Vince Cable makes the case for an NGDP target for the Bank
Vince Cable gave a speech at the Lib Dem-friendly Centre Forum think tank on Monday. Various parts were picked up, such as the Business Secretary’s lament for the demutualisation of many building societies, his call for more house building, plus some heavy hints that more infrastructure moves are on the way.
But Cable’s arguments on monetary policy were more interesting to me.
He made repeated references to how loose monetary policy (specifically coming off the Gold Standard) helped the country to escape the slump of the 1930s.
After welcoming the new Treasury/Bank plan to underwrite private banks’ borrowing costs in return for more lending, Cable had something to add:
“I would supplement these useful moves with an observation about how monetary policy is communicated. Quantitative Easing can sound like a powerful instrument – but if it does not succeed in making people expect rising money spending in the economy, it is likely to be far less effective than leaving gold proved in the 1930s. ”
This reference to expectations of “rising money spending” is significant since it suggests Cable has been influenced by that school of thought that says the Bank of England should be given a Nominal Gross Domestic Product, or NGDP, target.
First some background.
Some economists argue that monetary policy is proving ineffective at getting us out of this present economic malaise because the Bank of England is failing to push through enough stimulus, or, more importantly, failing to make it clear to the public and financial markets that it will do enough.
They put the blame on the Bank’s 2 per cent inflation target, which they say compels the Monetary Policy Committee to keep policy tighter than it really should be to support levels of spending in the economy.
Their solution is changing the Bank’s target and giving it a NGDP target. This means that the Bank would be charged with ensuring that activity throughout the economy, unadjusted for inflation, grows by a certain amount – say 5 per cent – each year come what may.
The theory is that this would allow the MPC to perform as much stimulus, in the form of asset purchases and low interest rates, as it takes to restore growth without having to obsess about the outlook for the annualised inflation rate as at present. More important, businesses and households would know that the Bank will always do what it takes to restore growth and will therefore have an incentive to spend and invest now. Expectations would change.
And it is expectations of spending levels, as I mentioned earlier, that Cable seems to think are too low.
So what are the arguments against shifting to NGDP targets?
Inflation hawks would argue that the Bank is already effectively ignoring its 2 per cent target already, with the Consumer Prices Index having been above that level for so long in recent years. But that misses the point. NGDP growth collapsed during the bust. And it’s still weak now, even with the higher than target inflation:
With an NGDP target you would expect to see a much smoother and steeper line. And with the 2 per cent target in place, there is always a danger that the MPC will remove stimulus prematurely.
It is true that not everyone on the inflation dove side is convinced that giving the Bank an NGDP target would be a panacea. Chris Dillow lays out some reasons for scepticism here.
Yet NGDP targetting would certainly be a radical approach – one that really would be worthy of the “Plan A plus” rhetoric of the Coalition.
And it’s something that Cable seems to be toying with. Indeed, earlier this year Cable was asked by Will Hutton of The Observer specifically about NGDP targetting and the Business Secretary said he was “very attracted”.
Whether the Coalition would ever summon up the courage to overhaul the mandate of the Bank of England, however, is another question entirely.Tagged in: bank of england, Centre Forum, doves, expectations, hawks, inflation, NGDP, Vince Cable
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