Opinion: Will Special Branch be knocking on the Old Lady’s door?

Today three reports have been published into the operations of the Bank of England. None of these pose the killer question: why, when for month after month in 2008 the UK’s Gross Domestic Product in money terms (the NGDP) fell from its stable long term annual growth rate of +5% to -5% a year, did the Monetary Policy Committee stubbornly maintained the Bank’s interest rate at 5%?

This excellent blog by Britmouse details, details the quarterly falls in NGDP and the inertia of the Bank which has the power to set the level of aggregate demand in the economy.

It is regrettable that the Treasury does not give the Bank a level target for NGDP growth, but instead gives it one for inflation. Thus, in 2008, whilst the Bank had its eyes firmly fixed in the rear view mirror on inflation,UKoutput and income plunged in a way not seen since the 1930s, making debts harder to pay and reducing the value of the securities behind them.

In this diagram David Beckworth illustrates the point for Europe, but the case stands for theUK too. Veer from the long term path of NGDP – allow a nominal income gap to establish – and the Debt/GDP ratio worsens, deleveraging gathers pace and the fall in aggregate demand accelerates exponentially.

Nominal Income Gap and the European Debt Burden

If you don’t believe that monetary policy can fix the problem of inadequate aggregate demand, that is not the view held in the Bank itself. In recent speeches, The Governor of the Bank of England and his Deputy Governor, Charlie Bean, explained their powers.

Bean said, ‘a highly stimulatory policy stance can encourage households and businesses to bring forward expenditure, boosting demand and mitigating the destruction of the economy’s supply capacity that can result from a prolonged period of weak demand as firms are driven out of business and the skills of unemployed workers atrophy.’

It is worth reading that again: ‘stimulatory policy … boosting demand … mitigating the destruction of the economy’s supply capacity … as firms are driven out of business and the skills of unemployed workers atrophy’

The Bank’s failure to remedy the fall in NGDP growth in 2008 may have been incompetence, but these speeches reveal that the dismal performance in national output since mid 2010 has been a deliberate policy to let the weak go to the wall.

Here’s how the real Mr Bean puts it – ‘such policy (monetary stimulus) can also delay the transition to a new growth path if it slows the process of balance sheet repair and inhibits the process of ‘creative destruction’ as unprofitable firms are closed and the liberated resources shifted to the expanding sectors.’

This is an intervention into industrial policy which should be the province of the Department of Business, Innovation and Skills in conjunction with the Quad.

With the economy well below full potential, with no pressure on wages, with thousands looking for work and extra hours, the gazelles don’t need their neighbours to fail for them to succeed. This is industrial sabotage on a grand scale.

If we really were on a war footing the Old Lady of Threadneedle Street should be due a knock on the door from Special Branch.

* 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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  • Bringing forward expenditure does not increase the total expenditure, it creates an inflationary wave.

    So the consequence of a stimulus now must inevitably be slackening of demand later – increase the upside stimulus, increase the downside slackening. Boost above trend, correct back to trend. Continuing to intervene increases the ante that’s got to be reckoned with eventually.

    If you don’t stop medicating the patient before the medicine starts to change the body chemistry a whole new set of unpredictable factors come into play. What part of temporary is so difficult to understand?

  • mike cobley 6th Nov '12 - 10:27am

    Bill is completely correct – this is thoroughly in tune with the Coalition policies on tax (deliberately supressing the revenue take by various means, ie cutting HMRC staff, and cutting benefits, among others), cutting tax take from corporations (cuts in corporations tax), ruthless shoehorning of market mechanism into all areas of public services, even to the point of strangling central govmt funding to councils, forcing them to cut back on local community services. All based on the insane notion that the market will magically step in, wave its magic wand, sprinkle that entrepreneurial pixie dust around, and presto magico! a new, vibrant nation springs out of the ground, and no one goes without a job, and all is smiles and roses. Yeah, because that always works – just as it did between the industrial revolution and WW2!

  • Oh dear, not NGDP again.

    1) The WHOLE POINT about NGDP is the split between inflation and real output growth. If you have 5.0% NGDP growth and 5.0% inflation then the economy isn’t growing. End of story.
    2) This is largely out of control of the Bank of England, being determined by outside factors like oil, food and international commodity prices, as well as wage rises;
    3) “these speeches reveal that the dismal performance in national output since mid 2010 has been a deliberate policy to let the weak go to the wall.” What kind of conspiracy theory is this?
    4) You can’t force people to borrow money they don’t want. At the moment, banks and households are deleveraging. You can push as hard as you like on the monetary string with low interest rates, but it won’t work.

    I’m sorry, but I do have to ask what Bill le Breton’s credentials are in talking about economic policy.

  • Richard Dean 6th Nov '12 - 9:10pm

    Bill. your conclusions may or may not be right, but your argument is seriously flawed.

    If you look at the second graph by Beckworth you will see that there were essentially two distinct periods, one before and one after a step change in European NGDP. In the graph you have quoted, all the points clustered on the right come from the trend before the crisis, as seen on Beckworth’s second graph, and represent random scatter about a single mean trend. All the points clustered at type right come from after the crisis, as seen on beckworth’s 2nd graph, and essentially represent the same upwards trend but offset downwards by the step. This means that your graph actually shows only two statistically significant points. One of the statistically significant points is for pre-crisis, at about 0, 72. The second is for post-crisis, and about -8, 83..

    In my profession, a joke is that you never want more than two data points – two allows you to draw a straight line but three just makes life unbearable!. The Beckworth graph that you quote really means very little – it’s a description of two states of the economy with random scatter. It’s not any kind of evidence for any kind of economic law or truth.

  • Richard Dean 7th Nov '12 - 3:58pm

    It might be better to interpret the graphs in the following different way. The crash in European NGDP was 8% after government action. The 13% increase in debt would have been due to

    > loss of tax receipts, probably around 25 of NGDP (a quarter of 8%)
    > increased social security burden, perhaps another 4 % (if the 8% was an employment loss requiring increased benefits))
    > Keynsian action to prevent further collapse, which must therefore have been about 13 – (2+4) = 7%

    I suppose it suggests that the crash would have been twice as great without government action,. What do you think?

  • Richard Dean 7th Nov '12 - 3:59pm

    11 not 13.

  • Bill,

    you are right to point out that the reports into BofE operations in the lead up to the financial crisis do not pose the killer question of why the Bank was so slow to act in the face of collapsing demand. Equally, the question of how and why the regulatory system allowed the UK Banking sysyem (apparently unnoticed) to come to such a state of instability that the entire economy was threathened by a 1930’s style depression.

    If we are not to repeat the same mistakes in the future, these lessons wil need to be heeded and embedded in the new financial protection systems and infrastructure to be implemeted.

  • Bill le Breton 7th Nov '12 - 6:24pm

    Richard, as I see it, the very point is that they are from two periods. The first occurring after a more than decade long period of near 5% trend growth that produced stable expectations which under pinned investment decisions by borrowers and lenders. The second set coming after a period when nominal incomes have become less than expected and have generated (with a four months lag) higher debt burdens.

    In your second comment , any so called Keysian action was immediately countered by the ECB continuing its over tight monetary policy and in fact increasing that defaltionary policy. Remember how quickly and disastrously the ECB endeavoured to start raising rates and how slow it was to commit to unconventional easing when it was forced into removing that increase.

    Those who don’t see the 2008/09 crisis as a monetary crisis wish to ignore the fact that during that period in the UK when NGDP fell at 5% a year (following that stable period of NGDP growth) the Bank of England kept its policy rate at 5% for six of those months in a row.

  • Bill le Breton 7th Nov '12 - 6:40pm


    What I find really disturbing are those two speeches by King and Bean. They clearly admit that they could if they wished increase AD by monetary policy, but they are choosing not to because they want the ‘creative destruction’ (Bean’s exact phrase) of sending marginal firms to the wall so that their resources are available for exporters. It is not because they can’t, it is because they won’t.

    Yet it is precisely these types of firms, established, good employers who have been hanging on to workers with staff who have taken shorter shifts and pay cuts which form the fabric of our society and which, given a normal AD environment of around =5% a year, would be viable.

    We are seeing – no doubt your clients are seeing – inequality between these types of firms and those either blessed with the label – gazelle or high growth – or have sufficient cash to hunker down and try to find their way through.
    But as each year of stagnation passes more and more of these will eventually give up. You can see this in the high streets and industrial estates outside of the SE.

    We are heading for a society of those without work (especially the young), those with fewer hours than they wish for (the 16 hours/minimum wage earners) and state pensioners cut off from the opportunities and life chances of an almost separate nation. Each year of stagnation making the divide wider and deeper.

  • Richard Dean 7th Nov '12 - 8:20pm

    Yes, two periods, so just two points. What’s more, the second significant point, around -8, 83 represents a choice about how much increase debt. It differs from the first point by -8, +11. If you think about what some of the other choices might have been, you might come up with some points like this:

    -18, 0 …… governments take no defensive action against the collapse
    -13, 5 …… governments increase their borrowings by 5%, mitigating the crisis a little bit
    -8, 11 …. governments take stronger action

    If you now plot these points on the graph, you will begin to understand some of the options available to governments, and this may help you to reassess your critique of the BofE. Government action cannot be infinite, because increasing the debt now has the effect of impoverishing the future.

    The crisis was never a monetary crisis, but a demand assessment crisis. Increasing availability of riskier credit meant that production was geared to an idea of demand that was unrealistically high. When the debts couldn’t be paid, production had to adjust downwards. This adjustment is what the step change in NGDP was, and no monetary hocus pocus can fix it.

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