UK Monetary Policy Revolution

A James Alexander post

The great mid-2015 tightening

From the August 2015 Inflation Report opening remarks:

Policy outlook

The MPC’s projections are conditioned on Bank Rate following the gently rising path implied by
market yields. Under this assumption, demand growth is expected to be sufficient to return inflation to the target within two years. Inflation then moves slightly above the target in the third year of the forecast period as sustained growth leads to a degree of excess demand.
….
As the UK expansion progresses, speculation about the precise timing of the first move in Bank Rate is increasing. This is understandable and is another welcome sign of the economy returning to normal. The likely timing of the first Bank rate increase is drawing closer.

The great mid-2016 loosening

From the August 2016 Inflation Report opening remarks  :

Policy trade-off

The MPC’s Remit recognises that when the effects of shocks persist over an extended period, the MPC is likely to face an exceptional trade-off between returning inflation to target promptly and stabilising output.
When this is the case, the Remit requires the MPC to explain how it has balanced that trade-off, including the horizon over which it aims to return inflation to target.

Fully offsetting the persistent effects of sterling’s depreciation on inflation would require exerting further downward pressure on domestic costs. And that would mean even more lost output and a total disregard for higher unemployment.
In the Committee’s judgement, such outcomes would be undesirable in themselves and, moreover, would be unlikely to generate a sustainable return of inflation to the target beyond its three-year forecast period.

As a result, in order to mitigate some of the adverse effects of the shock on growth, the MPC is setting policy so that inflation settles at its target over a longer period than the usual 18-24 months.

ja-uk-mp-revolution

Headline CPI could now stay below Core CPI for 10 years

A James Alexander post

The inflation doom-mongers are out again with today’s US Consumer Price Index numbers and, to a lesser extent, in the UK where, headline inflation really is just too low for most hawks to shout too much about steady core inflation.

We must all ignore “headline” inflation and focus on “core” inflation. Core is the measure for inflation-worriers because … it is currently higher than headline. When headline was above core they worried about headline, naturally enough. Normal service will be resumed as there will be a very short period before headline inflation goes back above core inflation, pulling up the latter. But will it?

In the UK everything about CPI (and the RPI in its former life) has to be taken with a large health-warning since the index is not a proper economic statistic because it is never revised, but it remains a very politically and financially sensitive one nonetheless.

UK headline inflation (CPI All Items) was above core (CPI excluding food, energy, alcoholic beverages and tobacco) for ten years in a row before falling below core one and half years ago – by an average of 70bps per annum. Some feat. Although this does include 2008 (the notoriously heavily revised year for proper economic statistics) when the gap was 200bps.

The story in the US is much the same. Although it looks as if headline bounces around the core trend, for the same 10 years (2003-2013) as in the UK headline was 50bps above core inflation.

JA UK US CPI

Is there any reason not to think that we may have ten years of headline being below core? Not really. These things should be fairly random and even out over the very long term. But you just know the inflation-worriers won’t be pointing this out.

Monetary Policymakers don´t lack the tools, they lack the will!

From Larry Summers:

Global economy: The case for expansion: …The problem of secular stagnation — the inability of the industrial world to grow at satisfactory rates even with very loose monetary policies — is growing worse in the wake of problems in most big emerging markets, starting with China. … Industrialised economies that are barely running above stall speed can ill-afford a negative global shock. Policymakers badly underestimate the risks… If a recession were to occur, monetary policymakers lack the tools to respond. …

This is no time for complacency. The idea that slow growth is only a temporary consequence of the 2008 financial crisis is absurd. …

Long-term low interest rates radically alter how we should think about fiscal policy. Just as homeowners can afford larger mortgages when rates are low, government can also sustain higher deficits. …

First off: the level of interest rates do not define the stance of monetary policy. This and reasoning from a price (or quantity) change are the most common conceptual errors made by economists of all stripes, including Prizewinners!

Even those like Bernanke, who know best, having stated very clearly in 2003 that interest rates are not a good indicator of the monetary policy stance, saying we should look at NGDP (or inflation, but let us leave that one aside, not only because it is far below “target” everywhere that counts).

The chart indicates that for a significant fraction of “industrialized economies”, monetary policy has been “tight”, certainly not “very loose”!

Lack of will

Prior to the crisis, nominal spending growth was the same in the US and UK (around 5.4%) and much lower in the EZ (4.2%).

Note that after the initial pullback from the deep recession, the ECB under Trichet pulled the brakes hard in early 2011, throwing the EZ economy back into hell. Meanwhile, in tandem, the US and UK said “that´s enough nominal spending growth” (4%). No wander inflation languishes (as does real growth and employment).

Why did all those central banks, the ECB more radically, put a premature stop to the recovery? The obvious answer is fear of breaching their inflation target, even for a “moment”!

In that they sorely lacked what came to be called a “Volcker moment” (or, to paraphrase FDR, a “Volckerian Resolve”). Ironically, or maybe not, the country that has been in hell for longer, Japan, is now trying to get back to savoring some “worldly goods”. Let´s hope the others “get smart” more quickly!

On October 6 1979, the Fed made an announcement (HT David Andolfatto):

Lack of will_1

We know that didn´t cut it. Inflation was only brought down permanently when NGDP growth was adjusted down:

Lack of will_2

Now the Fed (and others) have to adjust NGDP growth up. But please, not through more government (which Japan´s experience also shows doesn´t have lasting effects).