Team transitory vs team permanent

Inflation has risen in the US, the UK, the Euro Area and elsewhere, as demand has increased following the opening up of the economy after pandemic-induced lockdowns, and supply chains have been disrupted.

This has produced a debate amongst the economic commentariat about whether they are on ‘team transitory’ [the rise in inflation will be temporary] or ‘team permanent’ [you get the idea]. Participants have been updating their guesses about which team will win, as each inflation print is released.

The debate does not really make much sense. It is very difficult to justify being on ‘team permanent’. There are not many circumstances whereby the rise in inflation could become permanent and they they require extreme and counterfactual views to take them seriously.

One way to get a validation of ‘Team Permanent’ is by central banks choosing unilaterally to raise their inflation targets.

In the case of the UK this is impossible, as their target is set by the government. The Fed and the ECB have ‘price stability’ mandates’, which they translate into operational targets of 2 per cent. It is extremely far fetched that they would revisit these targets [in both cases on recently reviewed] and push up the number above 2. There are solid grounds for doing so [I’m actually in favour: you can reduce the time you might spend at the floor to interest rates], but they have met with very little support in the central banking community and in the ECB and the Fed in particular.

A second possibility is that central banks are forced to target higher inflation by their respective governments. This is possible in the UK [we have a government with a majority that can and does do things] but highly unlikely. There is still a consensus across the political spectrum for the current inflation target. A rise in the target forced on the ECB would require a change in the foundational treaty of the European Union, which would need agreement of all member states [including the infamously hawkish Northern European states], is not going to happen. In the US, the idea is not on the political agenda and would not gain the necessary bipartisan cooperation to get through both houses.

Even without consciously changing targets, or having such changes forced on them, central banks could be forced into higher inflation, or lose control of it, due to fiscal pressures. We have coherent theoretical models of money, debt and inflation that could explain how this could happen. But there is no sign of it happening in reality. [See bond yields].

So, everyone should be in Team Transitory.

The only real debate is, given the current scheme/rule the Fed [or whoever] has for responding to events, and how they see the effect of those events playing out, how long will inflation end up being away from target?

If you think you have a better view of how events will play out [by which I mean what shocks are hitting the economy, and how they will percolate into inflation and other things the central bank cares about] you will think that you can forecast what the Fed will do better than they can do it themselves; and if you are selling your advice to people buying assets whose value depends on those interest rates, and expectations of them, precisely where you are on the ‘Team Transitory’ spectrum will colour what advice you give.

And if you are into normative policy, shouting at central banks for the hell of it in other words [as some aspiring or frustrated central bank chairs are], you will translate where you are on Team Transitory into policy advice.

A better way to frame the debate is : what is going on in the economy, and what should the central bank and fiscal authorities do about it; how much of a spike in inflation should they curate and how long should they hope that it lasts?

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Should Mervyn recuse himself from the House of Lords Economic Affairs Committee enquiry on QE?

I just noticed that Mervyn King, former Bank of England Governor, has taken a place on the HoL Economic Affairs Committee, and is therefore due to take part hearing evidence in an enquiry on quantitative easing [QE].

This is a curious state of affairs.

Lord King was head of the Bank when QE was instigated in March 2009, and piloted the program, which involved not just monetary policy decisions by the MPC, but also important execution decisions in the markets area, with the set up of reverse auctions, and decisions about what assets to purchase.

An enquiry into QE is bound to either explicitly touch on, or have looming in the background, certain questions that involve issues about King’s own views and actions. For example: should QE have been embarked on at all? Did it give adequate consideration to distributional issues? Was it executed well and with proper regard to debt management, public finances, market efficiency? Did the Bank understand properly what it was doing, whether it would work, how? Did it communicate the policy well and in a way that helped its effectiveness?

Mervyn is perfectly capable of being impartial on these matters. And there are not so many as qualified to talk about them, given his experience.

But appearences matter. And it cannot help but appear that King’s sitting on the Committee during the enquiry compromises its credibility as willing and able to examine QE impartially.

There are many criticisms one could level at QE: that it was embarked on singularly and without putting appropriate effort into alternatives [like forward guidance for interest rates, or lowering interest rates further]; that it did not purchase more private sector assets, arguably more stimulative; that it was communicated badly, focusing on the element of the program that at the time was considered least important [money creation]; that the MPC itself was not given a proper chance to debate these alternatives; that no regard initially was given to the distributional implications of QE, even if, later, when prompted, the Bank did consider them; that it was unnecessarily opaque about its forward plan for QE; that it did not properly foresee the fact that regulatory change and the post financial crisis climate would mean that a considerable portion of QE would never be unwound…. and more.

All of these arguments – themselves contested, I am not stating these as uncontroversial conclusions – can reasonably be put to witnesses, but it would be highly peculiar for King to put them himself as they would constitute self-criticism.

The best role for the former BoE Governor would be as a witness, grilled by the other members of the Committee on his own views and conduct.

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New piece in Prospect on vaccine nationalism

You can find it here. Anyone teaching international trade, game theory, time consistency, should find this period full of great – if tragic – teaching material.

I just read this great thread by one of the researchers involved in the Oxford/AZ vaccine too, so read this.

It is extraordinary how covid19 has affected not only all our lives, but all our social and economic policy debates.

Although it would be relentless and depressing, you could teach an entire economics degree using covid19 as a case study.

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Has the window closed for a Centre for Econ and Epi?

A while back I argued that the government should set up an independent body charged immediately with producing integrated economic and epidemiological forecasts, analysis and virus/fiscal policy options.

With the vaccine roll out proceeding at >400k shots per day, and the end of lockdown measures in sight, has the time for a body like this come and gone?

I don’t think so.

For a start, if we had such a body now we could be debating openly and transparently how to allocate vaccines; and how to time the relaxation of social distancing measures. This would make policy more easily scrutinized, and begin to reduce the uncertainty about what the immediate post covid19 future looks like.

There is also the point that to a greater or lesser extent there may not be a post covid19 future.

We may face new mutations that need vaccine tweaks that happen with a sufficient delay that there are new bouts of social distancing required. Or even without these mutations, perhaps waning immunity will become apparent and social distancing will be needed again if top ups don’t come quickly enough.

Morever, many of the things in the terms of reference I suggested for the Centre are about the post covid legacy. How the disease’s legacy, or the expectation of another pandemic, might affect the spatial economy, remote working, transport, de-urbanization.

Finally, a body like this could help other countries taking longer to win this phase of the covid19 battle, being a channel for technical assistance overseas. Fantasising wildly, one can imagine a global network of similarly constituted bodies doing this, helping suppress the virus now and sustaining better analytical preparedness for the future.

It is not too late.

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How a Brexit transition end and covid19 compound

Talking to a friend today he pointed out how the pandemic, and a potential disorderly Brexit, compound each other.

The way for consumers and firms to get through a threatened interregnum in essential supplies, to ensure continuity of services and, in the case of the consumer, of life itself! is to stockpile. An unusually large surplus of spare parts, inputs, or just food, can tide you over in case the sudden imposition of trade frictions, or panic about them, causes supplies to dry up.

However, stockpiling costs money. The opportunity cost is the cost of finance. Although risk free rates are low, the rates already stretched people and firms might cofront are very high, if marginal finance was available at all.

So covid19 will make it much harder for them to insure themselves against a no deal end of transition.

The government could address this, at least for firms, by offering new subsidized loans tailored for purpose. I doubt they will, because that would amount to admitting that they were creating a problem that needed to be insured against.

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Terms of reference for a new Centre for Economics and Epidemiology

In a previous post [scroll down!], I called for the UK [and other countries] to set up new, local centres for Economics and Epidemiology.  This is because the economic-epidemiological outlooks are impoverished by the two disciplines – at least at the point of making contact with policy and actual forecasts – are cleaved in two.  Epidemiological forecasts have too little economics;  macroeconomic forecasts have no epidemiology.  The result is public health and economic policymaking that is not on a sure foundation.

The problem can be remedied relatively cheaply.  Perhaps £5-10m per 5 year period.  In replies to my tweets about the idea, many suggested this thing start as an outgrowth of existing institutions, like the IFS, or NIESR.  I think this is a bad idea.  The task is important and special enough to demand a singular focus, and a custom-built pool of expertise.

I tweeted out a hypothetical terms of reference.  This post recaps on that thread.  I would propose that such a centre is asked:

  1.  To reflect on the risk of future pandemics, their macro implications, and the policy trade-offs inherent in policies to mitigate, with a view to understanding optimal prevention and mitigation policy.
  2. To provide high frequency updates on the progress of an ongoing epidemic, including the macroeconomic implications of the epidemic, and the epidemiological implications of the economic outlook and social distancing measures, public and private.
  3. To undertake, facilitate and sponsor state of the art research into models of economic epidemiology, with a view to designing and updating tools to undertake [for example] tasks 1 and 2 above.
  4. As part of 3, to pay particular attention to fostering inter-disciplinary collaboration, knowledge exchange between academic and other economists and epidemiologists.
  5. As part of 2 and 3 above, reflect and advise on the spatial dimension of the effects of the economy on the epidemic, and vice versa.
  6. Again as part of 2 and 3 above, reflect and advise on the distributional implications of the health and economic consequences of the epidemic, and policies to mitigate;  and how other policies can be used to redress those consequences.
  7. Understand the microeconomics of the epidemic, in particular the effects of health and safety, labour market, welfare regulations on the economy and the epidemic;  also the effects of land use, building design, planning laws and transport infrastructure and choices on the supply side and epidemiological risk.
  8. Act so as to encourage the establishment of similar centres overseas, and liase with those that exist currently, sharing and returning insights gained.
  9.  Develop resources for public information and education about the interplay between economics and epidemiology, the trade-offs and choices that it throws up for society.
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We need a new UK Centre for Epidemiology and Economics

The UK covid19 crisis kicked off with forecasts of the epidemic with and without mitigation measures like lockdowns.  They were ultimately alarming enough to persuade the government to lockdown.

The forecasts joined epidemiological insights with social science – evidence on the propensity of different groups to contact each other.  But they did not tread further into economics.  Economists like Toxvaerd and Fenichel, and subsequently many others who joined in after covid19 emerged  [including Moll, Werning, Acemoglu, Eichenbaum, Trabandt, Rebelo and more] showed how to take this extra step.

In a variety of relatively simple models these authors study how behaviour responds to the progression of the epidemic;  how the risk of infection affects incentives to work and consume.  The contribution of private social distancing;  how behaviour differs across groups differently affected by the health risks;  the benefit and costs of lockdowns.

Since the opening salvo of epidemiological policy models with no economics, we have had a lot of economics coming out of government and other economic institutions [like the Bank of England, the OBR and others] with no epidemiology.

The Government’s lockdown release program – seemingly motivated by the desire to get the economy going again – has been rhetorically and probably analytically disconnected from a scientific analysis of the consequences for the epidemic, and thus aftewards for the economy itself.  We restarted some social contacts.  Allowed more exercise.  The formation of bubbles.  Opened pubs.  Then gyms and swimming pools.  None of this was done with open and coherent analysis of its economic and epidemiological consequences.  Yet it was done!

The policy decisions taken affect all of us, and a small minority, tragically.  Each alternative path for reopening and restarting connections implies a predicted number of contacts and hospitalisations, and subsequent disability and death.  How much death should we choose?  How much disability?  Every month that goes by with restricted economic activity and schooling hits the young and those who are not earning, and those who will ultimately fork out the taxes to pay the debt incurred to fund the income support schemes.  How much poverty and missed education should we choose?

These decisions were not made on a sound analytical basis, or at least all the evidence is that they are not.  It might be that the analysis is being done and kept secret, but I doubt it.

Institutions like the OBR and the BoE and other macro oriented non-Governmental economics bodies are not equipped and have been understandably reluctant to cross into epidemiology.  But someone needs to do it.

It would fulfill an urgent policy need if we were to have a new research institution for economics and epidemiology.  Relative to the sums required to support vaccine and therapy development, which run into the tens of billions, such an institution would be very cheap.  £5-10m would fund it for a few years easily.  In the grand scheme of things, this is not peanuts, it is mere dust.   And given the phenomenal gaps – at the interface between econ and epidemiology – in the heart of policymaking, and policymaking scrutiny, I think the returns would be very large.

This is not a task that can be bolted onto academic economic or epidemiology jobs unproblematically.  You can’t get publications out of questions like ‘what will happen if we open gyms and swimming pools and should we do it?’.  Many of the questions will arrive and have to be turned around at high frequency.  The methods used to answer them will soon become unoriginal and mundane, but the answers needed all the same.  [See, for example, the outputs of macro models, which rarely generate journal articles].

But then again you will need the economic and scientific heft and to tempt people who have it in to such work [analogously to recruiting economists who can operate at the frontier in a central bank] you will have to offer them research time, especially since staff who spend time in a place like this will probably want to have the option to go [back?] to academia or a similar destination afterwards.

Academic economists are turning in numbers towards epidemiology, seemingly.  [Some of them have been ploughing the furrow for a long time!]  But they are always going to have to prioritize first of all publications in peer reviwed and high ranking journals.

Such an institution would need to have good access to, and be oriented at economic/epidemiological policy.

It would probably be best if it were parochial;  the urgent questions are specific to UK government policies;  and to UK specific information about the spatial dimension to our social and economic behaviour.  An international centre in Geneva, or wherever, is not going to prioritize simulating the effects of a Leicester lockdown on the midlands economy.  Even better, of course, if there were a network of similar bodies elsewhere to share experience, staff and expertise.

It would need to be responsive to but independent of government, and completely transparent, with code, forecasts, policy analysis, minutes and so on all openly available.

Given our new ways of working, it would be relatively straightforward to set such an institution up quickly.  One would not need premises to begin with.   Intensive computing resources, as Twitter followers with more up to date IT than I told me, can be bought from the cloud.  All that is needed is a very small amount of money – small relative to the investment in vaccines, and relative to the sums that can be wasted with policy errors – and the will.

We would have been in a better position had such a body existed at the start of the outbreak.  But it is not too late for such an effort to make a difference.

The government made a hash of the lockdown – moving far too late – and seem to be making a hash of the reopening – taking unwarranted risks.  So the chances are the virus will be with us for a long time yet.  Even with a vaccine or therapy, this will take time to deliver;  may well not give complete immunity, or be avoided by many, and may not reach large populations in the rest of the world.  And, as we are all very aware, this is probably not going to be the last pandemic.

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Vouchers: with poor timing, perhaps the worst kind of counter-covid recession policy

I am crystallizing my concern about retail vouchers, part of Rishi Sunak’s latest package [and recommended by others, including one of my affilliations/clients, Resolution Foundation], and mostly thanks to a Jason Furman tweet.

Sunak has seen his challenge as wanting to target stimulus and support policies at the sectors hardest hit by the covid19 crisis.  This motive is understandable.  Despite what the MMT headcases will tell you, fiscal support involves the government using scarce current and future tax raising powers.

So you want to maximise the bang for your buck.  Why give money, in this case, to sectors or people that were not particularly hard hit, and therefore don’t need it?

A related issue of waste-avoidance is giving money to people who are not short of money, and therefore might save it and not spend it.   ‘Forced’ saving by those able to carry on working from home during the covid19 crisis has been pronounced.   Borrowing to give those people even more money to save is rightly judged not to be a good use of future taxes.  Money saved lowers the cost of finance for those who want to borrow, but this is low anyway.  The effect on others’ income and spending power if government handouts are spent is much greater.

A solution to both of these problems is to give people time-limited discounts or spending vouchers, aimed at the sectors that were hardest hit.  The money is attached to spending and can’t be saved.  And in the case of the restaurant discounts it is obviously only of value there:  part of the hospitality sector hardest hit by the pandemic.

However, the clear problem with this is that it is straining to encourage us to engage in the risky, contact and infectiion-inducing behaviour that the government itself banned at the start of the lockdown.

Unless the risk of infection had passed [the small numbers infected so far means still a lot suceptible] or the activities that were risky were now no longer risky [social distancing measures are required, but they seem lax and are not going to eliminate risk, or be perfectly enforced], this activity is going to generate more covid19 cases.  Videos of Rishi Sunak playing waiter, not socially distancing, holding customers plates with his bare hands, and not wearing a mask, are not a good signal of the government’s strategy to transform formerly risky activities into safe ones.

The dilemma is that the policy that maximises a naively-interpreted stimulus impact is also one that maximises new covid19 cases.

I say ‘naively’ here, because, as Stephen Bush pointed out in his morning email today [subscribe if you don’t already, it’s great], the vouchers not only amount to a reversing of course for the lockdown policy, but they have to lean against the fears people have for their own health when they contemplate resuming social activities that now carry new risk.  Stephen gives the example of hypothetically slashing taxes on cigarettes, hoping people will ignore the health risks.

For vouchers to be the right policy  you would have to believe that consumers are overestimating the risks they face;  and that you will persuade them to spend in spite of the risks.  Even then, the risk overestimation needs to factor in that going to a restaurant entails risks not only for themselves, but in making themselves a vector for the rest of us.  An ‘externality’, in the jargon.

Returning to analogies, the restaurant discount is like paying people to drink and drive:  doing so stimulates the economy [more alcohol sales] but puts in mortal peril those on your route home.

If there were spare capacity in the test/trace/isolate system in the UK, you might believe that the extra infections generated by encouraging risky restaurant attendance could be contained successfully.

Assessing the efficacy of this system from the outside is not easy, but there are lots of discouraging signs.  Tales of confusion, accidental and deliberate, in the test statistics;  pseudonymous anecdotes penned by idle and farcically managed trainee testers;  evidence that local authorities are not getting timely and accurate information about the case load in their own jurisdictions [see, for example, Leicester].

Most discouraging of all is that the reopening and stimulus policy is so rhetorically detatched from how it is made possible [or limited] by test and trace.  It is almost as if the virus had just gone away and there was something about its nature now that meant we did not have to worry about resuming our old ways.  That would only be approximately true if, contrary to most of the evidence so far, it turned out that enough people had acquired immunity one way or another [either by exposure to covid19, or some other condition] to make it hard for infected people to encounter new vectors to propagate the virus.

It is hard to quell the thought that the government know that test and trace is not up to it, but hope that we are so desparate to get going again that we will forgive a new surge of deaths, or somehow judge it to be an unfortunate error only with hindsight.

In the absence of firm hope and evidence that test and trace can mop up infections after restaurant goers and other risk takers have had their fun with government vouchers, it would be better simply to give those sectors hardest hit money, [or rather to continue to do so] without using us consumers as virus vectors to carry the funds to them and demand that they put themselves at risk working for those funds.

 

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Make the BoE work for their oak panelled offices and get them to identify the missing stimulus needed

The Bank of England is, arguably, at the end of the road as far as currently agreed methods of monetary stimulus are concerned.

Interest rates are at their effective floor – in the UK, as understood by the Monetary Policy Committee – 0.1 per cent.  QE purchases of assets stand at £745bn.   This is unlikely to have done much harm [although some contest this] but equally, has probably not, at least as far as its later increments are concerned, imparted much stimulus either.  At root QE policy is about swapping one zero interest, default-risk-free asset for another [reserves for gilts].

It would be reasonable to ask what the Bank’s senior officials are doing, then, in the oak panelled offices that they periodically visit, or on those zoom meetings that we presume happen.  OK, so there are financial stability concerns and there have been interventions to stave off market dysfunction in the gilts market, but my rhetorical point is about the efficacy of monetary policy as conventionally understood.

Long before the covid19 crisis, many commentators, myself included, [but importantly see Krugman, Wren-Lewis, Portes and others] have wondered about the need for a variety of monetary-fiscal cooperation in the vicinity of the zero bound to interest rates.  The pandemic has underscored the need for it.  As news about the state of the virus itself, the ebb and flow of social distancing information, and economic indicators rolls in, there will be a need for successive rounds of fiscal stimulus, even contraction as we get to the point where good news arrives.

The BoE could be contributing to this, using its expensive and considerable analytical heft, currently functionally idel, and giving the government technocratic cover for fiscal fine- tuning that otherwise would be entirely political.

The Bank of England Act in 1998 was an attempt to delegate macroeconomic management to the central bank and remove it from the corrosive influence of politics.  With the benefit of hindsight, an inflation target that was too low [2 per cent] was chosen, and we have been stuck at the interest rate floor since the onset of the financial crisis.  Since that point, in large part, business cycle management has reverted to the Treasury, by default, with all the attendant costs [politics, smaller centre of expertise] and benefits [democratic legitimacy].

A relatively minor institutional reform could improve things while we are stuck with conventional monetary policy levers exhausted.

This would be to have the Bank of England publish its estimate of what it sees as the missing stimulus:  what would it like to do with interest rates, if only doing that was stimulative, on the assumption that interest rate cuts had their nomal effect [the impact they have far from the zero bound]?  The next step would be for the Treasury to decide whether to accept or reject this advice [thus retaining ultimate control over fiscal levers], to explain why if it declined, and to design a stimulus plan [with details of what spending and tax instruments, and unwound over what period, presenting evidence as to how this implements BoE advice], and with the Office for Budget Responsibility commenting on how the plans rated for long run fiscal sustainability.

Critics might wonder why I have framed this question around the exhaustion of conventional instruments, and not suggested that the central bank contemplate helicopter money.  I am not completely against that as a policy option;  but at currently very low interest rates I don’t see the point of crossing that rubicon yet when there is no constraint on conventional fiscal stimulus measures in the next few years.  I certainly don’t see it as a motivation that helicopter money be considered above conventional fiscal stimulus for the sake of having the central bank be the author of it, rather than the government.  This would be a superficial authorship only.

Absent a reform like this, the BoE will anyway have to steel itself to point out why and the degree to which it can’t meet its flexible inflation target mandate, begging the question, therefore, why the government does not do something about it [the mandate was, after all authored by the government in the first place].  What I am suggesting happens in an orderly and premeditated way will, therefore, happen, to a degree, by default, but with a clumsiness and potential for conflict, or inhibited and impaired communication, that will make things work much less well, and without the checks and balances provided by the OBR input.

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Why did we release lockdown too early? Perhaps because we started too late.

It has been much commented on that the UK entered its lockdown to combat covid19 too late.  This had the consequence of allowing the virus to gain more of a foothold, generating an increasing flow of infections that quickly swamped our test and trace capacity at that point.

That in turn had the effect of meaning that the lockdown we did introduce needed to be in place for longer than otherwise.  The lockdown has the effect of reducing the reproductive rate of the virus, by reducing the number of contacts we have and the infections produced from them.  If the number of cases that our test and trace capacity can deal with is X, and we start from a number greater than that, Y, a reproductive rate of the virus that is less than 1 can convert Y into X over a certain time period, as infections cycle through the population.  If you start from a number greater even than Y, that lower reproductive rate has to do its work for longer.  [Or, equivalently, you would need a tighter and more costlier lockdown for the same amount of time].

Locking down the economy involves an enforced shuttering of some sectors of the economy, depriving those who work in them of their income, and the rest of us of their outputs.  The Governing party bore the political costs of this, and had to do it knowing that the costs come before the benefits [successful suppression of the virus at some date into the future].   Intertemporal sacrifices of this kind are notoriously hard for a government to make.  The UK governing party also had a significant strain of covid19 denialism;  and the interventions entailed by the lockdown and the income replacement schemed accompanying it ran counter to its [at least pre-Brexit] laissez-faire instincts.  For these reasons, it’s likely that there were forces acting to shorten the lockdown distinct from those connected with the public health rationale.

The decision to begin relaxing the lockdown, at a case load that was arguably high relative to our capacity to test and trace – the way of to define ‘early’ – is therefore potentially a consequence of starting the lockdown too late.   [‘Late’ defined analogously, as in ‘time elapsed once it became clear that the virus would, absent intervention, or alread had, exceeded test and trace capacity’].

You would normally hope that a social system had in-built mechanisms to self-correct and learn from its mistakes.  But this seems to be a candidate illustration of the opposite.  One tragic policy error necessitates another, compounding one.

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