Left Outside

Mervyn King on the “mismatch recovery”

Some time ago Chris Dillow argued that it was possible that economic recovery was sluggish because of a mismatch. It seems that Mervyn King is coming round to this view (via).

What is limiting our ability to do more is not on the monetary side, it’s on the real side that the economy has to adjust to a new equilibrium. That is what I think is going to pose the constraint.

What we need now – it’s very clear if you look at the numbers – what the UK economy needs is more demand in the rest of the world to buy goods from the United Kingdom. And that is the key bit that’s missing from our attempt to rebalance and that’s why the challenge is so great.

The Bank of England hasn’t released the model it uses (much to Simon Wren-Lewis’s chagrin), but given the above this is how the model Mervyn is working with must look.

Imagine there are only two firms. One firm gives haircuts and the other firm makes hats. Haircuts can’t be exported, but hats can. Theoretically if people in the UK decided to wear hats less and get more haircuts workers at the one could shift to the other firm to avoid unemployment. However, if there are non-negligible costs to retraining these people and matching them to new jobs a shift in the competition of demand could result in high inflation and high unemployment.

Now because haircuts cannot be exported but hats can we end up in the odd situation where domestic demand as delivered by the central bank through interest rate cuts or quantitative easing or whatever won’t work. External demand will boost employment by helping people find work in the hat industry, but domestic demand will not because people would rather spend the money on haircuts. Domestic demand causes inflation not job growth but external demand (say from China) causes job growth but not inflation.

This is a neat story for Mervyn, because as a story it completely lets him off the hook! Imagine that. A central banker who manages to create a model where he is not responsible for the catastrophic screw up which happened on his watch.

However, there are a number of weaknesses with this model. Firstly, if Mervyn wants more external demand he can create that by weakening the pound. In fact, I’m not even sure how Mervyn could ease monetary policy without weakening sterling and increasing external demand. Secondly, it is a very pessimistic view of the economy. I thought the deal was that markets could sort this stuff out? Five years is a long time to wait for a rebalancing.

Mervyn King is still well respected and it seems he is creating “just so” stories to justified this continued respect. Unfortunately the stories just don’t add up.

Filed under: Economics, , ,

How not to hire a central banker OR Are you fucking kidding me Cameron?

Perhaps the fourth most important job in the world is up for grabs. If you (*ahem*) want to be the UK’s chief central banker, the job is available – applications are due by 8th October to 1 Horse Guards Road, London. I say fourth most important because there are only three economies larger than the UK in the same depressed state: the US, Japan and the Eurozone. Unfortunately those doing the hiring have no idea how and why this job is important.

Why is this job so important? It is important because the central bank, to a large degree, determines how quickly we recover. If the bank keeps money tight we will recover very, very slowly, if it gets money right we will recover very, very quickly. I’ve decided to stop demanding loose money because that isn’t what I really want. Monetary policy should be set at the level that is predicted to produce the outcome you want, neither loose nor tight, but right.

For several years that is exactly what the Bank of England did. From mid-2004 to mid-2008 they set policy so that they expected 2% inflation in two years time. As this graph cribbed from Britmouse shows.

Since 2008 they have consistently set policy too tight to hit their target, that is, even by they own preferred metric they have been hamstringing the recovery. Money has been tight so growth has been slow. This makes the quality of the successor to Mervyn King very important indeed. Even doing his job properly would be an improvement on the Bank’s current practice.

I would argue that even this is not good enough. Someone who could do Mervyn King’s job well and set policy that is predicted to succeed, not fail as he has, will not get us the recover we need to put a million people back to work. We will remain depressed because inflation is a bad indicator of an economic recovery, much better is something like nominal GDP, which I have been going on about ad nauseum because people still don’t get it. (Click on the two graphs in the right of the blog for more info on this)

Below is a graph that shows the gap that has opened up between where the UK’s nominal GDP should be and where it is.

The economy wants to produce £1.7trn of goods and services a year, but tight money has restricted it to about 1.57trn of goods and services a year. £170 billion is what the UK economy is missing out on each and every year because our central bankers are not good enough at their jobs (nor currently authorised by the treasury) to bring us back to trend. The total loss currently totals around £500,000,000,000 or half a trillion pounds.

So what is a good central banker worth? Well, about £500,000,000,000 would be one answer, but bygones are bygones so lets be more constructive about it. A good central banker is one who closes that gap as quickly as possible. In the US they estimated that thier (bad) central bankers has cost their economy $4trn in lost output and will cost the economy another $4trn by 2018. A good central banker could be worth $4trn to them if they could return the economy to trend twice as quickly, which seems possible.

Lets copy the mechanism they employed here and makes some assumptions. First, a bad central banker closes that gap by 2018 during which the gap steadily closes. Second, a good one does it in half that time and the gap closes correspondingly until then. After a fairly convoluted process involving my half remembered A level maths I’ve decided that a bad central banker costs us a total of £500 billion in lost output, while a good one loses us “only” £250 billion in lost output. So doing this job correctly is worth perhaps a sixth of everything the UK can produce in a single year.

That they’re paying Sir Mervyn’s replacement a measly £307,792 a year suggests to me they aren’t taking things seriously enough. By our metric of good banker versus bad, they are only expecting an economist 0.0001% better than Mervyn King. Which might be setting the bar a little too low, even as a replacement for our worst central banker since the 1930s.

Of course, it being the coaltion, things are even worse than they at first appear. They aren’t even looking for an economist 0.0001% better than Mervyn King, they’re looking for a financial regulator. Read this paragraph and weep:

The successful candidate will have experience of working in, or with, a central bank or similar institution; or will have worked at the most senior level in a major bank or other financial institution. He or she will demonstrate strong leadership, management and policy skills; will have an advanced understanding of financial markets and good economic knowledge.  He or she will be a strong communicator, have good interpersonal skills and will be a person of undisputed integrity and standing.

Advanced knowledge of financial markets, but only “good” economic knowledge? Forgive me a moment, but are you fucking kidding me Cameron?

They don’t want a central banker, they want a financial regulator. A financial regulator needs to prevent fraud and ensure banks adhere to the rules laid out by parliament. A central bank is in charge of nominal demand because they issue currency. The two needn’t have anything to do with each other. Now that the Bank has to take on the FSA’s financial regulation duties they are going to let their other  responsibilities go by the wayside. Ignorance will damn us, not incompetence. As Scott Sumner has said of the 1930s, the last time we got things this wrong:

The elite bankers and financiers of Wall Street were pretty smart people.  So were the central bankers of the US, Britain, and France.  But they weren’t smart enough… So the wealthy conservatives of the interwar period who dominated central banking dug their own graves, and the graves of millions of others.  Not through greed but through ignorance.

This time is perhaps worse. At least in the 1930s people had a rough idea what a central bank was meant to do. Today, those in charge don’t know for which job they are hiring, so those who are hired won’t know what they’re meant to do, and the rest of us will all suffer for it.

This in’t because any of us deserve it or because those doing the hiring or being hired are necessarily bad people, but because life is hard and confusing sometimes. Everyone is finding it hard and confusing and this is why I keep shouting about this, because nobody needs to be evil to inflict suffering, just wrong. So we need to stop being wrong as quickly as possible.

Filed under: Economics, , , , , , ,

Help Mervyn King or Sack Him

Mervyn King acts as though monetary policy is currently about right to hit a medium term inflation target of 2%, but insufficient to put Britons back to work. This is because his job is to provide price stability because this is meant to stabilise aggregate demand. Stabilising aggregate demand is something which was achieved very well until 2008 when it allowed it to crash and unemployment to rocket.

The mandate for price stability he has been given is not currently compatible with full employment. Merv has been told to target price stability and financial stability and although he has been relatively dovish in executing his duties, he has not been nearly forceful enough in explaining their shortcomings.

I don’t really want to call for Merv’s head because he seems to be more dovish than average for the Bank of England’s Monetary Policy Committee. I am beginning to think he is no longer capable of delivery the recovery we need. His recent comments indicate that he isn’t being clear enough why he can’t deliver the recovery people want. Today he gave evidence to the Treasury Select Committee that suggested we should be grateful for a decade of stagnation.

When this crisis began in 2007, most people did not believe we would still be here. I don’t think we’re yet half way through this. I’ve always said that and I’m still saying it. My estimate of how long it will take to recover is expanding all the time. We have to regard this as a long-term project to get back to where we were, but we’re nowhere near starting that yet. We’re in a deep crisis with enormous challenges.

In June he was one of the MPC members calling for further QE in response to the worsening situation in the Eurozone. He was entirely right to do so, even if it is the least he could have done that wasn’t nothing.

Regarding the stock of asset purchases, five members of the Committee (Charles Bean, Paul Tucker, Ben Broadbent, Spencer Dale and Martin Weale) voted in favour of the proposition [no extension of QE]. Four members of the Committee voted against the proposition. The Governor, David Miles and Adam Posen preferred to increase the size of the asset purchase programme by £50 billion to a total of £375 billion. Paul Fisher preferred to increase the size of the asset purchase programme by £25 billion to a total of £350 billion.

He has now admitted he is either unable or unwilling to do anything more. We know that there is plenty more the Bank could do because he voted for one of those things in June. We also know that there are other examples of Banks running highly accommodative policy through the exchange rate, some serious, some not so serious, which the Bank has not yet even attempted.

Mervyn King knows he isn’t going to do much about unemployment. A genuinely reflationary policy which put people back to work would threaten price stability and the Bank isn’t authorised to make that call, only the Treasury is. Since Meryvn is acting like he is happy current policy is on track but that the track includes at least five years of suffering we can help him by criticising him. He has to be enticed to explain to everyone that unemployment could be lower but that the Treasury doesn’t want it to be and that he can’t do anything on his own. Mervyn King wants more accommodative policy but is unable to deliver it with the current MPC and Bank mandate.

Rather than ignore this he should be making clear the limits of the mandate he has been given. If he is happy with doing nothing about unemployment he should be made to say so and ejected from his job, if he is unhappy he should make it clear his hands are tied unless the Treasury change his mandate. If he is unhappy with being honest about the limits of what he can delivery legally and what he can delivery technically we need a new Governor of the Bank of England.

In the US, as in the UK, criticism of central banks has predominantly been that monetary policy has been too loose. Monetary policy looks loose if you only look at interest rates but other indicators tell us monetary policy has actually been incredibly tight. Nominal GDP growth has been low all through the developed world, as has inflation. Even in the UK where inflation has been high a large portion of this has been due to tax increases not monetary looseness.

Criticism of the Fed from people like Scott Sumner and Paul Krugman have helped to shift the Overton Window, the bounds of acceptable discussion, to include the possibility that money is too tight. I don’t think it is viable to have somebody in charge of macroeconomic stabilisation who thinks it is acceptable to spend ten years recovering from a crisis. Either we help Meryvn come out of his shell or we help organise the coup of Threadneedle Street.

___

PS The Treasury Select Committee need to update their website more quickly. Sir Merv’s testimony is still missing. The latest story is a push piece about Merv’s upcoming appearance, but there’s no link to the testimony now it has happened. I had to crib from the Telegraph.

Filed under: Economics, Politics, , , , , , , , , , , , ,

For the nth time, already!

I just want to inform all my international readers that there are no institutional problems with the UK adopting NGDP  level targeting. Failure is a choice.

First of all, for those keeping score, we’re still doomed. Secondly, the coalition can still, at any time, prevent doom, by changing the Bank of England’s mandate to target nominal gdp and to ease policy until it returns to trend.

If NGDP level targeting can be adopted quickly somewhere it is here. If somewhere needs to lead by example, I would recommend the UK too. NGDP is below trend, our banking system is weak, we are closely tied to the Eurozone, inflation expectation are falling and all anyone needs to do is to convince David Cameron’s cabal that this policy would get them elected. Conservatives *love* getting elected.

Britain has a parliamentary system with a lot of power vested in the executive. This is normally very good for getting things done. Sadly it also means you get bad legislation passed “when something needs to be done.” Something needs to be done and for a change it would be nice were the Government to do the right thing.

Filed under: Economics, Politics, Society, , , ,

Policy Pragmatism

What concrete step caused the British Pound to appreciate rapidly on the 18th April?

The correct answer is “we’ll never know what confluence of events caused that particular movement.” Any concrete answer should be ignored. But please allow me to tentatively suggest (tentative suggestion is fine) that the price of Sterling, and hence the stance of British monetary policy, was changed by news that Adam Posen had withdrawn his support for more Quantitative Easing. This unexpected action caused sterling to hit a 19 month high against the euro.

So when Chris says to Nick Rowe “that relying upon expectations to do work is to rely upon a weak lever” I am somewhat sceptical. Adam Posen changed monetary policy by changing the future expected path of monetary policy – his actions lessened the chances of more QE and brought forward rate rises and the unwinding of the Bank’s balance sheet – and the market acted accordingly.

A similar mechanism might be all that is required for NGDP to work. A credible commitment to change the path of future policy would have immediate effects, we know this because (I tentatively suggest) we have already seen it happen.

Similarly, if Chris agrees that a higher sterling reflects tighter Bank of England policy and if Chris agrees a looser policy would help create jobs – as the sentence “I don’t doubt that more QE – the likeliest tool of an NGDP target – would create some jobs” implies – then there is something illogical in his pessimism towards adopting NGDP targeting.

I don’t think it could come from the Bank; Andrew Sentence is completely unable to offer a credible commitment to NGDP level targeting. But were the Treasury to change the Bank’s mandate then it could commit to change the path of future policy easily. Thanks (!) to  New Labour’s habit of concentrating power ever more in the executive, this change could happen at any point because the Treasury is empowered to change the Bank’s mandate at will.

I don’t think you can accuse me of Policy Utopianism, as I said in my last post many problems would remain after the adoption of NGDP level targeting. If the Doctor’s creed is “first do no harm,” the economic policy maker’s should be “first pick up the free lunches.” To ignore monetary policy, as Chris often does, is to leave all-you-can eat buffets to one side. Pragmatism requires adopting policies that put what labour, capital and land available to work. Even a “small improvement” would be a huge improvement to thousands.

Filed under: Economics, , , , , , , ,

How to End this Depression!

Targeting the path of Nominal Gross Domestic Product (NGDP) is probably the most “fashionable” solution proposed for dragging the developed world’s economies out of depression. This post will refer to the UK, but lots more work has been done on the US from this perspective, particularly by Scott Sumner and David BeckworthBritmouse has blogged about NGDP from a UK perspective.

Real GDP is a proxy for our incomes adjusted for inflation, how well off we are. Nominal GDP is the same but refers to our incomes in cash terms. This nominal measure deviating from trend has been what has driven the wild swings in employment and production the developed world has seen since 2007.

NGDP matters because wages and debt are sticky.

Wages: NGDP can decrease if all other prices decrease with it, the relative prices between them will not change and apart from updating some menus nothing will have really changed. But it is incredibly hard to cut wages, look at the clustering of wage changes around zero in the below graph (via Paul Krugman). This means a decrease in NGDP relative to wages will throw people out of work as employers become unwilling to employ them at the prevailing nominal wage.

Debt: We care about what real resources we can consume but all our contracts are written in nominal terms. If I owe someone £10,000 then at some point I have to hand over some bits of paper, or packages of electrons, to someone for that amount. But, if NGDP grows below trend the total nominal size of the economy will be smaller than expected when I took out the debt, but the size of my debt will not. The real cost of my debt will have increased and this will work to depress the economy because this dynamic will affect a number of people.

If NGDP sinks below trend there are then at least two mechanisms which can act to depress an economy. [1] Has it sunk below trend? Yes it has.

Is off trend NGDP growth associated with weak real GDP growth? Yes it is.

Are changes from trend NGDP correlated with changes in employment? Yes they are.

That might be a little difficult to make out for some. So I zoomed in and inverted the unemployment figures. Are they correlated? Yes, and closely.

Let me tell you a story with a different ending to the one you know. The year 2007 began with NGDP growing to trend, and employment decreasing against the backdrop of international inflationary pressures and financial distress. NGDP reversed course and began to decline during the second quarter of 2007 as did employment, crucially this was before the Lehmann Brother’s bankruptcy and the ohmygodwereallgoingtodie stage of the financial crisis. Unemployment had already increased by nearly 200,000 after NGDP began declining but before the financial crisis began in earnest.

This doesn’t exhonerate any bankers, they put the Bank and Treasury in this position after all. But it does imply different priority for actions. Occupy Threadneedle Street, my friends, not the London Stock Exchange.

Scott Sumner and Ben Bernanke

Looking at the third graph you can see NGDP decline, recovery and stagnation correlating closely with decline, (mild) recovery and stagnation in UK employment. The Bank of England controls the country’s printing presses and hence the nominal economy and responsibility for this depression lies with the Monetary Policy Committee for doing too little to avert it and with the Treasury for doing so little to force them to do more.

In the UK and US the last couple of decades have seen NGDP grow at about 5% a year, and this nominal growth has been split between price increases and economic growth. In 2008 NGDP collapsed and we saw deflation, disinflation, and recession. To date NGDP has not yet recovered to trend, in fact it remains over 10% below trend – and this is our main problem.

Increase NGDP and employment, incomes and taxes would increase, many intractable problems would vanish (though many would not). There are risks and there are methodological problems, but there huge gains for everyone if they right policy is adopted and I want to do my part to try and make sure the right policy is adopted.

____

[1] Data from here, I’ve used basic prices to strip out the effect of VAT jumping up and down

Filed under: Economics, Foreign Affairs, History, Politics, Society, , , , , , , ,

Inflation trends upwards

After abating in the first quarter of the year inflation has edged up to 3.5%.

Inflation was pushed up by increases in the cost of clothing and food. The uptick in inflation has been imported, but with it I worry  came a dose of timidity for the Bank of England. The Bank  has remained tolerant of inflation but has suffered because of it. I’m known for my dovishness about inflation and these numbers do little to change that.

More domestic demand, even if it results in a little more inflation is just what we need in a depressed economy. But these inflation numbers appear to be little influenced by changes in domestic demand and much of these price increases have been imported. This means they may lead us to be poorer in two ways, one direct, one indirect. Higher import costs are like a supply shock, we really are poorer because of it. The indirect effect is that higher costs still look like the Bank of England is stimulating the economy too much and can lead to the bank doing to little or being actively counterproductive. This is the problem with a central bank targeting inflation. It can be a very, very bad idea as we saw in Europe in mid-2008.

Sometimes inflation increases because that is what getting poorer looks like, things get more expensive. A monomaniacal inflation targeting central bank, for example the ECB under the impeccable Trichet, will take this sort of inflation number as a sign that the economy is overheating, that we are not getting poorer but getting rich too quickly and will act to reduce inflation, usually by throwing lots of people into unemployment. Sometimes by throwing a whole continent into chaos (slow hand clap for Trichet).

Today’s inflation numbers mean nothing in isolation. They are provisional, subject to revision and they refer to an arbitrary length of time with little macroeconomic importance. Nevertheless  they have the power, if they become politically salient, to influence the actions of the Bank of England. These numbers already signal we’re all a little poorer, were the Bank to start to tighten policy today’s numbers could help make us all poorer all over again.

Filed under: Economics, , , ,

Adam Posen WIN

Bank of England increases QE by £75bn

Britain’s interest rates-setting body voted to expand its purchases of gilts in an effort to bolster a badly flagging economy that is already showing signs of stagnation. At the same time rates were left unchanged.

The Bank said it would increase asset purchases by £75bn, taking the total to £275bn.

Good news. Although, I’d much rather the Bank just gave people money rather than swapped one asset for another.

If people want to hold money, and money is free to produce, then we can just give them money – we stop when expected future inflation gets too high and inflation predictions are not looking too high.

The alternative to giving people free money is that they spend less to increase the amount of money they hold. If everyone does this at the same time, we have a recession until people hold as much cash as they want to.

Avoiding this outcome is what monetary policy is for and I’m glad the BoE are taking their job seriously.

I am sceptical of QE because as far as I’m concerned monetary policy works better through expectations than through what a bank does in the here and now. So the £75bn extra doesn’t concern me too much other than as a good sign that Andrew Mellon Sentance is losing and that Adam Posen is gaining the upper hand.

Filed under: Economics, , , , , , , , ,

When NGDP is Depressed, Employment is Depressed

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Increase NGDP, Put These People Back to Work

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