Unfocused vacation musings on money – part 1

It is vacation time for the Christensen family. We are in the Christensen vacation home in Skåne (Southern Sweden) and my blogging might reflect that.

There are really a lot of things going on the in world and I would love to write a lot about it all, but there is not enough time. But here are a few observations about recent global events from a monetary perspective.

Egyptian Regime Uncertainty

I am not getting myself into commenting too much on what is going on in Egypt other than I fundamentally is quite upbeat on the Egyptian economy, which I easily could see growth 7-8% y/y in real terms in the next 1-2 decade (with the right reforms!)

Remember the Egyptian population is going from 80 to 90 million within the next decade and the labour will be growing by more than 1% a year in the same period (as far as I remember). With the right reforms that is a major growth boost. So Egypt is a major positive long-term supply side story – short-term it is a major negative supply side story.

What we have in Egypt is of course a spike in what Robert Higgs calls Regime Uncertainty. That is a negative supply shock. The Egyptian central bank should of course allow that to feed through to higher prices – don’t fight a supply shock with monetary policy. There is a lot to say about how Egyptian monetary policy should be different, but monetary policy surely is not Egypt’s biggest problem. If you want to understand Egypt’s problem I think you should read “Why Nations Fail”.

I earlier wrote a post on the implications of recent Turkish political unrest from an AD/AS perspective. I think that post easily could be copy-pasted to understand the economics of the Egyptian crisis.

A Polish deflationary monetary policy blunder

I have followed the Polish economy closely for well over a decade and I love the country. However, recently I have got quite frustrated with particularly the Polish central bank. Yesterday the Polish central bank (NBP) cut its key policy rate by 25bp. No surprise there, but the NBP also (wrongly) said it was the last rate cut in the rate cutting cycle.

Say what? Poland is likely to have deflation before then end of the year and real GDP growth is well-below trend-growth. Not to talk about NGDP growth, which has been slowing significantly. I am not sure the NBP chief Marek Belka realises, but it did not ease money policy yesterday. It tightened monetary policy.

When a central bank tells the markets it will cut interest rates (or expand the money base) less than the markets have been expecting then it is effectively monetary tightening. That was what the NBP did yesterday – pure and simply. Now ask yourself whether that is the right medicine for an economy heading for deflation soon. To me it is a deflationary monetary policy blunder. (I will not even say what I think of the recent FX intervention to prop up the Polish zloty).

A confident Kuroda should not be complacent

This morning Bank of Japan governor Kuroda had press conference on monetary and economic developments in Japan. I didn’t read up on the details – I am on vacation after all – but it seems like Mr. Kuroda was quite confident that what he is doing is working. I agree, but I would also tell Mr. Kuroda that he at best is only half way there. Inflation expectations are still way below his 2% inflation target so his policies are not yet credible enough to declare victory yet. So let me say it again – more work on communication is needed.

Carney’s long and variable leads (I would have hoped)

Mark Carney has only been Bank of England governor since Monday, but it is tempting to say that he is already delivering results. The macroeconomic data released this week for the UK economy have all been positive surprises and it looks like a recovery is underway in the British economy. So why am I saying that Carney is already delivering results? Well because monetary policy is working with long and variable leads as Scott Sumner likes to tell us. There is a wide expectation in the markets that Carney will “try to do something” to ease UK monetary policy and that in itself is monetary easing (this is the reverse of the Polish story above).

However, my story is unfortunately a lot less rosy. The fact is that the market is not totally sure that Carney will be able to convince his colleagues on the Monetary Policy Committee to do the right thing (NGDP targeting) and judging from the markets a major change in policy is not priced in. So Carney shouldn’t really take credit for the better than expected UK numbers – at least not a lot of credit. So there is still no excuse for not doing the right thing. Get to work on an NGDP level target right now.

Summertime reading…

I hope to be able to do some reading while on vacation – at least I brought a lot of books (yes, one of them is about Karl Marx). Take a look…

Vacation books

PS It is 4th of July today. The US declaration of independence is surely something to celebrate and here in the small city of Skyrup in Skåne our neighbour always fly the Stars and Stripes on July 4th so we won’t forget. I like that.

If there is a ‘bond bubble’ – it is a result of excessive monetary TIGHTENING

Among ‘internet Austrians’ there is an idea that there is gigantic bubble in the global bond markets and when this bubble bursts then the world will come to an end (again…).

The people who have these ideas are mostly people who never really studied any economics and who get most of their views on economics from reading more or less conspiratorial “Austrian” school websites. Just try to ask them and they will tell you they never have read any economic textbooks and most of them did not even read Austrian classics as “Human Action”. So in that sense why should we worry about these views?

And why blog about it? Well, because it is not only internet Austrians who have these ideas. Unfortunately many central bankers seem to have the same kind of views.

Just have a look at this from the the Guardian:

A key Bank of England policymaker has warned of the risks to global financial stability when “the biggest bond bubble in history” bursts.

In a wide-ranging testimony to MPs, Andy Haldane, Bank of England director of financial stability, admitted the central bank’s new financial policy committee is taking too long to force banks to hold more capital and appeared to criticise the bank’s culture under outgoing governor Sir Mervyn King.Haldane told the Treasury select committee that the bursting of the bond bubble – created by central banks forcing down bond yields by pumping electronic money into the economy – was a risk “I feel acutely right now”.

He also said banks have now put the threat of cyber attacks on the top of their the worry-list, replacing the long-running eurozone crisis.

“You can see why the financial sector would be a particularly good target for someone wanting to wreak havoc through the cyber route,” Haldane said.

But he described bond markets as the main risk to financial stability. “If I were to single out what for me would be biggest risk to global financial stability right now it would be a disorderly reversion in the yields of government bonds globally.” he said. There had been “shades of that” in recent weeks as government bond yields have edged higher amid talk that central banks, particularly the US Federal Reserve, will start to reduce its stimulus.

“Let’s be clear. We’ve intentionally blown the biggest government bond bubble in history,” Haldane said. “We need to be vigilant to the consequences of that bubble deflating more quickly than [we] might otherwise have wanted.”

I must admit that I am somewhat shocked by Haldane’s comments as it seems like Haldane actually thinks that monetary easing is the cause that global bond yields are low. The Bank of England later said it was not the view of the BoE, but Haldane’s “personal” views.

If Haldane ever studied Milton Friedman it did not have an lasting impact on his thinking. Milton Friedman of course told us that low bond yields is not an result of easy monetary policy, but rather a result of excessively TIGHT monetary policy. Hence, if monetary conditions are tight then inflation and growth expectations are low and as a consequence bond yields will also be low.

Hence, Milton Friedman would not be surprised that Japanese and US bond yields have risen recently on the back of monetary easing being implemented in the US and Japan.

In fact the development in global fixed income markets over the past five years is a very strong illustration that Friedman was right – and why Haldane’s fears are misguided. Just take a look at the graph below – it is 10-year US Treasury bond yields.

10y UST

(If you think you saw this graph before then you are right – you saw it here).

If Haldane is right then we should have seen bond yields decrease following the announcement of monetary easing. However, the graph shows that the opposite have happened.

Hence, the announcement of TAP and the dollar swaps lines in early 2009 was followed by an significant INCREASE in US (and global) bond yields. Similarly the pre-announcement of ‘QE2’ in August 2010 also led to an increase in bond yields.

And finally the latest sell-off in the global fixed income markets have coincided with monetary easing from the fed (the Evans rule) and the Bank of Japan (‘Abenomics’)

If you think there is a bond bubble

then blame the ECB’s rate hikes in 2011

Looking at US 10-year yields over the past five years we have had three major “down-legs”. The first down-leg followed the collapse of Lehman Brothers in October 2008. The second down-leg played out in the first half of 2010 following the hike in Federal Reserve’s discount rate in February 2010 and the People Bank of China’s increase in the reserve requirement in January 2010.

However, the biggest down-leg in US 10-year bond  yields followed the ECB’s two rate hikes of 2011 (April and July). Believe it or not, but the ECB was “able” to reduce US 10-bond yields more than the collapse of Lehman Brothers did.

Hence, if there is a ‘bubble’ in the global fixed income markets it has not been caused by monetary easing. No if anything it is a result of excessively tight monetary conditions.

In fact it is completely absurd to think that global bond yields are low as a result of central bank ‘manipulation’. Global bond yields are low because investors and households fear for the future – fears of low growth and deflationary tendencies. Global bond yields are low because monetary policy have been excessive tight.

Rejoice! Yields are rising

Unlike Andy Haldane I do not fear that day the bond ‘bubble’ (it is not a bubble!) will burst. In fact I look forward to the day US bond yields (and UK bond yields for that matter) once again are back to 5%. Because that would mean that investors and households again would believe that we are not heading for deflation and would once again believe that we could have ‘normal’ GDP growth.

And unlike Haldane I don’t believe that higher bond yields would lead to financial armageddon and I don’t believe that Japan will default if Japanese bond yield where to rise to 3 or 4%. Banks and countries do not go belly up when growth takes off. In fact the day US bond yields once again is back around 5% we can safely conclude that the Great Recession has come to an end.

Concluding, there is no ‘bond bubble’ and Andy Haldane should not have sleepless nights over it. The Bank of England did not cause UK yields to drop – or rather maybe it did, but only because monetary policy has been too tight rather than too easy.

PS I never heard any of these ‘bubble mongers’ explain why Japanese property prices and equity prices have been trending downward for nearly two decades despite interest rates being basically at zero in Japan.

PPS the graph above also shows that “Operation Twist” in 2011 failed to increase growth and inflation expectations. Any Market Monetarists would of course have told you that “Operation Twist” would fail as it did nothing to increase the money base or increase the expectation for future money base expansion.

—–

Related posts:

When US 30-year yields hit 5% the Great Recession will be over
Confused central banks and the need for an autopilot
Two cheers for higher Japanese bond yields (in the spirit of Milton Friedman)
Tight money = low yields – also during the Great Recession

A five-step plan for Mark Carney

I am on the way to London – in fact I am writing this on the flight from Copenhagen – so I thought it would be fitting to write a piece on the challenges for the new Bank of England governor Mark Carney.

I fundamentally think that the UK economy is facing the same kind of problems as most other European economies – weak aggregate demand. However, I also believe that the UK economy is struggling with some serious supply side problems. Monetary policy can do something about the demand problem, but not much about the supply side problem.

Five things Carney should focus on

Bank of England’s legal mandate remains a flexible inflation targeting regime – however, in latest “update” of the mandate gives the Bank of England considerable leeway to be “flexible” – meaning it can allow for an overshoot on inflation in the short-run if needed to support growth. I am not happy with BoE’s updated mandate as I fear it opens the door for too much discretion in the conduct of monetary policy, but on the other hand it do also make it possible to put good policies in place. I therefore strongly believe that Mark Carney from day one at the BoE needs to be completely clear about the BoE’s policy objectives and on how to achieve this objective. I therefore suggest that Carney fast implement the following policy changes:

1)   Implement a temporary Nominal GDP level target: The BoE should announce that it over the coming two years will bring back the level of NGDP to the pre-crisis level defined as a 4% trend path from the 2008 peak. This would be fairly aggressive as it would require 8-10% NGDP growth over the coming two years. That, however, is also pretty telling about how deep the crisis is in the UK economy. Furthermore, the BoE should make it clear that it will do whatever it takes to reach this target and that it will step up these efforts if it looks like it is falling behind on reaching this target. It should similarly be made clear that the BoE is targeting the forecasted level of NGDP and not the present level. Finally, it should be made clear that once the temporary NGDP target is hit then the BoE will revert to flexible inflation targeting, but with a watchful eye on the level of NGDP as an indicator for inflationary/deflationary pressures. I would love to see a permanent NGDP targeting regime put in place, but I doubt that that is within the BoE’s present legal mandate.

NGDP UK Carney

 

2)   Institutionalise the Sumner Critique: According to the Sumner Critique the fiscal multiplier is zero is the central bank targets the NGDP level, the price level or inflation. I believe it would greatly enhance monetary policy predictability and transparency if the BoE so to speak institutionalized the Sumner Critique by announcing that the BoE in it conduct of monetary policy will offset significant demand shocks that threaten it’s NGDP target. Hence, the BoE would announce that if the UK government where to step up fiscal consolidation then the BoE will act to fully offset the impact of these measures on aggregate demand. Similarly the BoE should announce that any change in financial regulation that impacts aggregate demand will be offset by monetary policy. And finally any shocks to aggregate demand from the global economy will be fully offset. The “offset rule” should of course be symmetrical. Negative demand shocks will be lead to a stepping up of monetary easing, while positive demand shocks will be offset by tighter monetary policy. However, as long as NGDP is below the targeted level positive shocks to demand – for example if financial regulation is eased or fiscal policy is eased – then these shocks will not be offset as they “help” achieve the monetary policy target. This offset rule would to a large extent move the burden of adjusting monetary conditions to the financial markets as the markets “automatically” will pre-empt any policy changes. Hence, it for example British exports are hit by a negative shock then investors would expect the BoE to offset this and as a consequence the pound would weaken in advance, which in itself would provide stimulus to aggregate demand reducing the need for actually changes to monetary policy.

3)   Introduce a new policy instrument – the money base – and get rid of interest rates targeting: There is considerable confusion about what monetary policy instrument the BoE is using. Hence, the BoE has over the past five years both changed interest rates, done quantitative easing and implement different forms of credit policies. The BoE needs to focus on one instrument and one instrument only. To be able to ease monetary policy at the Zero Lower Bound the BoE needs to stop communicating about monetary policy in terms of interest rates and instead use the money base as it’s primary monetary policy instrument. The annual targeted money base growth rate should be announced every month at the BoE Monetary Policy Committee meetings. For transparency the BoE could announce that it will be controlling the growth of the money base by it buying or selling 2-year Treasury bonds from risk and GDP weighted basket of G7 countries. The money base will hence be the operational target of the BoE, while the level of NGDP will be the ultimate target. The targeted growth rate of the money base should always be set to hit the targeted level of NGDP.

4)   Reform the Lender of Last Resort (LoLR): Since the outbreak of the crisis in 2008 the BoE has introduced numerous more or less transparent lending facilities. The BoE should get rid of all these measures and instead introduce only one scheme that has the purpose of providing pound liquidity to the market against proper collateral. Access to pound liquidity should be open for everyone – bank or not, UK based or not. The important thing is that proper collateral is provided. In traditional Bagehotian fashion a penalty fee should obviously be paid on this lending. Needless to say the BoE should immediately stop the funding for lending program as it is likely to create moral hazard problems and it unlikely to be of any significantly value in terms of achieving BoE’s primary policy objectives. If the UK government – for some odd reason – wants to subsidies lending then it should not be a matter for the BoE to get involved in.  My suggestion for LoLR is similar to what George Selgin has suggested for the US.

5)   Reform macroeconomic forecasting: To avoid politicized and biased forecasts the BoE needs to serious reform it macroeconomic forecasting process by outsourcing forecasting. My suggestion would be that macroeconomic forecasts focusing on BoE’s policy objectives should come from three sources. First, there should be set up a prediction market for key policy variables. There is a major UK betting industry and there is every reason to believe that a prediction market easily could be set up. Second, the BoE should survey professional forecasters on a monthly basis. Third, the BoE could maintain an in-house macroeconomic forecast, but it would then be important to give full independence to such forecasting unit and organizationally keep it fully independent from the daily operations of the BoE and the Monetary Policy Committee. Finally, it would be very helpful if the British government started to issue NGDP-linked government bonds in the same way it today issues inflation-linked bonds.  These different forecasts should be given equal weight in the policy making process and it should be made clear that the BoE will adjust policy (money base growth) if the forecasts diverge from the stated policy objective. This is basically a forward-looking McCallum rule.

This is my five-step program for Mark Carney. I very much doubt that we will see much of my suggestions being implemented, but I strongly believe that it would greatly benefit the UK economy and dramatically improve monetary and financial stability if these measures where implemented. However, my flight is soon landing – so over and out from here…

PS it takes considerably longer to fly from Canada to the UK and from Denmark to the UK so Carney have more than two hours to put in place his program so maybe he can come up with something better than me.

Duncan Brown’s interesting NGDP wonkery

If you write a blog you obviously want people to read what you write and even better you want to inspire discussion. I was therefore very happy when Duncan Brown sent me his two latest blog posts, which both are inspired by stuff I have written.

Duncan’s posts are very interesting. The first post – Shocking supply and volatile demand – uses a (crude) method I developed to decompose demand and supply inflation. Duncan utilizes this method – Quasi-Real Price Index – on UK data. The second post – In the 1950s, Rab Butler sets an NGDPLPT mandate… – also uses one of my ideas and that is to look a what inflation historical would have been had the central bank had an NGDP target. Duncan looks at the UK, while I earlier have looked at the US.

A Quasi-Real Price Index for the UK

I first time suggested that inflation could be decompose between supply and demand shocks with what I inspired by the brilliant David Eagle termed a Quasi-Real Price Index in a blog post in December 2011.

This is from my 2011 post – A method to decompose supply and demand inflation:

David Eagle in a number of his papers on Quasi-Real Indexing starts out with the equation of exchange:

(1) M*V=P*Y

Eagle rewrites this to what he calls a simple equation of exchange:

(2) N=P*Y where N=M*V

This can be rewritten to

(3) P=N/Y

(3) Shows that consumer prices (P) are determined by the relationship between nominal GDP (N), which is determined by monetary policy (M*V) and by supply factors (Y, real GDP).

We can rewrite as growth rates:

(4) p=n-y

Where p is US headline inflation, n is nominal GDP growth and y is real GDP growth.

Introducing supply shocks

If we assume that we can separate underlining trend growth in y from supply shocks then we can rewrite (4):

(5) p=n-(yp+yt)

Where yp is the permanent growth in productivity and yt is transitory (shocks) changes in productivity.

Defining demand and supply inflation

We can then use (5) to define demand inflation pd:

(6) pd=n- yp

And supply inflation, ps, can then be defined as

(7) ps=p-pd (so p= ps+pd)

Duncan uses this method on UK data and I must say that his results are vey interesting.

Here is a graph from Duncan’s post on the decomposing of UK inflation.

UK-qrpi

Based on his results he concludes:

“Policy may have looked loose in terms of interest rates, but relative to context, this was one of the most extreme tightenings on record. The implication is that while we’re always going to be prey to supply shocks which will create some volatility in output and employment, we need to be careful to allow demand to grow in a predictable, sustainable way. The trouble with an inflation target is that the nightmare combination of an adverse supply shock and a damaging tightening of monetary conditions looks – as it did at the time – like things are on track. Policy should aim to stabilise demand inflation, even as supply inflation moves around; it is a pity that the mandate most likely to be able to achieve this result (a nominal output level path) has been ruled out by the Treasury.”

As a Market Monetarist it is hard to disagree with Duncan’s statement. However, it should certainly also be noted that Duncan’s results give reason to think that the nature of the present crisis in the UK economy to some extent is different from the crisis in the US or the euro zone economies. Hence, it seems like the present subdued growth in the UK economy to a larger extent than is the case in the US or the euro zone (overall) is due to supply side problems (Weak demand is the primary problem, but supply issues seem more important than in the US). In that sense the UK economy might share some similarities with the Icelandic economy. See my earlier post here on why the Geyser crisis to a large extent was caused by an supply shock rather and a demand shock.

A counterfactual inflation story for the UK

In his second post Duncan tells the counterfactual story of what inflation would have been in the UK since the 1950s if the Bank of England had been targeting an 5% NGDP growth path. The method is similar to the one I used in my post The counterfactual US inflation history – the case of NGDP targeting.

You can see Duncan’s counterfactual inflation data in this graph.

Duncan’s results for the UK are rather similar to the result I got for the US. However, it seems that UK inflation under NGDP targeting than would have been in the case in the US in recent years. That do indicate that that the low growth in the UK economy to a larger extent than is the case in US. That, however, also mean you need lower demand inflation to achieve the Bank of England’s present 2% inflation target.

It is not all I agree with in Duncan’s two post – for example I think he misinterprets his results to mean that the primary shocks to the UK economy has been supply, while I think his results in fact shows that demand shocks have been the primary driver of the UK business cycle – but I would nonetheless recommend to all of my readers to have a look at Duncan’s blog. It’s good wonkery.

 

 

Mr. Farage made me happy and then worried. UKIP should support NGDP level targeting

If there is anything that the governing Tory party in the UK is fearing then it is the UKIP. The anti-EU UKIP wants to take the UK out of the EU, but it also wants something less – monetary reform!

This is UKIP leader Nigel Farage in the City AM:

“WHEN Mark Carney takes over as our new governor of the Bank of England, at this time of “exceptional” economic crisis – his words not mine – he must be fully armed and working to a clear political direction from the start. Carney’s first day on the job should be an economic D-Day for the UK.

That is why I want to be the first UK political leader to commit my party to changing the Bank of England’s mandate. It’s time to put the Bank, with its increasing powers and broadening economic reach, on the side – incontrovertibly – of the struggling people of Britain.

The status quo is not an option. British voters have made it clear in three by-elections, each time with rising force, their feeling of intense anger at the Westminster and Brussels elite. Ukip carries the flag for these voters. I’m proud that I can give voice to their anger, while offering them something positive to do with their vote. But Ukip offers more. We offer a future in which Britain is free to govern itself, to enforce its own laws, to control its borders, and to make its successful way economically – trading at a profit and able to honour promises to its citizens. A first and crucial step is that we take back the commanding height of our economy – the Bank – and put it to work driving employment, growth and confidence.

I expect George Osborne to use this Budget – three years late – to open the debate on the objectives of the Bank, and to lay out the options for change. But I call on him to go further. He must put some red British meat into the dish. He should announce which option he prefers, and set a fixed timetable for the consultation and the decision. He must guarantee that, by Carney’s first day, the new framework is in place.

Why do I put this pressure on him? Because one of the many failures of this government has been its inability to take the decisions needed to put growth and confidence first. The list of its jellied failures to decide is long – on energy, aviation, housing, roads, and infrastructure investment. Neither the public nor businesses know whether to be confident and spend, invest, or hire.”

When I saw Mr. Farage’s comments today my response was wauw! This is pretty incredible – the Tories are coming under attack from the right to change the mandate of the Bank of England in a more pro-growth oriented direction.

So what is the Market Monetarist response? Well, it is easy. Yes Mr. Farage is completely right – the BoE’s inflation target is terrible and should be changed. He is also right the that the UK economy needs monetary “stimulus” in the sense that nominal GDP has fallen well-below the pre-crisis trend level.

However, I must say that Mr. Farage’s comments also come across as being advocating a significant level of monetary activism which I find very problematic. In fact it seems like Farage is just calling for monetary stimulus – yes that might be needed at the moment, but it is terribly dangerous if the institutional framework is not correct. We don’t want a return to the inflationary 1970s. We want a monetary constitution for Britain. Not a hawkish or a dovish monetary policy, but a neutral monetary policy. UK monetary policy has been overly tight so monetary easing should be welcomed, but I much prefer this to happen within the framework of a proper NGDP level targeting regime.

Therefore, Mr. Farage you are right to be outraged by the UK government’s lack of action on changing the Bank of England’s mandate, but you should be more clear on the mandate you want. Ask for an NGDP level target for Britain. It is in the country’s best interest!

Mathilde, Mathias and Carney – family life and blogging

Thursday was a very interesting day for me. You might think it was so because Mark Carney – the next Bank of England governor – was testifying in the British parliament. But frankly speaking even though Carney said some interesting things I have to disappoint you dear Mark – I wasn’t really listening. I had more important things to do.

What can be more important that than? Well, as Bob Hetzel expressed it – the Christensen household grew by 33% on Thursday as my wife gave birth to a beautiful Daughter – Mathilde. Her soon to be three year old brother Mathias is very proud – and his parents are very prod and happy as well.

So why do I tell you that? Should blogs be personal? No not necessarily, but the great thing about both writing and reading blogs is that they are written in a personal way with few disclaimers and that is why blogs are here to stay. And that is what I really want to reflect a bit on.

First, all when I write a blog post I do it at odd times when I can sneak in 5 or 30 minutes to do it. It is typically late at night when the rest of the family is sleeping or early in the morning – or when I am traveling, which I do quite a bit. That means that I rarely think about the structure in my posts. I just write. It is just about getting things off my chest or rather get out stuff that is in my head. Having been thinking about monetary policy issues a lot for more than two decades have led to a certain “overload” and I need to empty my head a bit. And yes, I desperately want people to read what I write and I want them to like what I write. But it is actually more about expressing my views than anything else. I think that is the case for most people writing blogs – whether it is about monetary policy or wine.

Obviously it makes it much easier to write blog posts when you don’t think much about the structure of the posts and write what you think rather than what you think people would like you to write. And editing? Forget about it – yes, I do read through my post, but frankly speaking you will have to live with my typos. The important thing is the message. It should be noted that I have people that are so very kind to help me editing in the sense that they will send me corrections to my text. That I always gladly welcome and I do try to correct my typos when I have time. So you are always welcome to drop me a mail about anything in that regard (lacsen@gmail.com).

I enjoy my blogging tremendously and it has brought me into contact with extremely interesting people from all over the world – particularly in Northern America. Another very enjoyable thing about blogging is that it is completely unpretentious and there is certainly nothing snobbish about it. I have many commentators who are completely normally people – “Amateur economists” who are interested just interested in understand the world they live in. I love that. As I have said many times “Economics is not an education. Economics is a state of mind”

But I must admit my favourite readers likely are the many economics students and PhD students that follow and comment on my blog. I love when I get mails from you guys about that world and what to make of it. You are all a great inspiration.

The worst temptation in blogging is to become a “blogging asshole”. Any blogger will tell you that they every single day will check out how many visitors their blog have had on a given day. I certainly do that – and I am surely more happy on days when a lot of people have visits my blog. I have noticed that I can maximize the number of visitors to my blog and the easiest way to do that is to become a “blogging asshole”. So what is a blogging asshole. To me it is somebody who first of all is hostile to other bloggers. Somebody who in more or less nasty ways attack the views of other bloggers and commentators. In fact I think that if I did a “I hate Paul Krugman” post every week it would do a lot to boost the number of visitors on my blog, but it would also generate traffic that I would consider as unwelcomed. I love debates about monetary policy issues, but I mostly just want people to get the message. I am no saint. I have been an blogging asshole from time to time when you thing has upset me. Here is an example.

I believe that blogging has become increasing influential and will continue to play an important role in public debate and that is especially the case in the area of economic policy. The case of NGDP level targeting is obviously a very good example. As a central bank governor from a not to be disclosed European country said to me recently “Lars, you must be happy these days. Everybody is talking about NGDP targeting”.

But blogging is not scientific research and we should not forget about the importance of scientific research. That said the two things do certainly not rule out each other. As my readers know I like to share research I have read (or plan to read). Here is the latest example.

Anyway, time to go with my son Mathias to pick up my beloved wife Hanne and our daughter Mathilde.

PS Mark Carney, just relax I did find time to read your comments in the British parliament. I was slightly disappoint that we did not have a more clear endorsement of NGDP level targeting, but I certainly understand the politics of this issue so I also understand that we might be much closer to NGDP level targeting in the UK than Carney’s testimony could lead one to conclude.

Pricing in Carney

Here is a paper I did with my colleague Anders Vestergård Fischer on the Bank of England and what to expect from the new BoE governor Mark Carney – obviously with a special focus on NGDP level targeting.

Our conclusion is that the markets are not in any way priced for NGDP targeting in the UK yet.

Chuck Norris and why Mark Carney is already easing UK monetary policy

These days we are getting a proper illustration of the Chuck Norris effect – that the central bank can ease monetary policy through sheer credibility without even printing more money. In fact in the case of Mark Carney he is now easing monetary policy in the UK even before he has become Bank of England governor. That is pretty impressive, but also good news for the UK economy. It is of course the expectation that Mark Carney as coming BoE governor will be in charge of introducing some form of NGDP level targeting.

This is from Bloomberg today:

“U.K. inflation expectations rose to the highest level in 21 months amid speculation Mark Carney will expand monetary policy and spur price rises when he takes over as Bank of England governor in July.

The so-called break-even rate increased for a fifth day before Carney testifies to U.K. lawmakers this week after telling the World Economic Forum’s annual meeting in Davos, Switzerland, last month that policy in developed countries isn’t “maxed out.” Ten-year bonds fell after an industry report showed U.K. services expanded in January, undermining demand for fixed-income assets. The pound weakened against the euro.”

Market expectations of inflation in my view are one of the best measures of changes in the monetary policy stance. When inflation expectations are inching up it is a very clear indication that monetary conditions are getting easier. That is what is happening in the UK at the moment.

Central banks essentially have two monetary policy instruments. First of all they can print money – increase the money base. Second they can guide expectations. The latter is often much more important and that is exactly what we are seeing in the UK markets these days.

Effectively Mark Carney is already in charge of UK monetary policy – the only thing he has to do is hint what he would like to see happen with UK monetary policy going forward.

Are half a million hardworking Poles to blame for the UK real estate bubble?

The answer to the question of course is no, but let me tell the story anyway. It is a story about positive supply shocks, inflation targeting, relative inflation and bubbles.

In 2004 Poland joined the EU. That gave Poles the possibility to enter the UK labour market (and other EU labour markets). It is estimated that as much as half a million poles have come to work in the UK since 2004. The graph below shows the numbers of Poles employed in the UK economy (I stole the graph from Wikipedia)

Polish-born_people_in_employment_in_the_UK_2003-2010_-_chart_2369a_at_statistics_gov_uk

 

 

 

 

 

 

 

Effectively that has been a large positive supply shock to the UK economy. In a simple AS/AD model we can illustrate that as in the graph below.

Positive supply shock

The inflow of Polish workers pushes the AS curve to the right (from AS to AS’). As a result output increases from Y to Y’ and the price level drops to P’ from P.

Imagine that we to begin with is exactly at the Bank of England’s inflation target of 2%.

In this scenario a positive supply – half a million Polish workers – will push inflation below 2%.

As a strict inflation targeting central bank the BoE in response will ease monetary policy to push inflation back to the 2% inflation target.

We can illustrate that in an AS/AD graph as a shift in the AD curve to the right (for simplicity we here assume that the BoE targets the price level rather than inflation).

The BoE’s easing will keep that price level at P, but increase the output to Y” as the AD curve shifts to AD’. Note that that assumes that the long-run AS curve also have shifted – I have not illustrated that in the graphs.

Positive supply shock and demand shock

At this point the Austrian economist will wake up – because the BoE given it’s monetary easing in response to the positive supply shock is creating relative inflation.

Inflation targeting is distorting relative prices

If we just look at this in terms of the aggregate price level we miss an important point and that is what is happening to relative prices.

Hence, the Polish workers are mostly employed in service jobs. As a result the positive supply shock is the largest in the service sector. However, as the service sector prices fall the BoE will push up prices in all other sectors to ensure that the price level (or rather inflation) is unchanged. This for example causes property prices to increase.

This is what Austrian economists call relative inflation, but it also illustrates a key Market Monetarist critique of inflation targeting. Hence, inflation targeting will distort relative prices and in that sense inflation targeting is not a “neutral” monetary policy.

On the other hand had the BoE been targeting the nominal GDP level then it would have allowed the positive shock to lead to a permanent drop in prices (or lower inflation), while at the same time kept NGDP on track. Therefore, we can describe NGDP level targeting as a “neutral” monetary policy as it will not lead to a distortion of relative prices.

This is one of the key reasons why I again and again have described NGDP level targeting as the true free market alternative – as NGDP targeting is not distorting relative prices contrary to inflation targeting,which distorts relative prices and therefore also distorts the allocation of labour and capital. This is basically an Austrian style (unsustainable) boom that sooner or later leads to a bust.

So is this really the story about UK property prices?

It is important to stress that I don’t necessarily think that this is what happened in the UK property market. First, of all UK property prices seemed to have taken off a couple of years earlier than 2004 and I have really not studied the data close enough to claim that this is the real story. However, that is not really my point. Instead I am using this (quasi-hypothetical) example to illustrate that central bankers are much more likely to creating bubbles if they target inflation rather than the NGDP level and it is certainly the case that had the BoE had an NGDP level targeting (around for example a 5% trend path) then monetary policy would have been tighter during the “boom years” than was actually the case and hence the property market boom would likely have been much less extreme.

But again if anybody is to blame it is not the half million hardworking Poles in Britain, but rather the Bank of England’s overly easing monetary policy in the pre-crisis years.

PS I am a bit sloppy with the difference between changes in prices (inflation) and the price level above. Furthermore, I am not clear about whether we are talking about permanent or temporary supply shocks. That, however, do not change the conclusions and after all this is a blog post and not an academic article.

Mr. Osborne: “There is a lot of innovative stuff happening around the world”

It is hard not getting just a bit excited about the discussions getting under way in the UK after the coming Bank of England governor Mark Carney basically has endorsed NGDP level targeting. So far the UK government has not given its view on the matter, but it is pretty clear that UK policy makers are aware of the issues. That is good news and today we got a “reply” from the UK government to Carney’s (near) endorsement of NGDP targeting in the form of comments from UK Chancellor George Osborne.

This is from the Daily Telegraph:

The Chancellor said he was “glad” that Mark Carney, the next Governor of the Bank, had raised the prospect of ending central banks’ inflation targets to concentrate more on gross domestic product.

Mr Osborne described the suggestion (NGDP level targeting) as “innovative” and said he was pleased Mr Carney was discussing such ideas.

“There is a debate about the future of monetary policy — not exclusively in the UK, but in many countries. There is a lot of innovative stuff happening around the world,” he said.

“There is a debate going on. I am glad that the future central bank governor of the UK is part of that debate.”

Asked if he was considering making the change suggested by Mr Carney, Mr Osborne said: “There is a debate going on. Any decisions, any future decisions are a matter for government.”

He added: “I have no plans to change the framework. There is a debate going on. I think it’s right there is a debate.”

Mr Osborne said he had had “lots of discussions” with Mr Carney about monetary policy before appointing the Canadian to the Bank of England. But he declined to confirm they had discussed the inflation target, sating the conversations were “private”.

Although he signalled he was open to changing the target, he said that the current inflation target has “served us well” and he would have to be persuaded to changing it.

…A similar debate about nominal GDP targets has been underway for some time, Mr Osborne noted, adding: “It would be a good thing for academia to lead the debate and government to follow.”

This is certainly uplifting. Osborne signals that he don’t necessarily think that NGDP level targeting is a bad idea (it is a great idea!). Obviously for those of us who think NGDP targeting is a great idea it is natural to cheer and scream on Mr. Osborne to get to work on changing the BoE’s mandate immediately. However, for once I will be cautious. I think it makes very good sense for Mr. Osborne to encourage discussion about this issue. Changing a countries monetary regime is an extremely serious matter. Yes, I strongly believe that an NGDP level targeting regime would be preferable to the UK compared to today’s regime, but I also think that the “institutional infrastructure” needs to be sorted out before completely changing the regime.

That said as far as I understand the legal framework (and I am certainly no specialist on this) the Chancellor actually can change the BoE’s mandate simply by sending a letter to the Bank of England governor. So with the stroke of his pen Mr. Osborne could make the  UK first country in the world that had an NGDP targeting regime. I would compare such a policy move to the decision in 1931 that took the UK of the gold standard. That saved the country from deflation and depression. Mr. Osborne could write himself in to the economic history books by showing the same kind of resolve as the UK government did in 1931.

Mr. Osborne deserves a lot of credit for encouraging debate

While I do not agree that the UK’s inflation targeting regime has “served the UK well” I would also say that the UK could have had much worse regimes – just think of monetary policy in the UK in the 1970s or the failed experiment with pegging the pound with with the ERM in the early 1990s.  The is no doubt that an inflation targeting regime is preferable to both alternatives – discretionary inflationary madness or a misaligned fixed exchange rate regime.

However, the inflation targeting regime in the UK likely added to fueling the UK housing bubble (sorry Scott – there was a UK housing bubble) and it has certainly made the crisis much deeper since 2008. An NGDP level targeting regime would have meant that UK monetary policy would have been tighter in the “boom year” just prior to 2008, but also easier over the past four years (but maybe with much less QE!). That would have led to more conservative fiscal policies, more prudent lending policies from the commercial banks and a small housing bubble prior to 2008 and most defiantly much stronger public finances and less unemployment after 2008. Who would seriously oppose such a monetary policy regime?

So I certainly think that an NGDP level targeting regime would have served the UK better than the inflation targeting regime. But Osborne is right – there need to be a debate about this and think the Mr. Osborne deserves a lot of credit for calling for such a debate instead of just declaring that nothing can ever be changed. That is wonderfully refreshing compared to the horrors of the (lack of) debate about monetary policy in Continental Europe (the euro zone…)

 

%d bloggers like this: