UK monetary policy is an example of “Meet the New Boss,Same as the Old Boss”

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.

Economic Growth

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.

This entry was posted in GDP, General Economics, Growth, Inflation, Quantitative Easing and Extraordinary Monetary Measures, Stagflation, UK Inflation Prospects and Issues and tagged , . Bookmark the permalink.
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  • Drf

    Hi Shaun,

    “My question for readers today is whether the phrase “economic growth” needs to find a home in my financial lexicon.” My response is Yes, but the definition should explain that like “temporary” “economic growth” when used in political economic terms means regression in real terms!

  • Anonymous

    Real growth will improve my spending power – nominal growth with high inflation will NOT. Targeting nominal growth is a pointless and futile exercise. It’s an exercise in deception that probably aims to obscure democratic accountability.

    It’s like a football coach having a target of 1 goal scored regardless of whether the opposition score many.

    We need to vote out these inflation happy, deficit denying clowns form both sides of the house. On a musical note from Genesis “Oh superman where are you now ?”

  • JW

    Hi Shaun
    If every central bank/government follows the same policy , how long will it be before the point is reached when concurrent devaluation against non-fiat ‘asset’/debt write-off has to take place?

  • Patrick, London
  • DaveS

    We have borrowed too much – far too much to ever pay back, also far too much to service at any reasonable market rate (e.g. when you allow for 3% inflation with upside risk).

    For a while they might have believed their own lie that “growth” would be quickly restored and the debts would become manageable again. They have stopped believing this now – hence nominal gdp targets.

    So either we hard default and tear up the Gilts – would bankrupt UK banks and pension funds and risk financial contagion. Or we soft default via inflation and lie to the ignorant populace that its temporary and fiddle the stats to make it look less bad, In the meantime the banks are saved and a lucky few make even bigger fortunes.

    Its obvious which they would choose. These fools think they are in control.

    But there are 2 problems that I see

    1. They can inflate public debt away with nominal gdp targeting – but in a consumer economy it won’t work unless they also inflate private debt away. That means wage inflation.

    2. Most of the developed world is heavily in debt and they will all inflate together. Commodity prices, particularly oil will go through the roof. For non-commodity exporting nations that means imported inflation.

    In my view monetary+commodity+wage inflation = hyper-inflation.

    And what happens if inflation runs away from them – well they just raise rates – but with our debt burdens then that would risk hard default – tricky balancing act

    What are the odds they might just get it wrong……

  • mike

    Sulely the Funding for Lending Scheme is QE+++ by another route?
    Quietly and with liitle fuss, with £80 billion of tax payers borrowings @ 0.5% the FLS seems much more akin to the proverbial helicopter showering money down to would-be borrowers than any previous QE, directly targeting more house price inflation, and regrettably again hitting millions of modest savers with swinging cuts in interest income.
    Such market manipulation pushing a false sense of mortgage affordability is likely to backfire isn’t it? Just as a runaway stockmarket based on more more more QE is likely to come unstuck too don’t you think?

  • Rods

    Hi Shaun,

    The answer is yes, “Economic Growth” does need to go into your financial lexicon. I suspect a true definition will be along the lines of: “A negative number expressed as a positive value, when inflation using government massaged figures rather than real values are used”!

    I guess if the IMF threatened to expel all member countries for the manipulation of their countries financial figures, rather than just Argentina, they would very quickly end up as: “Billy no friends”!

    When you consider that we have already had a 13.2% drop in real wages with virtually no growth since 2007, it makes one ask the question: “How far will they have to fall for us to be competitive again?”

    With public sector wages still significantly outgrowing the private sector and no sign of any public / private sector re-balancing of the economy, I suspect as was commented yesterday, somewhere south of 30%.

    The problem of nominal growth figures from what I can see is that if you have high inflation, then this is basically targeting savers and people like pensioners on fixed incomes. Hitting pensioners is particularly bad as many have no change of doing any work, due to age, illness or being too infirm to supplement what is in many case inadequate incomes to cover more than the bare essentials or less.

    Surely the approach should be targeting inflation and then setting the correct conditions for an economy to grow. Our current high tax economy, with a new plan every week to scam another sector of the populous or the economy with another dodgy tax is surely fulfilling what Churchill best described (with the OECD figures confirming this) of trying to achieve economic growth: “by standing in a bucket and trying to pull yourself up by the handle”.

    Without a re-balancing of the economy in favour of the private sector, a reduction in red tape and and a real effort from the government with some sort of growth plan then all I can see on the horizon is at best stagflation.

  • John

    Thanks for the article. It throws a light on some topics that have been worrying me for a while. In any field, other than economics, to be so far out in predicting the future would count as a total failure for the theories being used. They would be scrapped, their proponents would be marginalised if they didn’t find a better, more accurate hobby-horse. It serves no-one if they get it wrong. The commentators must by now realise how wrong they are, both now and over time. It would be good to see criticism in the media increasing.

    It might be a cliche, but one persons spending is another persons income. To me, its difficult to see how our economy is going to expand with the business sector saving and the domestic sector paying off debt wherever it can, whilst the government is refusing to back the british economy by spending. As the governments cuts really get going in the months to come, I suggest that GDP is likely to remain flat or decline. OK, it will wobble around a bit, there may be bright spots that will light up the chancellors face, but there will be other news that darkens it again. A major factor will be the result of the fiscal cliff discussions; anything that takes the US into zero or negative growth will ripple out into Europe, causing problems everywhere.

    I have viewed QE as an asset swap, providing financial institutions with currency that they have felt the need to invest rather than loan. This has provided a means for speculative price bubbles that is seen in the UK as inflation. Had that money been spent by the government into the UK economy (supporting the private sector, giving them a reason to invest), I suspect we would have seen a fall in unemployment and a reduced benefit bill. The angst we now have need never have happened

  • Anonymous

    Hi Drf
    Okay so rather than no progress you want it to reflect a shrinkage? I can see that the new definition will need several nuances…..

  • Anonymous

    Very good,very good….

  • Anonymous

    Hi JW

    You make a good point/question. Before the credit crunch it would be easy to assume that this would start with a combination of exchange rate devaluation/depreciation and inflation. But for the majority that is not possible as even the Japanese yen is falling now meaning who is left to fall against? Not many…

    So the initial phase will be led by inflation and it will be unfair and destructive. At what point (if any) people will say no is unpredictable. I am doing my best to make them aware not only of it but of the alternatives…

  • Anonymous

    Hi DaveS

    Quite high as so far they have…

    As to point one the problem is that I do not think that they have any real plan except for the hope that inflation will do the job. But they either do not care or do not realise that inflation is very unfair on many and in particular those who are least able to protect themselves. They also did not think through the impact of falling real wages on private debt levels or how individuals would respond.

  • Anonymous

    Hi Mike
    In terms of favoring debtors vis a vis savers yes FLS is similar to QE. However there is a difference in that it is more flexible and therefore could be more easily reversed.

  • Anonymous

    Hi Rods
    In essence they are trying to make it look like they are doing something when in fact the underlying policy stays the same.

  • Anonymous

    Hi John
    We face a list of problems which I believe are solveable but first we need to face up to them. Policies such as QE were presented as a type of Holy Grail but they had and have the issue that they are fiddling at the edges. Or to use your analogy asset swaps will not get us out of this.
    I do not like inflation as a way out as it is unfair but it also allows our plitical class to think that matters are in hand and the vital day when we realise the problems that need sorting gets kicked ever further away.
    I would start with out banking sector whereas they forever indulge and feed it.

  • Michael

    Hi Shaun,

    Can you help me understand the link between GDP and inflation? Am I correct in assuming that if all else in the economy remains equal and inflation is say, 3% over the year, then as measured GDP (like for like) will have grown by some fraction of this 3% over the year? (not all activity will have increased in cost)

    Or is this accounted for somehow in the GDP figures?

    I ask because UK inflation has been consistently high for the last few years and yet UK GDP is scraping along, broadly flat. Does this mean real underlying GDP has actually been negative and only high inflation has kept the GDP figure more or less stationary?

    Apologies if my question is economic nonsense!

  • DaveS

    Michael – the GDP numbers that you see quoted are inflation adjusted i.e. they are real GDP.

    So if GDP (real GDP) is flat and inflation is 3% – then that means nominal GDP has gone up approx 3%. Indeed for UK, nominal GDP is still increasing and so the nominal tax take (bit less than 40% of GDP I think) is also increasing.

    If your nominal income (i.e. tax take for the exchequer) grows faster than the debt + interest then over time your debt will be inflated away. It will become a smaller multiple of your income.

    Of course they have a “special” inflation measure to calculate GDP – the GDP deflator. It gets less public attention than other inflation measures and consequently is ripe for a bit of quiet fiddling. All sorts of tricks are used to come up with a more acceptable number e.g. hedonics. I would personally question how much of the reported growth of the last 20 years was due to these little “adjustments” to the deflator.

    In fact Argentina is an excellent example – they have basically been lying about inflation for many years. Consequently their real GDP growth is also a lie and now the IMF are getting a little bit embarrassed by them. Not quite the economic miracle recovery being reported.


  • Anonymous

    Hi Michael

    I can see that Dave S has already given you an answer to this so simply let me add a link to a post where I discussed this issue.

  • Drf

    Hi Shaun,

    It’s not that I want it to; I feel the reality is that it already is shrinking once the manipulated and false statistics are stripped away. My conclusion is that with the declared policies of Carney real GDP properly measured and properly inflation adjusted will regress.

  • Drf

    Hi DaveS, I cannot agree with your claim that “the GDP numbers you see” (presumably referring to the ONS’s published numbers) are real. In fact they are seriously and deliberately distorted and manipulated. As one example numerous public sector services are included in the ONS’s number. However they are not real GDP at all but are a cost on the nationally produced wealth, so they do not contribute to it at all!

  • DaveS

    By “real” I meant inflation adjusted as opposed to non-inflation adjusted nominal GDP – not real as in reflects any kind of reality !

    I quite agree, all government economic statistics are open to abuse and the trend has been to increasingly abuse them. Argentina is an extreme example but the same dishonesty is increasingly evident in supposedly trustworthy regimes e.g. BOE “improving” RPI or US core inflation.

    I was horrified when I learnt of some of the tricks widely used to distort GDP to the upside.

    I think its a fundamental problem of economics – the input data is often manipulated or unreliable or unverifiable. Unlike Shaun many economists seem quite willing to accept the numbers unquestioned – or at least when it suits their argument perhaps.

    When Central Banks start lying we are entering a new phase – possibly the start of the end of the current monetary system.