Yesterday whilst the focus was on the Spanish government and its new austerity plan there were some significant and interesting developments in the data released on the UK economy. However before I move on from Spain we have a new lesson from the Euro zone crisis. If a country has a pension reserve fund do not give politicians the option of raiding it! The value destruction that has been inflicted on the National Pension Reserve Fund in Ireland seems to be the likely model for what will happen as time goes by to Spanish pension reserve assets. Indeed the whole Spanish plan is looking rather Irish if we were to step back in time.
The UK’s Economic Growth Figures
I hope that regular readers were not taken in too much with the mainstream media’s -0.4% is better than -0.5% hurrah type spin. As I discussed on the in my analysis of the flaws in Gross Domestic Product figures they are nowhere near that accurate. Indeed the progression from the originally released -0.7% to -0.4% may not be statistically siginificant either. Sorry but these numbers give us an idea of how we have done but the pressure for a spot number makes them seem much more accurate than they are.
Tucked away in the detail was something much more significant as it relates to a current economic debate. Let me give you the numbers first. 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 what you might think? Well if I tell you that the gap is a measure of inflation and on that basis it was running at an annualised 5.6% in the second quarter of 2012 I think you see what attracted my attention.
This inflation rate is the implied deflator or GDP deflator and as opposed to consumer inflation measures it covers a wider area as in theory the whole economy is covered. The official reading was 2.7% and this was up 1.1% on the previous quarter. So whichever way you look at it this inflation measure which is the widest we have showed an inflation pick-up in the second quarter of this year just as so many were telling us inflation was waning!
Nominal Gross Domestic Product Targeting
Economics does have fashions and this is one of the current ones which has become akin to a religious belief from some. This is that nominal GDP targeting by central banks can and should replace inflation targeting. A paper by Michael Woodford at the Jackson Hole economics conference has become influential.
An example of a suitable target criterion would be a commitment to return nominal GDP to the trend path that it had been on up until the fall of 2008. This would … make it clear that policy will have to remain looser in the near term than a purely forward-looking Taylor rule would imply
As you can see there is an implication here that policy should be even looser than it is now and Mr.Woodford goes on to tell us this in case you are wondering whose eyes lit up on reading this document.
At the same time, commitment to a nominal GDP target path by the central bank would increase the bang for the buck from fiscal stimulus
As you can see there would be some doing a jig reading this as a scholarly work apparently supports what they wanted all along. However to my mind there are implications here with which I can only completely disagree.
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.
This relies on the fact that central banks still have trust and credibility when they have spent the last 4 to 5 years eroding that. Also I can only completely disagree with the next bit.
For those who worry that fiscal stimulus always comes too late and goes too far, there would be the central bank’s commitment to revert to a policy of active control of aggregate demand through monetary policy once the nominal GDP target path is reached.
Again this relies on faith in central bankers that I simply do not have.
Just as a summary of the Woodford paper it is scholarly but has bits I agree with as for example he has doubts about the effectiveness of Quantitative Easing but some I completely disagree with of which the extreme is forward guidance by central banks on interest-rates. Mr.Woodford can write over 40 pages on this subject when I only need one word,otiose.
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.
As ever there is the danger of relying on one quarters numbers and I wish to remind readers of that even when they suit my case. But the underlying principle is that nominal GDP targeting has inflation risks and to my mind is likely to stoke it as we have ex ante no real way of stopping it. Or as a supporter of nominal GDP targeting Martin Wolf of the Financial Times puts it.
inflation might overshoot
The UK Trade Problem
Last week I tried to get Channel Four to ask the Governor of the Bank of England what happened to the “economic rebalancing” he promised and forecast after the depreciation of the value of the pound in 2007/08 of approximately 20%. Accordingly the latest numbers provided quite a bit of food for thought.
The United Kingdom’s (UK) current account deficit was £20.8 billion in the second quarter of 2012, up from a revised deficit of £15.4 billion in the previous quarter
Ouch! But actually if we put it this way it looks even worse.
The current account deficit equated to 5.4 per cent of GDP at current market prices in the second quarter of 2012, compared with 4.0 per cent in the previous quarter
If we consider that we were doing this with a shrinking economy there might be genuine fear as to what would happen if we were growing! Although this may well be for us an example of David Byrne’s “Same as it ever was”
The UK has run a combined current and capital account deficit in every year since 1997 and every quarter since the fourth quarter of 2009.
I have to confess that the way trade figures have been treated in my career is bemusing. It used to be that everyone waited for US and UK trade figures with baited breath and now no-one seems to care much at all! We have gone from one extreme to another. Let me nail my colours to the mast, they do matter but any analysis has the issue that the recorded numbers are often shockingly inaccurate.
UK Productivity is poor
This morning we have received the latest data on this front and it does not make for happy reading.
UK labour productivity fell by 0.9 per cent in the second quarter of 2012 on an output per hour basis. Market sector productivity fell by 1.5 per cent on this basis, to its lowest level since 2005
Just to make a poor situation worse take a look at our costs.
Whole economy unit labour costs increased by 0.3 per cent in the second quarter and were 3.2 per cent higher than a year earlier. Manufacturing unit wage costs increased by 4.0 per cent in the second quarter and were 5.7 per cent higher than a year earlier
No wonder we have a poor trade balance and negative to flat economic growth with numbers like that! Perhaps we also need a check on these numbers as they do not seem to coincide with the wages numbers that come with the unemployment report.
One way of looking at today’s analysis is to say that inflation issues,weak trade figures and poor productivity numbers could have been written at quite a few points of my career. In this instance deja vu is not welcome! Put another way it feels at times like the episode of Star Trek where Captain Jean-Luc Picard is trapped in a repeating loop.
However I hope that I have illustrated the danger of nominal GDP targeting. As even one of its supporters Martin Wolf admits inflation is an issue. They have no way of controlling the inflation – real growth mix and frankly no certainty that there will be any real growth at all. Still at least they are not preparing the ground by attempting to emasculate our measures of inflation. Oh wait a minute!
So there is my conclusion for today and I will put it simply. 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”.
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.