The BoE ignores the arguments for NGDP targeting

James of London sent me the BoE’s new policy document.  On pages 23-26 they discuss the arguments for and against NGDP targeting.  But it’s clear from the discussion that they either don’t understand the arguments for NGDP targeting, or they intentionally chose to ignore them.  They talk as if changes in productivity growth would create problems for NGDP targeting, whereas of course that’s the whole point of NGDP targeting.  When you have productivity shocks an adherence to inflation targeting will create business cycles.  Yes, inflation rates will fluctuate with NGDP targeting, but that’s what you want to happen.  Stable inflation is bad.

Their other arguments are also wrong.  The claim that the public understands inflation targeting is almost laughable in the current British context.  Inflation has been running above target for years and the BoE is trying to raise it even higher with policies like QE.  How is that “understandable?”  When inflation in America was 1% and Bernanke announced that he was trying to raise inflation up to the target, the public was outraged.  Almost no one in the public understands inflation targeting.  “How can a higher cost of living be a good thing?”  If they said they’d like to see the aggregate incomes of the British people rise at a steady 4.5% a year, people would at least understand the objective.

The revisions issue is a red herring, as the central bank should target the forecast.

Very disappointing.


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45 Responses to “The BoE ignores the arguments for NGDP targeting”

  1. Gravatar of Ashok Rao Ashok Rao
    7. August 2013 at 06:42

    Carney had previously floated the AS argument against NGDP, which was very puzzling. Anticipated this, though hoped for better:

    http://ashokarao.com/2013/06/20/new-man-new-mandate/

  2. Gravatar of W. Peden W. Peden
    7. August 2013 at 06:45

    “The claim that the public understands inflation targeting is almost laughable in the current British context.”

    As a reasonably-informed member of the British public, I’m still trying to wrap my head around what the BoE’s inflation target is. Goodness knows what people who don’t read economics blogs are thinking…

  3. Gravatar of Arthur Arthur
    7. August 2013 at 06:57

    “(…) setting policy so that nominal GDP grew in line with its pre-crisis average rate could cause inflation to rise further above the 2% target.”

    “That could make it difficult for the general public to relate movements in nominal GDP growth to the MPC’s inflation target.”

    “(…) and that might be perceived by the public as the MPC becoming less determined to meet the inflation target.”

    “(…) inflation and, therefore, inflation expectations could rise materially and the credibility of the MPC’s medium-term commitment to the inflation target could be undermined.”

    “(…) expectations remained anchored to the inflation target, but that could risk undermining the use of nominal GDP as an intermediate indicator for policy.”

    Scott,

    Sorry, but the brits are right. NGDP growth or level targeting is a lousy way to hit your inflation target.

    The problem is not their analysis of the pros and cons of NGDP targeting, is that they want to keep an inflation targeting.

  4. Gravatar of Adam Adam
    7. August 2013 at 07:17

    Meanwhile, on Twitter, Adam Posen claims that NGDP is somehow harder to measure and less understood than the academic fiction that is “inflation”:

    @ryanavent Rightly so. NGDP is frequently revised, infrequently issued, unnecessarily complicated, too vague about inflation and work goals— Adam Posen (@AdamPosen) August 7, 2013

    @ryanavent Revealed complexity. You and a few clever blokes insist it is clear. But no one else in markets, public, or central banks agrees— Adam Posen (@AdamPosen) August 7, 2013

  5. Gravatar of ssumner ssumner
    7. August 2013 at 07:19

    Arthur, Yes, NGDP targeting is a lousy way to hit your inflation target. And getting on the plane bound for NYC is a lousy way to get to Australia. What else is new?

    NGDP targeting is a replacement for inflation targeting, I thought that was obvious.

    If they want to keep targeting inflation, why not just say so, instead of wasting three pages talking about “problems” with NGDP targeting.

  6. Gravatar of Sina Motamedi Sina Motamedi
    7. August 2013 at 07:26

    I agree with Arthur. The problem is that they are trying to keep the inflation target, with 0.5 percentage points above the 2% target a deal breaker — 0.5 pp is not flexible inflation rate targeting. I don’t think the market will buy it.

    When Carney and the Bank of Canada issued forward guidance in April 2009, they said they wouldn’t raise rates for more than year as long as inflation didn’t go crazy without giving a specific range. In their words, “conditional on the outlook for inflation.” That worked very well.

    I suspect Carney would rather use his old BoC wording. Who knows.

  7. Gravatar of James in London James in London
    7. August 2013 at 07:50

    W Peden
    The British public are seeing 7.8% LFS Unemployment as very close to 7%, and worrying anew about mortgage rates, so saving more, spending less. 180 degrees opposite to the desired outcome. Well done Mark!

  8. Gravatar of Mark A. Sadowski Mark A. Sadowski
    7. August 2013 at 08:00

    “The revisions issue is a red herring, as the central bank should target the forecast.”

    I completely agree, however even what they said about timeliness and revisions is *wrong*:

    “A nominal GDP growth indicator performs badly against the third criterion, data reliability. Nominal GDP data are not particularly timely – the first estimate for a given quarter is published two months after that quarter ends – and tends to be revised substantially, often well after the event.”

    It’s true that the ONS produces estimates of NGDP one month later than their estimates of RGDP but that’s purely a matter of choice as the RGDP estimates are *derived* from the NGDP estimates. Furthermore, high frequency (monthly) estimates of NGDP are available (at least in the US). They’re just not estimated by the government. It would be simple matter to have the ONS prepare their own estimates of monthly NGDP.

    Now with respect to revisions, there’s two main ways of measuring the size of the revisions of the components of national income and product accounts: 1) Mean Revision (MR) and 2) Mean Absolute Revision (MAR). For rate targeting MAR is the more appropriate measure, and in fact the MAR of inflation is usually smaller than the MAR of NGDP. However, for level targeting MR is more appropriate. And at least in the US (Page 27):

    “The MRs for the price indexes for GDP and its major components are generally not smaller than those for real GDP and current-dollar GDP and its major components.”

    http://www.bea.gov/scb/pdf/2011/07%20July/0711_revisions.pdf

  9. Gravatar of Mark A. Sadowski Mark A. Sadowski
    7. August 2013 at 08:03

    In fact over 1983-2009 the MR for the final revision to quarterly NGDP is 0.14 whereas over 1997-2009 the MR for the final revision to the GDP deflator and the PCEPI is 0.20 and 0.12 respectively. And over time the revisions have trended downward:

    http://www.bea.gov/scb/pdf/2008/02%20February/0208_reliable.pdf

    So I suspect that the MR for NGDP is actually smaller than PCEPI over 1997-2009.

    None of this should be surprising as inflation is a totally artificial construct requiring that we come up with an estimate of the extraordinary abstraction known as the “aggregate price level.” To see how preposterous this is imagine equating the aggregate price level between what it is now and what it was in say 14th century England. The goods and services are so different it requires the complete suspension of one’s disbelief.

    Inflation is the difference between NGDP and RGDP, meaning inflation is nothing more than the estimated residual between a nominal variable, which is relatively straight forward to measure, and a real variable, which is fundamentally an exercise in crude approximation.

  10. Gravatar of Arthur Arthur
    7. August 2013 at 08:36

    Scott,

    They did say so. They were looking into NGDP target as an intermediate target to hit their inflation target on the medium term while stimulating the economy on the short term.

    I thoght that NGDPLT was a substitute to inflation targeting was obvious too. I guess we always underestimate the ability of central bankers to impress us.

    “Section 5 sets out different options for linking guidance to intermediate thresholds, and concludes with the MPC’s decision.”

    “The MPC’s remit allows it to provide support to real activity in the short term provided that such actions remain consistent with inflation being at the target in the medium term.”

  11. Gravatar of Justin Irving Justin Irving
    7. August 2013 at 09:13

    One way to get around the revision issue is to make the NGDP-linked bonds or futures contracts payout with a 1 year delay (pay the going government bond rate to keep the holder happy). Then the market would go to work, trying to anticipate the coming NGDP revisions. We’d not only get a market forecast for NGDP, but also an implicit market forecast for NGDP revisions, at least after the CB had switched to targeting the next year’s NGDP contract.

  12. Gravatar of Midday Links | Across All Sports Midday Links | Across All Sports
    7. August 2013 at 09:32

    […] The BoE Ignores the Arguments for NGDP Targeting (Scott Sumner at his blog) , […]

  13. Gravatar of Saturos Saturos
    7. August 2013 at 10:05

    Some interesting comments on exiting QE: http://www.project-syndicate.org/online-commentary/the-looming-qe-exit-risks-by-pingfan-hong

  14. Gravatar of Philo Philo
    7. August 2013 at 10:07

    Bernanke seemed knowledgeable, but performed disappointingly in office. Carney is showing signs of fitting that pattern.

  15. Gravatar of marcus nunes marcus nunes
    7. August 2013 at 10:08

    Only thing I could think of after reading the NGDP section of the document:
    “God, please forgive them for they don´t know what the heck they are talking about”!
    Note that they discuss NGDP as an ‘indicator’ not a target. The target remains inflation.

  16. Gravatar of Bob Murphy Bob Murphy
    7. August 2013 at 10:21

    Good thing they didn’t pay Carney a billion dollars…

  17. Gravatar of Saturos Saturos
    7. August 2013 at 10:27

    Kudos to this kid for the Diablo III reference (II was a way better game though), however I fear that none of his professors will ever tell him that higher interest rates ceteris paribus *increase* inflationary pressure: http://www.res.org.uk/SpringboardWebApp/userfiles/res/file/Essay%20competition/2013%20winning%20essays/Tom-Rutter-802-1.pdf

  18. Gravatar of Ben Ben
    7. August 2013 at 10:55

    “If they said they’d like to see the aggregate incomes of the British people rise at a steady 4.5% a year, people would at least understand the objective.”

    The UK has had years of inflation and wages have been static at best. What makes you think wages will magically increase? What about people on fixed incomes? Our demographics are dire.

  19. Gravatar of Ben Ben
    7. August 2013 at 10:59

    Also what is 4.5% rise – nominal? If so then it’s just a tax on fixed income!! Surely state nominal vs real…

  20. Gravatar of Justin Irving Justin Irving
    7. August 2013 at 10:59

    @Ben,

    Unless you think NGDPLT would lower the labo(u)rshare, then more NGDP will mean more laborshare*NGDP.

    Also, dire demographics should help wages. Remember the Black Death?

  21. Gravatar of Britmouse Britmouse
    7. August 2013 at 12:15

    Tragically bad. What a mess. 🙁

  22. Gravatar of Coleton Stirman Coleton Stirman
    7. August 2013 at 14:05

    Philo

    Amen, what good is your paper trail if you come into office and buy into “the system” that’s opposed to your record.

    Come on Carney!!

  23. Gravatar of IR Reaction, Roundup | uneconomical IR Reaction, Roundup | uneconomical
    7. August 2013 at 14:59

    […] Sumner is very disappointed by the BoE’s justification for rejecting […]

  24. Gravatar of Geoff Geoff
    7. August 2013 at 16:50

    Speaking of disappointing…

    “Almost no one in the public understands inflation targeting. “How can a higher cost of living be a good thing?””

    Even after being corrected numerous times on your responses to the statement in quotes, there is still utter confusion surrounding its meaning.

    For the 29,037th time, the statement in quotes IS NOT INCORRECT, if you understand that it applies to those whose wage rates do not rise as fast as the price inflation. For these people, who number in the millions, they are perfectly justified in at least questioning the claim that higher price inflation is innocuous on standards of living, let alone (legitimately) arguing against it.

    Every time you advocate for higher price inflation, you are ipso facto advocating that millions of people across the country suffer a lower standard of living, just so that you can sit in your armchair watching some arbitrary statistic change in an arbitrary way.

    Real people suffer unjustifiably because of what you advocate, and for you to have the gall to insult their intelligence by accusing them of not understanding price inflation targeting, is the height of intellectual hubris.

    You ought to be ashamed of yourself.

  25. Gravatar of Michael Michael
    7. August 2013 at 17:16

    Geoff wrote:

    “For the 29,037th time, the statement in quotes IS NOT INCORRECT, if you understand that it applies to those whose wage rates do not rise as fast as the price inflation. For these people, who number in the millions, they are perfectly justified in at least questioning the claim that higher price inflation is innocuous on standards of living, let alone (legitimately) arguing against it.”

    In your world, though, these same people would still be seeing their real incomes fall, no?

  26. Gravatar of ssumner ssumner
    7. August 2013 at 17:28

    Mark, Great comments, as usual.

    Arthur, You said;

    “They did say so. They were looking into NGDP target as an intermediate target to hit their inflation target on the medium term while stimulating the economy on the short term.”

    It makes no sense to do NGDP targeting for a few months and then drop it. You go all in, or don’t do it at all. If you go all in, then you are no longer doing inflation targeting.

    Of course if you care about inflation in the very long run, you can gradually adjust the NGDP target as productivity changes. It’s pointless, but it might make central bankers feel better.

    Justin, If the revisions are forecastable than the government is even more incompetent that I thought. But yes, that would work too.

    Saturos. The real risk is macroeconomic, not financial. No one cares about 1994-style bond market “bloodbaths”.

    Philo, Both have to work with others. I’d guess that’s the main problem.

    Bob, Pay for performance. That’s the key.

    Ben, I said incomes, not wages. And yes, obviously I meant nominal.

  27. Gravatar of Don Geddis Don Geddis
    7. August 2013 at 17:35

    @Ben: you seem new here. You might want to try to understand the basic story of Sumner’s NGDPLT, before you try questioning some random sentence in one random blog post. (Look in the blog FAQ, read through one of Sumner’s papers, etc.)

    The 4.5% suggested increase is nominal. It will magically increase, because the central bank has absolute control over nominal variables. Fixed incomes aren’t actually “fixed”, but instead vary with overall GDP growth. If GDP growth increases, then so will the income from “fixed” investments. Hence it’s not a tax on fixed incomes.

    As to why a central bank policy target of 4.5% level-targeted annual aggregate wage increase, would improve overall economic growth … well, you’re going to have to do a little background reading first. Try the FAQ, or maybe the Re-Targeting the Fed paper.

  28. Gravatar of Ben Ben
    7. August 2013 at 18:06

    Justin – I think the black death victims didn’t need constant care over 10 to 20 years…

  29. Gravatar of Ben Ben
    7. August 2013 at 18:08

    Don – thanks for the links

  30. Gravatar of Jacob Jacob
    7. August 2013 at 20:20

    “Yes, inflation rates will fluctuate with NGDP targeting, but that’s what you want to happen. Stable inflation is bad.”

    WOAH, WHAT!?

  31. Gravatar of Jim Glass Jim Glass
    7. August 2013 at 21:19

    None of this should be surprising as inflation is a totally artificial construct requiring that we come up with an estimate of the extraordinary abstraction known as the “aggregate price level.”

    Let’s not fall into the fallacy of the excluded middle here. The fact that a measure isn’t perfect doesn’t mean it is a worthless artificial construct of an abstraction.

    E.g., in the USA over the last 50 years the correlation between changes in the CPI and the average hourly wage rate is 99+%.

    That’s a heck of a coincidence if the CPI measure of inflation is nothing but a totally artificial construct of an estimate of an extraordinary abstraction. Especially given that MMers think the wage rate is real and important enough.

    That doesn’t mean that as a central bank target the CPI doesn’t have all the faults that MMers ascribe to it. But let’s not fall into the trap of simply ridiculing measures and concepts that have real meaning and serious implications for many purposes, just because they cross our purpose of the moment — and of mocking those who cite those measures as naifs or worse. In my experience, it’s not a very effective method of persuading those who need to be persuaded. (Too Krugmanish.)

    BTW, this correlation also fully puts paid to the 29,037th and all additional claims that inflation impoverishes the masses because their wages fail to keep up with it. Not that I expect this mere bit of factual reality will stop that claim counter from ratcheting up higher and higher.

  32. Gravatar of Failing to plan is planning to fail. Plain planning to fail is worse. | Left Outside Failing to plan is planning to fail. Plain planning to fail is worse. | Left Outside
    7. August 2013 at 23:31

    […] at NGDP targeting, which I and many others favour, and decided it is a bad idea (largely it seems, because they don’t want to understand it). He’s had the option of targeting lower unemployment more rapidly, but […]

  33. Gravatar of George Selgin George Selgin
    8. August 2013 at 03:14

    I’m reasonably certain that Charles Bean is esponsible for the study’s discussion of NGDP targeting. He offered similar criticisms earlier this year at a speech at the IEA that was later published by the BIS: http://www.bis.org/review/r130228c.pdf

  34. Gravatar of W. Peden W. Peden
    8. August 2013 at 03:55

    Simon Ward has an interesting argument that the UK’s unusual recent labour productivity performance means that the BoE just committed to raising rates SOONER than previously thought-

    http://moneymovesmarkets.com/journal/2013/8/7/uk-guidance-rate-commitment-hinges-on-questionable-productiv.html

  35. Gravatar of ssumner ssumner
    8. August 2013 at 04:15

    Jim Glass, Good point. But I do have posts that very carefully explain what’s wrong with inflation.

    Thanks George.

    W. Peden, That’s what occurred to me as well.

  36. Gravatar of James in London James in London
    8. August 2013 at 04:45

    Fortunately Charles Bean, the Deputy Governor for Monetary Stability, has wishes to retire. He only stayed on because Mervyn King was moving on too. Perhaps the real appointment we have to watch out for is Bean’s replacement, which should be announced fairly soon.

  37. Gravatar of Jim Glass Jim Glass
    8. August 2013 at 08:35

    “Yes, inflation rates will fluctuate with NGDP targeting, but that’s what you want to happen. Stable inflation is bad.”

    WOAH, WHAT!?

    Stable NGDP growth rate or stable inflation, pick one.

    You’ve concluded the other is bad (at least relatively).

  38. Gravatar of Links for 08-08-2013 | Symposium Magazine Links for 08-08-2013 | Symposium Magazine
    8. August 2013 at 11:03

    […] The BoE ignores the arguments for NGDP targeting – TheMoneyIllusion […]

  39. Gravatar of ThomasH ThomasH
    8. August 2013 at 14:41

    I think a dual mandate makes sense. Too bad the Fed does not try to carry it out. Most Fed announcements seem to reflect their difficulty in forecasting what they will do rather than announcing policy contingent on specifiable events.

  40. Gravatar of Geoff Geoff
    8. August 2013 at 16:36

    Michael:

    “In your world, though, these same people would still be seeing their real incomes fall, no?”

    You mean in the real world.

    Yes, there are millions of people whose real incomes fall when price inflation goes up. These are the people who, like I said, earn a wage that does not keep up with inflation.

    Please don’t expect me to believe that every wage earner in the country gets a 2% annualized raise every month. Not only would it contradict the whole darn “wage stickiness” crutch that so many of you rely on, but it is also ludicrous just considering it.

  41. Gravatar of Michael Michael
    8. August 2013 at 17:26

    Geoff wrote:

    “You mean in the real world.”

    No, I mean in your ideal world, where there is no central bank and no inflation.

    “Yes, there are millions of people whose real incomes fall when price inflation goes up. These are the people who, like I said, earn a wage that does not keep up with inflation.

    Please don’t expect me to believe that every wage earner in the country gets a 2% annualized raise every month. Not only would it contradict the whole darn “wage stickiness” crutch that so many of you rely on, but it is also ludicrous just considering it.”

    I agree that very few if any get a 2% annualized raise every month, and that inflation without a nominal raise leads to lower real wages.

    Let’s say John Doe gets a job at a nominal salary of $50,000. These is 2% inflation, and Mr. Doe doesn’t get a raise. That means his real wage falls as the price level declines. If this goes on for 2 years, then Doe’s pay has been cut by ~4% in real terms.

    Does that mean that if inflation had been 0% instead of 2%, John Doe would have had a higher real wage after 2 years? No – unless you think there are nominal wage rigidities that make it difficult for employers to cut the nominal salary of their employees.

  42. Gravatar of Michael Michael
    8. August 2013 at 18:05

    Edit: That means his real wage falls as the price level increases.

  43. Gravatar of ssumner ssumner
    9. August 2013 at 05:56

    James, That’s good.

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    10. August 2013 at 21:11

    […] Sumner, “The BoE ignores the arguments for NGDP targeting”  The Money Illusion, […]

  45. Gravatar of Geoff Geoff
    17. August 2013 at 05:25

    Michael:

    “You mean in the real world.”

    “No, I mean in your ideal world, where there is no central bank and no inflation.”

    But what I said applies to (human) worlds with central banks, Michael.

    “I agree that very few if any get a 2% annualized raise every month, and that inflation without a nominal raise leads to lower real wages.”

    Can you remind me again whether you are in “my” world or not?

    “Let’s say John Doe gets a job at a nominal salary of $50,000. These is 2% inflation, and Mr. Doe doesn’t get a raise. That means his real wage falls as the price level declines. If this goes on for 2 years, then Doe’s pay has been cut by ~4% in real terms.”

    “Does that mean that if inflation had been 0% instead of 2%, John Doe would have had a higher real wage after 2 years? No – unless you think there are nominal wage rigidities that make it difficult for employers to cut the nominal salary of their employees.”

    But you just presumed his wage remains at $50,000 for two years.

    If you’re going to compare 2% price inflation with 0% price inflation, and you don’t want to hold wages constant between the two, then you must be connecting price inflation to wages in some respect. But price inflation can fall to 0% as productivity increases, with no downward pressure on nominal wages.

    But this is besides the main point I am making. GIVEN we have 2% price inflation, and GIVEN that very few wage earners receive 2% annualized salary increases every month, then like you agree, real wages for those individuals falls. They fall BECAUSE of the inflation.

    Remind yourself of this every time Sumner (and other “do what I say but not as I do” inflationists) rabbles for higher inflation from the coercive monopolists.

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