One of the features of economic life is that there are a lot more reinventions of old ideas than there are new ones! One of these has been exhumed and shocked back to life by The Economist magazine and it is nominal GDP (Gross Domestic Product) targeting. Perhaps they hoped that everyone has forgotten! But the gist of the argument is that there were flaws in the system of targeting consumer inflation in the run-up to the credit crunch and that nominal GDP growth targeting would be a better system. Firstly let me agree that the advent of the credit crunch plainly did show up the flaws inherent in the consumer inflation targeting system of central banks. However as someone who replied to the Bean Review of UK Economic Statistics on Friday and is off to discuss the matter this evening at the Royal Statistical Society it is clear that so many issues are raised here.
What does the Economist argue?
It opens with this.
That is because the usual relationship between inflation and unemployment appears to have broken down.
Although he was looking at average earnings and unemployment Ben Broadbent of the Bank of England was not convinced of this.
Uncannily, the regression line was pretty much exactly the same as that identified by A.W.Phillips
But if we continue with the theme we are told this.
Now, by contrast, unemployment has fallen to remarkably low levels, but inflation remains anaemic.
Unlike The Economist I see this as a good thing! Fewer people are out of work and to coin an old phrase “the pound in their pocket” is going further or at least being much less affected by the ravages of inflation. To continue with the theme it is implied that this is a bad thing.
Their recoveries have instead proved nearly inflation-free
This has then proved to be a problem for central banks in setting policy. You may note the implied view is that a few central bankers are more important than the general population who are having their best economic phase for a while. So there is a bit of a straw man issue here but let us investigate the proposed solution.
Oh and perhaps no-one at The Economist has tried to buy a house in the past couple of years.
Nominal GDP targeting
Let us first check on what is meant by nominal GDP or NGDP.
the sum of all money earned in an economy each year, before accounting for inflation
This would do the following according to The Economist.
A target for NGDP growth (ie, growth in cash income) copes better with cheap imports, which boost growth, but depress prices, pulling today’s central banks in two directions at once
Does it? As it is reduced itself by lower inflation I think that they should be very careful with that argument. Let me explain with some numbers. The NGDP target has usually been for 5% with the breakdown hopefully for its supporters being 3% real GDP growth and 2% inflation. So in the UK right now we have not far of 3% real GDP growth but very little inflation, so they would stimulate the economy to hit the 5% target? That does not seem to help much! Rather than tighten central bankers would be easing into a boom, what could go wrong?
Some may think the real reason for NGDP targeting is shown blow which is why I have emphasised this sentence.
Nominal income is also more important to debtors’ economic health than either inflation or growth, because debts are fixed in cash terms.
With apologies to Meghan Trainor this sounds rather like this.
I’m all about that debt.
So many so-called reforms boil down to this which is in effect as confession that there is too much debt and we need to inflate it away except of course they are trying to do so by creating a fog where this is hidden. A bit like those who want a 4% inflation target. So in a world where in one sense there has been plenty of printed narrow we discover as we look at the wider situation that the situation is Simply Red.
Money’s too tight to mention
Oh mo-ney mo-ney mo-ney mon-ey
Mo-ney’s too tight to mention.
Debts are fixed in cash terms
Someone had better tell the UK Debt Management Office as it has some £506.6 billion of UK index-linked Gilts in issue by market value. These are indexed to Retail Price Inflation in the UK. Whilst the UK has a relatively large inflation-linked bond market it is far from alone.
The other problems with NGDP targeting
The Economist addresses the issue in one sentence.
Critics fret that NGDP is hard to measure, subject to revision, and mind-bogglingly unfamiliar to the public.
I have no idea why they are so hung up on the last bit as it could be explained. If we look at the numbers and assume a 5% target we have another problem. According to FRED (San Francisco Fed) UK NGDP growth has gone 4.7%,4.6%,4.3% and 3.4% over the past four quarters so we should be stimulating the economy?
Oh and there is another problem you see back in the second quarter of 2010 NGDP growth was running at an annual rate of 6.25%. Well actually not a problem for me as I was arguing that the UK was heading for inflation problems and needed to take action but I was rather alone, oh and correct. But for NGDP targeters there was 5%,6.25% and then 5% so happy days! What happened next?
Can we measure NGDP reliably?
Nope. GDP is often revised heavily and if we look back into UK economic history we see that the 1967 devaluation of the UK Pound £ was not necessary and that Denis Healey probably did not have to call in the IMF in 1976. More recently there was the “triple-dip” for UK GDP that in fact was not! You may be spotting something of a flaw here.
As a flow concept it measures construction of things but does not measure destruction meaning that wars for example boost it. There is a wide margin of error which invariably gets forgotten. I also think that it is poor at adjusting for technological changes -one of my points made to the Bean Review was about the measurement of the UK service-sector- and right now is a period of extraordinary technological change in many areas.
I guess some of you are thinking right now about the contribution of Volkswagen and perhaps quite a few other car manufacturers to GDP!
Another way of considering this is to look at the troubled series for US GDP in the 1st quarter of 2015. The nominal version went +0.1%.-0.9% then -0.2%. The annualisation makes this worse but there is a problem here.
Oh and there are three versions of GDP which are output expenditure and income. Most countries use output but Japan for example uses expenditure. They should come to the same answer but they do not except in the UK! Are we better at it? No, back when he was Chancellor Nigel Lawson insisted on it. Meanwhile in the United States the income and output measures give rather different answers. Or as the Bureau of Economic Affairs puts it.
For a given quarter,the estimates of GDP and GDI may differ for a variety of reasons, including the incorporation of largely independent source data.
Perhaps this was in someones diary to try again in three years as pretty much that time ago I pointed out this.
Put another way it feels at times like the episode of Star Trek where Captain Jean-Luc Picard is trapped in a repeating loop.
By escaping from the loop Captain Picard did better than the economics profession which is back to the past. Three years ago I pointed out this.
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!
This neatly fits with one of the points I intend to make tonight at the Royal Statistical Society. If you put in asset price inflation such as house prices you get a very different picture where there is disinflation in some areas but inflation in others. One thing we can be sure of is that establishment wheezes to try to hide inflation will continue.
In many ways it would suit the new economic advisory panel for the Labour party although no-one seems to have suggested it yet