After writing about the UK growth figures yesterday I had some time for more reflection. If we allow for the Office for National Statistics estimate of the impact of the bad weather then growth would have been zero or flat. This would still have been a disappointing result and led me to look again at the numbers produced by the National Institute of Economic and Social Research or NIESR. On January 13th they produced an estimate for UK economic growth in the fourth quarter of 2010 of 0.5% and as they do monthly figures they have a quarterly figure ending in November ( and so avoiding the bad weather) of 0.6%. So according to them growth was still fairly strong up to November with a slight slowdown in December. This radically differs from the pattern reported by the ONS. According to the NIESR their accuracy is as follows.
Our track record in producing early estimates of GDP suggests that our projection for the most recent three-month period has a standard error of 0.1-0.2% point when compared to the first estimate produced by the Office for National Statistics.
The obvious thought is not this time it wasn’t! However having looked at the back data for 2010 until we came to December the pattern between the NIESR and the ONS was quite similar. My view therefore is that whilst it looks very much like there was a slowdown in the last quarter of 2010 it may be much less than what the ONS has estimated. Their statistics have been questioned in other areas recently and I suspect these numbers will be questioned more and more as time goes by. I will also point out one more time that much of the mainstream media puts too much emphasis on these flash estimate numbers which only have around 40% of the data set. Even with the full set arguing over 0.1 or 0.2% is a degree of accuracy the numbers simply do not justify.
Bank of England Governor Mervyn King seeks to justify his policies
After writing yesterday about a member of the Monetary Policy Committee who feels that UK interest-rates should rise today I have a speech for the defence from the Governor. As well as defending his case he also made some sweeping statements about real wages and savers. Let us look at what he had to say. First he tells us that in his opinion supply side shocks have caused the rise in inflation
Taken together, those three factors by themselves would account for a remarkable 12% addition to the price level over four years, or an average increase in the inflation rate of 3 percentage points a year. Since the consumer price index as a whole rose by not much more, the contribution of domestically generated inflation over that period was close to zero, and obviously well below the target.
Before we congratulate him on hitting his apparent inflation target we have to remember that he has not done so.Also we need to remember that one of the factors he quotes a falling exchange rate is one of the transmission mechanisms of monetary policy which must briefly have slipped his mind. I am afraid you cannot take the credit for favourable transmission mechanisms and ignore the unfavourable ones. Then Mr. King tells us what he considers his job to be in such an environment and the emphasis is mine
An appropriate monetary response is to accommodate the first round price level effects, while ensuring that changes in the published twelve-month inflation rate do not alter inflation expectations and lead to second round inflationary changes in wages and prices. … Since shocks may take several months to have their full effect, a horizon of about two years is a reasonable one over which to try to bring inflation back to its target. But if shocks are sufficiently large – in either direction – then it may be sensible to extend the horizon over which inflation returns to its target level
Firstly Mr.King appears to be interpreting his own inflation target here. The role of the Bank of England is supposed to be to aim to hit the target 2 years hence. He now seems to feel he can choose his own time span which coincides with a period whereby he has not hit it in the 2 year time horizon. Rather convenient timing some might think! Furthermore I highlighted the section above because Mr.King has set a criteria for policy but later he tells us.
There is some evidence – for example from household surveys – to suggest that inflation expectations have moved higher.
But of course just like the timescale it would appear that this can be ignored too at Mr.King’s whim. We appear to have a policy framework that only exists when it is convenient which hardly raises its credibility. It is perhaps no surprise therefore that he forecasts the following for inflation in 2011.
With the standard rate of VAT rising to 20% this month, and recent further increases in world commodity and energy prices, inflation is likely to rise to somewhere between 4% and 5% over the next few months, before falling back next year.
Mr.King seems to again have a failure of memory because the rise in VAT is simply replacing one of the same size a year ago so there will be no particular impact on inflation and sadly over the post credit crunch period he always predicts a fall in inflation which always turns out to be wrong!
Mr.King’s prescription for savers, real incomes and debtors
Mr.King’s low interest-rate policy has punished savers who have got low returns on their savings but never fear he feels sorry for them. I feel that this is crocodile tears from a man who has deliberately set out to punish the generally prudent to reward the imprudent as in those debtors who are in trouble. He has created an enormous moral hazard in my view by doing this.
When that time comes, it will I know be a relief to many people dependent on income from savings. I sympathise completely with savers and those who behaved prudently who now find themselves among the biggest losers from this crisis.
Unfortunately his objective of bailing out those in debt does not appear to be going as well as he hoped due to the divergence between market interest-rates and the official one. About which he has done precisely nothing.
Indeed, since the onset of the crisis the interest rates faced by many households and companies have changed rather little, and in some cases have increased. Other households and small businesses, with little housing equity, may be unable to borrow at all or are able to borrow only in the unsecured market – where rates are much higher than before the crisis.
For those who are in work Mr.King does not offer much hope on the question of what they are likely to earn and admits to a squeeze on wages. (Well apart from the banking sector which caused this!)
As a result, in 2011 real wages are likely to be no higher than they were in 2005. One has to go back to the 1920s to find a time when real wages fell over a period of six years.
I have made my views clear on what I consider to be a failed strategy in the past. However there is also from Mr.King an attempt to rewrite history when he says.
Even if we had known a year ago that 2010 would bring further increases in food, energy and other import prices, as well as a rise in VAT, it would not have been sensible to pretend that a tightening of monetary policy to offset those upwards pressures on CPI inflation was consistent with aiming to keep inflation at the target in the medium term.
This is plain wrong as back in 2009 and 2010 he used his own forecasts of low inflation to justify his policy. His forecasts as usual turned out to be wrong. Also if we use his two-year time horizon Mr.King is telling us that back in 2009 he would have been undertaking Quantitative Easing and asset purchases even if he felt that inflation would be over target in 2011! This is a sign of a man who knows that things are going badly and feels that a smudge or two on the history books will help.
Monetary Policy Committee Minutes show more discord
These were released this morning and they show that a second member Martin Weale voted for an interest-rate rise so Mr.King is finding that his committee is slipping away from him. On the other side is Adam Posen who voted for an extra £50 billion of asset purchases. I find Mr.Posen’s view intriguing as it would appear that the first round of our asset purchases has helped lead us into a stagflation scenario and I personally fail to see how more of it might help. He often quotes Japan as an example and it is trying yet another round of this policy as I type but looking at its economy it hasn’t done much good. Put another way the fact another round is required perhaps is the most eloquent observation! I suspect if we follow that route we will be trapped on the same treadmill of forever calling for more.
A large increase to the UK’s National Debt
Yesterday saw the figures for UK public finances in December which were a little better than the disappointing ones for October and November. However I wish to discuss a much larger influence which according to the Office of National Statistics goes as follows.
The release published on 25 January 2011 includes, for the first time, data for the Lloyds Banking Group (LBG) and the Royal Bank of Scotland (RBS).In the period up to September 2007, before the classification of Northern Rock to the public sector,the level of public sector net debt (PSND) largely reflected central government’s net debt. By the end of December 2008, the classification to the public sector of, first, Northern Rock and subsequently Bradford & Bingley added around £130 billion to PSND. Including the Lloyds Banking Group and RBS in the public sector finances, adds around a further £1,300 billion to PSND.
Ouch! You might think and you would be right. You might also wonder why it has taken so long for these numbers to be added to the figures and here I feel that the ONS does have questions to answer. Some of the answer is provided by the figures shown below I feel for the UK national debt.
net debt of £2,322.7 billion including interventions, equivalent to 154.9 per cent of gross domestic product
net debt of £889.1 billion excluding interventions, equivalent to 59.3 per cent of gross domestic product
As you can see there is quite a difference and one immediately wonders what the ratings agencies will think of this. Personally I have always produced and analysed numbers including financial interventions because we have intervened. The official line is that “These effects are considered temporary”, in which case there is no problem and we will soon be able to deduct them will we not? Otherwise that poor old word temporary is taking a pounding again. Many commentators use the numbers excluding financial interventions which I have long suspected is because the ONS puts them at the top of the list!
However some care is needed with these numbers because the banks do have assets to set against these debts. However there is something troubling in that if we analyse this and the emphasis is mine.
This series is calculated as financial liabilities less liquid assets; it includes most liabilities but excludes illiquid assets for instance, in the form of lending to businesses; for mortgages and holdings of corporate bonds. The latter exclusion is important because the public sector banking groups have considerable amounts of illiquid assets.
The reason why I have highlighted this is that some 2 to 3 years ago this is precisely how the credit crunch spread. So after all this time we appear to be not a lot closer to knowing exactly where we stand and this is my biggest criticism of all of official policy and Mr.King. The time should have been spent making sure that as far as humanly possible we do know and responding if necessary rather than trying to kick the can down the road.
The US Economy
As today’s article is already rather long I will merely point out that there were further signs of housing market weakness in the United States yesterday continuing the recent trend. The State of the Union Address talked about reducing the fiscal deficit but in my view there was more talk than likely action. As the FOMC is holding a meeting I will look at the US economy tomorrow.