George Osborne lashes out at the BBC

This morning [4/12] on BBC Radio 4’s Today program, George Osborne lashed out at the BBC’s coverage of the budget labelling it ‘hyperbolic’.

This is a pretty low tactic, and also substantively wrong.  All the BBC were doing is pointing out what Osborne’s budget ombudsman the Office for Budget Responsiblity had said, which was that planned [but as yet unspecified] spending cuts would reduce the size of the state [government spending as  a share of GDP] to levels around those last seen in the 1930s.

As Chris Cook pointed out on Newsnight last night, this is amazing in the history of modern capitalism.  That history charts a steady rise in the size of the state, either as it gains new competencies and enlightened insight into its proper role (my view), or interest groups hijack it to nefarious ends (Tea Party view).

The comparisons the BBC and OBR made highlight very well how incredible Osborne’s plans are, because there is surely not any support for such a shrinkage, even in the bulk of Tory voters.  On my view, you have to persuade people they don’t want something they should be getting.  Even on the Tea Party view, you have to wage war against so far entrenched interest groups to cut spending.

That fact no doubt explains why so little of the spending cuts needed to deliver the Autumn Statement forecast have actually been specified, because doing so would immediately lose them the election.

Osborne’s next ploy, to say ‘all the disaster that was forecast last time just did not happen, so why hasn’t the BBC learned this time around’ is also equally off the mark.  Last time, disaster was averted – for the economy and for his Party – because deficit reduction was postponed.  Wise, as I have frequently pointed out, when the Bank of England is unable to inject more stimulus at the floor to interest rates.  Moreover, as others have made clear, electoral disaster – or further obfuscation – is more likely next time because the next round of cuts will be harder.  Why?  Because they will fall on spending by definition identified as higher priorities (hence not cut) in the last spending review.

Even with a good case, Osborne should refrain from hacking at the BBC in this way, outside of all due process.  That tactic takes us further down the US road where discussing government policy becomes entirely a matter of competing fictional narratives, and detached from fact.  But he didn’t have a good case.

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Aditya Chakrabortty’s one sided Radio 4 polemic on economics

Last night I caught AC’s Radio 4 program on teaching economics after the financial crisis.  It’s a great story, well told.  But, it is just that.  In its totality, a distorting dramatisation, on account of allowing multiple silly, uninformed critiques to go unchallenged in the program.  Yet presented as a reasonable, impartial take on what is going on in economics.  If this were an op-ed in a newspaper, it would be forgivable.  Most people know that when they read comment that they are getting selective advocacy.  But I think a lot of listeners think of Radio 4 as a station they can trust to explain things how they really are.  This program reveals that sometimes the editors slip up.

Here are some examples the one-sidedness that undermines AC’s attempt to portray himself as your friendly, impartial, interlocutor.

1.  The tale of the panics and bubbles course that Manchester University refused to incorporate into their module.  The story told is of a rare piece of enlightened teaching, done voluntarily, leading to the termination of the contract of the dissenting teacher.  I blogged before on what I thought of this course [AC was sent this blog, but either chose not to read it, or ignored it].  From the reading list the students were given, I guessed that the lecturer either knew very little about what was going on in the literature on panics and bubbles, or deliberately set out to give them a haphazard pot-pourri of his favourite tracts.  I won’t claim to be the final arbiter on this [though I do think my views are representative of those working in the intersection between macro and finance].  So presenting only my view, or something like it, would have been just as bad.  But that view did not get heard.  Also, AC plants the inference that the teacher’s contract was terminated solely because of his giving up his own time to offer a dissenting course, and to propose a regular one.  But we don’t get to hear what Manchester University think happened.  Did AC try to speak with them and they declined?

2.  AC caricatures mainstream economics as blindly applying rational choice, pitting a 20 second soundbite from Danny Quah explaining the idea, against a catch-all alternative from Ha-Joon Chang.  The other side of the story about the mainstream is this.  First, there are now hundreds of papers in top journals using what you might call crudely ‘behavioural’ alternatives to rational choices.  Robert Shiller just won the Nobel prize for pointing out the failures of rational choice to explain finance.  Second, most of those I read and know who use rational choice use it in a more nuanced way than you would guess from ACs program. A philosophy I’d characterise like this:  we know people don’t behave literally like this in all its minutiae, but maybe the rational model captures enough of what’s going on to make progress explaining what we see.  Plus, there is the practice of using the contrast of rational choice models with the data to point the way to better models.  [Example:  Shiller again].  Any hint of this in AC’s narrative?  No.

3.  AC, as if to explain what’s wrong with mainstream academic macro, puts the ridiculous question to Steve Keen as to whether Keynes would get published in a top journal now.  This is just such a daft hypothetical.  Things have moved on so much since then.  Who knows what Keynes would write now.  Would you ask whether 75 year old physics papers would get published now?  And:  papers in top journals are literally drenched in Keynes.  It’s probably Keynes’ influence that’s pretty much why the dominant model in central banks has sticky prices, and many have unemployment.  Keynes is everywhere in the modern debate about the power and usefulness of government spending increases in recessions.  [Added 4/12:  AC repeats this silly tactic, asking about Minsky’s chances of getting published.  And a moments’ sensible thought would give the same answer.  PS here’s what I think about Minsky].

4.  In the same breath, Keen states baldly that you can’t publish in top journals if you don’t use the assumption of rational expectations.  False.  I know many dozens of examples.  But here’s Nobel laureate Tom Sargent this time using models with learning, a framework he pioneered.  [That’s funny, two Nobel laureates flouting the AC stereotype of economics.]  If AC had wanted more, he could have googled ‘expectations, learning, business cycles, adaptive’ or something like that.  Perhaps throwing in ‘heuristics, self-confirming’ for good measure.

5.  We’re told that the other thing you can’t write about now in the mainstream is animal spirits.  False.  Try reading Roger Farmer, who climbed to the top of the US university system publishing papers on just that.  Or, try googling ‘animal spirits, business cycles, recession’.

6.  George Soros is quoted telling us that mainstream economics is wrong because it’s based on ‘General equilibrium theory’ which gives you the answer that markets always work perfectly, and their outcomes cannot be improved.  False.  Some such theory does, but there are thousands that don’t.  [eg, any model with sticky prices, or unemployment, or credit frictions, like this one, or……].

7.  Soros again telling us that finance assumes always that risk can be quantified.  False.  Sure, a lot of it does, but, now, there’s lots that explores Knightian uncertainty.  [Oh – is that more Keynes again?  Surely not!]  Try looking at the collected works of Cogley, Sargent, Hansen [Nobel Prize winner again?], who model the effect of agents’ doubt about their models of risk – and the caution that injects into their investment strategies – on asset prices.   Or, google ‘asset prices Knightian uncertainty dividends business cycle’.

8.  Steve Keen is allowed to assert that mainstream macro ignores money, lending and banks.  False.  Take a look at some of the papers on my putative panics and bubbles course.  Or have a read at the mainstream ‘Journal of Money, Credit and Banking‘, or ‘Journal of Monetary Economics‘, or ‘Journal of Banking and Finance‘.  The titles are a bit of a give away.  I’m not sure what Gertler, Rajan, Gale, Brunnermeir, Kiyotaki, Diamond, Keister and others who devoted their lives to modelling banks in macro would make of Steve Keen’s claim or AC’s unsceptical playing of it.  They might say ‘try googling “banks, credit, business cycles, friction, spread” ‘.

9.  Keen makes the subtler accusation – still false! – that where mainstream macro does include money, it’s simply ‘a veil over barter’.  Well, a lot could be described like this. But a lot is not at all like this.  For example the overlapping generations models of money in the Karecken and Wallace volume;  or the ‘new monetarist‘ models of Kiyotaki, Wright, Williamson, Lagos and others.  But even where money is a kind of veil, things are not so silly as Keen makes out.  Those models embody the view that inflation is costly – for which there is some empirical evidence.  They explain the phenomenon at the zero bound that increases in money don’t lead to increase in prices – contrary to the inflation hawks’ worries.  And anyway, not all questions need a model of money to answer them.

10.  AC interviews Andrew Haldane at the Bank of England.  He says ‘it turns out that the model we had was false’.  Which model was that?  I thought all models were false?  And that that was the point of them?  I think Andy is referring to the New Keynesian model of monetary policy and business cycles, varieties of which leave out banking and finance, used across central banks [and still, incidentally, in the banking and finance-less version, at the Bank of England].  But, you know what? I don’t think any of the monetary policymakers I worked for or read believed much of that model.  They worked off hunches, gut instinct, practical experience.  And the judgement that i) finance would not go wrong and ii) monetary policy should and could not try to sort it out if it did.  i) was clearly wrong.  But I think ii) is still a respectable position to take.  So Andy’s quote doesn’t really do justice to what was in the minds of influential people in the profession.

11.  We don’t really get the other side of the story from student’s point of view.  There are interviews with some contrarian Manchester students who are happy with the department.  But what about other universities?  Manchester’s National Student Survey scores plummeted because of the Post-Crash-Economics campaign, but how about talking to the universities that did best?  In fact, Steve Keen’s Kingston Universty aside, try talking to any other university.  Were those students happy because their curriculum was supplying them with lots of heterodox economics?  I don’t think so.  But that is the inference you will draw from AC’s program.

12.  AC voices the complaint that Ha-Joon Chang’s career has suffered solely because of tribal discrimination.  He doesn’t get promoted simply because he fails to publish in top journals, and is not properly compensated for his successful book-writing career.  What about the other side of that story?  Perhaps publishing in peer-reviewed journals does a fair job at quality assuring someone’s grasp of, perseverance and creativity in pushing the frontier?  Perhaps Steve Keen’s assertion that he can’t publish in top journals is not because they are run by religious cabals, but they are all clever and reasonable people?  That the profession has, over a long time, settled on ways of formulating economic ideas and seeing how well they fit the data?  That’s pretty much my view.  I accept that there might be something to the fads and cabals critique on occasion.   But as an explanation for the entire published canon?  Come off it.  Do we get these views in AC’s program?  Nope.  We get Steve Keen’s revelations as unchallenged fact.

The program does have some mainstream voices, so the piece is not 100% propaganda.    Danny Quah is allowed a few seconds on rational choice.  And there is Diane Coyle [not sure what she must have felt about being the token mainstreamer] and Wendy Carlin [who’s excellent new textbook is now out] both making great points.  But they are deliberately drowned out by AC pushing his own distorted story.  The effect conveyed is:  ‘there are one or two who disagree, but, hey, common sense tells you that these students have got it exactly right’.

When I tweeted about this last night, AC’s response was to say ‘merely shouting false…is a better way to draw attention to yourself than actually making an argument’.  This motive-questioning escallation was ironic.  I think you could make a case that AC’s program is  ‘shouting’ to get ‘attention’.  At most turns in the narrative, he fails to maintain journalistic scepticism and balance, and reveals that he didn’t even fancy a quick google, which most of the time would have contradicted things that were put to him.  To speculate about his own motives:  I’d say that a more balanced narrative just wouldn’t be as engaging.  ‘Fair-minded, hard-headed mainstreamers engage in many flowers bloom approach following crisis, having made as good a fist of it as fallible human beings usually do’ [Hold the front page!]

 

Dear Ed and George

Dear Ed and George.

Today, on the Andrew Marr show, the debate between you on public finances and macroeconomic policy seemed to reach new lows.

1.  The focal point of today was the part-leak-part-preannouncement of policy.  Surely better for all to wait until the Autumn Statement itself?  Instead, George succumbs to the temptation to try to extract more good news and a weekend political victory, hoping to catch Ed out on the sofa.

2.  For your part, Ed,  it was mystifying to hear you say simply that your NHS funding plans would be on top of whatever the Tories were announcing or meaning.  Presumably there would be some extra amount of money that would mean the Mansion-Tax-funded £2.5bn a year would not be needed?

3.  Both of you are stuck unable to describe fiscal policy in macroeconomically literate terms [insult borrowed from Simon Wren Lewis].  Why don’t you face up to the fact that, right now, with interest rates pressed against the zero bound, and QE of uncertain impact, large deficit funding is needed to support monetary policy?  We can be fiscally virtuous, but not now.

4.  Ed, you are onto something when you curse Coalition fiscal policy for being too tight, and deepening the recession.  But that criticism, which you repeated today, is out of date.  What you should be pointing out is that the Coalition did relax fiscal policy, pretty much as you would have recommended, and it was because of that that growth resumed.

5.  George, your describing the government’s conduct as following through on plan A doesn’t help the quality of debate either.  Much better to say that initially caution was needed, until it was clear that we were not going to be viewed in the same light as the Southern European sovereigns, and only then was it possible to turn on the taps again.  If you had set out a contingent plan in the first place, you would not have needed to confess to a change of direction.  As it is you place the need to look like a government of resolve  above the need to look like a government of rationality.  And you seemed to reveal that the future consolidation would be of the same ‘come what may’ variety as the last one that you (thankfully) didn’t follow through on.  I guess that you therefore calculate you weren’t caught out last time.  You might be right, which is a depressing thought.

6.  Ed, the Mansion-Tax for NHS top up proposal is gimmicky.  Hypothecating tax revenues might be arguable in a state that was failing, illegitimate and unable to collect taxes.  But not in ours.  Where would such a process end?  [Before you answer that, could you just tell me who is paying for the replacement of Trident?  Is it me?]  The gesture seems a perversely reactionary one.  Why offer an explicit financing plan for this tiny part of the NHS budget, before you customarily knuckle down to costing the entire budget?  This is a case of presentational imperatives trumping all.  You are reluctant to maintain explicit, all-encompassing fiscal plans, preferring instead to keep as much time for vague ‘oppose everything’ strategies, but in order to look serious, you pick out micro-policy-costings like this.  But following this strategy, you risk it being judged that the case for taxing high value houses stands or falls on the existence or otherwise of an NHS funding problem.  Which is not the case.  You don’t help the debate about social justice and redistribution – surely exactly what your party is for – by tying the two together like this.

7.  George revealed that the next come-what-may consolidation would be achieved entirely through spending cuts.   To me and others this looks like an opportunistic shrinking of the state, right when it’s most hazardous to attempt it [when monetary policy cannot or will not compensate].  You must know that people judge such an extreme tactic as undeliverable, not just practically, but politically?  Yet you risk uncertainty festering about just what you will do by taking up this position.  I find it hard to believe that your median Tory target voter really wants it either.

8.  Oh, and there was the confusion about how much new money was really being announced.  It was trailed as £2bn extra money.  But this wasn’t quite true, was it?  Actually 0.7bn was a reallocation within the existing NHS budget.  That was a particularly petty piece of media warfare.  Catch Ed out on the sofa, then leave the less important facts to work themselves out in the chattersphere.

9.  The two of you make an excellent case for delegating more control over fiscal policy to technocrats.  [You might think:  he would say that wouldn’t he?].  I don’t know how such delegation, over levers of iconic democratic importance, could be made politically acceptable.  Especially when our economics profession is licking its wounds after largely failing to realise that the financial system was going to explode.  But some way has to be found so that your successors can have a better conversation.  A debate about the average size of the state, the strength of the automatic stabilisers, whether discretionary fiscal policy is needed on top of that (eg at the zero bound), and, if so, on menus of latent measures that could be triggered as such stimulus or tightening was needed.  Such a conversation would involve you setting out explicit and different positions on how much risk sharing the state should be doing across regions, income groups and generations, which spring out of your different political philosophies.  I hope at least that Ed’s proposal that the OBR should be tasked with vetting your manifestos will prove hard to resist, and that this might be a first step along the way to the utopia I and other economists are seeking.

 

Oil prices and monetary policy

In 2002 I was seconded at the ECB, and tasked – with another, from the research department – with writing a note to the Governing Council on oil prices and monetary policy.  If I remember correctly, in the 3 months up to the time we were writing the note, oil prices had risen in euro terms by 1/3.  Consequently, my coworker and I hit on the idea of beginning the note with the phrase ‘In the last 3 months, oil prices have risen by a 1/3 in euro terms’.  This sentence got purged on the grounds that it was ‘too alarming’, and replaced with ‘From time to time the oil price changes’.   I hope that material flowing to the ECB policymakers is written more directly now, or, if not, that the custom widespread at the time – according to my contacts in member state central banks – of disregarding entirely briefing emanating from the centre, is still prevalent.

Right now, arguments could be made for doing nothing, cutting, or even tightening in response to the oil price fall.  But I hope that in so far as this is possible, they loosen, since this would be the policy that minimises the risk of making the worst mistakes.  In the jargon, this would be the robust thing to do.

The argument for doing nothing is that oil-intensive-final good prices like refined petroleum are highly flexible, and can therefore be ignored.  (Modern orthodoxy says just stabilise sticky prices).  Or that the effects on inflation will be so temporary that they will be gone before anything can be done about it.

The argument for loosening is that on account of oil being a major input, it will raise potential output relative to actual output.  Which in models like those central banks uses is deflationary.  Also, if inflation expectations are extrapolative, ie they look at changes in total inflation and project those forwards, a temporary oil price fall would lower inflation expectations, transmitting into core inflation.  (Inflation itself being lower on account of the fall in expected inflation).

It’s conceivable there’s an argument for tightening.  If the demand/confidence effects of the improvement in the terms of trade for a net oil importer come through before the boost to potential output.

By far the largest risk to me is the risk of setting too-tight policy, since there is no proven or politically feasible instrument to use to loosen further in the ECB, and, to a lesser extent, in the US or the UK.    So if possible, better to loosen now rather than face the possibility of needing to, but being unable to loosen by a great deal more later.

Events might prove a loosening wrong, of course.  But in that case the ECB can simply raise rates, or the Germans can gallop to the rescue and tighten fiscal policy.  And anyway, an inflation target overshoot would be welcome for most.

So, ECB policymakers, recall those wise words [inserted by my superior] ‘from time to time the oil price changes.’  Most often, the risks are balanced, and it might be safe to ignore those changes.  But not now!

Buiter’s reassurances about the value of government currency

A quick and incomplete response to Buiter’s note for Citi [which is a great read], quoted extensively in FTAlphaville today.

Buiter compares the properties and usefulness of government fiat currency, and other intrinsically worthless assets like Gold and Bitcoin.

He reports that only in models with flexible prices can an economy suddenly spit out a zero value of a fiat currency.  Noting that in the real world, the prices of goods in terms of government currency are sticky, yet the relative price of goods and gold or Bitcoin are flexible, he offers this as evidence supporting that the value of fiat currency is more assured than that of the others.

Two notes of caution.  First, although he doesn’t say precisely what results he’s referring to, I am sure he is talking about models that invoke rational expectations.  So in that respect they are not to be taken as comprehensive ways to adjudicate on the relative properties of these different currencies.  [Buiter himself notes that sticky prices are sometimes justified on the grounds that agents are less than ‘rational’ in the (confusing) sense typically meant in this literature].

Second, I don’t think Buiter’s observation that the ‘world is Keynesian’ – relative price of government fiat money and goods is sticky – can be taken to be the final word.  It may well be, but we don’t really understand why if it is, and don’t know what models that encoded a better understanding would tell us about this.   For example, it also seems to be that prices are sticky until they aren’t!  Extreme monetary events have greatly increased price flexibility.  [witness the unidad de fomento in Chile, with prices indexed, or most hyperinflations or instances of dollarization].

So, if that government-printed note is burning a hole in your pocket, spend it, and don’t miss out on a Black Friday bargain just because a few sticky price monetary models make you think you are safe.

 

Inflation truthing, asset prices, discount rates, QE

A thought-provoking post from Toby Nangle on this topic raises some difficult questions that go to the heart of monetary economics and policy, and take in important practical questions like what are official statistics for.

In his post, Toby recaps on the arguments of those who have become known as ‘inflation-truthers’.  These are commentators, who, reasoning from versions of the quantity theory of money, [pq=mv], predicted that money expansions associated with quantitative easing might generate runaway inflation.  When they didn’t see this inflation, they speculated that it was there, just that the authorities had conspired to manipulate public statistics so that it could not be seen.

Toby doesn’t try to rescue this conspiracy theory.  It’s hard to disprove it, although you will find that almost every practising economist who has ever interacted with government or the ONS will dismiss it as absurd.  Unfortunately, the experience of Argentina, where this does seem to be happening, gives this dark view life it does not deserve.

Instead what Toby does is to get at something that did happen, and might be the source of what is itching inflation truthers.  And that is that quantiative easing lowered yields and thereby raised the cost of providing for a given lifestyle in the future by saving.   In so far as it raised this cost, the argument is put that this is a kind of inflation, so perhaps this is the inflation that the inflation truthers were thinking would happen all along as a result of the money expansions.   And, extrapolating the logic, perhaps, if it is a kind of cost, we should include it in a proper definition of inflation.  Such a suggestion harks back to debates at the end of the 1990s and early 2000s when inflation targeters’ inflation was low and on target, but asset prices were booming.  Proponents then wanted tighter monetary policy to curb the boom they thought would lead to a crash (and which eventually did, of course) and some thought that the way to do that was to redefine inflation so that it included the asset price inflation [short hop from implicit yield] that would make the target index overshoot.

The more I think about this, the more I conclude that there are not any definitive answers to the questions raised here.  There are some points we can make about monetary theory, which the inflation truthers get wrong, but the theory is just that, and all the more a work in progress since we had to think about QE.  And there are some practical and historical points to be made about inflation indices, but about which different people could reach different conclusions.

The first question raised is whether the fact that QE lowered yields proves the inflation truthers right all along about the fact that MV=PT would assert itself somehow. From theory, the answer is no. PT=MV is not so much a theory as a piece of book-keeping. Standard monetary theory that accounts for the existence of an effect of QE on yields tells us that the monetary expansion bit was of no consequence, except in so far as it might have signalled something about lower future interest rates. The bit that lowered yields was the bit that involved a twist of the maturity structure of government assets out there, replacing long dated securities with short-dated equivalents. The thought experiment of two ‘bits’ of QE is just that, but recognise that buying long dated securities with reserves – what the Bank of England actually did – is the same as doing a conventional open market operation, (reserves for bills), and then a twist (bills for long dated gilts). MPC emphasised the importance of the expansion of money in the early days of QE. And some of their educational literature still does. But this was just hopeful bluster, at least as far as the theory we have tells us.

Empirical evidence on the effectiveness of QE doesn’t refute this basic notion.  Though it shows that money expansions lowered yields, it also shows that twists lowered them.  And the fact that money expansions did lower them might have nothing to do with the ‘money leg’ of the transaction.

Note that the inflation-truthers’ contention, that PT=MV asserts itself somehow, wasn’t anyway true at the zero bound. As the economy approaches the zero bound, velocity [jargon for how much real balances people want] falls [real balance demand rises] which is not surprising, since economics 101 tells us that as the price of something falls we want more of it [the price being the nominal interest rate in this case].

The second question raised is whether the fall in yields constitutes a cost for those trying to provide for their savings. This is certainly true, other things equal. Lowering yields means that yields on savings are lower! Implying that you need more of them to leave you with the same sized pot as you had thought. But, as the BoE explained pretty well in its evidence to the House of Lords, other things are not equal. Absent QE and the lowering of yields, it’s plausible that real activity and the value of funds invested in private assets, would have been much lower. So the reduction in the yield does not tell the whole story for savers.

Even if we had established that the ‘cost of saving’ had risen, this would not mean that QE was a bad idea either. If it had the effect of redistributing funds from savers to borrowers, then one might have anticipated that this would raise aggregate demand, since the latter we think have a higher propensity to consume out of income than the former.

This then leads us to the question of whether this ‘cost’, if it was a cost, should be included in the inflation index.  This is impossible to answer definitively.  In a free country, anyone can construct whatever weighted averages of things they want!  So whether adding other things to what one conventionally thinks of as inflation is worthwhile depends on why we are doing it.

Conventional practice is to define inflation to mean the change in the amount of money needed to buy the same basket of consumption goods: or, if this basket changes, and, to dig down to the theoretical fundamentals, to generate the same amount of utility that such goods provide.

This definition has certain theoretical purposes. For example, in macroeconomic models with flexible prices, it is this definition that provides the instantaneous link between the level of the money supply [requiring its own definition!] and the level of prices, referred to  by the P in PT=MV.  And it is the definition which allows us to connect the rate of growth of money and the rate of growth of prices.  Using this definition, we can also develop reasoning about long run optimal monetary policy [the optimal rate of growth of money, or level of nominal interest rates].   In this flexible price world, that policy is to  induce negative inflation equal to the real rate, so that the return on holding money is the same as holding other risk free assets.  Thus maximising the social benefits to holding money.  You could still figure out optimal monetary policy if you added to this definition a weighted sum of the real rate embedded in a long security and Brazilian rainfall, but it would make life slightly harder.  A more economical way to put this is that we define inflation to be the thing that monetary policy can choose, and the thing that can only be determined by monetary policy, in the long run.

In models of macroeconomies with sticky prices – like those used by all the major central banks – the same concept of inflation produces a refined steer about the appropriate long run monetary policy, and also a guide to short run, cyclical monetary policy.  The refined steer about long-term average levels of interest rates is that they need to be a bit higher than in worlds without sticky prices.  The same force in flexible price models works to pull optimal policy to try to equalise the return on monetary and other assets by generating deflation.  But this force is offset somewhat by the fact that changing prices invalidates the price choices of those who can’t readjust, so the optimal rate of inflation becomes a weighted sum of the Friedman Rule and zero.  And thus average nominal interest rates are higher.  The steer from these models about short run monetary policy is that we should try to keep inflation – conventionally defined – as close as possible to this long run level, traded off against other short run objectives too, like controlling real activity.   Once again, there could be no particular theoretical objection to defining ‘inflation’ to include Brazilian rainfall.  It wouldn’t affect the setting of interest rates in this model world.  But it would make communication of policy tricky in the real one.

That said, if you wanted to record the cost of those trying to provide for a certain level of utility in the future in terms of resources set aside today, you could adjust the inflation rate for a change in real returns.  But those returns are not something that conventional monetary policy can do much about in the long run [except via reducing nominal uncertainty in the economy].   This ‘cost’ is something that the ‘fiscal’ bit of monetary policy [the twist bit of QE] should pay attention to.  But, weighed against the other effects of QE, it might well still prove to be the right thing to do.

 

November Inflation Report Treasury Committee post mortem

This morning the Treasury Committee, the cross-party Parliamentary body charged with scrutinising the activities of the Bank, held a hearing on the Bank of England’s November Inflation Report.  It seemed like an anti-climax.  Lots to talk and grill the BoE about, but not much progress made.

There was a lot of jokey chaps humour between Carney and Tyrie [TC chair] and others.  At a time when the economy is not yet out of the woods, with the conventional monetary policy instrument trapped against its natural floor, and with all the other scrutiny the Bank faces on issues of malpractice in the industry, even inside the Bank itself, it doesn’t seem like the time for funny stuff.  This is really the fault of Tyrie and the other TC members for failing to set the right tone, and being unable to resist the temptation to crack clever jokes on TV with the celebrity policymaker.  Pompous though it seems to say it, as I read this back, isn’t this the sort of stuff that turns people off politics?  I suppose that it’s a fairly low risk forum, as only a few hundred BoE watchers will be tuning in.

Committee members bombarded Carney and the others with questions on migration.  These were an abuse of the process.  Members were trying to get the Bank’s officials, who have to study the labour market closely to figure out the appropriate stance of monetary policy, to make comments that could be used in the political debate about whether we should seek to try to renegotiate the EU Treaty to prevent freedom of movement of labour.  But time scrutinising the Bank is scarce, and when there are lots of important things to question them on, and the Bank’s accountability process is stretched – the BoE having so many more important responsibilities these days – it is a great shame to waste Committee time on issues that are not inside the BoEs remit.  Moreover, if the tactic of luring the Bank into political debate had been successful, it would have helped to corrode the Bank’s independence and impede its ability to do its job.  Just the opposite of what the Committee is for.

Kirsten Forbes improvised a cop-out of the migration question to the effect of ‘the academic literature on migration is a complete muddle’ [sic].  I don’t blame her for finding a way to get out of answering.  But I don’t think that is a particularly accurate summary.  I read the literature as arriving at some emerging points of agreement.  For example, the economics 101 prediction that inward migration would significantly lower wages into the markets were migrants compete, seems to have been refuted, highly germain to the false  sense of grievance that is being cultivated around immigration.

I missed Carney’s exact remarks, but read later that he reportedly played down the risk of deflation.   Well, if you buy some of the larger estimates of the biases in CPIs due to new goods bias and the difficulties of adjusting for quality change, as I remarked before, it’s conceivable that we are experiencing deflation now.

Measurement issues aside, I was looking for a good explanation of why a larger forecast undershoot of the target in the November Inflation Report – despite some yield curve softening – warranted no further action to try to loosen.  But if it was there I missed it.  If the economy were starting from steady state, with inflation on target, and interest rates well away from the zero bound, I could understand the MPC being relaxed about a widening 3 year undershoot of the target.  But right now, with rates pressed against what the MPC have decided is its floor of 0.5 per cent, I would expect hyper-sensitivity to any negative news on forecast inflation, and for them to go to excruciating lengths to explain why it is not possible or desirable to do anything about it.

TC members seemed to have been briefed extensively on Danny Blanchflower’s comments on the labour market aspects of the forecast.  One line of questioning was whether the MPCs forecast for real and nominal wage growth wasn’t just a prediction of mean reversion.  Carney managed to close off the questioning by remarking that this was a ‘fair comment’.  But the real point never got made or addressed, indicative of the general air of lethargy on the Committee side of the table.  The substantive point is tricky.  Danny has a point that forecasts of real wage recovery have so far been disappointed.  But then the eyeball econometricians on the Bank side of the table can readily claim that it’s fair to predict that old, average relationships reassert themselves, in this case meaning a return to productivity and real wage growth.

For more on the hearing, read Emily Cadman’s FT story, which cites Rob Wood [another ex BoE economist now at Berrenberg] and myself.