A year ago to the day, here on LDV, I called the turn in the UK economy. We had experienced a double dip recession (later confirmed) and everyone was battening down the hatches for an unprecedented triple dip.
I wrote then in praise of Chancellor Osborne who the day before had authorized a briefing of two Financial Times journalists. Under the title Osborne to Hand Carney New Powers, they had written, ‘George Osborne’s Budget, will pave the way for Mark Carney, incoming Bank of England governor, to come to the rescue of the economy as the chancellor sets the scene for a new era of looser monetary policy.’
The journalists were told that options included ‘(1) giving the monetary policy committee greater time to bring inflation back to the 2 per cent target, (2) giving the BoE a Federal Reserve-style dual mandate to target both employment and inflation, and (3) even targeting cash spending in the economy rather than inflation’ i.e. targeting Nominal Gross Domestic Product (NGDP).’
As I anticipated, the pick up in the UK’s NGDP was almost immediate as investors and firms took the hint – rates would be lower for longer. The power of these expectations predictably meant that no-one had to wait a further three months for the arrival of Carney in person or the five months it would take for him to negotiate among his 8 other Monetary Policy Committee colleagues and announce that they were taking options (1) and (2) above, and holding (3) in reserve.
As NGDP rose and used up some of the slack in the economy, inflation remained subdued and virtually all the increase in NGDP was made up of an increase in real output. So began a sudden recovery.
We should not be surprised that such straightforward political support for a change in monetary policy would work so dramatically. FDR had achieved the same impact on the US economy in May 1933 when immediately after his election he used Executive Order 6102 to change the price level, and again in November 2012 when, as I described at the time, Liberal Democrat leader, Shinzo Abe, declared he would adopt an NGDP target.
There is still time for us to show our mettle in protecting the recovery. Already the hawks are out calling for tighter monetary policy, even though NGDP growth is still not back to its long term trend rate, domestic inflation is subdued, wage inflation almost non existent, and unemployment and underemployment levels indicate that there is still slack in the economy that can and must be put back to work before incomes can rise and the recovery become sustainable.
Everyone talks of the ‘time’ that the Bank rate should change; next month? next year? No one talks about the ‘situation’ in which that rate should change, such as ‘when NGDP growth reaches 6%’ or ‘after we have had two years of 5.5% NGDP growth’.
There is another budget coming and an opportunity for our cabinet members to conduct their own ‘ambush’ pressing openly for an Option (3) type solution with a target like the ones above. Once again we have the chance to give Carney the political support he needs to fend off the hawks and sustain the recovery. Seize the day.
* Bill le Breton is a former Chair and President of ALDC and a member of the 1997 and 2001 General Election teams
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19 Comments
Not again. *sigh*
NGDP growth is composed of real growth and price inflation. Given that almost all of the inflation seen in the past five years has been imported inflation from things like oil, gas and food, determined largely at a global level, I fail to see how targeting NGDP growth helps when we can’t control the inflation element and so can’t control real output growth.
Could Bill please explain the solution to this fundamental problem with the concept of NGDP targeting, because I still have yet to hear one.
Far more likely as a reason for the improvement in real demand in the UK economy is the change in the price of commodities, including oil, metals, food, gas etc.
http://www.indexmundi.com/commodities/?commodity=commodity-price-index&months=120
As you can see from the chart, this collapsed during the recession but zoomed back up to a double peak between 2011 and 2012, choking off the recovery. Since then prices have been largely static, allowing real purchasing power to recover. This, I believe, is one major answer to why the UK economy has lifted itself off the deathbed, more than any other factor, including fiscal and monetary policy.
Bill le Breton yet again tries to promote NGDP targeting without showing he understands why it could work and failing to mention completely why it might not work. If anyone wants to know why it could work then they need to watch this video:
http://www.bankofengland.co.uk/education/Pages/inflation/qe/video.aspx
And if people want to understand why NGDP targeting might not work then they need to read this article, from a member of the Bank of England’s Monetary Policy Committee (the group who vote on interest rates).
http://blogs.independent.co.uk/2013/01/30/martin-weale-ngdp-target-is-playing-with-fire/
For the record, I strongly believe loosening monetary policy again will harm the economy.
I’m pretty worried about Carney. His suggestion that bank assest could rise to 9 times GDP by 2050 was the most alarming comment by a public official recently. The only countries with banking sectors that size were Iceland and Cyprus!
With monetary policy I guess we all know the conflict. Raise rates and you choke off the recovery. Keep them as they are and the danger is another housing bubble particularly with the new Help To Buy scheme and lack of supply. I’ve heard Martin Wolf say this is pretty much government policy.
We have just about the lowest saving rate, lowest investment rate, most private debt and most expensive housing in the OECD. The current direction of travel frightens me.
A couple of critics of ‘Le Bretonomics’ trot out a few simplistic criticisms.
But where are all the other loyal fans of The Orange Book? It seems odd that in a party which the media tels me is spit between Social Liberals and Economic Liberals the latter do not seem to have much to say on economics. How does their Economic Liberalism differ from whatever The Treasury said sat week? One assumes that Danny Alexander must be the true hero of the Economic Liberals but I would bet that we will not encumbered with a lot of links to speeches, pamphlets or books on economics from Danny explaining how more of the same from the Osbourne-Alexander duo is really Economic Liberalism in practice.
Bill le Breton ends his piece — “….There is another budget coming and an opportunity for our cabinet members to conduct their own ‘ambush’ pressing openly for an Option (3) type solution with a target like the ones above. Once again we have the chance to give Carney the political support he needs to fend off the hawks and sustain the recovery. Seize the day.”
Can any self-confessed Economic Liberal in the party, who does not hide behind a screen name, actually explain why the party shoud not do exactly what Bill cals for ?
@ John Tilley
“But where are all the other loyal fans of The Orange Book?”
I don’t know, but I’m not one of them. I refer you to my comment on the Orange Book thread. Simply pointing out the holes in the NGDP argument doesn’t make you an Orange Booker.
John Tilley, NGDP targeting causes inflation, which hurts those on fixed incomes, especially pensioners. Here is a link from Age UK criticising the Bank of England:
http://www.ageuk.org.uk/latest-news/archive/compensation-owed-to-hard-hit-retirees/
It’s not a left wing policy and you only need to look at those who Bill is cheering on to see this: Mark Carney and Shinzo Abe. I am not a left winger, but this isn’t even about compassion, it’s just not fair to erode away people’s savings and incomes in order to fund bankers bonuses and high salaries, under the threat of a banking death spiral if we don’t.
To make this very clear: I think the risk of a banking death spiral if we increase interest rates is very low. The City are just panicking about their bonuses and they have captured the Conservative Party hook line and sinker. Lib Dems need to counter these arguments.
@RC
I’m afraid that to John Tilley you’re either a follower of the True Path or The Other Path. As usual, “Orange Booker” just means “person who doesn’t agree with me in an economic argument”.
The advantages of an NDGP level target over an inflation target are seen at their best in the circumstances RC describe.s. Only school economics is required to understand this.
The increase in the price of oil, say, is a supply shock. The Short Run aggregate Supply curve shifts to the left, output falls, prices rise.
Under inflation targeting the central bank tightens monetary policy. the resulting shift in aggregate demand lowers prices, but further lowers output. The very expectation of this in response to an oil price rise is enough to see the private sector cutting output, laying off staff and postponing investment. Staff cuts and fear of job loses mean employees cut back, shifting aggregate demand still further.
Of course I am also describing what happened in 2007 and continued into 2008 even when both nominal and real output was plunging. Inflation targeting turned a recession into the Great Recession.
with an NGDP level target the central bank does not tighten. Rather, in response to any fall in output the Bank will loosen policy, shifting the aggregate demand curve to the right, restoring output. Expecting this to happen firms do not cut back at the initial sign of the oil price hike because they know that aggregate demand, and their own customers demand, will not fall.
In fact these expectations among businesses mean that the central bank does not actually have to do anything. And employees do not fear job losses, wage cuts or cuts in hours worked so they don’t cut back on their expenditure.
Even so, to worry today about too much aggregate demand is to ludicrous. The great fear is too little aggregate demand. Prices and expected prices continue to fall and the recovery is vulnerable.
Just have a look at this survey on inflation expectations published by the Bank today http://www.bankofengland.co.uk/publications/Pages/news/2014/013.aspx
If we are not careful we are going to sabotage this nascent recovery. NGDP growth to end 2012 was just 2%. With the arrival and expected arrival of Carney that rose to 3.4% by end 2013 and is probably growing at an annualised rate of 4.5% now! but this is still under the long term trend for the UK. There is slack left that can be taken up if we delivered NGDP growth up to say 6% before we started to raise rates and reverse QE.
If however the increase in aggregate demand stalls and falls from 4.5% because the Bank doesn’t compensate for the continuing reduction in public spending and those falling inflation expectations, firms will worry again about their customers and their customers will worry about their wages. And with the policy rate at 0.5% the next recession will arrive with not ‘conventional’ monetary fire power.
The weakness in wage inflation is a huge worry that can only be improved when firms expect demand for their products and services to rise.
We are at a cross roads. Which is why the Coalition needs to use the budget speech, as Osborne did last year, to tell the Bank it should change its remit. This time setting an NGDPLT or some target for increased income, as recommended in the SLF economics amendment in Glasgow.
Or it won,t be just the Eurozone that has to struggle with deflation.
Bill has resorted to talks about demand curves in the hope of shaking off opposition, but I understand demand curves too and he’s got these wrong as well. The demand formula bill is using only holds when the money supply is kept constant, an overly simplistic scenario, which is probably why it is only used in “school economics”. You can’t boost the money supply and then use the same demand formula, measured by prices.
I have to say I think I got a bit too cynical before. The risk of a banking death spiral from increasing interest rates is higher than very low, but I also think there is kind of a banking-industrial-complex where the banking sector and those around it have begun to believe it is more important and skilled than it is.
Mr Salmon, I wrote above “Under inflation targeting the central bank tightens monetary policy. the resulting shift in aggregate demand lowers prices, but further lowers output.”
What do you not understand about the relationship of “tightens monetary policy” and a change in the money supply?
Why can you not accept that a reduction in the money supply (from a tightened monetary policy) reduces aggregate demand?
Do you think the problem with the UK economy is too much aggregate demand, too little or about right, given that inflation expectations are falling, we still have unemployment at over 7%, that’s there are millions who consider themselves underemployed, that wage inflation is 1% (that is real wages are falling) and that the recovery needs real wages to be rising In order for it to be sustainable?
If you think there is still insufficient aggregate demand, what policy would you propose to increase it?
Malcolm Todd 7th Mar ’14 – 4:40pm
“@RC I’m afraid that to John Tilley you’re either a follower of the True Path or The Other Path. ”
This would be hard for you to justify on the basis of anything I have said in LDV. If there is a True Path on macroeconomics I am not sure that I know what it is. I would welcome some sensile discussion of the topic. So I do find it interesting that those who describe themselves as ‘Economic Liberals’ or followers of the Orange Book have so little to say on the subject.
Two days ago Bill le Breton set out the latest in a number of pieces he has written with a consistent theme. So where are the comments from the Economic Liberals? Or is it that they know nothing about economics and that is just a label signifying something else?
Do you have a view Malcolm Todd? Are you an Economic Liberal? And if so what does that mean in the context of this thread? Instead of attacking me for something that I have not said, why not reveal what you think?
Bill – as you increase the monetary base to increase demand you drive up inflation which means that you must now reduce the monetary component to reduce inflation which… in physics the “2-body problem” (e.g. gravitation interaction between two bodies) is trivially solvable with a pocket calculator, but when you introduce a third object (the “3-body problem”) it becomes impossible to solve except with powerful computers using advanced algorithms (in mathematical parlance it has no analytical solution).
It seems to me that moving from inflation targeting to NGDP is like switching from a 2-body problem to a 3-body problem. It creates complicated feedbacks that must be factored into the equation moving forward and which can result in lurches (the derivative of acceleration) to inflation and monetary policy.
I wouldn’t want to characterize NGDP as “print money and buy stuff”, but it does consciously attempt to offer a fig-leaf of cover for high inflation and discourages saving (if it could conceivably be any more discouraged than at present) while creating dependencies and feeback in inflation and monetary targets that make my head ache.
As an addendum I could put my cynical hat on (as if I ever take it off) and comment on the um… flexible approach that Carney has shown to targets – weren’t interest rates supposed to have gone up by now? The forward guidance has simply changed from “interest rates will go up when unemployment falls below n%” to “interest rates will go up when I think it’s time for that to happen”. How does it aid in establishing expectations in peoples’ minds when the guidance changes to a bizarre “I’ll know it when I see it”? Is this the Wittgenstein school of economics?
And I would point you to the remarkably frank comments of William White last week who observed that central bank targets are more a reflection of national history and business culture than anything else: The analytical underpinnings of what we do are actually pretty shaky… People are making it up as they go along… I’m more and more convinced that all the models we are using are basically useless… We’ve got the potential to do so much harm by not getting the creation of fiat credit and money right.”
Bill, you could at least get my name right. We have spoken enough for you to know it is Sammon and not Salmon. A reduction in money supply doesn’t always lead to reduced aggregate demand. You are measuring aggregate demand by consumption in £ terms rather than real terms, so you are missing out the GDP deflator to get a comparable year to year figure.
Mr S , my apologies. It is not forgive able to get your name wrong, my only excuse is that it was possible that the auto correct kicked and I didn’t notice. I am away from home and using a tablet.
I am not missing out the GDP deflator. For the years quoted above: The 2012 deflator was 1.8 and the rgdp 0.3. For 2013 the deflator was 1.6 and rgdp 1.8.
Just have a quick look at this diagram http://en.wikipedia.org/wiki/File:AS_%2B_AD_graph.svg then read my long comment above.
Paul in T, I,d like to convince you, but have to dash off, but should be home in 5 hours.
Paul in Twickenham, I have heard White say such things before. It is rather defeatist.
The meat of the issue is; which would be better a rule based or a discretionary system.
The recent publication of the proceedings of the FOMC in 2008 show members of the Committee operating a system which remained largely discretionary. And making the huge mistake of keeping monetary policy tight (for fear of inflation) when demand in the economy was plunging.
What is ever more disturbing is that no such records exist for the debates in the MPC during the same period. It is not that they are kept in a vault awaiting the 30 year rule or the 100 year rule. They were destroyed as soon as the minutes of their meetings were published. Extraordinary.
What we can say is that whilst both Committees delayed or prevaricated in loosening monetary policy in 2008 NGDP in both countries (and in Europe) fell by rates no seen since the1930s.
If they had said (or indeed if they had been implementing a system) in which they had been charged to maintain the rate of NGDP growth there would not have been the same level of deleveraging (or running for the exit door before everyone else). There would have been a temporary dip in output because of the supply shock, certainty about the Central Bank’s determination to increase aggregate demand sufficiently to restore/defend the target for NGDP growth plus the extra needed to make up for the dip – the level target element.
Asset prices may have dipped by soon recovered, security of loans would have remained within acceptable levels and the economy would have soon regained its moderate momentum that had held good for a decade and a half.
If you doubt this was possible, recall the dot.com bust. The adequate loosening of monetary policy and the very clear communication of that policy meant that the recessionary forces were soon eliminated.
What was the difference between 2002 and 2008 – those operating a discretionary system got it all wrong in 2008 and all right in 2002.
So – I believe there is a very Liberal appeal for a rule based system based on nominal gross domestic product level targeting – removing the discretion of unelected and unaccountable MPC members and putting the policy objective (not the operational policy) in the hands of Parliament. Had the 2010 June budget included a similar statement on the remit, that Osborne made in 2013, but saying that the Government’s policy was to keep NGDP growing at its long term trend rate after two years of catch up, we would have ridden the storm, (including that from Europe) as Poland and Sweden did at the time (two other currency issuers) and the ‘rule’ would have provided sufficient monetary loosening to offset the reductions that were required in public spending to return to a more normal dept to GDP ratio (as has occurred in the US in 2013 despite its considerable fiscal retrenchment.
Central Bankers recoil because it challenges their power of discretion. All a central bank has to do is maintain over time the long term trend in NGDP or income. To get the wisdom of the market on the current state of NGDP the central bank could create a futures market in NGDP contracts – another element of liberalism in the system.
The idea of NGDP targeting goes back to the 1980s but was revived by a small group of US economists (Scott Sumner and David Beckworth the former a student of the Great Depression). Other thinkers include Marcus Nunes, Nick Rowe and Lars Christensen.
A good expression of the thinking is by Scott Sumner http://mercatus.org/sites/default/files/NGDP_Sumner_v-10%20copy.pdf If find it hard to see why Liberals cannot see its attractions.
At present the MPC is using its discretion to get a ‘feel’ for the size of the output gap – what is the slack is the central issue for it. Commentators talk of when something should happen. How much better for everyone to know the situation in which monetary policy might need to change. How much more Liberal (and not economically Liberal) but Liberal, Liberal is that