UK NGDP bleg
In the next few days I will write a short paper on NGDP targeting in the UK. I’d be very interested in knowing why inflation remains fairly high. It looks to me like RGDP growth was about 2.35% from 2000:2 to 2008:2, and NGDP growth was about 5.15%, meaning inflation was about 2.7%. Since 2008, NGDP has been rising about 0.2%, and RGDP has fallen at about 2.2%, implying about 2.4% inflation. That’s not much of a slowdown in inflation.
Perhaps more of the UK recession is real and less is nominal than in the US. I know that London is a big international banking center. Has the financial crisis hurt the UK more than the US? I’d be curious as to whether the fall in UK RGDP is more concentrated in finance than in the US. I notice jobs have fallen much less than in the US, but that’s true most places in Europe.
Update: I forgot to mention, I’d also be interested in knowing 2, 5, or 10 year TIPS spreads in the UK.
On another topic, my critics often say that central bankers are wedded to inflation targeting; you can’t expect them to suddenly switch over to NGDP targeting. I thought of those criticisms when I read this interesting article from the Financial Times, sent to me by Ashwin:
Very subtly, Bank insiders, including members of the monetary policy committee, are beginning to complain that the criticism is overblown and the Bank should not be in the line of fire for specific price rises about which it can do little. Would it be better to bring down inflation quickly with a large immediate tightening of monetary policy and ignore the consequence on jobs and growth, some insiders ask in rhetorical asides. Others are open that the Bank is really targeting nominal gross domestic product growth of about 5 per cent a year regardless that this is not consistent with the Bank’s strict 2 per cent inflation target objective.
Secret Sumnerians? Have you noticed that every day the world seems to get a bit more “quasi-monetarist” (to use Krugman’s term for our small band of NGDP proponents.) And this article also fits with another theme I’ve been emphasizing, the illogical discussion of monetary and fiscal stimulus. There is currently a fierce debate in the UK over the coalition government’s plans for fiscal austerity. Many argue it will lead to high unemployment. But if that’s the case, then the criticism of the BOE for being too easy is borderline schizophrenic. People can’t have it both ways. If the UK has an AD problem, then, ipso facto, high inflation is not a problem. Indeed it needs to be even higher. (Draw an AS/AD diagram if you don’t believe me. QED.) If they don’t have an AD problem, then there are no valid grounds for criticizing Cameron’s fiscal austerity. So which is it? And for those Brits who do worry about inflation, why aren’t you demanding even greater fiscal austerity? Why blame the BOE?
And while I’m pathetically trying to claim credit for powerful trends in the world economy, why stop now. Here’s something Liberal Roman put in the comment section of the previous post:
I am still amazed that after the events of the past few months (which vindicated Scott in my eyes once and for all and made me a tidy investment profit) that no one and I mean NO ONE!!! is making the connection between QE and the improved economic performance the past few months.
Be they right or left, the pundits still throw out the SAME lines when it comes to monetary policy (Pushing on a string, banks not lending despite Fed printing, etc., etc., etc.).
I blame Krugman and DeLong almost as much as I do the right wingers. They are STILL apathetic towards monetary policy. Still, pining for fiscal stimulus. UNREAL!
Of course I’m far too modest to take credit for enriching my commenters, but not too modest to quote others. Seriously, there is one flaw in Roman’s argument; I claim to have no forecasting ability, because I believe in the EMH. But let’s entertain an alternative hypothesis. Suppose I am right about monetary policy and wrong about the EMH. A few months back when bloggers were listing what they had been wrong about, I mentioned the effect of QE1 on the bond markets. I would have expected the announcement to raise long term bond yields (due to the income and inflation effects) as often occurs with unexpected monetary stimulus. But yields fell sharply on the announcement. I also pointed out that yields then turned right around and rose strongly as the economy seemed to recovery a bit in mid-2009. As if markets started reading my blog.
This time around the yields fell on rumors of QE2, as it was widely anticipated by the time it was adopted. And what has happened since? Exactly the same as QE1, yields started rising rapidly almost immediately after the formal announcement, as inflation and real growth expectations rose. I presume this is where Roman made his money.
I’m guessing that my teaching income is tiny by the standards of investment banking. Surely there must be an investment bank or bond fund out there who would love to have my insights on monetary policy before they go into my blog. I don’t mind enriching my readers, but I also have to think about my family. (BTW, when businessmen use the line about “taking care of their family,” they are about as sincere as when politicians say they want to “spend more time with their family.”)
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13. January 2011 at 08:56
There is currently a fierce debate in the UK over the coalition government’s plans for fiscal austerity. Many argue it will lead to high unemployment. But if that’s the case, then the criticism of the BOE for being too easy is borderline schizophrenic. People can’t have it both ways. If the UK has an AD problem, then, ipso facto, high inflation is not a problem. Indeed it needs to be even higher. (Draw an AS/AD diagram if you don’t believe me. QED.)
Yeah, good point, it’s impossible to have high inflation *and* stagnation. I mean, what would you even call that? “Stagflation”? lol
13. January 2011 at 08:57
Silas, Have you considered studying logic?
13. January 2011 at 09:05
We few, we happy few. We band of buggered. (just another Buffy quote)
13. January 2011 at 09:21
My guess is that the fall in sterling vs the euro, coupled with a UK trade deficit, helps explain the more-persistent inflation here (in the UK).
13. January 2011 at 09:33
Interesting FT article–thanks to Ashwin for bringing it to Scott’s attention. After reading it I couldn’t resist looking at the UK NGDP data. Here is what I found.
13. January 2011 at 09:48
Surely ‘secret’ NGDP targeting is ineffective. It has to be communicated to work.
13. January 2011 at 10:07
Is logic the field where they teach you that any economic stagnation can be solved by tricking people into buying crap they don’t want in order to goose a historically-informative measure? If so, I have not studied it nor considered doing so.
13. January 2011 at 10:26
UK is California. Part of the *real* effect is due to flight by skilled native Britons and the significant increase in relatively unskilled immigrants. Plus entry into the laborforce of 2nd gen immigrants. Maybe the numbers aren’t big enough to explain everything but it seems to me that if the UK becomes 1% less Britain, and 1% more Pakistan\Somalia\wherever that the AS curve might just adjust a bit.
The Economist has had a few stories on the Brain Drain part anyway, cant seem to find the article I want http://www.economist.com/blogs/freeexchange/2008/02/british_brain_drain
Anyway I didn’t want to sound nasty and point out that if you take out some of the most skilled, and replace them with the unskilled that the economic aggregates wont do well (at least in the medium run but in the long run too depending on the causes of the skill difference), but I guess I did it again. Please don’t call me an evil racist. I am sure there are countless skilled and wonderful immigrants and decedents of immigrants in the UK. I am not saying anything normative about immigration police, just the consequences.
13. January 2011 at 11:30
at JP Irving
I don’t have time to dig up the research, but African and Asian immigrants catch up to their native counterparts in the UK fairly rapidly. Although Caribean blacks do less well than whites, all the other major groups (Pakistanis, Indians, Chinese, Bangladeshis, Africans) do just as well as native born white britons of in the case of Indians and Chinese substantially better. After taking social class into account, the second generation immigrant advantage is huge. The UK has a lot of trouble culturally integrating minorities, but economically immigrants do just fine.
13. January 2011 at 12:11
Uhm, I think if you read Simon Ward (right next to Sumner in my RSS reader), you’d be expecting inflation and not been surprised when it arrived:
http://www.moneymovesmarkets.com/journal/2011/1/12/should-king-say-sorry.html
And second, did Scott Sumner just indicate there could be a “real recession”?!?
Here I thought such antiquated things were impossible if only we targeted NGDP.
—-
Seriously Scott, you need to start warning your liberal readers that sooner than later you are going to be screaming, “screw the unemployed! we have to take away the punch bowl!”
You don’t want to shock them.
13. January 2011 at 12:23
If I were an investment bank, I’d hire you. As for now, I have to settle for reading your blog at the same time as the rest of the public.
Perhaps you should try to impress some investment banks by having a segment where you say: “If I didn’t believe in the EMH, here’s what I might predict…”
Which reminds me, if you didn’t believe in the EMH, what might you predict? My sense — and I am a trader who puts his money where his mouth is — is that just as the Fed has historically risen or lowered rates in a trend over time — that the Fed will now continue to loosen policy over the next couple years. They may not call it QE3 or anything like that, but whatever they do I expect the trend to continue and the market to follow.
Also, I wish you’d smack down Tyler Cowen a bit on his Zero MP theory.
Whatever the case, great blog.
13. January 2011 at 12:30
Maybe this Adam Posen speech will be of interest.
http://www.bankofengland.co.uk/publications/speeches/2010/speech467.pdf
On a related point, John Ross here claims that U.S. trend growth is slowing to 2% per annum. If that is the case where does that leave targeting 5% NGDP?
http://ablog.typepad.com/keytrendsinglobalisation/2011/01/slowing_of_the_us_economy.html
http://blogs.ft.com/gavyndavies/2011/01/12/is-us-financial-optimism-misplaced/
13. January 2011 at 12:33
JPIrving: on the student test scores evidence, the UK is better at picking migrants than the US. (And us Australians are world-beaters at cherry-picking migrants: more of our relentless pragmatism I guess.) The Anglosphere generally does better with its migrants than Europe: being an English-speaking country may have an attraction factor.
There is a second-generation male migrant problem in Europe in that non-European male migrants appear, on the employment evidence to be “de-assimilating”, but less so in the UK than France or Germany.
13. January 2011 at 12:43
Morgan, please.
Scott doesn’t have to ‘warn’ his liberal readers because you do such a fine job of it already.
And remember, “level targeting”.
13. January 2011 at 12:54
@gnikivar
I guess I will doubt my view a little more. Still I want to see some data. Here in Sweden, or in Germany where I have seen the data it is incontrovertible that immigrants on the whole do less well than the median. There is of course huge skill heterogeneity in this group. But maybe it is different in the UK, I an skeptical though.
13. January 2011 at 13:32
David – nice work on the NGDP graph.
Scott – as David’s graph shows, you can’t take credit for this one, unless the BoE staff have been following you for a very long time! 🙂
And your point on the fiscal policy criticism is spot on. Given the empirical evidence or the theory (small open economy), it is ridiculous to say that the BoE cannot generate inflation. I’m not saying that the fiscal belt tightening is a good thing but you can’t criticise it with a New Keynesian model.
On what ails the UK, I’m not sure anyone has a good answer. Best guess – finance slowdown exacerbated by Dutch Disease from finance driving up costs, uncompetitive banking sector reluctant to lend to small biz.
13. January 2011 at 14:59
Hmmm, count me in as a commenter who thinks you’re right about monetary policy and wrong about EMH. I guess my issue with EMH is that economists quote it like they’re quoting Newton’s second law, but really it’s an exercise in circular logic. Even the weak form assumes that there is nothing to gain from looking at previous prices, because anything to gain from previous prices is already priced in by the market. But if everybody believed in EMH, who would trade on these patterns to begin with to make sure they go away?
In reality, there are traders who make outsize gains which far outpace mere coin-flipping (Buffett, Soros, Drunkenmiller, Tudor, Klarman, many, many more who have only earned mere millions, but nevertheless have consistently beat the market). That said, stock trading is typically a fool’s game unless you are very, very special in some way to beat everybody else and see what others don’t see. Most traders are eaten up by transaction costs and Wall Street, like the customers, get the yachts.
Now, on monetary policy, I agree with NGDP targeting but it may have an issue with less flexible European markets. Let’s put it this way, no amount of NGDP targeting would have allowed Soviet Russia to attain western-level standards of living. Most of the extra money would go into inflation and less would go to RGDP growth.
Europe is suffering a lesser form of the same disease. Even if they target NGDP, they will suffer from inflexible labor markets, higher unionization, higher taxes, more regulation, more people on the dole, etc. What NGDP will do is make sure that these pernicious effects on the real standard of living aren’t compounded by the effects of possible deflation. Even if Greece severely overpays for government workers and nobody does any real work, businesses who actually do real work won’t be affected by sticky wages. Once deflation happens, though, even those few people who do real work will suffer more unemployment and Greece’s trouble will be compounded.
13. January 2011 at 15:01
Ugh, I meant to say “Wall Street, unlike the customers, get the yachts.”
13. January 2011 at 15:22
Hi Scott,
A couple of quick thoughts.
1. The UK is a small open economy. The BoE blames high commodity prices for missing its target. A Straussian reading of this would be that this is just for public consumption and that in reality that they are intentionally missing their target.
2. Related to (1) the value of sterling plummeted after 2008 so imports became more expensive.
4. I don’t buy the idea that the UK recession has been more real or more structural than the US recession. Finance has not declined that much. The banks are now doing very nicely now out of QE.
5. Other difference between the US and UK: the UK housing market has not declined nearly as much as the US one due to supply constraints.
13. January 2011 at 16:55
malavel, Not so few anymore.
Nick, It’s not the inflation per se, it’s the inflation combined with slow growth that interests me.
David, Thanks, that graph looks a lot like the US.
W le B, It works better if public.
Silas, I was discussing an AD shortfall and you responded with a comment about AS.
JPIrving, Those are long term trends, I’m trying to figure out the recent business cycle.
Morgan, I think most of my readers have studied the AS/AD model, well except for a certain unnamed reader who commented above.
Thanks Dirk, I’ll just say what I think, and let readers draw whatever investment implications they see.
Richard, The Posen speech was interesting, but I kept thinking how he could make his points much more effectively by talking about NGDP. (I know, his mandate forces him to discuss inflation.)
If RGDP trend growth falls to 2%, which is certainly possible, it has no effect on optimal NGDP growth. That’s because all the costs and benefits usually attributed to inflation are actually associated with NGDP growth.
Ashwin, You said;
“Scott – as David’s graph shows, you can’t take credit for this one, unless the BoE staff have been following you for a very long time!”
But there’s a problem here. My critics say the Fed would never go for NGDP targeting. And yet you could produce the exact same graph for the US.
I agree with your other points. One reason the UK looks more like a real shock is that the pound depreciated sharply in 2008, while the dollar appreciated sharply. Thus the UK better fits the standard financial crisis model–which often is partially a real crisis.
Matt, You said;
“In reality, there are traders who make outsize gains which far outpace mere coin-flipping (Buffett, Soros, Drunkenmiller, Tudor, Klarman, many, many more who have only earned mere millions, but nevertheless have consistently beat the market).”
Wrong. Only a few traders have made billions from investments, exactly what the coin flip model would predict. I once did a post showing Buffett’s success might well be luck–20 heads in a row, 20 years of above average returns in a row. People say the odds of 20 heads in a row are one in a million, but Buffett’s returns are also the best of a million active traders.
Nobody is claiming NGDP targeting solves real (structural) problems.
Mark, But output has fallen far more in the UK than the US. So if it’s not housing and fiance, where has the huge fall in GDP occurred? You would not expect manufacturing, as the pound has depreciated. What about services? There must be data.
Everyone, My first bleg in two years, and no TIPS spreads, no data on where output is falling in the UK?
13. January 2011 at 17:04
Scott,
This is OT, but I thought it might interest you. You have argued in the past that the October/November 2008 drop in stocks occurred with little news, and that it was due to Fed policy and not the financial crisis. But the markets were rife with rumors at that time, and as always discount not just present news but likely events. Anyway, for the sake of perspective, here’s a glimpse of what was rumored by traders at the time (and it went way beyond Citi), and which we now know to have been true:
“Citigroup, the nation’s third-largest bank by assets, was on the verge of being closed by regulators the week of Nov. 24, 2008 as depositors rapidly withdrew money and the bank’s counterparties declined to provide it credit, according to a government report released Thursday…
“We were on the verge of having to close this institution because it can’t meet its liquidity Monday morning,” said Sheila Bair, chairman of the Federal Deposit Insurance Corporation, during a meeting the previous Sunday night, according to the report by the Special Inspector General for the Troubled Asset Relief Program.”
http://www.huffingtonpost.com/2011/01/13/citigroup-was-on-the-verg_n_808721.html
13. January 2011 at 18:10
A graph of 10 year inflation expectations in the UK:
http://www.moneymovesmarkets.com/storage/graphs/uk-implied-200410.gif?__SQUARESPACE_CACHEVERSION=1271763090547
As to why the UK is having inflation problems…
http://worthwhile.typepad.com/worthwhile_canadian_initi/2011/01/us-productivity-exceptionalism.html#more
Employment in the UK has fallen only about 1% while GDP has fallen by 4%. Compare that to the US, where employment is down 5% and GDP only 1% (the UK is actually the polar opposite of the US even among the Euro countries included – least %employment lost per %GDP). I won’t try to explain why that is, but it seems pretty clear the UK has much less excess capacity than the US. Inflation hawks are probably going to point to the UK to claim QE2 will create inflation in the US, but they are really in a very different situation.
13. January 2011 at 20:56
Well, I will look for the post. Buffett hasn’t had 20 years of success though, he has had 40, maybe more. There is the argument that bargains were easier, much easier, to find in the 50’s, 60’s and 70’s when he started out, but even from 1980 he has roughly been successful 30 years, a 2^30 chance of getting heads every time or one on a billion. As he pointed out, too, a number of other disciples of Benjamin Graham have been successful over many years, a success rate with astronomical odds.
By the way, I’m speaking as somebody who used to believe in EMH but the evidence was too strong to the contrary that it doesn’t exist in its typically pure form. Economists would be better off with not being so dogmatic about it, saying instead that market imperfections exist and it is possible to capitalize on them, but it is very, very, very difficult. Dogmatic allegiance to ideas like EMH will just serve to undermine ideas which do make sense, like NGDP targeting.
13. January 2011 at 21:21
By the way, looking at your EMH arguments, it seems like they’re may be confusion about what EMH means and what it implies. EMH, to me, has always meant that prices reflect all publicly available information and price securities appropriately. Many bubbles, though, simply refute that this is true. There was absolutely zero chance that Internet stocks were accurately valuated in terms of future free cash flow. Zero. Also, subprime-backed CDOs, not a stock but nevertheless a traded security, were priced at a level that could simply not reflect the future cash flows from the subprime borrower, unless housing prices went up forever. There are a number of examples where security prices simply could not have reflected reality, under even the rosiest or most dire circumstances.
It also looks like you cite mutual funds a lot to back up EMH, which is unfortunate. I have read the paper that some mutual funds had alpha in the 70’s and zero had alpha had 80’s and I agree with that. But it’s also no coincidence that just about nobody I mention with beating the market are mutual fund managers. Mutual fund managers start out with a lot of hindrances. Most cannot hold cash and have to be fully invested and only long stocks. Also, most have investors who tolerate losses when the market is losing, but will not tolerate mediocre or no gains while the market is overvalued. A money managers’ career is pretty much over if he wants to leave money on the sidelines during, say, 1999, and even the least overvalued stock in 1999 was likely to lose money because it is, after all, overvalued.
Now, I do agree that Buffett others help make EMH “true,” or at least closer to reality. Since Graham wrote security analysis, the trend has been towards better, smarter investing, albeit with some big outliers. In the 50’s, one could find stocks with market cap smaller than current assets minus all liabilities, a silly price in just about any circumstanstance. Those bargains have mostly gone away since 1980 and it’s harder to be an investor to consistently get good returns.
13. January 2011 at 22:59
Matt W: EMH, to me, has always meant that prices reflect [1] all publicly available information and price securities [2] appropriately. Many bubbles, though, simply refute that this is true. There was absolutely zero chance that Internet stocks were [3] accurately valuated in terms of future free cash flow. My response would be that (2) should read “accordingly” and that (1) and (2) do not imply (3).
There may well be “friction” in the transfer of information to prices, but once people in the market start acting on specific information, prices will reflect that. The corollary to this is that there is no systematically better way than reasonably open markets to price assets. Quite so. But the notion that the efficient market hypothesis (at least in its weak form) precludes asset prices bubbles is surely a misreading of what EMH implies. (It says nothing about the quality of the information, for example.) General expectations of capital gains are part of the information feeding into the market. It is all very well to say that prices have diverged from the value of expected income from said asset but that says nothing about how long they will continue to do so, or how far they will diverge. And while they do so diverge, the expectations of capital gains will continue to be realised.
For there is no guarantee that capital gain will be limited merely by expectations about future income. If there is a general expectation that an asset will show capital gain over time, its value can become largely determined by that expectation. It is all very well to say that its value should be determined by its expected income, but capital gains based on expectation of capital gains are very real: people can borrow against it, they can realise it by selling the asset. The capital gain is real – until it is not.
No doubt EMH gets misused, but a genuinely weak form of it is surely eminently defensible.
14. January 2011 at 00:40
In Bank of englandhttp://www.bankofengland.co.uk/Statistics/yieldcurve/index.htm
nominal and real yields curve
14. January 2011 at 00:41
http://www.bankofengland.co.uk/Statistics/yieldcurve/index.htm
14. January 2011 at 01:03
UK 5y inflation breakeven: 2.747%
UK 10y inflation breakeven: 3.182%
2y doesn’t seem to be available.
Source: Bloomberg
14. January 2011 at 01:29
Scott,
The UK cpi inflation with constant indirect tax rates, ignoring the rise in VAT for example, shows inflation of 1.6% YoY.
That is from bloomberg, UKHPCTXY Index.
You can get data from the ONS here:
http://www.statistics.gov.uk/statbase/tsdtables1.asp?vlnk=mm23
14. January 2011 at 04:20
I don’t think you can take i/l gilt (UK tips) yields at face value. Because of regulation there is massive demand for long-dated real bonds from corporate pension funds (which are much bigger in the UK) and this has shifted the market significantly. The goverment has effectively forced pension funds to invest a large part of their assets in this class and this has depressed yields for a long time. Plus there used to be a tax arbitrage between real and nominal bonds which depressed yield in the short term (as the inflation appreciation was tax free and the bonds reset on an 8-months lag making them tax-free t-bills close to expiry). It’s even more complicated now with VAT going up and down all the time (it has changed 3 times in 3 years).
14. January 2011 at 09:10
The Guardian have a datablog which has GDP information on the UK here
http://www.guardian.co.uk/news/datablog/2009/nov/25/gdp-uk-1948-growth-economy
I think they have NGDP which they refer to as “GDP not been adjusted for inflation”, I don’t know if I’ve been reading here too long, but I find that quite quaint.
There’s some other infor you may find useful. Hope that helps.
14. January 2011 at 16:41
David, I think I said the October 2008 stock market crash occurred with little news. Certainly there was some news in the first 10 days of October, but nothing like Bear Stearns, AIG, Lehman, etc. In my view the big problem was falling NGDP expectations.
Cameron, I can’t get that link to work, but elsewhere I saw data showing inflation expectations in the 3% to 4% range. if that’s right, then the BOE policy was something of a sham. They obviously weren’t really targeting 2% inflation. Indeed neither was the Fed.
I agree that we probably have a much bigger output gap than Britain.
Matt,
The post is called “Being There.” Buffett hasn’t been successful every year, he lost a ton of money in 2008. I’m sure my portfolio has done much better than his since 2003.
You said;
“Dogmatic allegiance to ideas like EMH will just serve to undermine ideas which do make sense, like NGDP targeting.”
That certainly doesn’t describe me; I’ve argued the theory is not literally true, but rather is useful.
And it’s not just mutual funds, there is all sorts of other evidence in favor of the EMH. Fama argues that there was a possibility that the internet stock prices would be justified. So I don’t agree there was zero chance. Some companies like Google and Facebook have done very well. Overall they did much worse than expected, but that doesn’t show irrationality, just that people made mistakes.
Luis and Richard, Thanks. Interestingly, your data doesn’t quite match, as Luis’s data shows 2% inflation over 2 years and 3% over 5 Years. Unless I misinterpreted the yield curve, perhaps the data wasn’t cumulative.
And someone else sent me data showing 4% inflation over 10 years.
Adam, Thanks, that suggests the VAT is the main problem and inflation is not that high.
A Carraro, Thanks, I wonder if changes in the spread over time are useful. Is there an RPI futures markets? (We have a CPI futures market.)
Left Outside, The graph is completely inconsistent with the data they report (which shows GDP rising 2% in 6 months. And the GDP definitions drive me nuts. When they talk about nominal interest rates do they discuss “interest rates that have not be adjusted for inflation?”
19. January 2011 at 06:57
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