Martin Weale: NGDP target is playing with fire
1) Warns that NGDP target likely to prove inflationary; emphasises practical problems of implementing
2) Says that QE “certainly not parked”
3) Sees no evidence that fiscal multipliers have been higher than Bank and others assumed
4) Believed that Office for National Statistics should have ditched RPI
Should we adopt an NGDP target – a debate Mark Carney has kickstarted?
Quite a good argument against is the measurement problem. Whereas the consumer price index is there every month, nominal GDP is produced only quarterly. Then, as people keep reminding us, [it] is subject to substantial revision. I did get a student years ago at Cambridge to look at the effects of revisions on money GDP targeting – how big the impact would have been. As it turned out in the period we looked at they worked in your favour, but one can’t assume that would always be the case. So I think that is a factor that needs to be borne in mind. And this is where our recent experience is very different from that of the US and indeed Canada. Of course we’ve had a sustained period of inflation being above target and if you change your targeting regime after an experience like that then the risk of expectations of higher inflations getting built into people’s behaviour seem to me much greater than if you were thinking of changing the regime after a period when inflation had been close to target. Some of the things I’ve read about in the press, that you should replace the inflation target with a price target. If you think about what that would mean for the UK, it would mean that the MPC would be trying to claw back the effects of the inflation that we’ve had in the last few years and I think that most people would say that imposing a sharp squeeze on the economy now in order to bring inflation close to zero to make up for the years when it was above target would be the last thing we want. I certainly think it would be the last thing we want. The point I would like to make is that whether different arrangements might appear attractive or not depends very much on the context in which you see them. The US which hasn’t had an explicit inflation target in the way we have, but has enjoyed inflation much closer to 2 per cent that we have, for the US to be thinking of adopting something is one use. For us to be thinking about changing the target in the aftermath of a period when inflation has been appreciably above target is a very different thing. I do think the Governor was quite right to draw people’s attention to the experiences of the 1960s and 1970s. No one is expecting inflation to take off in the way that it did in the 1970s. I think people would look back and say that’s not an experience we would like to repeat. We wouldn’t want to repeat the experience of the last five years either.
So you’re saying that in other countries the pros might outweigh the cons, but in the UK the cons probably outweigh the cons for an NGDP target?
I think in the current circumstances they do. For example, suppose we were to adopt an NGDP target for 4 per cent per annum and suppose also that productivity didn’t pick up just because the MPC tried to stimulate the economy. If it were to deliver the target inflation would pick up to 4 per cent a year. Given where we’ve been recently it would be very surprising if inflation expectations didn’t pick up on the back of that.
One of the arguments of NGDP target advocates is that it doesn’t actually matter if inflation is high. In fact that’s part of the goal. It doesn’t actually matter what the mix of growth and inflation is so long as people have an expectation that prices are going to rise and that they start spending. So you shouldn’t be concerned about that mix while your goal is to get NGDP up. Do you reject that argument?
The point I would make is that lots of things can appear easy if you can have an increase in inflation without an increase in inflation expectations. The argument made by supporters of money GDP targeting is that inflation expectations would be stabilised because eventually productivity growth will return to something we think of as normal and then we will get 2 per cent inflation we’re targeting. That may happen, or it may not happen, but when people started to discuss what had gone wrong with economic management in the 1960s and 1970s the issue that they highlighted was that it was in some sense an attempt to manipulate the current inflation rate on the assumption that expectations didn’t respond. As the Governor reminded us, this did in the end fall apart in a rather unpleasant way. As with any other form of monetary policy it [NGDP target] does have distributive effects, it does transfer resources from one part of the population to another part. The traditional argument with monetary policy is that it’s cyclical so you do get swings and roundabout. But if we were to have faster inflation in the way you describe we would be hearing quite a lot from people on fixed incomes and we would probably also see the market drive up yields on government debt which could be something that would pose a burden for the taxpayer even if inflation did eventually come down.
You mentioned the practical difficulties. Do they make it impossible for you, sitting where you’re sitting, to imagine trying to hit an NGDP target? Or could it be done?
It would be very difficult to say you had hit the target when the NGDP number might be revised several years afterwards. The ONS makes revisions for all sorts of very good reasons. The point about collecting statistics is that you learn more later than you know immediately. When people grumble about the fact that numbers are revised I just like to encourage them to think of the statistical burden that there would be if they were continually producing data from the ONS in real time. There would be no time to get anything else done! It’s in the nature of things that we will get revisions to nominal GDP. If nothing else that would change the discourse because instead of City commentators reporting that the Bank of England had missed its target they would have to say, ‘at the moment it looks as though it has hit its target or it hasn’t its target, but of course the numbers might look different in three months or six months’ time’. Could you say that the NGDP target was defined in terms of the first release of NGDP? You could, but before deciding if that was a good idea you’d have to repeat the sort of study my student did nearly 30 years ago, looking at what the implications of revisions would actually be, of course hoping that the pattern didn’t change in the future.
But don’t you have a similar problem now with targeting inflation two years ahead?
The mandate from the Chancellor doesn’t imply any particular horizon. We interpret it that we try to hit the target in about two years or so. One would do the same in terms of setting policy [targeting NGDP], but it would be rather harder to get a good impression of where you actually are. Estimates of where we actually are on inflation are quite important because they are things that we know [but] forecasts are forecasts.
The Fed has committed to keep policy loose until unemployment comes down. Is that any more appropriate than an NGDP target?
It may be something that works in on some occasions and in some circumstances. But if you were to say ‘let’s make that the focus of policy’ you would run the risk of changes in the structure of the labour market meaning that it was impossible to attain that target while keeping inflation stable at any level. Again, that was the experience of Britain in the 1970s and 1980s. We had high unemployment. Money spending was growing fairly robustly but it came out in prices and not a reduction in unemployment. In the US, in setting out policy in those terms, policymakers have to be fairly confident that the experience of the last few years and higher unemployment hasn’t had any significant impact of the ability of people who may have been long-term unemployed to find jobs and so on. That may be true in the US. Everyone would like to see unemployment come down. Obviously unemployment is particularly a problem for young people. But at the same time you have to remember that although our GDP hasn’t done as well as that of the US, employment is now higher than it was before the crisis in Britain, whereas in the US it is perceptibly below where it was before the crisis. So they’re talking in terms of a target for unemployment. If you looked at employment, you’d have to say that by that metric we had been doing fairly well.
Are you saying that present monetary policy regime is fit for purpose then and doesn’t actually need any substantial change to the mandate?
No. Nominal GDP has issues. Commitments [to hit unemployment targets] have issues. All of these things have advantages and disadvantages and in coming to any sort of view on whether you ought to change you need a sensible assessment of the advantages and disadvantages. You can’t just say that it’s self-evident that this or that would work better. The risks of a change in Britain are probably greater in countries that haven’t had our recent history of inflation.
Do you worry about the political independence of central banks around the world?
Like George Osborne I welcome a debate. It would be quite wrong to say that having adopted this framework nearly 20 year ago you should never stop and think ‘could we do better?’ What I’m saying is that in the debate you need to stop and think of the advantages and disadvantages and because those are never clear cut you need to think of the risks associated with them. On the issue of independence, of course the MPC is operationally independent, but the Government sets the target. It’s perfectly open to the Government to change the target if it wants to and thinks it’s a good idea, taking account of the balance of risks. It wouldn’t require any change to the framework and its operational independence wouldn’t be threatened if the government were to decide to change the target. If it decided it wanted a NGDP target, or if it were to change the number associated with the inflation target.
Going back to the regime we have, there’s £375bn in QE. Do you worry that the scope for further QE to boost demand is diminishing?
More than a year ago I said that I thought the Bank’s central estimate of the effect of QE were at the upper limit of what I thought was likely. [But] I’m certainly not saying that I think it had no impact. It has a positive impact and it does support the economy. But I was reading the report of the Treasury Select Committee yesterday [and] I can see why outsiders think it’s not having a powerful and instantaneous effect. What we’ve also seen since last summer with the introduction of the FLS [Funding for Lending Scheme] is that the Bank has looked at other things. We’ve been around for over 300 years and done quite a lot of different things in those 300 years.
Do you think the focus from now on will be on the FLS and that QE is effectively parked?
I certainly wouldn’t say that I see QE as parked. Obviously our forecast is a gradual improvement in the growth rate and it’s been reassuring to see that the FLS looks as though it’s had quite a marked impact on mortgage rates and so on. Obviously this we’ll be looking to see that feeding through into actual lending and to see what’s happening to lending to small businesses. If you look at the November forecast that showed that with the policy stance as it is we expect the inflation rate to come close to target over the horizon. In those circumstances the case for strong further support would be if you thought it could be made without any substantial effect on inflation, if you thought that extra demand would appear mainly in quantities rather than in prices.
What’s your view of the size of the output gap as a share of GDP?
That’s not the way I see it. The way I look at it is: what are the likely effect of pressures in the labour market? How are they likely to feed through to prices? In the circumstance of the moment will firms likely increase their mark ups or reduce their market up to increase market share? Those are the sorts of issues that I look at. The assumption that there is an output gap that feeds straight through into inflation is a very simplistic model. We also need to look at what’s happening to administered prices. No one would expect what’s happening to university tuition fees, or rail fares, to be terribly dependent on the output gap. And those sort of things are having a substantial impact on inflation.
Your former MPC colleague Adam Posen recently made criticisms about the governance of the Bank of England and the ability of the Court to challenge the Governor. Do you share any of those criticisms?
Speaking as someone who has run an organisation – nothing as remotely grand as the Bank of England – you need someone who is clearly in charge of the organisation and who is responsible for what goes on in the organisation a day to day basis. That’s not to say they shouldn’t be open to challenge. You need a board of directors, or a Court. That in operational terms seems perfectly consistent with the committee structure of policy making. The Governor has one vote like everyone else. He can be in a minority.
Monetary policy is more than just Bank rate and QE. You and other external members wrote to the Governor to complain about not being informed over the construction of the FLS. Do you agree that it wasn’t handled in the way it should have been?
In a speech I made in June I said that regular and repeated use of instruments of that type, that sort of thing has to be the responsibility of the MPC. That is my view. The Winters report [on Bank liquidity operations] did say something rather similar. Obviously the executive of the MPC is responding to the Winters report. We’ll see what they say on the matter.
Winters also said there was a tendency for other members of the Bank staff to stay in their shells, that there was “filtering” of information presented to the Governor. Is that something you recognise?
I remember on one occasion in one meeting, I think it was to do with what we were expecting for wages, one staff member saying: “while this was the MPC view it certainly wasn’t her view or the staff’s view”. Other things do contradict. Views from the staff that disagree with the MPC view do surface. I could imagine that at the same time it’s perfectly possible that staff feel that if they said something once and the MPC hasn’t responded to it, is it worth saying it again? Many of us would react in that sort of way. In any organisation you can always look back and say X or Y thought this and didn’t say it to the MPC and wouldn’t it have been helpful if they have. Sometimes with hindsight this will always be true.
There’s a strong debate started by the IMF over the size of fiscal multipliers. Is that something that MPC has been looking at with regard to the UK?
Different people will have different views on multipliers. If I were to look back at the past year the disappointing performance of our exports seems to me a very important factor. Exports of financial services have performed very badly. You might say on that if you think back to before the crisis, had we had a hidden subsidy to the textile industry then the textile industry would have been a booming exporter. That sort of adjustment may have been a consequence of the changes that have had to be made in the government’s relations with the financial sector to make sure that taxpayers aren’t exposed to the sort of risks we were exposed to in 2008. I think the exports sector have performed more weakly than we would have hoped because of problems in the euro area. I think those have had a spill over into the domestic economy. Businesses have been thinking: ‘let me put this off – why should I take a risk at the moment’. One hopes that mentality will change from that to: ‘If I don’t do this now, someone else will grab the opportunity’. You have movements in fuel prices and so on [too]. None of those explain why productivity has been poor.
You feel those factors are sufficient to explain the growth shortfall, without the Bank needing to go back and re-evaluate assumptions about the multiplier?
One always needs to go back an re-evaluate. Some of the discussion on the fiscal multiplier has been based on the argument that if monetary policy can’t be relaxed to offset a fiscal tightening then the combined policy package is tightened. [But] we have been doing QE. While I’ve had my doubts that it’s as effective as the Bank has claimed that’s quite different from saying that it’s had no effect. We have introduced the FLS.
You don’t see any merit in the argument of Olivier Blanchard, chief economist of the IMF, that the pace of cuts should be slowed in the March Budget to support demand in the economy?
I’m very happy to have to think about monetary policy and not to have to think about fiscal policy as well. Given what’s happened to the economy people are obviously discussing that, but that’s really an issue for the Government not the MPC.
In your former life in the NIESR you said you said on Gordon Brown’s Golden Rules that you could “smell the fudge cooking in the Treasury kitchen”? Do you think that something has been lost in clarity in the Coalition’s books with the Gilt coupon transfer?
They’ve explained what they’re doing and it’s clear what it means. People who want to think about fiscal policy and where it’s going can do so in the light of that.
You were in favour of rate rises in early 2011. What would you say you got wrong?
You say I was voting for a rise in interest rates [but] I was voting for a quarter point increase. The reason I was doing that was that I didn’t think inflation would fall back to target as rapidly as our central forecast suggested. So you might say that looking at where we are now far from getting things wrong I got that aspect of things right. Of course what I didn’t anticipate – and I don’t feel embarrassed about not anticipating – was the way the crisis in the euro area intensified. The risk that created – it was a risk that I think we have averted – of a sharp new liquidity crisis much like that of 2008. I think the Bank was quite right to relax policy and introduce the other innovations that it did. Would it have happened if we hadn’t done that? Well of course I don’t know. But I think anyone would say there was a very real risk. I changed my vote from wanting to increase interest rates to supporting QE because the situation had changed very markedly.
Should the ONS have ditched RPI?
I’m a member of the Consumer Prices Advisory Committee. The international advice is: don’t use the Carli measure. But the CPAC is advisory and that statistics board has to take in other wider aspects. I wasn’t actually able to go to all of the meetings. Certainly my sense of it was that was what the advisory committee thought. Does that mean I should feel offended that my advice wasn’t taken? Not a bit of it. Because it’s in their remit to look at a wider range of things.
How do you think history will judge Mervyn King’s legacy?
Obviously the financial crisis and the way we eventually get over that will be the basis for historical judgement and so as Zhou Enlai said about the French revolution it’s rather too early to say at the moment.
Has King done a good job in taking on the bankers?
If you look at the historic function of the Bank of England governor that was a large part of the job. Having a financial regulation of the Bank back with the Bank was very much the right thing to do. The current Governor has done a very good job in standing up to the City. We’ve been hearing bankers talking the book, that if something’s good for the banking industry it must be good for the country. It’s not terribly difficult that there are a number of chains in that argument and you need to look rather closely at all of them.
If you had to give advice to Sir Mervyn’s successor, Mark Carney, how would you advise him?
On monetary policy, yes, you need to keep an open mind on things but at the same time you need to consider all the risks. I’m sure he’s doing that. No policy decision or framework is risk free, but what one always need to do is think about the balance of risks.
Is his job too big for one person?
As we know one man – or one woman – have run the affairs of whole countries and that’s more complex than just the Bank of England. The key to doing that is to have appropriate structures. Quite a lot of thought has gone into that. We’ll wait and see what Dr Carney makes of where we are now. If you have a change of Governor you expect some things to change.
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