Yesterday brought news about inflation targeting but before we get to what you might think is the headline act, it has been trumped by Prime Minister Abe of Japan. Before I get to that let me wish him well with his health issues. But he also said this in his resignation speech.
JAPAN PM ABE ON ECONOMIC POLICY: WE HAVE SUCCEEDED IN BOOSTING JOBS, ENDING 20 YEARS OF DEFLATION WITH THREE ARROWS OF ABENOMICS. ( @FinancialJuice)
You might think that this is almost at a comical Ali level of denial at this point. For those unaware this was the Iraqi information minister who denied Amercan soldiers were in Baghdad when well I think you have figured the rest. Even the BBC is providing an opposite view to that of Abe san.
The Japanese economy has shrunk at its fastest rate on record as it battles the coronavirus pandemic.
The world’s third largest economy saw gross domestic product fall 7.8% in April-June from the previous quarter, or 27.8% on an annualised basis.
Japan was already struggling with low economic growth before the crisis.
The current situation is bad enough but even if we give him a pass on that there is that rather damning last sentence. Let me give you some context on that. You could argue the 0.6% contraction in the Japanese economy was also Covid related but you cannot argue that the 1.8% contraction at the end of last year was. Indeed the quarter before that was 0%.
So Japan had not escaped deflation and in fact the problems at the end of last year were created by an Abenomics arrow missing the target. People forget now but the economic growth that Abenomics was supposedly going to create was badged as a cure for the chronic fiscal problem faced by Japan. In fact the lack of growth and hence revenue was a factor in the Consumption Tax being raised to 10%. Which of course gave growth another knock.
Inflation
Another arrow was supposed to lead to inflation magically rising to 2% per annum. How is that going? From the Statistics Bureau this morning.
The consumer price index for Ku-area of Tokyo in August 2020 (preliminary) was 102.1 (2015=100), up 0.3% over the year before seasonal adjustment, and down 0.4% from the previous month on a seasonally adjusted basis.
So it has taken five years and not one to hit 2%. For newer readers that was also the pre pandemic picture in Japan and it has mostly been possible to argue that there is effectively no inflation because the low levels are within any margin for error.
Also as a point of detail there is even more bad news for inflationistas which is that something which they clain cannot happen with zero inflation has. If you look in the detail food prices have risen by 7% and the cost of education has fallen by 7%, so you can have relative price changes. Looking at the national numbers it has been a rough run for fans of Salmon and carrots as prices have risen by more than 50% over the past 5 years.
The US Federal Reserve
The speech by Chair Powell opened with what may turn out to be an unfortunate historical reference.
Forty years ago, the biggest problem our economy faced was high and rising inflation. The Great Inflation demanded a clear focus on restoring the credibility of the FOMC’s commitment to price stability.
It is hard to know where to start with this bit.
Many find it counterintuitive that the Fed would want to push up inflation. After all, low and stable inflation is essential for a well-functioning economy. And we are certainly mindful that higher prices for essential items, such as food, gasoline, and shelter, add to the burdens faced by many families, especially those struggling with lost jobs and incomes.
I will simply point out that I am pleased to see a recognition that what are usually described by central bankers as “non-core” such as food and energy are suddenly essential. Perhaps the threats ( from The Donald) about him losing his job have focused his mind, although he would remain an extremely wealthy man.
He then got himself into quite a mess.
Our statement emphasizes that our actions to achieve both sides of our dual mandate will be most effective if longer-term inflation expectations remain well anchored at 2 percent. However, if inflation runs below 2 percent following economic downturns but never moves above 2 percent even when the economy is strong, then, over time, inflation will average less than 2 percent. Households and businesses will come to expect this result, meaning that inflation expectations would tend to move below our inflation goal and pull realized inflation down.
This really does come from the highest of Ivory Towers where the air is thinnest. Many households and businesses will not even know who he and his colleagues are! Let alone plan ahead on the basis of what they might do especially after the flip-flopping of the last couple of years. Even worse the 2% per annum target which was pretty much pulled out of thin air has become a Holy Grail.
This next bit was frankly not a little embarrassing.
In seeking to achieve inflation that averages 2 percent over time, we are not tying ourselves to a particular mathematical formula that defines the average. Thus, our approach could be viewed as a flexible form of average inflation targeting.
So it is an average but without the average bit?
Canada
This week the Bank of Canada inadvertently highlighted a major problem. It starts with this.
Deputy Governor Lawrence Schembri discusses the difference between how Canadians perceive inflation and the actual measured rate.
You see we are back to you ( and I mean us by this) do not know what you are paying and we ( central bankers know better). Except it all went wrong in a predictable area.
Over the last two decades, the price of houses has risen on average more than twice as fast as the price of housing, at a rate of 6 percent versus 2.5 percent.
There is the issue in a nutshell. Your average Canadian has to shell out an extra 6% each year for a house but according to Lawrence and his calculations it is only 2.5%. Someone should give him a pot of money based on his calculations and tell him to go and buy one.
The Euro area
We looked at variations in the price of Nutella recently well according to The Economist there are other issues.
Three enormous boxes of Pampers come to €168 ($198) on Amazon’s Spanish website. By contrast, the same order from Amazon’s British website costs only €74. (Even after an exorbitant delivery fee is added, the saving is still €42.)
This happens even inside the Euro area.
The swankiest Nespresso model will set them back €460 on Amazon’s French website, but can be snapped up for €301 on the German version. They could then boast about their canny shopping on Samsung’s newest phone, which varies in price by up to €300 depending on which domain is used.
I point this out because official inflation measurement relies on “substitution” where if the price rises you switch to something similar which is cheaper. But if people do not do this for the same thing inn the real world we are back in our Ivory Towers again.
Comment
Firstly we can award ourselves a small slap on the back as we were expecting this. From the movements in the Gold price ( down) and bond yields (up) far from everybody was. If we note the latter there are two serious problems for Chair Powell. The first is that if there is a body of people on this earth who follow his every word it is bond traders and they were to some extent off the pace. Thus all exposition about expectations above is exposed as this.
Every man has a place, in his heart there’s a space,
And the world can’t erase his fantasies
Take a ride in the sky, on our ship fantasii
All your dreams will come true, right away ( Earth,Wind & Fire )
Next is that if you take the policy at face value bond yields should have risen by far more than the 0.1% the long bond did. They did not rise by the 0.5% to 1% you might expect for two possible reasons.
- Nobody expected the Fed to raise interest-rates for years anyway so what is the difference?
- If there is a policy change it is mostly likely to be more QE treasury bond purchases which will depress bond yields.
So back to the expectations we see that the Fed is responding to expectations it has created. What could go wrong? Putting it another way it is living a combination of Goodhart’s Law and the Lucas Critique.
I brought in the Japanese experience because it has made an extraordinary effort in monetary policy terms but the economy was shrinking before Covid-19 and there was essentially no inflation.
However the stock market ( Nikkei 225) has nearly trebled since Abenomics was seen as likely. Oh and the Bank of Japan has essentially financed the government borrowing.
Podcast
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Hello Shaun,
I have not expected MSM to be anything except sensationlist and have the memory of a guppy.
It’s remit is all sales and attention seeking , it tells so many stories that the truth slips out by accident.
Yah, we both know that last year was a struggle , then we get this SARS2 virus .
So the economy was stagnent , ie sustainable ( only zero growth is sustainable – infinite growth in anything reaches its limits of its domain and people really do not understand the exponetional function) .
What cam be done?
Well just keep things stable I think, and let Goverments do the work ( if they can get their act together and stop panicking )
We shall see.
Forbin
Hi Forbin
There is an air of unreality about all this. Later today Bank of England Governor Bailey gave a speech suggesting he is a fan of unwinding QE to which I will add two counterpoints.
1.So far it has unwound not a single £.
2.He is only doing it so that when he does even more of it he can claim it was against his wishes but he had no choice etc….
Maybe he too will move to average inflation targeting but that in the UK is up to the Chancellor.
It all feels like shuffling deck chairs on the Titanic.
Sustainable growth is only impossible if you don’t believe:
1) our lives will stop constantly changing & nothing like tvs washing machines or home computers will stop being invented.
2) Industries which cause growth will cease to be invented by govts. (The “Climate Change” industry)
And so it goes on, the lies the distortions, the omissions, the fraud ad the treason, all aided and abetted by the governments and MSM.
In case we are ever accused of bias or groupthink on here, I challenge anyone to show any evidence that inflation targeting creates or leads to economic growth – the real kind I mean – not the statistical three card trickery used by classical Keynsian economists that include the inflation the central bank has created as GDP growth or under report the true inflation figure to make their bogus GDP number look better. Please someone just find that evidence, because as far as I know, no one has ever done it, so why do central banks persist in targeting an inflation figure they cannot even accurately predict let alone measure?
And as for Powell’s pathetic justification that peoples future expectations of lower inflation might lead to lower demand again no one challenges this patently absurd statement. As I have said on here before what consumer looks forward to paying more for goods in the future or seeing their buying power eroded by persistent inflation of any figure let alone 2%pa?
Who delays or cancels purchases because they might be cheaper tomorrow? A washing machine can be bought for £300 – the same price it was twenty years ago, but in the interim I don’t remember hearing stories from anyone whose machine had died and wanted to buy another waiting for the price to fall further do you?They would be still waiting and handwashing clothes twenty years on.The same goes for TV’s computers and most consumer electronics,if the price of food falls will consumers stop eating?if petrol prices fall will they stop driving until prices go back up?If they need an operation urgently will they hold off until the price stops falling?
It is just beyond absurd, but they know it but cannot tell you the REAL reason there has to be inflation. When a loan gets created, eventually it will be paid off so the accounts at the bank and the borrower will be balanced, er not exactly as there has in theory been no change in the money supply(when the loan was repaid the money was effectively cancelled)what about the interest? Where has the money come from to pay the interest? THAT is why the money supply has to be inflated continually in order to produce the money to pay the bank the interest, it is not difficult to see then that banking turns us all into hamsters running faster and faster on wheels just to keep our heads above water at the mercy of central banks who can increase rates and our repayments at a whim, or print more money to devalue your earnings and saving.
Good isn’t it? That’s why Henry Ford said if people knew how banking worked there would be a revolution in the morning. And that is why the MSM make sure no one ever does and has their economics correspondents/presstiutes tell them higher inflation is good for them.
In answer to your inflation targeting..
All central banks are duplicitous because
if any one of them decided to use common
sense or true accuracy their figures would
immediately look awful and we can’t have
that can we!
hi kevin,
you know , I think CB are just as trust worthy as second hand car sales person or estate agents……
what ever reason they give , they change the goal posts soon as it is met ( or looks as if it will be met). And MSM just can’t see the King has no clothes ……
oh well
Forbin
No second-hand car salesman will cause untold misery for 10s of millions, losing their homes, incomes & self-respect, whilst smiling & enjoying “rock-star” status.
The difference is orders of magnitude, which require a certain type of psycopathy.
The only “delayed purchase” I ever made was an airline ticket in the days when the last few seats were the cheapest (NY for £99 on Standby !) But then Stelios arrived and turned the whole business model upside down.
Kevin, I think you are asking the wrong question. Monetary policy is generally ineffective in targeting real variables of any kind, including real GDP growth. On the other hand, it can target the money supply, nominal GDP or the inflation rate. Not just in the UK, but in other countries, inflation targeting was tried because targeting of monetary aggregates was found wanting. I don’t expect that inflation targeting wiil be around for a thousand years, but for now I think it is still useful in the countries that have it and it should be reformed rather than replaced with average inflation targeting or whatever. In the G7 countries I think the problems with inflation targeting is the same for all of them: the target rate of inflation is too high and the target inflation indicator is wrong. However, maybe help is at hand. If the ONS updated its CPIH(NA) series so it was synchronous with the CPI and RPI release, it would be the best macroeconomic consumer price series in the world.
Just in case Powell’s explanation was too confusing for you, here is my translation:
We need lower rates to help the economy
Problem:Rates are already at zero
So we need higher rates!
So if we let inflation go out of control we then have a justification for raising rates
That will then give us the opportunity to then lower rates to help the economy!!!
Clear?
Its clear that once inflation is out the bag the FED and other central banks won’t be able to control it.
So zero chance of lower rates once they take off. (which means the f’ers have lost control)
I agree, Arthur, it’s a real worry. Robert Kavcic of BMO Economics wrote in “Low for Long-er-er”: “Keep in mind that bringing 10 years of 1.5% core PCE inflation back to 2% would require a decade at 2.5%, a serious task.” Long before that decade passed, I suspect the US Fed would have driven up inflation expectations and raised the costs of keeping a 2% target. The target rate would be raised to 2.5% or higher. If the same average-inflation targeting framework were maintained then the target rate could be ratcheted up some more.
Bank of Jamaica also very clear (and apparently want everybody in the world to know, loudly) that they want the “middle” amount of inflation, too little and the economy just won’t go… without explaining why that is.
It is interesting that prices do, in fact, seem to move about reasonably happily relative to each other in a zero or near-zero inflation environment. Which is one of the traditional arguments out of the window. However, do wages move around quite so easily? Particularly if you’ve got lots of people in formal employment contracts, rather than lots of self-employed and gig-economy workers, I can imagine that still being pretty sticky.
Thanks, MyBurningEars. I liked the ad with the sexy female guitarist best. The Bank of Jamaica’s target inflation range was set pretty high: 4% to 6% in 2017. With a 5% inflation rate, prices will double in 14 years. I wonder if they wouldn’t be better off with a currency board, pegging their currency to the US dollar. I know what Steve Hanke would say.
Great blog as usual, Shaun, and thank you very much for alerting me to Larry Scchembri’s speech to the Canadian Association for Business Economics (CABE). If I didn’t read your blog, I would have no idea what was happening in Canadian monetary policy!
Larry Schembri used to be an economics professor at Carleton University in Ottawa, where I first majored in economics, so I shouldn’t be mean to him, but unfortunately his speech and his answers in the Q&A were a continuation of a disturbing trend of the Bank of Canada (Boc) disseminating disinformation rather than information.
Before getting to house prices, at the 39:00 minute mark of the video, Larry is asked how the BoC’s 2% target rate was arrived at. He responded in part: “The 2% target has been in place since roughly 1993. We started off with a fairly wide band when we adopted inflation targeting in 1991 and it narrowed over time to the 1 to 3% band we have now with 2% as the midpoint.” In fact, the initial inflation-control agreement signed in February 1991 established a target of 3% by the end of 1992, 2½% by the middle of 1994 and 2% by the end of 1995, with a lower target rate consistent with price stability to be established with the first renewal agreement. So the 2% target was established in February 1991, but only applied to the end of 1995. In 1993 itself, the BoC was still supposed to be trying to achieve a 2½% target. The idea that the target range started broad and narrowed over time is entirely wrong. The 3% target was at the mid-point of a 2% to 4% target range, and the 2½% target at the mid-point of a 1½% to 3½% target range. Neither is the paper itself accurate in saying that “we established this specific [2%] target in 1993”, when as I just said, it was established in 1991, as a target for a period almost five years after. The significance of 1993 is that in December 1993, the first renewal of the inflation-control agreement, announced that the 2% target would continue to apply in 1996 and 1998, with the lower target rate compatible with price stability to be decided at the time of the 1998 renewal. The 1998 renewal in turn just kicked the ball down the field again, extending the 2% target to the end of 2001, with the lower target rate compatible with price stability to be determined then. The 2001 renewal agreement was, in fact, the first renewal agreement that made no promise of lowering the target rate with the next agreement and its language was even purged of references to price stability. The year 2001 might more appropriately be considered the year that 2% became the indeterminate BoC target rate.
Larry also made no reference to the last renewal agreement in 2016. According to the BoC’s own research, just as orange is the new black, 2.2% is the new 2%, since the 2% target adopted in 2016 was equivalent, given improvements in how the inflation rate was measured, to 2.2% at the time of the 2011 renewal agreement.
Larry notes “that a comparison of the CSCE with a similar survey published by the New York Federal Reserve Bank finds the perception gap is smaller and less dispersed in Canada than in the United States (Chart 2a and Chart 2b). This difference may reflect the impact of different communication strategies by the Bank of Canada and the US Federal Reserve.” Rather than taking credit for himself and his central bank, it might have occurred to him that part of the difference might be that the Canadian CPI does include housing and dwelling prices in it, while the US CPI contains neither. This is the more likely to be the case as until 1983, the US CPI adopted a net acquisitions approach to owner-occupied housing which gave a considerably greater importance to housing prices than they have in almost any country’s official inflation indicator today.
Larry also has an intriguing footnote: “There is a significant positive correlation between house price growth, as measured by the Teranet–National Bank House Price Index, and CSCE respondents’ inflation perceptions and expectations.” Not sure why this wasn’t in the main part of the paper. This index, very similar to the US Case-Shiller price index is probably the best index of existing house price change in Canada. The BoC itself obviously holds it in high regard, and frequently puts its data in charts and tables when analyzing the housing market. By contrast it obviously doesn’t care for StatCan’s new housing price index (NHPI) at all, although this is the only index used to calculate the CPI. (Bizarrely, even for real estate commissions, which almost always relate to existing dwellings, the NHPI data is used to calculate the CPI, or at least that’s how it was in 2012 when I left.) To show just how different the index movements are, for July 2020 the annual inflation rate for the replacement cost (i.e. house depreciation) component of the CPI was 1.6%. The corresponding NHPI inflation rate for dwellings for June 2020 was 1.3%. (There is a lag of a month in incorporating NHPI data in the CPI, and tax adjustments must also be made to the data to take it from a producer price to a consumer price valuation.) Pace Larry at the 33:40 point in the video, the replacement cost CPI is NOT based on house prices, but on fictive dwelling prices, contractors’ guesstimates of what their houses would sell for if only the dwelling were sold. However, the NHPI for dwellings is usually highly correlated with the NHPI for houses. The 11-city composite for the Teranet-National Bank HPI for June has an inflation rate of 5.9%, which is a truly staggering difference from the corresponding 1.6% inflation rate for the CPI. One of the obvious reasons for this difference, supported by StatCan’s own data, is that the Teranet-National Bank HPI includes condos while the NHPI, and therefore the CPI, excludes them. The condo component of the quarterly residential property price index shows a 9.3% annual inflation rate for 2020Q2, based on six large metropolitan areas of Canada. This data really should be incorporated in the CPI, but so far the BoC has treated its exclusion with the same bovine indifference that it extends to virtually all of the CPI’s defects.
Ask any average worker in Japan about lack of inflation and watch him or her laugh in your face.