Did expansionary austerity actually fail in Britain?
I think so, but I’d like to be fair to the other side of the debate. Commenter Sean recently pointed me toward this interesting article:
It addressed the question of why, while the budget deficit in the coalition’s first two years came down in line with its June 2010 forecast, growth has fallen well short. Compared with a prediction that GDP would rise by 5.7% between mid-2010 and mid-2012, it only increased by 0.9%.
Where did the growth go? The biggest reason identified by the OBR is one frequently noted here. High inflation has eaten into real, or inflation-adjusted, consumer spending. Interestingly, consumers have been spending; the OBR’s forecast of a cash spending rise of 9.3% over two years was spot on. But it was eaten up by higher prices, leaving no room for “real” growth.
The other weak components of GDP were business investment, which the OBR attributes mainly to eurozone uncertainty and lack of credit, and exports, or net trade, similarly affected by eurozone woes.
Did it not allow enough for the impact of the fiscal tightening? Possibly, though any such effect is balanced by the fact that government spending so far has been significantly stronger than it expected.
The other useful report was from the ONS. To coincide with a seminar it held in Westminster on the great productivity conundrum – why has employment been so strong when GDP has been so weak? – it published a paper by Peter Patterson, its deputy chief economist.
Productivity is not the same as growth, though it is a key driver of it. It measures output per worker or output per hour. According to the latter, productivity was growing 2.4% a year in the decade or so before the crisis but has barely grown – a mere 0.2% a year – since mid-2009. An economy that does not generate productivity growth is in trouble.
Though most sectors of the economy are suffering from weaker productivity growth, two stand out. One is North Sea oil and gas, where output per hour has dropped more than 40% in five years.
The other is financial services, where productivity was growing by more than 4% a year, but in the past three years has been falling nearly 3% annually, as its output has plunged. Just these two sectors provide much of the explanation for the very weak productivity numbers.
If oil and finance explain “much” of the productivity shortfall, then ipso facto they explain “much” of the RGDP shortfall. And RGDP is the statistic that Keynesians point to in order to show that expansionary austerity has failed in Britain. In the US they like to point to the employment to population ratio, but that variable is doing very well in Britain, especially compared to the US.
Where am I in this debate? Somewhere in the middle:
1. Expansionary austerity would have worked if the BOE had kept NGDP growing at a brisk rate. I blame the BOE for the slow recovery, and I blame Cameron and Osborne for not asking the BOE to adopt a more robust NGDP target, as their Business Minister Vince Cable recommended (partly due to the influence of us market monetarists.)
2. However I don’t think expansionary austerity failed anywhere near as badly as the Keynesians assume. Keynesian stimulus is aimed at fixing output shortfalls caused by mass (involuntary) unemployment, not those caused by declining oil and gas output in the North Sea, or declining (measured) real output generated by a handful of financiers dressed in Savile Row suits. (Whether this measured “output” was real is an interesting question, but has no bearing on this post. It was measured.)
3. I believe Britain’s labor market is doing better than the RGDP numbers show, and worse than the employment to population numbers show. I think the unemployment rate gets it about right. Up from 5.5% at the peak of the boom, to the high sevens today. That’s actually not as big an increase as in the US, but it still suggests there’s some slack, and that stronger NGDP growth would have been helpful.
4. Due to the huge increase in the UK government sector during the first 10 years of this millennium, it’s possible the natural rate of unemployment in Britain has risen. I still think they have slack, but I have less confidence in my views on Britain than the US. I’d recommend that people look at Britmouse’s excellent blog; he recently did a wonderful post using Maradona as a metaphor for what Nick Rowe calls the Chuck Norris effect.
Update: That Maradona metaphor was actually from Mervyn King.
PS. One can regard both North Sea oil and super high incomes in the City as a sort of manna from heaven. I sucks when the manna stops falling.
Tags:
22. October 2012 at 11:23
Excellent post.
One point of disagreement: I don’t actually blame the BoE anymore. They’ve done the job they’re given: bring CPI inflation back to around 2% over the medium-term. Monetary policy has done exactly what it’s supposed to do in the UK, with QE keeping CPI from falling too far and too fast.
That places the problem at the feet of those responsible for the monetary policy target, which is the responsibility of the government.
Also, a lot of the recent inflation was caused by indirect taxation rather than NGDP growth outstripping supply. Preannounced inflation shouldn’t have much of an impact on unemployment, insofar as workers are foreward looking. What does seem to have had a positive impact on unemployment over the past 4 years has been supply-side reforms since the 1980s which have made it more possible for employers and employees to come to job-preserving arrangements, reduced barriers to entry in many areas, better training opportunities, and reduced marginal taxes on the low-paid combined with welfare cuts.
If the Universal Credit welfare reform (a movement closer towards a negative income tax system) works as planned from next year onwards, then the UK could standard to have an even bigger diversion from Okun’s Law.
22. October 2012 at 12:43
You could do austerity and basically print money and the printing of money would offset demand. However, when you print money, that’s someone else’s spending power being taken away via the Cantillon effect. Wouldn’t a better solution just be to run massive deficits financed by monetizing the deficit? As NGDP reaches its target, you start pulling back the amount of monetization. There’s no need to necessarily do “austerity”.
All that matters is that the money supply is increased. Running deficits and monetizing the deficits is a way of doing this. These deficits could be used to give massive tax cuts. For example, it the US, we could run larger deficits and just halve the payroll tax(or whatever tax you want to get rid of). When the economy starts to pick up; we stop the deficit monetization. The thing about printing money and putting it in bank reserves is that it takes away from my spending power and gives it to someone else(in this case, the banks). Why not just give the new spending power to regular citizens? Wouldn’t this be a better solution that pumping bank reserves and trying to inflate asset prices?
22. October 2012 at 13:31
ssumner:
I believe Britain’s labor market is doing better than the RGDP numbers show, and worse than the employment to population numbers show. I think the unemployment rate gets it about right. Up from 5.5% at the peak of the boom, to the high sevens today. That’s actually not as big an increase as in the US, but it still suggests there’s some slack, and that stronger NGDP growth would have been helpful.
Helpful…to whom exactly?
Obviously not those who are employed, who are non-idle capital goods owners. Their money and incomes will be diluted by those who receive the new money first. The “helpful” aspect of more non-market money creation and delivery would only benefit some at the expense of others, and in the process, distort economic calculation even more and prevent investors and consumers from setting a relative price structure that would tend to lead to physical capital structure sustainability.
Always with market monetarists it is treating the symptoms, not the causes. The causes of course are never the inflation itself, but rather its alleged incorrect rate of inflation, which of course is not discoverable by either arm chair scribbling on paper, or collecting data on unique historical happenstances. The ONLY mechanism by which any mortal human being can know the “correct” rate of money growth and delivery, is via the information provided by market process signals.
In our economy, money production is not subjected to the market test of profit and loss, and so this information on the “correct” rate of inflation and method of delivery is completely absent. Market monetarists are faced with this constraint, so they seek out crude “proxies” that allegedly provide us with market based information on what the correct rate of inflation should be:
1. For orthodox monetarists, they seek to impose price stability by non-market means, and then claim that to the extent the market responds by deviating away from price stability, this is allegedly the market saying the central bank should inflate at a higher or lower rate.
2. For market monetarists, they seek to impose aggregate spending by non-market means, and then claim that to the extent the market responds by deviating away from aggregate spending stability, this is allegedly the market saying the central bank should inflate at a higher or lower rate.
These two views are akin to setting a capital punishment target rate, and then changing the laws so that more or less people are sent to the electric chair should the people behave in such a way that would have them break fewer or more laws and thus deviate away from the capital punishment target.
I’d recommend that people look at Britmouse’s excellent blog; he recently did a wonderful post using Maradona as a metaphor for what Nick Rowe calls the Chuck Norris effect.
Yes, that post highlighted exactly what is wrong with central banking:
That’s quite correct. Market interest rates do not react to what market actors (savers, consumers, etc) are expected to do, but rather what a non-market institution is expected to do, and in the process, investors and consumers do not allocate their resources in accordance with actual market savings rates, but rather, in accordance with central bank influenced interest rates. This is precisely the core of the boom bust cycle. And no, it doesn’t matter that everyone correctly expects nominal interest rates. What matters is that everyone cannot observe market interest rates that are a function of market actor saving and consumption.
This is exactly why we saw such a divergent structural corrections post 2008:
http://i.imgur.com/NLoT1.png
It was because years and years of non-market low interest rates led investors to devote relatively too much capital and labor to interest rate sensitive industries such as construction and durable goods sectors, and relatively too little capital and labor to less interest rate sensitive industries such as retail and service sectors.
The strong focus on expectations, as it pertains to various monetarist proposals, has ironically enough been a core issue that shows precisely why monetarism is economically destructive. Investors and consumers come to form expectations in accordance with the Fed’s behavior, rather than each other’s behavior. You cannot expect coordination between investors and consumers if they are acting to coordinate their behaviors with the Fed.
——————–
There has been a very conspicuous pattern in central bank evolution. The Fed was originally allegedly designed to serve as a lender of last resort. Only when there are widespread bank panics, or defaulting governments, is the central bank to inflate. That original intent gave way to a stronger presence, in the form of constant inflation/deflation by buying government debt, in conjunction with deficits, to stabilize prices. That gave way to the dual mandate, which added employment to the mix.
Now consider what market monetarists are proposing. They propose an even greater presence of the Fed, in the form of the Fed not only buying treasury debt, but also private companies and whatever is necessary to achieve their central monetary plan. This is filed under the euphemism “unconventional policy”, but it just means they want the Fed to not be officially constrained into buying only treasury debt. Of course, as with most “new” central plans from political strategists who call themselves economists, the state usually is already doing what the economists say they should try out. Keynesianism was the exact same in this regard.
22. October 2012 at 13:48
Suvy:
You could do austerity and basically print money and the printing of money would offset demand. However, when you print money, that’s someone else’s spending power being taken away via the Cantillon effect. Wouldn’t a better solution just be to run massive deficits financed by monetizing the deficit? As NGDP reaches its target, you start pulling back the amount of monetization. There’s no need to necessarily do “austerity”.
That would just be the Cantillon Effect on Steroids.
All that matters is that the money supply is increased. Running deficits and monetizing the deficits is a way of doing this. These deficits could be used to give massive tax cuts. For example, it the US, we could run larger deficits and just halve the payroll tax(or whatever tax you want to get rid of). When the economy starts to pick up; we stop the deficit monetization. The thing about printing money and putting it in bank reserves is that it takes away from my spending power and gives it to someone else(in this case, the banks). Why not just give the new spending power to regular citizens? Wouldn’t this be a better solution that pumping bank reserves and trying to inflate asset prices?
You aren’t suggesting that the Treasury send checks to everyone, do you? Does that mean you want everyone to work all day and sell goods and services to the state, in exchange for newly created money from the state? Do you have any idea what kind of a society that would be? What it would look like and consist of?
Imagine a two person economy where one person works to produce food and shelter and clothing and other real goods and services for sale to the second person, and the second person presses a button that creates new paper bills with pictures of dead Presidents on them for sale to the first person.
Now multiply the first person by 300 million, with the same second person money printer, and you’ll get a grasp of how your idea will look like if implemented in society. It’s cash for clunkers going from a bowl of nuts to an entire fruitcake.
Your post reminds me of this video from Friedman, appropriately entitled “The most persistent economic fallacy of all time”:
http://www.youtube.com/watch?v=Hrg1CArkuNc#t=1m0s
22. October 2012 at 14:02
Imagine if the BoE economists were Italian seismologists;
http://seattletimes.com/html/nationworld/2019492783_apeuitalyquaketrial.html
‘Among those convicted Monday were some of Italy’s best known and most internationally respected seismologists and geological experts, including Enzo Boschi, former head of the National Institute of Geophysics and Volcanology.
‘”I am dejected, desperate,” Boschi said. “I thought I would have been acquitted. I still don’t understand what I was convicted of.”‘
22. October 2012 at 14:24
Major Freedom,
Right now, they’re printing money and putting the money in bank reserves and inflating assets. You have to tell me that giving people a tax cut(after all, taxation is theft) is a better response than doing that. Of course, the Cantillon Effect is still going to be there. My point is that giving people more of their own income to spend(cutting their taxes) is better than giving it to a bank. People that don’t work wouldn’t get a break because people that sit around and don’t work don’t get paid. This would be benefiting the average person who’s seen a cut in their incomes from Alan Greenspan screwing up.
22. October 2012 at 14:26
Major Freedom,
Right now, they’re printing money and putting the money in bank reserves and inflating assets. You have to tell me that giving people a tax cut(after all, taxation is theft) is a better response than doing that. Of course, the Cantillon Effect is still going to be there. My point is that giving people more of their own income to spend(cutting their taxes) is better than giving it to a bank. People that don’t work wouldn’t get a break because people that sit around and don’t work don’t get paid. This would be benefiting the average person who’s seen a cut in their incomes from Alan Greenspan screwing up. I think stealing less money from them via taxes is better than printing money and giving it to the banks.
22. October 2012 at 14:29
“There has been a very conspicuous pattern in central bank evolution.”
>> Indeed. As insidious as the original Federal Reserve Act and Federal Reserve System may have been, the evolution from central bank to central planner over the years has taken a most peculiar and frightening turn:
1. From protecting the gold dollar to expanding base money at a whim and a keystroke
2. From providing credit to solvent institutions against good collateral in times of cyclical need to funnelling $trillions in loans to insolvent domestic and foreign institutions
3. From listening to financial markets to leading them
4. From passive banker to waging a direct assault on market supply and demand and the market pricing mechanism
5. From a world where financial means were a by-product of prosperity to using financial means in hope of somehow magically inducing prosperity
With respect, I fail to see how there is any room for the word “market” in “market monetarism.”
22. October 2012 at 14:52
Mike, You do realize that we oppose almost all those changes, don’t you?
W. Peden, Perhaps you are right, I don’t fully understand their mandate.
22. October 2012 at 15:41
Scott Sumner,
I’m not sure anyone really understands the entire monetary/regulatory system set up in the late 1990s. A lot of it was based on importing American models for the sake of fashionable modernity and reverence for the Clintonian Third War approach. So, in that same period, we got a Supreme Court, devolution of powers to new Scottish and Welsh assemblies (which hadn’t been thought through by the Prime Minister) and we only avoided replacing the House of Lords with a Senate because the former operates as a useful retirement home for many politicians.
The independent BoE system hasn’t worked much better than 1993-1997 policy of the Chancellor having largely transparent consultations with experts. Similarly, the independent regulator approach of having the FSA formally regulate the banks rather than the informal businesslike approach of the Bank of England regulating the commercial banks over tea and biscuits has not been a succcess.
22. October 2012 at 15:45
Their mandate is covered under the Bank of England Act 1998. Currently price stability is 2% CPI. Changing the mandate to something else merely requires the Chancellor to write a letter to the MPC.
In relation to monetary policy, the objectives of the Bank of England shall be –
(a) to maintain price stability, and
(b) subject to that, to support the economic policy of Her Majesty’s Government, including its objectives for growth and employment.
12 Specifications of matters relevant to objectives
(1) The Treasury may by notice in writing to the Bank specify for the purposes of section 11 –
(a) what price stability is to be taken to consist of, or
(b) what the economic policy of Her Majesty’s Government is to be taken to be.
23. October 2012 at 02:23
Wrong predicate (admittedly, making the same probably willful mistake every other easist makes); the purpose of austerity is not immediate recovery, but to secure (non-inflationary) solvency. When judged on that criterion, austerity has been moderately successful, even in Greece.
Those who reject austerity should tell us when and how they expect to repay the debt that they advocate taking on (and, if this involves some kind of spontaneous natural recovery, what happens if that does not occur), and why it should be any easier to pay the debt down later than now. Put yourself in the position of the bond market as a bank manager; would you be sceptical of your own story? I suspect that the unstated thinking of many easists is that either (1) they don’t care if their solution does end up in inflation or (2) they don’t care about the future because that will be someone else’s problem.
As Richard W writes, the legislative basis of the BoE’s mandate is easily understood; the BoE has no business to even consider growth if their inflation target is not being met. And I would blame the BoE for prolonging the UK slump by not sticking to their mandate – ie because they are leaving an incipient asset price correction overhanging the British economy.
23. October 2012 at 02:45
@Patrick R. Sullivan, that article on the Italian seismologists (for which, thanks) is really frightening. I have been worried that the frustration of ordinary people in understanding and dealing with the difficulties presented by a changing world might allow them to be turned against rigorous and honest economists; now it seems that they might be susceptible to persecuting rigorous and honest experts in general!
23. October 2012 at 03:59
In this article I argued that Krugman’s handling of the “British austerity” episode is dubious. Scott, I don’t think you mentioned it here, but they raised the top income tax rate from 40 to 50 percent. Surely that’s not “expansionary austerity” at least from a supply-side perspective, right?
23. October 2012 at 04:05
Tyler Cowen reviews Tim Congdon: https://docs.google.com/document/d/1tKl_u9F_u0iCUVGf0qxEsjJgU0sXxNVDdJPSFSM8XcI/edit?pli=1
And the Maradona analogy was actually Mervyn King’s, not Britmouse’s!
23. October 2012 at 04:55
Bernanke has privately announced he won’t seek another term: http://dealbook.nytimes.com/2012/10/22/casting-dual-roles-at-treasury-and-the-fed/
23. October 2012 at 05:00
Maybe Romney has a chance after all (QE3 really isn’t working): http://www.businessinsider.com/percentage-of-companies-reporting-sales-beats-2012-10
23. October 2012 at 05:13
I will continue fighting against supply-side pessimism until we actually see what happens if (when!) we have a revival of NGDP. I see some anecdotal evidence the CPI is overstated when demand growth is so compressed (2% annual NGDP growth over the last year), and hence have a tendency to believe RGDP growth is mildly understated.
The Maradona analogy is from Mervyn King, and I loved it as well. Chuck’s long-lost cousin.
I think W. Peden is much too generous about the BoE, though I agree with him (and this post) that Osborne/Cameron are ultimately accountable for their failure. The BoE have been consistently failing to do Svenssonian forecast-targeting. They deliberately allowed Sterling to strengthen this year so as to get inflation down, an unnecessary shock in the middle of a recession.
23. October 2012 at 05:14
Me: “1. From protecting the gold dollar to expanding base money at a whim and a keystroke
2. From providing credit to solvent institutions against good collateral in times of cyclical need to funnelling $trillions in loans to insolvent domestic and foreign institutions
3. From listening to financial markets to leading them
4. From passive banker to waging a direct assault on market supply and demand and the market pricing mechanism
5. From a world where financial means were a by-product of prosperity to using financial means in hope of somehow magically inducing prosperity
With respect, I fail to see how there is any room for the word “market” in “market monetarism.”
Scott: “Mike, You do realize that we oppose almost all those changes, don’t you?”
>> Respectfully, I fail to see how you do.
1. Certainly you require a fully flexible fiat currency to effectuate policy. One anchored in a commodity or anchored by anything for that matter would not be workable.
2. From http://www.themoneyillusion.com/?paged=20
“Because bank bailouts are really, really, undesirable, that’s a huge advantage of NGDP level targeting. Even so, this doesn’t mean the Fed necessarily made a mistake in bailing out the banking system in late 2008.”
In fall of 2008 I believe 12 of our top 13 banking institutions were either insolvent or on the verge of insolvency. I understand you wish the Fed had done more, sooner. However, even if the Fed began easing much sooner, surely some of that credit would have went to banks whose balance sheets were already toxic and in danger of insolvency.
3. From: http://www.themoneyillusion.com/?p=16745
“I knew this would happen. QE3 raised stock prices by about 2%. That’s not very much. Even the roughly 5% rise that might be attributable to rumors of QE3 is not all that much. The article incorrectly claims stocks have fallen since QE3. I suppose that’s true if you start the clock from the day after QE3 was announced, but why would you do that? Stocks are up 1% from the day before the announcement. Standard finance theory suggests that the only response that matters is the movement of stocks in reaction to the announcement, perhaps including rumors of the announcement.”
and later
“The QE3 did a little bit of good, but not enough to spur a rapid recovery. If you want more (and I do) then we need to press for NGDPLT.”
>> That’s leading financial markets thru monetary policy, no?
4. Artificially expanding credit to bid up prices on financial assets to carry out policy creates a non-market demand for those securities and thus distorts market supply/demand not to mention the effect of yield suppression (even though that may not be your objective) on distorting perceptions of risk by conveying confusing pricing signals to market participants.
5. The whole idea of utilizing monetary policy to effectuate some pre-determined desirable macroeconomic outcome (eg 5% NGDP target) is using financial means to induce prosperity, no?
23. October 2012 at 05:18
Scott, on the whole do you think politicians were right to support bailouts in 2008 given the setting of monetary policy?
23. October 2012 at 05:18
David Beckworth just upgraded his blog, looks much better. Meanwhile Scott appears to be hosting this one on ENIAC…
23. October 2012 at 06:52
Am with Richard W and W Peden on the BoE’s job – and anyway, the BoE has erred on the upside of its mandate, even when you take taxes into account.
But am also with Britmouse that the BoE could do better at thinking through the consequences of different parts of its work. To exchange rates, I’d add not considering the consequences of bank recapitalisation, which probably increased ‘leakage’ from QE.
ONS GDP data has been subject to substantial later revision for over twenty years now; the recovery from the 1990s recession was badly underestimated.
23. October 2012 at 08:18
‘Maybe Romney has a chance after all….’
If Obama keeps pretending to be a military historian, he does. We’ve had ‘boats that go underwater’ since the Civil War. The Lusitania was sunk by one in 1916.
Aircraft carriers came along in the 1920s. Maybe someone growing up in Hawaii might be expected to have heard of the attack on Pearl Harbor by carrier launched planes.
And you want cold, hard steel;
http://www.mirror.co.uk/news/uk-news/soldier-who-led-charge-through-1347633
‘A soldier who led a four-man bayonet charge through a hail of Taliban gunfire has been awarded the Military Cross.’
Too bad Romney had been listening to Johnny Mercer’s advice to accentuate the positive and eliminate the negative.
23. October 2012 at 09:17
Bloody hell! Yichuan Wang just did a new post on healthcare, and the Browser picked it up! The freaking Browser!
https://twitter.com/TheBrowser/status/260742563504459776
The worst part it, it was largely a response to my nagging him to respond to libertarian critiques of ACA, on Twitter and on his blog! John Cochrane did a post just before him, rebutting most of his claims in advance (so I quoted him at length in the comments) but does the Browser quote John Cochrane? No, it links to Yichuan Wang.
I’m kidding, this is great for Yichuan, I’m pleased for him. Now if only they’d listen to him on stuff he was actually right about (market monetarism)…
23. October 2012 at 09:49
Bob,
I thought that the expansionary austerity argument was anchored by the belief that slashing the deficit will boost confidence and raise growth.
23. October 2012 at 09:53
-whether or not it comes from tax increases or spending cuts the driver is deficit reduction.
Saturos,
Holy **** that list of possible Bernanke replacements scares the crap out of me.
I’ll have my fingers crossed for Romer.
23. October 2012 at 10:18
[…] 1. Scott Sumner on what is wrong with the UK. […]
23. October 2012 at 10:36
Sovereign controlled penny for your thoughts on this article Scott?
http://www.telegraph.co.uk/finance/comment/9623863/IMFs-epic-plan-to-conjure-away-debt-and-dethrone-bankers.html
23. October 2012 at 17:43
Britmouse,
Getting inflation down is the BoE’s job. I can’t blame a central bank for fulfilling it’s goal; my problem is with the goal, not the striker.
I agree re: supply-side analysis. In terms of maintaining flexible employment markets during a recession, the UK economy has had a sterling performance (forgive the pun) and the productivity slowdown seems to be an effect of sector-specific issues.
Of course, if we had a better monetary policy target AND good labour markets (which could be improved even further) then we could see some seriously impressive unemployment numbers.
23. October 2012 at 18:03
W. Peden:
Getting inflation down is the BoE’s job.
The BoE generates inflation.
Saying the job of a central bank is to “fight inflation” is like saying the job of a wolf is to “fight” the number of sheep killed.
23. October 2012 at 18:08
Britmouse,
I’m not even sure one can blame the BoE for the recapitalisation programme, which has made a lot of QE necessary to keep the economy from a deep depression and which concomitantly creates needless doubts about QE’s effectiveness. Now, quite some time after Tim Congdon pointed this out, policymakers are confessing to the flamingo-up :
http://www.bbc.co.uk/news/business-20047863
http://www.bbc.co.uk/news/business-20051656
http://www.bbc.co.uk/news/business-20051656
Remarkably, all this was not advertised during the period when recapitalisation was sold in 2008 and Gordon Brown “saved the world”.
23. October 2012 at 18:15
Major Freedom,
A somewhat misleading analogy, since inflation (in the sense that is relevant here i.e. changed in the CPI index) is a consequence and goal of the direct actions of the central bank, whereas the killing of sheep is the direct action that the wolf uses to achieve its goal i.e. food.
A better pastoral analogy is this: the central bank is like a farm labourer who is sent to get only so many sheep into a field. The BoE was in the position of having too many sheep in the field and so had to cut down. Recapitalisation, ceteris paribus, logically entails a cut in the money stock and so the BoE was able to do this without any apparent action.
23. October 2012 at 18:31
W. Peden:
Maybe I am not understanding your argument, but would’t that make the analogy a sound one? The reason why I ask this is because your descriptions of both are exactly what I had in mind. Inflation is a GOAL of the central bank, and eating sheep is a GOAL of the wolf. Just like I find it strange if someone said that the wolf’s job is to fight the number of sheep eaten, so too do I find it strange if someone said that the central bank’s job is to fight inflation.
Borrowing from your analogy of the farm, I think it can be improved by assuming that the BoE sends sheep to only a select few farms, owned by the BoE’s friends. Every other farmer has to compete with those privileged farmers, and it can be safely assumed that in the long run, the privileged farmers will only grow in terms of market share.
After all, going back to the real world, in the US, the biggest 5 banks, those with access to the Fed’s sheep copying machine, have grown from 40% market share pre-2008, to more than 55% market share post-2008.
Many of the smaller farmers were obliterated or bought out.
23. October 2012 at 18:36
Mike,
1. My plan has an anchor, NGDP futures.
2. I would have opposed the bailouts if we had NGDP targeting. I’m not even sure I support them without.
3. The Fed should not target stock prices, nor should it try to influence them.
4. I don’t favor expanding credit to bid up financial asset prices.
5. I don’t favor using financial means to induce prosperity. I favor stable money, because unstable money induces a boom bust cycle.
You are completely 100% wrong on all 5 counts against me. What else do you got?
23. October 2012 at 18:43
Saturos, I honestly don’t know. I’d need to know the counterfactual movement in NGDP. If it would have been much lower, the bailout was needed. But it’s likely that a non-bailout would have forced the Fed to do something extreme, like level targeting. So I don’t know.
23. October 2012 at 18:46
Major Freedom,
Perhaps you misread me: I didn’t say that the goal of the BoE was to FIGHT inflation (it very clearly is not) but that when inflation (i.e. the rate of inflation) is above the BoE’s target then it’s job is to get inflation down. Since I know you understand inflation targeting, there’s no difference of fact here. We could go on about getting the analogies just right (I do love a good metaphor or simile) but not very productively.
“Borrowing from your analogy of the farm, I think it can be improved by assuming that the BoE sends sheep to only a select few farms, owned by the BoE’s friends. Every other farmer has to compete with those privileged farmers, and it can be safely assumed that in the long run, the privileged farmers will only grow in terms of market share.”
Actually here there is a factual point: unlike the Fed, the BoE operates its asset purchases through the secondary market or at least does so during QE. So we don’t quite have anything as farcical as the US primary dealer system. Anyone who wants to trade gilts or private debt in the secondary markets is free to do so.
23. October 2012 at 18:50
* We still have a primary dealer system for direct debt sales from the Debt Management Office, but there’s no hotline to the BoE such as some institutions enjoy with the Fed. I remember watching a George Selgin video on the US system and laughing out of my chair.
23. October 2012 at 18:52
Daniel, Interesting. I would not go that far. I’d like to see all FDIC-insured deposits be 100% backed by either reserves or Treasury debt.
Bob, Yes, that hurt, but the top rate went to 45% not 50%.
Saturos, When I read Soltas and Wang I feel like (in comparison) I was a moron at age 18 or 19.
Should I know who “Browser” is?
23. October 2012 at 18:59
“If lenders are forced to put up 100pc reserve backing for deposits, they lose the exorbitant privilege of creating money out of thin air.”
Which raises the question: if this is such an exorbitant privilege, and we are supposed to live in an egalitarian rather than feudal age, why should anyone have such an exclusive privilege?
23. October 2012 at 19:01
Oh, and-
“Anthropological studies show that social fiat currencies began with the dawn of time.”
– is a mind-numbingly stupid sentence that most children who have read a modest selection of books would see is wrong.
23. October 2012 at 23:05
Damn, now Yichuan has kicked off a whole reddit!
http://www.reddit.com/r/Economics/comments/11xrr1/healthcare_and_cars_are_not_isomorphic_why/
Scott, the Browser is, according to Tyler Cowen, the best site on the Web: http://thebrowser.com/
And plenty of kids are smart in college, not all of them go on to make massive contributions to human welfare like you will.
Good luck in D.C.! Looks as though things are going pretty good so far…
https://twitter.com/DavidBeckworth/status/260834749705248770/photo/1
(I love it – just two economists about to save the world…)
24. October 2012 at 00:04
Whether this measured “output” was real is an interesting question, but has no bearing on this post. It was measured.
Actually, if the measured output was mostly bubble, unsustainable output, it has a bearing on the all Central Bank performance. Against what standard is the most recent performance being measured? What is the “optimal” recovery after an unsustainable bubble has popped?
On Mike’s #2 — it seems likely to me that TARP bailout support for unsustainable BIG “private” institutions has extended the recession, due to a failure to restructure more quickly towards sustainable production.
Had the AIG – Goldman Sachs Big Financial companies gone into bankruptcy, with forced debt/ payouts to equity conversions (wiping out prior investors), the Fed could have insured thru QE+ that the loss/ reduction in size of irresponsible Big Banks doesn’t strangle main street.
Without the trillions of MBS based CDO/CDS deals, the banks should have reduced as much as house builders reduced in 2007.
Tiny typo “It” not “I”: I sucks when the manna stops
24. October 2012 at 05:16
W. Peden, on the bank recap programme do you mean that raising capital ratios has raised the demand for money and hence the BoE have had to expand the monetary base more than would otherwise have been necessary? Interesting view.
You are still too generous on the Bank. They claim to be doing inflation forecast-targeting, so they should be fired for incompetence as their own forecasts have said their policies will fail for most of the last four years.
If they are targeting headline CPI not the forecast, they should be fired for both incompetence and lying.
The BoE’s legal mandate is loose and allows them wide discretion over policy, so we must hold them to account in how they exercise that discretion.
24. October 2012 at 06:10
Britmouse,
It depends what you mean by money. If you mean broad money (as I do when I use the term “money”) I mean that recapitalisation requires a reduction in the supply of money, which has to be offset by QE.
This is because banks can raise their capital ratios in only two ways: (1) reduce their liabilities (i.e. lend less and buy fewer bonds) or (2) sell more shares. Now, it should be obvious how (1) reduces the money supply. As for (2), it is hard under current circumstances, but insofar as banks can sell more shares their buyers are converting monetary assets (deposits) into non-monetary assets (equity).
If you mean the base, then recapitalisation should presumably REDUCE base money demand on the part of the banks as a first effect, because they need less reserves with less deposit liabilities. As a second effect, the credit squeeze that results from recapitalising will drive down asset prices and encourage a flight to safety. This paragraph is spur of the moment speculation, though, because I don’t usually think about monetary policy in terms of base money demand/supply.
24. October 2012 at 06:12
Oh, I forgot about responding to your point: you’re right, I hadn’t considered the inconsistency because I’d forgotten about their claim to be doing inflation-forecast targeting.
24. October 2012 at 06:43
Scott –
You have just made the case for increased oil production. You have intimated increased US oil production may be the reason the US is the “bright spot” in the global economy today. Good for you! You’re the first economist beyond Jim Hamilton to recognize oil as an important component of incremental GDP performance. Congratulations!
Now, is oil consumption an important component of GDP performance? Is OECD oil consumption in secular decline? I argue that it is and has been–and will be. (See my 2009 article in Oil & Gas Investor: “Peak Oil Economics”; and also “Oil: What Price can America Afford?”)
Does that matter to GDP? It depends on how fast efficiency can grow, right? And how fast is that?
You’re now pulling on a thread. Keep pulling.
24. October 2012 at 07:17
Huh, Britmouse? You are diametrically wrong.
“their [the BoE’s] own forecasts have said their policies will fail for most of the last four years”. Actually, they usually forecast that inflation will converge on its target (to do otherwise would be either a signal that monetary policy is about to change or an admission that they are incompetent) and then it overshoots.
“The BoE’s legal mandate is loose and allows them wide discretion over policy”. No it isn’t, the wording is as watertight as a duck’s behind. They just choose to overlook their mandate as they know that this has tacit government approval.
24. October 2012 at 08:05
Rebel, that is true prior to 2008, but not since 2008, where they have been forecasting sub-2% CPI inflation on a two/three year horizon. Check the data or read my blog.
http://uneconomical.wordpress.com/2012/08/11/monetary-policy-stance-under-inflation-targeting/
“A signal that monetary policy is about to change”
That surely misses the point of forecast-targeting. If the forecast outcome of currency policy is off target, current policy is wrong, end of story.
“No it isn’t, the wording is as watertight as a duck’s behind. They just choose to overlook their mandate as they know that this has tacit government approval.”
The legal mandate defers the specific definition of “price stability” to the Chancellor. The Chancellor has given not tacit but explicit public written approval of their policy when they engage in the letter-writing charade. It is hard to argue they are breaking their legal mandate under such circumstances.
24. October 2012 at 09:53
You can’t really be that naive Britmouse; please! In your blog you write “As the CPI rate drifts high in late 2008, the Bank allows the forecast to drift downwards”. Let me decode the “forecast” for you. It is saying, “yes, we may have hit you with some unexpected inflation, but that is just an accident and inflation is set to fall really fast soon, so there is no need to sell gilts and bid up wages; trust us, honest!” You should present the inflation outturns against the forecast two years previously to give everyone a laugh.
In my view the BoE should not be allowed to publish an inflation forecast. Not that they cannot use their own internally, but the official forecast should be done by the OBR or ONS. Targeting their own forecast is not much better than allowing the BoE to measure inflation.
As you say, the government defines “price stability”, and they have not had the guts to change that definition. The BoE Act says nothing about the letters over-riding that inflation target, so the BoE is certainly breaching its mandate by not pursuing the official definition. But given that the BoE is letting the government off the hook for making difficult structural changes to improve Britain’s economic performance, you cannot expect the government to be critical in their replies to the BoE’s letter.
24. October 2012 at 16:26
“You are completely 100% wrong on all 5 counts against me. What else do you got?”
>> Well, let’s see.
1. NGDP futures doesn’t anchor the currency. The $USD today is essentially a derivative without an underlying. The only anchor is the arbitrary whim of who’s running the Fed. An NGDP target rate doesn’t change that.
2. Ok
3-4. I never said you favored targeting financial asset prices or distorting market supply/demand. I said that is the effect of open market operations conducted by a non-market participant buying financial assets based on carrying out monetary policy instead of based on profit/loss. The Fed, as an institution, is not burdened by market risk, but rather, political risk. Does your plan account for the effect on the suppression of sovereign and corporate debt yields as it reflects on an institution’s creditworthiness? Or do interest rates (even in the short-term) not matter? Again, even if interest rate suppression is not your objective, it is most certainly a likely consequence of such a policy.
5. If NGDP falls below/above your target rate, you support a monetary policy that would ease/tighten in the hope of raising/lowering NGDP. Correct? As I stated previously, how is that not “utilizing monetary policy to effectuate some pre-determined desirable macroeconomic outcome?” I actually thought I was just stating the obvious here.
7. November 2012 at 13:01
There was no austerity. Government spending went up in Britain. The government just said it was going to do austerity then talked about it as if it happened, while there was none.
7. November 2012 at 13:07
DocMerlin,
There was austerity, in the same sense that someone deep in debt who decides to increase their expenditure less income by $10,000 and then decides instead to increase it by $9,00 is being “austere”.
Yet apparentely it is this austerity and not the movement of UK inflation back to its general target area (at a time of indirect tax increases) that is responsible.
4. January 2013 at 08:16
[…] British fiscal policy, which has been caricatured by its critics, a number of observers, including Bentley University economist Scott Sumner, have argued that the real culprit behind Britain’s economic woes has been its monetary policy. […]