Finally, a voice of reason

The recent debate over stimulus in the UK has to count as one of the most bizarre spectacles of modern macroeconomics.  Here’s a recent comment by Matt Yglesias:

Bad central banking puts political authorities in a very tough place. There’s an interplay between fiscal and monetary issues. The goal of stabilization policy is to stabilize the path of overall nominal spending in the economy. Fiscal policymakers can’t really push nominal spending above the path that the central bank wants it to be on. So if King says “looser fiscal policy will force me to tighten monetary policy” then you’re in a tough pickle. Some folks, à la Scott Sumner, believe that the inverse of this is also true, that monetary targets are not only necessary but sufficient. It seems to me that King, Clegg, and Cameron were all counting on this being true. Most conventional New Keynesians””including Shadow Chancellor Ed Balls, Ben Bernanke, Paul Krugman, etc.””have had their doubts about this theory and actual events in the UK seem to be reenforcing this conventional wisdom. When the goal is to increase the volume of nominal spending in the economy you don’t want the largest spender (to wit, the government) reducing spending and raising taxes.

Usually Matt is the voice of reason, but not this time.  The claim here is that a more robust fiscal stimulus would result in higher nominal spending, and ipso facto, higher inflation.  This is the “conventional wisdom” that Yglesias contrasts with my unconventional take.  If Matt is right, you’d expect outrage in the UK regarding the policy of the Bank of England, more specifically, widespread criticism of its failure to push inflation up to its inflation targets (they are formally required to target inflation.)  OK, that’s the conventional wisdom; now let’s see what is going on in the real world.  Here’s the real voice of reason, Simon Nixon:

There was something surreal about today’s Bank of England press conference to discuss its latest Inflation Report. The BOE says quite clearly in its executive summary – and Governor Mervyn King repeated it continually – that “the chances of inflation being above or below the 2% inflation target in the medium term are broadly equal”. But there was nothing broadly equal about the line of questioning from the assembled journalists: unless I blinked at the wrong moment, I don’t remember a single question about the risks to the downside. Instead, the Governor was subjected to a sustained and faintly hysterical assault, with almost all the questions a variant on the accusation that the BOE had either deliberately or incompetently lost control of inflation. Under the circumstances, I thought Mr. King handled it rather well.

As Mr. King repeatedly said, the arguments over the medium-term implications of today’s high inflation numbers are evenly balanced and something on which it is possible for reasonable people to disagree. Unless one really believes that a committee of nine independent-minded economists have collectively agreed for reasons known only to themselves to ignore the mandate given them by a democratically elected government and concoct bogus arguments to cover up their mendacity, then it seems only fair to consider the BOE’s dilemma from both sides. As I see it, the risk of a tough year for the U.K. economy, with all that implies for inflation, is every bit as worthy of attention as the risk that everything goes swimmingly. Indeed, many of those attacking the BOE today for not doing more to cool the economy are those who normally fill their days attacking the government for leading the country to almost certain ruin. Odd.

Yes, very odd, and it’s nice to finally have someone in the press notice what is going on.  Unless every single reporter in the UK works for Fox News, I think it’s fair to say that the general perception is that inflation is too high, not too low, as the Krugman/Yglesias view would suggest.  That doesn’t sound like a failure of demand stimulus, it sounds like the UK has a pretty big supply-side problem.

Now in their defense, the Keynesians do have a good counterargument.  Maybe the 4% inflation figure is a fluke, there’s VAT and import prices mixed in.  Maybe the UK does need more demand stimulus.  I’m sympathetic, but it greatly undercuts their critique of King, for two reasons:

1. It that case isn’t it equally likely that the minus 0.5% Q4 RGDP number was also a fluke?  (I believe Japan and the Eurozone had similar numbers.)  If I’m not mistaken, that’s the number the Keynesians are using to pronounce Cameronomics a failure.  And unless I am mistaken hardly any of the Cameron budget cuts had taken effect by Q4.  And unless I’m mistaken the Cameron government was elected in May, and Q4 starts in October.  And unless I’m mistaken the prominent Keynesian Mark Thoma recent scolded me for making the preposterous argument that QE rumors in September might have affected the US economy in January—lags are much longer than that.  So are long monetary lags the official Keynesian view, or not?  If so, King’s “offset” policy hasn’t yet had time to work.

2.  I actually agree with Krugman and Yglesias that the UK could use a bit more stimulus.  I don’t buy the recent inflation number.  But my views aren’t what matters.  All the articles that I have read suggest that King is trying as hard as he can to maintain monetary stimulus, despite the unpopularity of 4% inflation.  Suppose the Keynesian fiscalists had they way, and Cameron did a lot more fiscal stimulus.  And rising NGDP started pushing inflation above 4%, maybe toward 5%.  Does anyone believe King could allow that to happen?

I think Yglesias is making the following error:

1.  King is trying hard to implement Sumnernomics in the UK.

2.  The UK economy sure looks messed up.

3.  Ergo Sumnernomics has failed.

BTW, I suppose the term ‘Sumnernomics’ sounds egotistical, but Yglesias did mention my name.

Now can we please talk about how negative IOR is doing in Sweden, by far the fastest recovering Western European country?

🙂

Britmouse sent me two great articles from the WSJ, the one cited above, and this one on the BOE’s real target:

These unemployment levels would have been unacceptable and therefore the bank was right to pursue the policy it did, runs King’s argument.

This seems to offer an insight into what may effectively be the new target the bank, unofficially, tracks: nominal GDP. That’s to say, GDP with inflation factored back in.

King explicitly denies that the monetary policy committee is tracking nominal GDP. But he can’t do otherwise. The MPC has an explicit and quite clearly stated central target of 2% consumer price inflation, plus or minus one percentage point.

A look at the bank’s latest median projections for U.K. CPI and real GDP, on which it bases its policy-making decisions, shows that bulges in inflation projections over a period of a year have tended to accompany declines in real GDP growth, and vice-versa, hinting at a nominal GDP target of around 5% or slightly higher.

Some academic economists are strongly supportive of nominal GDP targeting “” allowing inflation to run too hot at a time when real GDP is growing too slowly and then tightening after the rate of nominal growth exceeds a certain level, once previous shortfalls in nominal growth have been made up.

For now, the market seems content to ignore the BOE’s consistent and one-sided mistakes.

Or maybe they aren’t mistakes; maybe the markets understand Sumnernomics better than the media.

PS.  I hope Britmouse won’t mind me quoting from the email he sent me:

Merv King was forced to deny he targets NGDP in the Bank’s inflation conference today, then spent the rest of the time arguing that low rates are necessary for growth and we should ignore inflation.  He is becoming a hate figure in the left-wing (“inflation: bad for workers”) and right-wing press (“inflation: bad for savers”), so he must be doing something right.

Paul Krugman better stay out of Britain, or else he might be surrounded by an angry mob of left-wing union workers that opposes his high inflation policies.  Come to think of it, I’d better stay out to.

Update:  Marcus Nunes has a post showing that much of the recent inflation increase in Britain is the VAT increase.


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48 Responses to “Finally, a voice of reason”

  1. Gravatar of Mark A. Sadowski Mark A. Sadowski
    19. February 2011 at 12:52

    Scott,
    You wrote:
    “Now can we please talk about how negative IOR is doing in Sweden, by far the fastest recovering Western European country?”

    That greatly depends on what you mean by “Western European country”. Poland is “Western” by the Roman/Byzantine standard. And Poland is the only country in all of Europe that didn’t even have a recession throughout this preposterous and totally unnecessary debacle. Why? Because Poland hit the pedal to the metal with the printing presses and depreciated its currency more than any other EU member.

    I’ll probably have more to say (vent) later when I’ve digested your latest post more fully.

  2. Gravatar of Alexander Hudson Alexander Hudson
    19. February 2011 at 12:58

    You’ve convinced me that monetary policy can offset the effect on nominal spending of fiscal consolidation, but what about the breakdown between real growth and inflation? Shouldn’t we think of the UK’s rapid austerity measures as a sort of macroeconomic recalculation? Perhaps one that makes the country better off in the long-run, but in the short-run shouldn’t we expect that laying off government workers, raising taxes, and cutting benefits would lead to stagflation while the economy sorts itself out? If so, then I think there’s a strong argument to be made for consolidating the budget more gradually.

  3. Gravatar of ssumner ssumner
    19. February 2011 at 13:29

    Mark, It’s west of Belarus, I’ll give you that.

    Alexander, In principle you are right. But I recall reading that only a tiny number of government workers had been fired so far. Not enough to cause a significant recalculation problem. I’d guess the UK workforce is close to 30,000,000.

    I would be opposed to firing large numbers of government
    workers in the midst of high unemployment. If they work through attrition, they avoid the recalculation problem.

  4. Gravatar of marcus nunes marcus nunes
    19. February 2011 at 13:37

    Scott
    The “hysteria” over inflation in the UK is a joke. It would be hard to distinguish between the US and UK:
    http://thefaintofheart.wordpress.com/2011/02/17/what%c2%b4s-going-on-on-the-inflation-front/

  5. Gravatar of Mark A. Sadowski Mark A. Sadowski
    19. February 2011 at 13:48

    Scott wrote:
    “Mark, It’s west of Belarus, I’ll give you that.”

    What are you saying? Being Slavic and Western are incompatible? Just because I have full kissable lips and bedroom eyes doesn’t mean I can’t be counted as Western European! Put up your dukes (just kidding of course).

  6. Gravatar of Doc Merlin Doc Merlin
    19. February 2011 at 13:57

    “Now can we please talk about how negative IOR is doing in Sweden, by far the fastest recovering Western European country?”

    positive IOR was the worst idea ever.

  7. Gravatar of Doc Merlin Doc Merlin
    19. February 2011 at 13:58

    And no, Iceland is the fastest recovering, not Sweden.

  8. Gravatar of Mark A. Sadowski Mark A. Sadowski
    19. February 2011 at 14:02

    Doc,
    Poland didn’t even need to recover. (From what?) Iceland (and Sweden) were left in the dust.

  9. Gravatar of Shane Shane
    19. February 2011 at 14:12

    I don’t think Yglesias is primarily saying “that a more robust fiscal stimulus would result in higher nominal spending, and ipso facto, higher inflation.” He is simply noting that Fiscal stimulus, unlike monetary stimulus, is guaranteed to produce a level of RGDP growth. If fiscal had been added, then according to Sumnerism, this would cause the BOE to reign in NGDP growth to balance it out. But that would be fine in this particular case, even desirable, as it would replace empty NGDP growth with a kind guaranteed to produce RGDP growth.

    Yglesias is simply claiming a victory for the conventional wisdom that monetary and fiscal policy should work together for best results. This, to me, seems to look pretty right after the British experience.

  10. Gravatar of Shane Shane
    19. February 2011 at 14:22

    Actually, I think the case is even stronger in favor of New Keynesianism. In this instance, the Sumnerist argument that the central bank will counteract becomes _an argument for fiscal stimulus over monetary stimulus._

    1. By tightening, they are counteracting empty NGDP growth (i.e., inflation) that is not serving a useful function.

    2. Because NGDP and inflation are essentially interchangeable in this case, an inflation-target works every bit as well as an NGDP target.

  11. Gravatar of Scott Sumner Scott Sumner
    19. February 2011 at 14:24

    Marcus, Thanks, I added an update.

    Doc Merlin, I don’t think Iceland is growing faster, based on the last data I saw.

    Shane, You said;

    But that would be fine in this particular case, even desirable, as it would replace empty NGDP growth with a kind guaranteed to produce RGDP growth.

    I hope that’s not what Yglesias meant, because it would be wrong. Both fiscal and monetary stimulus raise NGDP. Whether the increase in NGDP produces more RGDP depends on whether the SRAS is flat or steep. It makes no difference whether it comes from money or fiscal policy (in the Keynesian model), and if you don’t buy the Keynesian model, monetary stimulus is likely to be better for the supply-side of the economy.

    BTW, It’s not just you who thinks this way, it’s obvious that 90% of the people in the press feel the same way you do. I have never seen a Keynesian model that produces the concept of “empty NGDP growth” in a deep slump, but maybe there is one I don’t know about.

    In academia only right wing anti-government types make the argument that you just made, is that the group you with which you wish to associate with?

  12. Gravatar of Scott Sumner Scott Sumner
    19. February 2011 at 14:26

    Shane, Regarding your second point, there is nothing at all “new Keynesian” in the argument that you just made.

  13. Gravatar of Shane Shane
    19. February 2011 at 14:31

    I have to be honest and say that I really don’t understand the response (not because it was unclear; it just really tests the limits of my paltry economic knowledge.) I’ll think more about your rebuttal. Obviously, I’m again out of my league (especially if I’m now fraternizing with the Austrians!) 🙂

  14. Gravatar of Mark A. Sadowski Mark A. Sadowski
    19. February 2011 at 14:35

    I think the effect of the VAT increase in the UK coupled with the energy price increase has implications for the Eurozone.

    The ECB needs to start considering a new target. Broad inflation is not an accurate measure of inflation inertia, especially in countries with a VAT.

    An NGDP level target would be better still, but then I’m one of the converted.

  15. Gravatar of flow5 flow5
    19. February 2011 at 15:01

    MONTHLY MONEY STOCK MEASURES (WSJ)
    Daily Average, in billions % CHANGE

    Seasonally adj ann rates

    …………………….3-mth……6-mth…….12-mth
    M1 SA………………..15.6…….14.2……..10.3

    SMOKIN!

    Real money is defined as the rate-of-change in the growth of the money stock, vs. the rate-of-change in the growth of inflation. The GAP is growing. Money flows are growing. NGDP is growing. But what do we do now if NGDP is currently growing too fast. NGDP’s 1st qtr isn’t reported until a month after the qtr ends. That might be after some damage is already done.

  16. Gravatar of Jon Jon
    19. February 2011 at 15:15

    Alexander writes:

    You’ve convinced me that monetary policy can offset the effect on nominal spending of fiscal consolidation, but what about the breakdown between real growth and inflation? Shouldn’t we think of the UK’s rapid austerity measures as a sort of macroeconomic recalculation?

    Not necessarily. Based on my look into the British austerity measures, its not clear it was ever appropriate to count those people as contributing to real-output. So one possible viewpoint is that those layoffs don’t contribute to a decline in real-output.

    In some sense this is exactly the problem. GB is a supply side disaster; one which the prior labor government spent 10+ years constructing. It frankly seems that the government isn’t going far enough in disbanding the quangos. They seem to be under the mistaken view that those committees, rather than be eliminated, should be folded into other departments.

    This is why Scott says that layoffs have not been numerous, and he is right.

  17. Gravatar of Morgan Warstler Morgan Warstler
    19. February 2011 at 15:43

    Sumner needs to sell a t-shirt with this on it:

    “positive IOR was the worst idea ever”

  18. Gravatar of Mark A. Sadowski Mark A. Sadowski
    19. February 2011 at 15:51

    Morgan,
    I’d buy it and then I’d be stuck explaining what it means when I wear it across my fat belly (a large billboard space) which means that more people know what it means. In retrospect, other than my extraordinariy inconvenience, it’s brilliant!

  19. Gravatar of Mark A. Sadowski Mark A. Sadowski
    19. February 2011 at 16:03

    Just to be clear, I’m not Jabba the Hutt. There just happens to be more a whole lot more of of me than I wish for. But in the meantime, I do make an excellent billboard.

  20. Gravatar of StatsGuy StatsGuy
    19. February 2011 at 16:40

    @ Morgan:

    “Sumner needs to sell a t-shirt with this on it:

    “positive IOR was the worst idea ever””

    Morgan, you surprise me. Where is your cynicism? Close your eyes, and imagine for a second that the people who implemented IOR are not actually stupid – they simply care about different things than you or me. You might end up imagining a world where Fed policy makers think like this:

    http://www.newyorkfed.org/markets/ior_faq.html

    In such a world, the Fed cares about NGDP and AD, just not as much as it cares about making sure large banks are solvent when key asset prices (housing) decline. Figuring they have other mechanisms to inflate asset prices, the Fed sets positive IOR to transfer capital to banks in a way that is deliberately opaque and thus less subject to public criticism, and simultaneously doubles down on other policy instruments.

    Under my new approach to understanding the Fed, “revealed policy theory”, the actions the Fed takes actually reveal its preferences. Imagine that! They actually mean what they do. (The alternative is the Fed is stupid, and remained stupid for 2 years even as cranky economists and foreign policymakers observed that positive IOR might not be an ideal mechanism to jump start AD.)

    As time goes by, the argument that the Fed is stupid and doesn’t understand what positive IOR does holds less water. If you accept Occam’s Razor, it increasingly looks like the Fed is simply complicit in the corruption of the financial system, not unbelievably moronic.

  21. Gravatar of Mark A. Sadowski Mark A. Sadowski
    19. February 2011 at 17:01

    Statsguy,
    You don’t need to sell me on realism. The Fed tanked the economy and failed to save it because the big banks were its major concerns. (Duh!)

    And the election of 2010 was too soon to save the economy strictly from a political point of view. (Duh!)

    Which leaves us whenever. Whenever they decide to let their grip off of our cateroid artery. (Yes, please master, can I have some more soon?)

  22. Gravatar of Shane Shane
    19. February 2011 at 17:11

    Prof. Sumner,

    I think I was confused because the Yglesias post is unclear as to which way it is going. At first he is arguing that the economy just needs higher nominal spending. But then he shifts to arguing that monetary policy alone is not sufficient to create growth. So his point changes implicitly from the BOE is not allowing enough AD to a version of a structural argument (perhaps the right-wing vein you detected): the goods and services no longer being purchased by the government have no market in the private sector. Hence, stimulating private sector demand is pointless for replacing this lost growth.

    Thus, a structural mismatch develops: these are Kenyes’s proverbial useless workers being paid to dig holes and fill them up again. This second argument is a political wild card: it is left wing in that it proffers a version of Keynes–the private sector can’t or won’t spend, no matter how much monetary policy stimulus takes place, so the government needs to step in–and right wing in that it implicitly suggests that there are too many useless workers and extra monetary stimulus will simply feed inflation.

    This is the same kind of cognitive dissonance I feel listening to Michael Hudson and even Stiglitz occasionally.

  23. Gravatar of Richard W Richard W
    19. February 2011 at 18:04

    A couple of points that might not be clear to people:

    There are no huge layoffs of public sector workers. The tax side is doing most of the heavy lifting to balance the government cyclical total managed expenditure budget until 2012. After 2012 there are real terms cuts. Only 40,000 public sector workers are forecast to lose their jobs in a workforce of 30 million before 2012. A rounding error. The vast majority of the forecast 400,000 reduction in public sector workers over the next five years is through natural wastage of not filling vacancies when workers retire or leave.

    Any union leader I ever see on TV is fully supportive of the BoE stance. Zero of them want the Bank to raise the bank rate.

    Mr King is fair game for criticism because he put himself in play. For the past three and a half years he has allowed his role to be politicised. He is a public servant of an independent central bank. If he wants to make public comments about fiscal policy he is stepping outside his remit and the politicians and press will attack him. No politician of any party should be able to say that the governor of the Bank of England supports the policies of the government. That is a horrible compromise of the independence of the central bank. Moreover, he is just one of a committee of nine and does not speak for them all.

    The British press do not care about the economics of the issue. If their readers are complaining about inflation they will go hunting for someone to blame. Ideally it would be someone in the EU, Mr King put himself in play so he will do as a hate figure.

    The 4Q is an outlier and it is only an estimate that is almost certain to be revised upwards. The economy is growing but not robustly. A 2.2% RGDP for this year would be my prediction.

    CPI is almost certain to reach almost 5% before starting to decline in the 2H. I think the Bank position that CPI will broadly be on target in two years is credible. Although, there is also a credible argument that money supply growth figures indicate that monetary policy is too loose.

    Many in the markets last June believed that there was an implicit pact between the chancellor and the governor. The government would follow a tight fiscal policy and the Bank would maintain a loose monetary policy to offset. Whether the Bank can keep their side of the pact or be bounced into raising the bank rate is now doubtful. The markets are forecasting three quarter point hikes this year.

    I think the government over the five year period are going too far and too fast in deficit reduction. There was absolutely no pressure from the markets to eliminate the deficit in five years. All the markets wanted was a credible plan and commitment for deficit reduction. There are some indications that the government are getting over their deficit phobia and understanding that what matters is growth. We need a massive investment of capital expenditure on infrastructure and it has never been cheaper for the government to do it. Not for any multiplier reasons but because it needs done.

  24. Gravatar of Lorenzo from Oz Lorenzo from Oz
    19. February 2011 at 18:05

    Shane: this post from Scott might be helpful. I have posted my attempted summary for novices here.

    Mark: There just happens to be more a whole lot more of me than I wish for. Another triumph of revealed preference over expressed preference.

  25. Gravatar of Mark A. Sadowski Mark A. Sadowski
    19. February 2011 at 18:43

    Lorenzo,
    Of course my preferences may differ from others. I considered extremely myself “hot” up until about 10 years ago. But I totally let myself go. Amazingly many girls go for my more “zaftig” appearance these days. There’s no accounting for tastes, and you got to love it.

  26. Gravatar of Doc Merlin Doc Merlin
    19. February 2011 at 19:27

    “Doc Merlin, I don’t think Iceland is growing faster, based on the last data I saw.”

    Seems you are correct, I misremembered, real growth rate was smaller in Iceland than Sweden. What would have been accurate to say was that Iceland was growing faster relative to the size of the crash in its banking sector. Sweden’s banks were compared to iceland, untouched.

  27. Gravatar of Doc Merlin Doc Merlin
    19. February 2011 at 19:29

    @StatsGuy
    “As time goes by, the argument that the Fed is stupid and doesn’t understand what positive IOR does holds less water. If you accept Occam’s Razor, it increasingly looks like the Fed is simply complicit in the corruption of the financial system, not unbelievably moronic.”

    I believe it was Bryan Caplan (or Arnold Kling, I forget which) who said as much at the beginning of the crisis… but he hangs out with Austrians at George Mason, so you can expect him to be a bit skeptical of the Fed.

  28. Gravatar of Morgan Warstler Morgan Warstler
    19. February 2011 at 19:43

    @Stats

    You are preaching to the choir. Though Sumner still fights it…

    So then, granted it is true, there is an obvious political strategy to change it:

    1. Empower and favor SMB profits in the tax code over all other forms of corporations.

    2. Dismantle PE Unions – so that Dems lose the bulk of their political donations and must rely far more on Banksters. This allows the GOP to run without their $.

    1 & 2 create the positive circumstances for taking down the bankers first model, it forces Banksters into the clear title as rent seeker, and puts Local Wealth, States Rights, and general Libertarianism into the ascendancy.

  29. Gravatar of Mark A. Sadowski Mark A. Sadowski
    19. February 2011 at 19:52

    Ahh, the Morgan wakes up.

  30. Gravatar of StatsGuy StatsGuy
    19. February 2011 at 20:25

    … comment hit a filter – short version, yes, Mark & Doc – you were right about Bernanke et. al., I can no longer argue it’s indeterminate whether he was captured or merely mistaken.

    Morgan – check back when the sequestered comment plays a jail break card.

  31. Gravatar of Mark A. Sadowski Mark A. Sadowski
    19. February 2011 at 21:00

    While we’re all waiting for statsguy’s substantive response I’d thought that I’d provide some mindless entertainment:

    http://www.youtube.com/watch?v=ZclddLcOYYA

  32. Gravatar of Morgan Warstler Morgan Warstler
    19. February 2011 at 22:03

    Stats, near as I can figure – three links in a post is the magic bounce.

  33. Gravatar of Mark A. Sadowski Mark A. Sadowski
    19. February 2011 at 22:25

    Oops. Maybe tomorrow? I’ll be up for good bout of fistycuffs (after my coffee).

  34. Gravatar of W. Peden W. Peden
    20. February 2011 at 02:00

    Prof. Sumner,

    I think you said it best when you pointed out how people in Britain (and generally) are assuming that monetary policy affects inflation, while fiscal policy affects output. The logical origins of this idea are interesting: is it a consequence of the fact that monetary authorities have generally targeted prices (including exchange rates) while governments have traditionally tried to take the credit for gains in output? Or is it because people have an idea of the transmission mechanism of fiscal policy-to-output (they understand that government demand creates supply) and an idea of the transmission mechanism of monetary policy-to-inflation (most people have an Alan Walters-style monetarist intuition about inflation being caused by the amount of notes & coin) but not the reverse?

    At any rate, the prevalence of this concept has made it very easy for me to stump my (almost entirely left-wing) friends on economic policy recentely. Even Adam Boulton had Ed Balls flubbering about in an interview, simply by hinting at the inconsistency between Ed Balls’s views on fiscal policy and his views on inflation.

    Macroeconomics is in such a mess.

  35. Gravatar of Bogdan Bogdan
    20. February 2011 at 05:31

    I’m almost convinced 🙂

  36. Gravatar of marcus nunes marcus nunes
    20. February 2011 at 07:25

    Scott. Very ingenious:
    http://milehighecon.blogspot.com/2011/01/krugman.html

  37. Gravatar of David Pearson David Pearson
    20. February 2011 at 07:52

    Scott,

    A change in relative prices that leads to higher inflation is evidence of accommodation by the central bank. You are probably arguing that this accommodation is warranted because the effect on inflation is likely temporary. That depends on whether the VAT-induced spike affects expectations and behavior. Perhaps the media is focusing on the spike because their viewers/readers are concerned about higher prices. If that is the case, then changing inflation expectations might be having an impact on behavior. Is this reflected in UK Gilts? I’m not sure it matters. Let me give you an example:

    The Fed believes that the commodity price spike, like the UK VAT spike, is transitory. What do firms believe? The Philly Fed Future Prices Paid component reflects the general input price inflation expectations of manufacturing firms. The number is the highest since 1998, and, since the 70’s, it has never been near this level without an already-restrictive Fed.* So firms are forming expectations of higher inflation. The question is, if you were a purchasing manager at one of these firms, what would you do about it? Well, you might consider avoiding some of the price increase by immediately purchasing more inputs and holding them in inventory. After all, the cost of financing that inventory is the lowest its been in memory — this is the Fed’s invitation to forward-purchase goods. Would Scott Sumner the Purchasing Manager pull forward purchases? If he would, what would be the impact on input prices and future input price expectations if most purchasing managers decided to do the same (remember, they are already near record levels)? If he wouldn’t, why not?

    *It was almost this high in the summer of 2008, but you argue the Fed was restrictive then as well. Since you now believe the Fed is accommodative, shouldn’t this index component continue to rise?

  38. Gravatar of Scott Sumner Scott Sumner
    20. February 2011 at 08:00

    Shane, Read my entire blog, starting at February 2009, and it will all be clear. Seriously, you aren’t the only one who is confused, indeed right now I’m in the small minority in making this argument.

    Mark, I agree.

    Flow5, M1 just isn’t a reliable indicator of monetary policy.

    Jon, I agree.

    Statsguy, Sorry, but when the banking system is already flat on it’s back (in mid-2008) letting NGDP fall at the sharpest rate since 1938 doesn’t make it easier for people to repay nominal loans. The resulting defaults cause huge losses to banks. The Fed did not do banks any favors. IOR is a relatively small item on the bottom line. The macro consequences were far worse.

    Shane, It would be highly amusing if Yglesias wandered off into recalculation. But I doubt he has.

    Richard, More and more countries are having the private sector build infrastructure. Has Britain considered that option?

    Also, see my new post, where Ed Balls suggests that higher inflation doesn’t boost growth. I think most voters would interpret that as Balls claiming the BOE is too easy.

    Thanks for the info on the tiny public sector jobs cuts.

    W. Peden, Thanks, send me the Balls quote if you can find it, in the meantime check out my new post.

    Marcus, Very creative!

  39. Gravatar of Scott Sumner Scott Sumner
    20. February 2011 at 08:09

    David, You said;

    “The Fed believes that the commodity price spike, like the UK VAT spike, is transitory. What do firms believe? The Philly Fed Future Prices Paid component reflects the general input price inflation expectations of manufacturing firms. The number is the highest since 1998, and, since the 70’s, it has never been near this level without an already-restrictive Fed.* So firms are forming expectations of higher inflation.”

    Whoa, not so fast. I agree that commodity input prices are rising fast, but output inflation expectations are still low.

    Of course to me this is all a moot point, as inflation doesn’t matter, NGDP growth expectations drive wages.

    You asked;

    “The question is, if you were a purchasing manager at one of these firms, what would you do about it? Well, you might consider avoiding some of the price increase by immediately purchasing more inputs and holding them in inventory. After all, the cost of financing that inventory is the lowest its been in memory “” this is the Fed’s invitation to forward-purchase goods. Would Scott Sumner the Purchasing Manager pull forward purchases? If he would, what would be the impact on input prices and future input price expectations if most purchasing managers decided to do the same (remember, they are already near record levels)? If he wouldn’t, why not?”

    No, because commodity prices follow a random walk. And it looks like they agree with me, as in 2010:Q4 final sales grew way faster than GDP. That doesn’t suggest inventory buildup.

    You said;

    “Since you now believe the Fed is accommodative, shouldn’t this index component continue to rise?”

    Again, it’s a random walk. And I don’t consider policy accommodative in any absolute sense, just more so than last summer.

  40. Gravatar of David Pearson David Pearson
    20. February 2011 at 09:23

    Scott,

    This is not about commodity prices. The Future Prices Paid component of the Philly Fed measures overall input price expectations — including industrial materials (such as chemicals) and manufactured industrial parts/components. I erred above, as the index has not been at these levels since 1988, not 1998. In 23 years, expectations for future input price increases have not been this high. Its been over 30 years since they have been this high without a already-restrictive Fed. Keep in mind that a big contributor to these expectations is price negotiations that are going on now. Many of these products have contract pricing and longish lead times, so Managers know in advance how they will increase six months from now. This hardly describes a “random walk”.

    Purchasing Managers believe that commodities, materials and parts prices will be higher six months from now, and this belief is as intense as it has been in 22 years; so what would Scott Sumner the Purchasing Manager do?

  41. Gravatar of ssumner ssumner
    20. February 2011 at 11:46

    David, If you are right, they should buy and add to inventories. In a way I hope you are right, as panic buying might jumpstart the economy and get us out of the “zero rate trap.” (Of course we aren’t really trapped, but it would clarify things if everyone knew that.

    Any thoughts on why final sales were so much stronger than GDP in the 4th quarter? Your hypothesis suggests the opposite.

  42. Gravatar of David Pearson David Pearson
    20. February 2011 at 13:35

    Scott,

    Your raise a good question – the 4q10 inventory drawdown was the opposite of forward buying. Its possible inflationary psychology had not taken hold yet, and perhaps firms chose to draw down inventories in response to suppliers’ initial attempts to raise prices. While plausible, this is admittedly a thin-reed of a theory.

    4q10 RGDP was quirky: the deflator was artificially depressed since most inflation came from imports in the quarter. I expect to change significantly in the quarters to come, as the oil price increase is passed through to domestic prices (which is what these ISM’s are telling us to expect).

  43. Gravatar of Doc Merlin Doc Merlin
    20. February 2011 at 17:36

    @Scott:
    “David, If you are right, they should buy and add to inventories. In a way I hope you are right, as panic buying might jumpstart the economy and get us out of the “zero rate trap.” (Of course we aren’t really trapped, but it would clarify things if everyone knew that.”

    Thats absurd.
    In the short run, buying inventory above the profit maximizing rate would just raise prices for everyone else and cause the anyone who is liquidity or cash constrained to suffer. Don’t sign on to the absurdity that is keynesianism.

  44. Gravatar of Scott Sumner Scott Sumner
    21. February 2011 at 17:32

    David, In that case I’d expect faster NGDP growth in Q1 and Q2. Let’s hope so,

    Doc Merlin, Keynesians are riht about the demand deficiency problem.

  45. Gravatar of nyd nyd
    24. February 2011 at 14:42

    @Scott: “unless I am mistaken hardly any of the Cameron budget cuts had taken effect by Q4”

    But they were announced previously, so expectations would have done the work — I thought that was your theory. E.g. the VAT hike was known well in advance of it’s implementation and therefore consumers would have adjusted their behaviour accordingly.

    re Yglesias: “you don’t want the largest spender (to wit, the government)”

    has mr yglesias bothered to look at the breakdown of GDP in the UK? or is that too much to ask?

  46. Gravatar of ssumner ssumner
    24. February 2011 at 18:44

    nyd, You said;

    “But they were announced previously, so expectations would have done the work “” I thought that was your theory.”

    Yes, and I’m happy to admit to the Keynesians that the budget cut announcements may have hurt GDP in Q4, just as soon as they retract all the nonsense that people like Krugman wrote in 2009 about fiscal stimulus not having any effect until the money was actually spent. So if they are fine with apologizing for all the smears against Republicans who claimed Obama’s stimulus wasn’t working in 2009, then I’ll happily accept that interpretation. I’m just saying it’s bizarre for them to claim the problem was fiscal austerity–that’s not their model. I don’t think it was the austerity, but for completely different reasons.

    Maybe Yglesias meant the largest single spender.

  47. Gravatar of Doc Merlin Doc Merlin
    24. February 2011 at 19:43

    “Doc Merlin, Keynesians are riht about the demand deficiency problem.”

    Nonsense, Scott.
    Demand isn’t an ‘amount’ it is a thing that provides direction for supply via the price mechanism. The very idea of ‘insufficient demand’ makes no sense whatsoever. Demand is what determines what gets produced and how we should allocate production. ‘Stimulating’ demand only distorts the actual demand curves of the economy, and then distorts prices leading to a distorted supply curve, it doesn’t make anything better.

    Note: I don’t consider a neutral rules based system like NGDP targeting ‘stimulus’

  48. Gravatar of Scott Sumner Scott Sumner
    26. February 2011 at 11:25

    Doc Merlin, When prices are sticky there can be a deficiency of NGDP. If you don’t want to call it demand, then fine. Indeed I agree that demand is a bad term.

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