After considering the issue of Helicopter Money which is generating ever more column inches yesterday there comes the issue of when and why it might be applied in the UK? At first it seems unlikely as the Bank of England targets an annual rate of Consumer Price or CPI inflation of 2% per annum and unless the price of oil continues to fall we will head back up towards that over the next year or so as services inflation is in fact above the 2% target.
However this ignores two factors the first of which is that the Bank of England looked the other way when both CPI and Retail Price Index or RPI inflation pushed above 5% in the autumn of 2011. This has posed a question to the Forward Guidance of Mark Carney and the Bank of England which itself has undergone continual changes and is now around version fourteen. The reason why it did not act in 2011 was based on another part of its remit which has been strengthened since then and the new version is below.
Subject to that, to support the economic policy of Her Majesty’s Government, including its objectives for growth and employment …….
There have been clear signs that the inflation target has become subject to the growth objective meaning that the Bank of England has become more like the US Federal Reserve. Also the definition of government policy poses a challenge for those who claim “independence” for the Bank of England as the description of the government’s economic objective opens with a clear implied direction for it.
Monetary activism and credit easing, stimulating demand, maintaining price stability and supporting the flow of credit in the economy;
As to QE and other similar policies well there seems to be even less “independence” here.
I shall expect the Committee to work with the Government to ensure the appropriate governance arrangements are in place to ensure accountability in the deployment of such instruments.
Also this bit seems to allow the Monetary Policy Committee to bring inflation back to target over an unspecified time period that it defines.
In exceptional circumstances, shocks to the economy may be particularly large or the effects of shocks may persist over an extended period, or both. In such circumstances, the Monetary Policy Committee is likely to be faced with more significant trade-offs between the speed with which it aims to bring inflation back to the target and the consideration that should be placed on the variability of output.
UK economic growth
The reason I raise this is that there are more and more signs of a fading in the economic growth achieved by the UK economy. The NIESR started this around a month ago.
Our monthly estimates of GDP suggest that output grew by 0.3 per cent in the three months ending in February 2016 after growth of 0.4 per cent in the three months ending in January 2016
They blame this on a weak December and think that the rate may be 0.4% now on a quarterly basis. Only this week we saw that the Purchasing Managers Indices or PMIs calculated by Markit came to a similar conclusion.
An upturn in the pace of service sector growth in March was insufficient to prevent the PMI surveys from collectively indicating a slowdown in economic growth in the first quarter. The surveys point to a 0.4% increase in GDP, down from 0.6% in the closing quarter of last year.
They also pointed out that this was affecting an area of the economy which has in the credit crunch era been the strength of it.
Across the three main sectors of the economy, firms reported the smallest increase in demand for just over three years, which in turn fed through to a reluctance to take on new staff. March saw the weakest rate of job creation for over two-and-a-half years.
A Bank of England with a growth objective will quickly be mulling a reduction in economic growth combined with for the first time in a while weakness in employment growth. Especially if this bit becomes true.
In contrast, the survey data suggest growth is more likely to weaken further in the second quarter. With the PMI already in territory traditionally associated with the Bank of England choosing to loosen policy………
There is a clear hint there and would the Bank of England use the fears it has contributed to over a possible Brexit from the European Union to ease policy and cut the Bank Rate? It would be Forward Guidance version fifteen if it did.
Monetary Policy has been easing
One area where UK monetary policy has seen an easing has been in the exchange rate of the UK Pound £. The strength of the US Dollar pushing us back to US $1.41 has been joined by the Euro pushing us below 1.25. My subject of earlier this week Japan comes back to the fore as the Yen rises to 155 to the Pound. If we look at the trade-weighted or effective exchange-rate it has fallen over the past year by the equivalent of a 1.5% reduction in Bank Rate. We are reminded once again that these days movements in exchange-rates are the major player in monetary policy. Actually the UK Pound £ rallied gently in 2015 so using the old rule of thumb you can argue that the equivalent of a 1.75% Bank Rate cuts has taken place so far in 2016.
We also see that Gilt yields have fallen so far in 2016. Of those the most significant is the 5 year Gilt yield because of the way it influences fixed mortgage-rates and it has fallen from 1.35% to 0.78% in 2016 so far. Thus we see that without the Bank of England doing anything monetary policy has eased in the UK in 2016. Indeed this makes its Forward Guidance look about as effective as King Canute’s effort with the tide.
There is inflation if you look
This morning we have received another taste of the UK house price boom.
House prices in the latest three months (January-March) were 2.9% higher than in the preceding three months ……. Prices in the three months to March were 10.1% higher than in the same three months a year earlier.
This is of course around 5 times the increase in real wages over this time period which is why first time buyers need so much “help” these days. Also according to the official data those renting are having problems too.
Among all renters, the proportion of household disposable income accounted for by rents has risen from 12% in 1986 to close to 20% in 2014. Among private renters the fraction is higher still: close to 25% on average in 2014. This ratio was highest in London in 2014 – where more than one-third of disposable income in privately renting households was absorbed by rent.
It seems to have all got more expensive without there apparently being any inflation or something like that.
As I have demonstrated today the Bank of England has in fact presided over quite an easing of UK monetary policy in 2016 so far. It has had an opportunity to actually deploy some of its Forward Guidance in response yet it has not. In fact with the talk of Helicopter Money we seem to find ourselves being led to another round of easing which is as I pointed out yesterday rather odd in a claimed boom, Perhaps it is worried what will happen when the beneficial impact of lower oil prices on domestic demand starts to wear off.