Today has seen the latest inflation figures for the UK and they come at a time which is particularly significant. If we just consider the issue of time we see that it is now three years since our official inflation target called Consumer Price Inflation exceeded its target of 2% per annum. It was back in December 2009 that it rose to an annual rate of 2.9% which if you recall those times was supposed according to the Bank of England to be a ”temporary” rise over target. So we know now that “temporary” means three years and counting as there is still no clear path to below target inflation. Crucially we also know that the policy of the Bank of England has been wrong as it is set aiming for inflation two years hence which it has continually forecast incorrectly over this period. So it has pursued a policy which aims to do this according to its website.
Without that extra spending in the economy, the MPC thought that inflation would be more likely in the medium term to undershoot the target.
They even raised the amount of Quantitative Easing by £75 billion in October 2011 when the annual rate of the CPI was 5% which is 3% over target! Apparently we were going to hit our inflation target by trying to raise inflation when it was persistently-and in this instance considerably- over target. What little credibility the Monetary Policy Committee had left was erased at this point I think.
Unfortunately if we look at the other side of the coin we see that we got very little economic growth over this period. When this inflationary episode began in the last quarter of 2009 our economic output or Gross Domestic Product was 100.5 and as of the latest numbers for the third quarter of this year it was 103.0. So in three years we have had 2.5% of economic growth and for QE to take the credit it would mean that you would have to ignore all other influences. No wonder supporters of it have ended up using words like “counter-factual” which means that without it everything would be worse! Sadly they are rarely asked as to how this explains the performance of nations not dissimilar to us who have not had QE which is as near to a scientific test as you get in economics.
Remember that word credibility?
Those responsible for UK economic policy have realised that they can no longer pursue the same policy as whilst officially they claim nothing is wrong unofficially even they must know that the policy has been shredded by events. It would be too much to expect a genuine change so it was not a surprise when the next Governor of the Bank of England Mark Carney hinted at a change to nominal GDP targeting last week. I expect this to be the same Emperor but with new clothes i.e we will continue with inflationary policies with the claim that they are to achieve economic growth.
I covered this subject in depth on September 28th so let me just dip into the salient points here.
Nominal GDP targeting in practice
This is often expressed as aiming for 5% nominal GDP growth a year. But here is my point we were not far off that if we annualise the second quarter of this year and what did we get? Falling real GDP growth. And why did we get that? Because we have plenty of inflation the old UK bugbear.
If we look at the numbers we see how that came about.
In the second quarter of 2012 UK GDP rose by 4.1% in nominal times if we annualise it but the level of real GDP fell by 1.5% if we annualise that.
So we were not far from what is considered the Holy Grail of nominal GDP targeting which is a 5% growth rate but crucially we got plenty of inflation. This meant that what we really want to affect which is real GDP did poorly and in this particular instance it fell. In other words my view is that this is essentially a representation or repackaging of the same failed policy.
You do not have to take my word for it. Here is a supporter of the policy Martin Wolf of the Financial Times.
inflation might overshoot
Also let me quote from what is maybe the seminal paper for this by Martin Woodford which tells us this.
And the existence of the central bank’s declared nominal GDP target path should also limit the degree of alarm that might arise about risks of unbridled inflation when special fiscal stimulus measures are introduced.
You might reasonably wonder why a supporter of the policy is discussing the section that I have highlighted……. You may also spot that just like my discussion on Japan yesterday we are seeing plans for a merging of fiscal and monetary policy. I have felt that this is coming for a while which I why I discussed this subject back on September 28th. My summary of what I felt would happen next from then is shown below.
They intend to inflate mate! The fact that such efforts have such a dreadful past record in the UK seems unlikely to deter them as they mutter to themselves another phrase with a dreadful track record. “This time it will be different”.
Also I would like to repeat my conclusion that it is the weak and the defenceless who will be harmed by this.
One of the reasons I think that this is wrong is that as we move from their theoretical calculations to the real world I fear that it is the poor and the weak who will end up being hurt the most by this.
Still we can rely on the new Governor Mark Carney can’t we?
This may not be going so well, from the Toronto Sun
OTTAWA – The impartiality of the Bank of Canada governor’s office has taken a hit because of what can only be described as a lack of judgment by its current occupant, Mark Carney, to accept an invitation to stay for nearly a week last summer at the Nova Scotia house of Liberal MP and finance critic Scott Brison.
Today’s inflation numbers
According to the Office for National Statistics here is the current situation.
The Consumer Prices Index (CPI) annual inflation stands at 2.7 per cent in November 2012, unchanged from October. The CPI stands at 124.4 in November 2012 based on 2005 = 100
The Retail Prices Index (RPI) annual inflation stands at 3.0 per cent in November 2012, down from 3.2 per cent in October.The RPI stands at 245.6 in November 2012 based on January 1987 = 100.
There were quite a few different influences on these measures with fuel prices falling but other prices rising. Part of the reason for the fall in RPI was that mortgage interest rates fell so let us hope that the Bank of England’s Funding for Lending Scheme is (finally) having an impact. The other main reason was different treatments of the cost of insurance.
Somewhat confusingly in the light of the above -rounding error at play- the annual rate of our old target RPIX also fell by 0.2% to 2.9%.
If we consider the UK inflation landscape we see that it has been persistently over target when the economy has been weak which is one of the definitions of failure. My expectation going forwards as I have explained today is that we are likely to see a supposed change of objective -from inflation to nominal GDP targeting- but that policy will head in the same direction. In fact if I am reading the runes correctly we will see even more inflationary measures deployed with the claim that they will generate economic growth. Some of this is likely to come from the merging of fiscal and monetary policy which of course will be denied.
My question for readers today is whether the phrase “economic growth” needs to find a home in my financial lexicon.
Real GDP targeting
Quite a few people have asked me if this would not be a better alternative and if we could do it they would be correct. Unfortunately this is an example of what Blondie described thus.
One way or another, I’m gonna getcha. I’ll getcha. I’ll getcha getcha getcha getcha
You see we start with a nominal GDP number and use an inflation number to get real GDP! So sorry but we end up with the same problem via another route.
Mind you as I have described before if you cannot change reality you can apparently change the way you measure it.