Pen pals

Stephen Kirchner sent me an excellent article from The Telegraph, discussing monetary policy in Britain. It linked to some recent letters, which are triggered whenever the BoE misses it’s inflation target by a wide margin:

Mark Carney


The Bank of England

Threadneedle Street



Dear Chancellor:

In November I wrote a fourth letter to you when CPI inflation remained more than one percentage point below the 2% target. Three months later, as expected, that is still the case: . . .

There’s much more. And here’s Osborne’s reply:

The Rt Hon George Osborne

Chancellor of the Exchequer

HM Treasury 1

Horse Guards Road



Dear Mark,

CPI Inflation

Thank you for your letter of 4 February on behalf of the Monetary Policy Committee (MPC) regarding December’s CPI inflation figure, written under the terms of the MPC remit. As expected at the time of your previous open letter in November 2015, inflation has remained around zero in the past few months, triggering a fifth open letter for inflation falling more than 1 percentage point below target. . . .

The Government’s commitment to the current regime of flexible inflation targeting, with an operational target of 2% CPI inflation, remains absolute. The target is symmetric: deviations below the target are treated the same way as deviations above the target. Symmetric targets help to ensure that inflation expectations remain anchored and that monetary policy can play its role fully. . . .

The MPC have revised down their forecast for real GDP growth and CPI inflation in the short term, implying weaker nominal growth. This, combined with threats from the international environment, mean we face the risk of a weaker outlook for nominal GDP. If realised this could present challenges for tax receipts in the future, and reinforces the importance of delivering our plan to achieve a surplus on the public finances by the end of the Parliament.  (emphasis added)

The article that linked to these letters is by Allister Heath, and it’s well worth reading. Here are a few highlights:

At the start of the year, investors expected the first interest rate hike to take place this October; the financial turmoil had pushed this back to March 2018 by the end of this week, helping to explain the pound’s weakness. After Thursday’s inflation report, the markets now expect the first rate hike to take place in August 2018. It’s an astonishingly quick shift – the fastest and greatest since the height of the eurozone crisis – which few have fully digested yet. . . .

The first sentence in the Inflation Report repeats, like a tired and utterly implausible mantra, that “the Bank of England’s Monetary Policy Committee sets monetary policy to meet the 2pc inflation target and in a way that helps to sustain growth and employment”. Who in the City and the financial markets really thinks that this is what this is about anymore? It may be that the MPC actually still believes it is doing this. It is certainly going through all the motions, producing all of the usual fan charts, even though their predictive ability has turned out to be embarrassingly limited. . . .

So here are a few suggestions. First, the Governor and MPC members should cease to give any sort of guidance about the path of interest rates. So far, all such interventions have merely injected noise into the system and made markets less, rather than more, efficient at processing information. Second, if the Chancellor wants the Bank to target a growth rate for nominal GDP then he should say so. He should scrap the intellectually bankrupt CPI target and replace it by a nominal GDP growth rate. Third, the Bank should be more open about the extreme difficulty of deciphering the economy. There would be no shame in admitting, for once, that nobody really understands what is going on.

At some point economic policymakers will admit the obvious—it’s all about NGDP. Inflation targeting was a mistake. It’s really just a matter of time.

PS.  Nobody does street addresses better than the British.  And I’m going to Britain this weekend.

Update.  Marcus Nunes directed me to an excellent James Alexander post, which discusses the sharp fall in British NGDP growth (down to 1%.)




20 Responses to “Pen pals”

  1. Gravatar of Alexander Hamilton Alexander Hamilton
    4. February 2016 at 20:54

    Great reply from George Osborne. He must have some good advisers in the treasury. If he starts to see slow nominal growth as harming the Conservatives chances of re-election then we could see him putting more pressure on the Bank of England to do it’s job.

  2. Gravatar of Benjamin Cole Benjamin Cole
    4. February 2016 at 22:02

    Ha! Threadneedle Street and Horse Guards Lane! Who would not like to see Old London town?

    I’m delighted to see more discussions of NGDP targeting. I would also like to see more discussion that it is better to err on the high side rather than the low, when targeting nominal economic output.

    Central banks being what they are, is very possible that they could adopt NGDPLT, and just set the target so low that it still asphyxiates the real economy. Or miss the target, and “wait ’till nex year.”

    Remember, these are central bankers, not real estate developers, manufacturers, tourism industry fellows, or labor representatives.

  3. Gravatar of Lorenzo from Oz Lorenzo from Oz
    4. February 2016 at 22:59

    The British invented the modern postal system, just like the US invented the internet. So British stamps used to be the ones that did not specify a country, just like US web addresses do not specify a country.

    The novelist Anthony Trollope played a significant role in the adoption of the pillar box, which was a major step forward in practical social freedom.

  4. Gravatar of Postkey Postkey
    5. February 2016 at 02:35

    “Great reply from George Osborne.”?

    “Ultimately, the credibility of our economic policy and our resilience to global risks rests on the strength of our public finances. In November the Government set out plans to deliver further consolidation measures at the Autumn Statement, following a rigorous Spending
    Review process.”

  5. Gravatar of Alexander Hamilton Alexander Hamilton
    5. February 2016 at 02:56

    @postkey So? Reads to me like he wants the Bank of England to keep nominal growth on track while the government continues to normalise the government budget as they promised the voters they would do.

  6. Gravatar of marcus nunes marcus nunes
    5. February 2016 at 03:41

    James Alexander got it right!

  7. Gravatar of W. Peden W. Peden
    5. February 2016 at 03:53

    Good stuff. I particularly like the connection between public finance and stable NGDP growth.

    By the way, Scott, have you read this paper by Fama? I find some of the stuff he says towards the end about interest rates in late 2008 particularly intriguing-

  8. Gravatar of Jose Romeu Robazzi Jose Romeu Robazzi
    5. February 2016 at 04:54

    @ W. Peden
    Read the portion of Fama’s paper you refer to. It seems his analysis confirms money was tight in the second half of 2008, don’t you think ? The interesting thing is that he seems to believe that market views show up in the short term rates as well as in the long rates …

  9. Gravatar of Dustin Dustin
    5. February 2016 at 05:56

    I really thought this was a bit of satire until I followed the links through to Anyway, if policy ever tilts so far as as targeting growth of NGDP, you certainly deserve credit for relentlessly spamming the message.

  10. Gravatar of Dustin Dustin
    5. February 2016 at 05:59

    Postkey, can you be more specific as to which part of Osborne’s statement you have a problem with? The importance of fiscal strength, or the goal of further fiscal consolidation?

  11. Gravatar of Dan W. Dan W.
    5. February 2016 at 06:04

    “it’s all about NGDP”

    So what is the plan to make it all about NGDP, how do you implement it and how do you maintain stability and control in that plan?

    Let me ask this question differently. Imagine Europe and the US with 5% NGDP growth. What do the financial indicators look like? What is the inflation rate? What are mortgage rates? What is the yield on long-term government debt? What percentage of government spending goes to debt payments?

    Now ask yourself this question: How do these economies get from where they are now to this imaginary place in the future? There would be considerable financial disruption along the way, would there not? You simply don’t have borrowing rates increase by several hundred basis points and expect smooth sailing, do you? And if you did reach the 5% target you would then need to taper this program of monetary expansion, without creating more economic and financial calamity. Easy to do on a chalkboard.

    In the US, the last recovery to higher interest rates failed (ie the transition in 2006-2008). The NGDP caucus is adamant the central bank goofed. Clearly they did. But you have not proved your plan would have done better! You have a theory and that’s all. Now go and do the work to show how an NGDP policy would actually respond to the disruptions caused by higher borrowing costs and the economic destruction that will result.

  12. Gravatar of ssumner ssumner
    5. February 2016 at 06:38

    Lorenzo, Interesting.

    Marcus, Thanks, I added an update.

    W. Peden, Thanks, I’ll take a look.

    Dan, Of course all your questions have been discussed here many times. Go back to February 2009 and start reading. And stop typing.

  13. Gravatar of Majromax Majromax
    5. February 2016 at 07:07

    > At some point economic policymakers will admit the obvious—it’s all about NGDP. Inflation targeting was a mistake. It’s really just a matter of time.

    I disagree here.

    Although I think NGDP targeting is a very interesting idea, the real “mistake” is the time derivative. A target of the “NGDP growth rate” would be just as prone to asymmetric-in-effect policy as is the current target of the “price level growth rate.”

  14. Gravatar of ChrisA ChrisA
    5. February 2016 at 07:23

    I just read the article and popped straight over here to post a link…

    In other news just off the plane from China, all the businesses I met there still seem pretty bullish, no sign to me of any slowdown.

  15. Gravatar of James Alexander James Alexander
    5. February 2016 at 07:34

    Thanks Scott.

    Good for you to prep up on our local debates before you come over.

    Wondered what you made of my comparison of 2011 ECB rate rises with current Fed rate rise(s)?

  16. Gravatar of W. Peden W. Peden
    5. February 2016 at 09:20

    Jose Romeu Robazzi,

    Yes, and I would add that if he’s right and the downward movements in short term rates were market-driven in late 2008, then that is very damning for the Fed.

  17. Gravatar of ssumner ssumner
    5. February 2016 at 10:36

    Majromax, Fair enough, but most NGDP proponents favor level targeting, and even without level targeting it would have prevented the recent Fed rate increase.

    China, Yes, but keep in mind that while 5% or 6% seems like a boom to us, it’s relatively slow to China. Also, I’d imagine you talked to more people in services, telecom, software, etc, rather than steel, coal etc.

    Nonetheless, thanks for that report, I’ve been predicting that China will avoid a recession.

    James, Good analogy, but I am reluctant to predict recessions, I think they are almost unforecastable.

  18. Gravatar of Britonomist Britonomist
    5. February 2016 at 10:48

    What brings you here this weekend, if I may ask?

  19. Gravatar of Ray Lopez Ray Lopez
    5. February 2016 at 20:12

    Sumner’s blog post: “The truth is the Fed has never dared fight the markets.” – and it’s only a small step from this to the premise that money is largely neutral. If the Fed follows the market, the Fed understands it has very little power (money = neutral).

  20. Gravatar of ssumner ssumner
    10. February 2016 at 19:53

    Warwick Economics Summit.

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