[I’m at a conference now and won’t have time to respond to comments for a few more days. Here’s an old post I never listed. I might dig up another old post tomorrow. I’ll read all comments when I return.]
Saturos sent me an interesting piece on the UK economy:
Both intellectually and practically, monetary policy has become something of a mess. Before the crisis, the Bank of England was guided by a simple and absolute inflation target, which it was relatively successful at meeting and was easy to understand. But since the credit crunch, it has taken on another purpose – that of bringing about a return to sustainable growth. This has brought the Bank into conflict with its primary objective. Since the crisis began, inflation has consistently been well above target, but for a brief dip in 2009, and it has twice been above 5pc.
. . .
Sticking to the inflation remit has become something of a charade but, ridiculously, the Bank still pretends that this is what it is trying to do. It is to be hoped that the new Governor, Mark Carney, can bring more clarity and openness to the Bank’s endeavours. Don’t expect miracles.
Fiscal policy has been equally badly wrong-footed. Lack of growth has derailed the Government’s deficit reduction plan, threatening certain fiscal crisis down the line in the absence of evasive action.
What’s more, the unwritten compact between Government and Bank of England, under which the Bank is supposed to compensate for tight fiscal policy with monetary activism, seems to be breaking down. At last week’s meeting, the Monetary Policy Committee decided to do nothing even though it judges risks still to be on the downside. To the chagrin of George Osborne, the Chancellor, Sir Mervyn seems to be saying there is little more that monetary policy can throw at the problem.
Mind you, the data as they stand would be enough to paralyse even the most sure-footed of policymakers into inaction. Can it really be true that an economy which has created more than a million private sector jobs over the past two and a half years is showing no growth at all?
Equally hard to understand is why the UK’s export performance continues to look so lamentable. The eurozone crisis provides only part of the explanation, since even Spain and Greece have done better on exports than Britain, and that’s without the “benefit” of a sharp devaluation in the currency.
Britain’s exceptionally large services sector, and its fast-growing digital economy, may provide partial answers to all these puzzles. Once you strip out disruptions to, and structural decline in, North Sea oil revenues, then there has been some underlying GDP growth.
Moreover, if you think of much of the growth that took place in the pre-crisis bubble years as essentially just the “candyfloss” of an out of control financial and property sector, then today’s stagnation looks much easier to understand. Service industries in general, and financial services in particular, are notoriously difficult to measure, both in terms of their output and contribution to exports.
More confusion in the UK over the roles of fiscal and monetary policy–nothing new there. But what interests me is the perception that prices can’t really be measured in the service economy. Is that just a minor problem? Not if services are 80% of GDP. If we can’t measure prices, what possible benefit could there be to stabilizing prices? Can someone show me a model that says that welfare is improved if we stablize prices than cannot actually be measured? Obviously we are a long way from the “menu costs of inflation,” because menu prices can be measured.
I don’t have much to say on the British productivity puzzle, except that it doesn’t matter. Indeed it doesn’t matter for two distinct reasons, which are both worth discussing. First, because monetary policy cannot affect productivity in any meaningful (noncyclical) way. So there is no reason for the central bank to worry about the issue. The BoE might (and I emphasize ‘might’) be able to put the British people back to work. But once they’ve done that they cannot wave a magic wand and make them as productive as Germans or Americans, or as unproductive and Chinese and Indians.
The second reason why productivity doesn’t matter is that it is not needed to determine the proper target path for monetary policy. If you really believed the BoE should target some sort of imaginary “inflation rate,” then we’d need to estimate productivity, in order to know how much of NGDP growth was “real” and how much was inflation. But that’s not necessary if you target NGDP growth, despite claims to the contrary by Mark Carney:
The main drawback of an NGDP level target in this regard is that it imposes the arbitrary constraint that prices and real activity must move in equal amounts but opposite directions. As potential real growth changes over time, either the nominal target will have to change or else it will force an arbitrary change in inflation in the opposite direction. The challenge of determining the UK’s potential growth rate at present highlights that this is not an academic concern (see answer to question 23). Another consideration is that statistics like nominal GDP are subject to revision, and these revisions can be large.
I’ve addressed revisions numerous times—it’s not a significant problem for NGDPLT. But the growth estimate problem reflects a widespread misconception that the “welfare costs of inflation” come from high and unstable inflation. In fact, they come from high and unstable NGDP growth. So inflation need not be measured or controlled. It’s only use is to provide fodder for parlour room debates over how fast “living standards” (and what’s that?) are rising or falling.
Back to the Telegraph article:
Looking at business investment, it was on a declining trend from long before the crisis and, to the extent that it was happening at all, there was a disproportionate emphasis on commercial property, great swathes of which now lie empty. Bulldozing this unwanted surplus would perhaps be the best solution, or at least converting it into housing.
So there’s another big chunk of past growth that has turned out to be of little or no long-term value. Strip these things out and it is by no means clear that the rest of the economy is suffering the crippling decline in productivity widely assumed. To the contrary, much of the anecdotal evidence points to significant advances, especially in the digital economy, which is growing faster in Britain than almost anywhere else.
According to a report by the Boston Consulting Group, the UK is now home to the largest per capita ecommerce market and the second largest online advertising market anywhere in the world.
Much of the growth in these markets, the productivity gains they drive, and the intangible benefits they deliver, are not caught by official GDP figures, which only attempt to measure the market value of the economy. In a paper just published, Jonathan Haskel of Imperial College Business School and others find that measured real value added has been understated by 1.1pc since the end of 2010 because of failure to capture intangible investment. Take this into account and there has in fact been no fall in productivity since then.
These musings lead to three conclusions. First and foremost, the Chancellor needs to act swiftly to recalibrate fiscal consolidation so as to give growth a supply-side, tax-cutting shot in the arm. Second, he should answer calls from both Sir Mervyn King and Mark Carney for a review of the Bank’s monetary remit. Finally, something has to be done about the GDP data, which beyond their capacity for political knock-about, have become about as useful as a chocolate teapot.
The concluding paragraph is perfect. And I’d add that this whole discussion reminds me that even NGDP is really not optimal. I’ve always thought a nominal wage target was the theoretical ideal, albeit not politically feasible. NGDP was a pragmatic second best option. But surely we can do better than NGDP. Does anyone know what the British national income data looks like? Is it more reliable than NGDP? If it’s revised, what types of income receive the greatest revision? If the BoE could keep the total national income, or even the wages and salaries portion of income, growing at a steady 4% per year then they could forget about inflation, RGDP, productivity, jobs, NGDP, etc, etc. Then get on with the supply-side reforms.