A “slight pickup in consumer goods inflation” is evidenced by a “rise” from an actual negative rate of 0.25% to a positive 0.05%. Whereby the official CPI projection has some appropriately wide fan charts to show the degree of error, when it comes to spotting future pressures the error charts disappear.



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

Two cheers for David Miles

A James Alexander post

David Miles is leaving the Bank of England rate-setting committee at the end of August and has been giving a few farewell interviews.

To his credit he never voted for a rate rise (or cut) during his term in office, but he does feel a bit frustrated for having “done nothing”. What he doesn’t understand is that monetary policy has loosened and tightened a lot during his time on the MPC nonetheless.

Any given rate stance of a central bank can be tight or loose monetary policy depending on NGDP Expectations. And those expectations have moved around a lot over the six years he’s been on the MPC, as it includes the early recovery from the GFC and the 2011 ECB-caused Eurozone crisis.

He’s done lots despite not tinkering with rates. And credit to him especially for not joining the UK hawks on the MPC in 2011 voting for rate rises.

Miles’ interview with Bloomberg does, however, contain this very common error, one central bankers on both sides of the Atlantic seem to be making:

Miles cautioned that delaying an increase might require faster tightening.

“The longer you leave it, the slightly more steep that trajectory becomes,” he said.

What is the evidence for this theory, or rather fear, of having to “catch-up”? None is ever presented. Have underlying inflation expectations ever shot up so fast that a central bank is forced to slam on the brakes? Of course not. Underlying inflation expectations change glacially slowly.

Headline inflation may jump about but VSP central bankers should be able to rise above such noise.

To make their lives easier central bankers should switch from Inflation Targeting to Expected NGDP Growth Targeting, and then they won’t get distracted by hard to measure inflation, wage growth or even employment/unemployment figures. In fact, central bankers could be replaced altogether for a machine that followed this simple rule.

No need to turn up for BoE’s first Super Thursday, but still a need to worry

A James Alexander post

Changes to the publication schedule mean that the the rate decision (no change, yawn), minutes of the discussion and the BoE Quarterly Inflation Report will all come out on the same morning – as well as a press conference.

At least two “hawks” are thought to be about to vote for a rate rise (Weale and McCafferty). Unfortunately, or rather fortunately, their credibility is zero having voted for a rate rise for five months of 2014 before backing down. Weale, infamously, even voted for rate rises for the first seven months of 2011. Frighteningly, he was not alone back then as two other hawks (Dale and Sentance), both now off the rate-setting committee, also voted for rises. God knows what might have happened if the UK had followed the ECB in its disastrous 2011 rate hikes. Slightly worryingly, one long term swing voter, David Miles, may join the hawks this week.

Why are the hawks getting so angsty? Inflation, headline and core, is nowhere to be seen. Early indications for both NGDP in 2Q15 growth are very poor. The unemployment rate appears to be leveling off.  Arguably, monetary policy is passively tightening at the moment. it is certainly no time to be actively tightening. The one “risk” is from the decent uptick in private sector wage growth that appears to be underway, finally. If true, this should be a cause for celebration not a shooting. And, who knows, it might even lead to some productivity growth.

James Post2

One saner voice appears to be that of the newish Chief Economist, but long-term BoE veteran, Andrew Haldane. His ability to think outside the box has not endeared him to conventional Inflation Targeters. His mostly excellent speech “Stuck” came in for a lot of criticism as he said he was undecided whether the next move in rates would be up or down.

His boss, the Governor, seems keener to tighten at some point in the near future, almost in conjunction with the Fed. Although Mark Carney has brought a much needed breath of fresh air to the BoE and much greater sensitivity towards markets than his predecessor, I have been disappointed he has not developed from his famous December 2012 speech on Guidance while still at the Bank of Canada, where he also raised the possibility of NGDP Targeting. Somehow, the BoE-borg (a close relative of the Fed-borg) has got hold of him and we are mostly still stuck in the Inflation Targeting mode of thinking.

I suspect that there is still a reluctance of old-guarders to move to take NGDP Targeting seriously as it would imply a criticism of the central bankers reaction functions back in 2007-2009. Carney did sort of move towards a mea culpa acknowledgement that something had gone wrong in his June 2015 Mansion House speech  but mainly as regards to liquidity, not monetary policy:

The Bank of England’s Role

All must play a role in building real markets, including the Bank of England.

Although the Bank does not regulate conduct or markets per se, it has responsibilities for, and powers over, the stability of the UK’s financial system as a whole.

In the run-up to the crisis, the Bank’s contribution to the effectiveness of markets fell short in three respects.  In all cases, the Bank is now responding.

First, the Bank’s framework for providing liquidity was shown to have lagged behind market developments.  Once under pressure, the Bank could neither stabilize overnight rates nor support the banking system.  Fortunately, in the jaws of the crisis, the Bank innovated rapidly and admirably to avoid a collapse of the system.

Those lessons are now embedded in a new, comprehensive framework for the Bank’s sterling market operations.  We have expanded the range of eligible collateral, and will lend to many more counterparties, at much longer maturities.  The Bank also stands ready to act as a market maker of last resort.

Constructive Ambiguity has been replaced by Open for Business.

Unfortunately, the near apology was lost in his populist bank-bashing proposals. Perhaps it will be the next Governor who makes the big paradigm shift, Carney just isn’t that revolutionary.