Why are central bankers so afraid of the truth?

We find ourselves in an era where central bankers wield enormous power. There is something of an irony in this. They were given the ability to set monetary policy as a way of taking power out of the hands of politicians.This led to talk of “independence” as they set interest-rates to achieve an inflation target usually but not always of 2% per annum. Actually this is the first falsehood because we are regularly told this.

The ECB has defined price stability as a year-on-year increase in the Harmonised Index of Consumer Prices (HICP) for the euro area of below 2%

They could also tell me the moon is full of cheese but I would not believe that either. I am amazed how rarely this is challenged but price stability is clearly an inflation rate of 0%, The usual argument that this stops relative price shifts collapsed when the oil price fall of 2015/16 gave us inflation of around 0% as plainly there was a relative price shift for oil and indeed other goods. Perhaps the shrieks of “Deflation” were a type of distraction.

Next has come the way that claimed independence has morphed into collusion with the political establishment. This moves us away from the original rationale which was to take monetary policy power out of the hands of politicians to stop them manipulating it for the electoral cycle. What had apparent success which was technocratic control of interest-rates has morphed into this.

  1. Interest-Rates around 0%
  2. Large-Scale purchases of sovereign bonds
  3. Large-Scale purchases of private-sector bonds
  4. Credit Easing
  5. Purchases of equities ( for monetary policy and as a consequence of exchange-rate policy)
  6. Purchases of commercial property so far via Exchange-Traded Funds or ETFs

Not all central banks have gone all the way down the list with the Bank of Japan being the leader of the pack and who knows may go even further overnight at its unscheduled meeting? I should add as people regularly look at my back catalogue that by the time anyone in that category reads this we may see many central banks at step 6 and maybe going further. But back to my collusion point here is some evidence.

I also confirm that the Asset Purchase Facility will remain in place for the financial year 2020-21.

This is almost a throwaway sentence in the inflation remit from the Bank of England but it is in fact extremely important in two ways, and in tune with today’s theme neither of which are mentioned. The Chancellor Rishi Sunak is reaffirming that Her Majesty’s Treasury is backing the QE ( Quantitative Easing ) policies of the Bank of England which currently are steps 2 to 4 above. Next comes the issue of the amount which is huge even for these times.

The Committee voted by a majority of 7-2 for the Bank of England to continue with the programme of £200 billion of UK government bond and sterling non-financial investment-grade corporate bond purchases, financed by the issuance of central bank reserves, to take the total stock of these purchases to £645 billion.

The 2 dissenters voted for “More! More! More!” rather than less and I expect the extra £100 billion they voted for to be something sung about by The Undertones.

Happens all the time
Its going to happen – happen – till your change your mind
Its going to happen – happen – happens all the time

So we have a doom loop for supporters of independence as the politicians via backing any losses from QE become the masters again and the central bankers become marionettes. As so often we see Japan in the van by the way the Abenomics of Shinzo Abe appointed Governor Kuroda to the Bank of Japan pretty much as they would appoint a minister. It is the most exposed in terms of monetary policy via its 31.4 trillion Yen of equity holdings with a break-even it estimates at around 19,500 in terms of the Nikkei 225 index. Also of course an individual company in which it holds shares could fold.

Forward Guidance

This had a cacophony of falsehoods as we were promised interest-rate rises which failed to happen. In my own country it became laughable as an unemployment rate of 7% was highlighted and then unemployment rates of 6% and 5% were ignored. Then at Mansion House in June 2014 Governor Mark Carney said this.

There’s already great speculation about the exact timing of the first rate hike and this decision is becoming
more balanced.
It could happen sooner than markets currently expect.

In fact a bit over 2 years later he cut them whilst promising to reduce them further than November to 0.1% before economic reality even reached Threadneedle Street and the latter was redacted. It is hard to believe now but many were predicting interest-rate rises by the ECB in 2019 based on Forward Guidance. Of course the US Federal Reserve did actually give it a go before retreating like Napoleon from Moscow and as we recall the role of President Trump in this I would remind you of my political collusion/control point above.

Negative Interest-Rates

This area is littered with falsehoods. In Beatles terms it took only a week for this.

Bank of Japan Governor Haruhiko Kuroda said he is not thinking of adopting a negative interest rate policy now,

to become this.

The Bank will apply a negative interest rate of minus 0.1 percent to current accounts that financial institutions hold at the Bank.1 It will cut the interest rate further into negative territory if judged as necessary.

As Hard-Fi put it.

Can’t believe it
You’re so hard to beat
Hard to beat

The new Governor of the Bank of England seems to be on the same road to Damascus. From Sky News yesterday.

Mr Bailey told MPs it was now studying how effective that cut had been as well as “looking very carefully” at the experience of other countries where negative rates had been implemented.

On the prospect of negative rates, he said: “We do not rule things out as a matter of principle.

Curious because that is exactly what people had thought he had done several times in this crisis.

Comment

There are other areas I could highlight as for example there is the ridiculous adherence to the output gap philosophy that has proved to be consistent only in its failures. But let me leave you via the genius of Christine McVie the central bankers anthem.

Tell me lies
Tell me sweet little lies
Tell me lies, tell me, tell me lies
Oh, no, no, you can’t disguise
(You can’t disguise, no, you can’t disguise)
Tell me lies
Tell me sweet little lies

Me on The Investing Channel

 

Why inflation is bad for so many people

Today I wish to address what is one of the major economic swizzles of our time. That is the drip drip feed by the establishment and a largely supine media that inflation is good for us, and in particular an inflation rate of 2% per annum is a type of nirvana. This ignores the fact that that particular number was chosen by the Reserve Bank of New Zealand because it “seemed right” back in the day. There was no analysis of the benefits and costs.

On the other side of the coin there has been a major campaign against low or no inflation claiming it is the road to deflation which is presented as a bogey(wo)man. There are several major problems with this. The first is that many periods of human economic advancement are exhibited this such as the Industrial Revolution in the UK. Or more recently the enormous advances in technology, computing and the link in more modern times. On the other side of the coin we see inflation involved in economies suffering deflation. For example Greece saw consumer inflation rising at an annual rate of over 5% in the early stages of its economic depression. That was partly due to the rise in consumer taxes or VAT but the ordinary Greek will simply feel it as paying more. Right now we see extraordinary economic dislocation in Argentina where a monthly inflation rate of 4% in August comes with this from Reuters.

The country’s economy shrank 2.5% last year and 5.8% in the first quarter of 2019. The government expects a 2.6% contraction this year.

Argentina’s unemployment rate also rose to 10.6% in the second quarter from 9.6% in the same period last year, the official INDEC statistics agency said on Thursday.

The Euro Area

The situation here is highlighted by this release from the German statistics office this morning.

Harmonised index of consumer prices, September 2019
+0.9% on the same month a year earlier (provisional result confirmed)
-0.1% on the previous month (provisional result confirmed)

This is around half of the European Central Bank or ECB inflation target so let us switch to its view on the subject.

Today’s decisions were taken in response to the continued shortfall of inflation with respect to our aim. In fact, incoming information since the last Governing Council meeting indicates a more protracted weakness of the euro area economy, the persistence of prominent downside risks and muted inflationary pressures. This is reflected in the new staff projections, which show a further downgrade of the inflation outlook.

That is from the introductory statement to the September press conference. As you can see it is a type of central banking standard. But later Mario Draghi went further and to the more intelligent listener gave the game away.

The reference to levels sufficiently close to but below 2% signals that we want to see projected inflation to significantly increase from the current realised and projected inflation figures which are well below the levels that we consider to be in line with our aim.

My contention is that this objective makes the ordinary worker and consumer worse off.

Real Wages

The behaviour of real wages has changed a lot in the credit crunch era. If we look at my home country the UK we see that nominal wage growth has only recently pushed above an annual rate of 4%. But if we look at the Ivory Tower style projections of the OBR it should have pushed above 5% years ago based on Phillips Curve style analysis like this from their report on the 2010 Budget.

Wages and salaries growth rises gradually throughout the forecast, reaching 5½ percent in 2014…………Thereafter, the more rapid increase in employment is sufficient to lower unemployment, so that the ILO unemployment rate falls to
6 per cent in 2015.

As you can see wages growth was supposed to be far higher than now when unemployment was far higher. If they knew the number below was associated with a UK unemployment rate of below 4% their computers would have had a moment like HAL-9000 in the film 2001 A Space Odyssey.

The equivalent figures for total pay in real terms are £502 per week in July 2019 and £525 in February 2008, a 4.3% difference.

Real pay still has some distance to go to reach the previous peak even using a measure of inflation ( CPIH) that is systematically too low via its use of Imputed Rents to measure owner-occupied housing inflation.

It is the change here which means that old fashioned theories about inflation rates are now broken but the Ivory Tower establishment has turned a Nelsonian style blind eye to it. Let me illustrate by returning to the ECB press conference.

While labour cost pressures strengthened and broadened amid high levels of capacity utilisation and tightening labour markets, their pass-through to inflation is taking longer than previously anticipated. Over the medium term underlying inflation is expected to increase, supported by our monetary policy measures, the ongoing economic expansion and robust wage growth.

This is the old assumption that higher inflation means higher wage growth and comes with an implicit assumption that there will be real wage growth. But we have learnt in the credit crunch era that not only are things more complex than that at times things move in the opposite direction. There is no former rejection of Phillips Curve style thinking than the credit crunch history of my country the UK. Indeed this from the Czech National Bank last year is pretty damning of the whole concept.

Wage dynamics in the euro area remain subdued even ten years after the financial crisis. Nominal wage growth1 has seldom exceeded 2% since 2013 (see Chart 1). Wages have not accelerated significantly even since 2014, when the euro area began to enjoy rising economic growth and falling unemployment. Following tentative signs of increasing wage growth in the first half of 2017, wages slowed in the second half of the year.

Comment

It is the breakdown of the relationship between wages and inflation that mean that the 2% inflation target is now bad for us. The central bankers pursue it because one part of the theory works in that gentle consumer inflation helps with the burden of debt. The catch is that as we switch to the ordinary worker and consumer they are not seeing the wage increases that would come with that in the Ivory Tower theory. In the UK it used to be assumed that real wage growth would be towards 2% per annum whereas in net terms the credit crunch era has shown a contraction.

If we look at the United States then last week’s unemployment report gave us another signal as we saw these two factors combine.

The unemployment rate declined to 3.5 percent in September, and total nonfarm
payroll employment rose by 136,000, the U.S. Bureau of Labor Statistics reported
today………In September, average hourly earnings for all employees on private nonfarm payrolls,
at $28.09, were little changed (-1 cent), after rising by 11 cents in August. Over the
past 12 months, average hourly earnings have increased by 2.9 percent.

It is only one example but an extraordinary unemployment performance saw wage growth fall. There have been hundreds of these butt any individual example the other way is presented as a triumph for the Phillips Curve. Yet the US performance has been better than elsewhere.

Oh did I say the US has done better, Here is the Pew Research Center from last year.

After adjusting for inflation, however, today’s average hourly wage has just about the same purchasing power it did in 1978, following a long slide in the 1980s and early 1990s and bumpy, inconsistent growth since then. In fact, in real terms average hourly earnings peaked more than 45 years ago: The $4.03-an-hour rate recorded in January 1973 had the same purchasing power that $23.68 would today.

All of this is added to by the way that rises in the cost of housing are kept out of the consumer inflation numbers so they can be presented as beneficial wealth effects instead.

The claims that higher inflation is good for us are not backed by reality

Some issues just keep returning like a boomerang and the idea that higher inflation is good for us is something that makes me think of these lines from Hotel California by The Eagles.

They stab it with their steely knives,
But they just can’t kill the beast.

This is an issue that the Ivory Towers return to again and again in spite of the fact that the evidence is the other way. Let me show you what has triggered the revival of this particular beast. From Eurostat yesterday.

Euro area annual inflation is expected to be 1.2% in May 2019, down from 1.7% in April according to a flash
estimate from Eurostat, the statistical office of the European Union.
Looking at the main components of euro area inflation, energy is expected to have the highest annual rate in May
(3.8%, compared with 5.3% in April), followed by food, alcohol & tobacco (1.6%, compared with 1.5% in April),
services (1.1%, compared with 1.9% in April) and non-energy industrial goods (0.3%, compared with 0.2% in April).

I have give you the full breakdown because as you note that inflation such as it is finds itself driven by energy and food prices. So the core measures so beloved of central bankers will be even lower than the headline. You can take your pick from the choices but if you exclude energy core inflation falls to 1% and the food category ( along with alcohol and tobacco) it falls even more to 0.8%.

The Perception

This is perceived to be a failure as inflation nutters look back to a headline inflation level of 2% last May. In terms of the ECB ( European Central Bank) target last May was bang on although if one indulges in some numerical pedantry we know that former President Jean-Claude Trichet defined the target as being 1.97%.

So we have fallen below it and the picture on the core measures is lower than that. Hence the argument that something needs to be done. This is added to by inflation expectations and here people like to concentrate on the 5year, 5year swap which this morning has fallen to 1.26% according to Bloomberg as opposed to the 1.8% that 2018 opened with. So if you believe it we will see lower inflation for the next five years.

Before I move on I would just like to be clear that I have little or no faith in that swaps contract as being reliable. Just like in other forwards markets it tells you what we know and think now which is not a reliable indicator of the future. Putting it another way Frederik Ducrozet has broken it down.

His breakdown, which is based on models used in a 2017 ECB working paper, show that actual inflation expectations have made up over 30% of the drop in the forwards pricing this year, up from less than 15% in the past year. ( from

As you can see even fans of the measure only think 30% of it is relevant

The Problem of a 2% Inflation Target

It is time for my regular reminder that the 2% inflation target was pulled out of thin air. Or to be more specific it was chosen because it “seemed reasonable” by the Reserve Bank of New Zealand. On that basis the 1.2% of the Euro area can also seem reasonable. Personally I would prefer it but I will come to that later.

Higher Inflation Targets

The Ivory Towers have regularly pressed for this as we step back in time to June 2014 and look at a working paper from the IMF.

This essay argues that a two percent inflation target is too low. It is not clear what target is ideal,
but four percent is a reasonable guess, in part because the United States has lived comfortably with
that inflation rate in the past.

Most of those would lived through such periods would not agree with that but remember it is a long way down to the reality of earth when your Ivory Tower is in the clouds. More recently Adam Posen of the Peterson Institute suggested this for the ECB.

committing itself to forms of fiscal quantitative easing, and working with other central banks to raise inflation targets above 2 percent.

As you can see we are being taken to extreme levels of central planning here. Back when he was at the Bank of England Adam Posen supported ever more extreme monetary measures but we never get an answer to the question why we always need more? Also of course he left the Bank of England due to this.

‘They should have somebody who gets it right and not me. I am accountable for my performance.’

You may not be surprised to read that he got inflation wrong after expecting a decline and getting an overshoot.

The Ordinary Person

If we look at a breakdown of inflation in 2018 from Eurostat the ordinary person might be convinced inflation is already at the levels the Ivory Towers want.

On average, household electricity prices in the European Union (EU) increased to €21.1 per 100 kWh (+3.5%),
between the second half of 2017 and the second half of 2018………Household gas prices increased by 5.7% on average in the EU between the second semester of 2017 and 2018 to €6.7 per 100 kWh.

Also the Ivory Towers look at inflation numbers and make a clear error which is not to acknowledge the fact that we require housing. The Euro area numbers only account for those who rent and not those who own so let me help out a bit.

House prices, as measured by the House Price Index, rose by 4.2% in both the euro area and the EU in the fourth
quarter of 2018 compared with the same quarter of the previous year. These figures come from Eurostat, the
statistical office of the European Union.
Compared with the third quarter of 2018, house prices rose by 0.7% in the euro area and by 0.6% in the EU in the
fourth quarter of 2018.

We do not know the more up to date numbers but if we take the broad sweep they would be an upwards influence if they were counted in the official measure as they were supposed to be. I will not tire you with the details here as it is an area of expertise for me and to cover it fully is worthy of an article on its own. But the summary is that after years of what the apocryphal civil servant Sir Humphrey would call “fruitful work”    we have arrived back at the beginning or if you prefer it in musical terms.

We’re on a road to nowhere
Come on inside
Takin’ that ride to nowhere
We’ll take that ride ( Talking Heads)

Thus our Ivory Towers with their core measures make a pretty clean sweep of missing the areas which are most vital as we note they include food,energy and shelter.

Comment

There are two essential problems with the arguments above. The opening one is the changed behaviour of wages. Pre credit crunch we had the so-called NICE period where wages growth generally exceeded inflation. It changed things and the pattern now is that the relationship was broken as we have seen periods where real wages have fallen. In my country the UK the sharpest real wages fall came when Adam Posen got the sort of thing he wanted as inflation went above 5% but wage growth did not respond. Putting it another way we got a real wage boost when inflation fell in the period 2015/16 which was exactly the reverse of the somewhat hysterical headlines from that period suggested. Also since my post of the 29th of January 2015 I have regularly pointed out that lower inflation has clearly been a boost for retail sales across a wide range of countries.

Next comes an issue which I will highlight with a simple question. Why do we always need more stimulus? The proponents of them never answer this. The issue that we may make marginal temporary gains but face permanent losses gets marginalised and pushed aside.

Also the stimulus has quite often failed in generating either inflation or growth. The place that has tried pretty much everything is Japan and here is Governor Kuroda from the end of last month.

Bank of Japan Governor Haruhiko Kuroda said major central banks may have to become more flexible targeting inflation, as they are missing targets due to the price dampening effects of technological innovations and globalisation.

He is getting so desperate he now needs to present “technological innovations ” as a bad thing. I bet he will not be getting rid of his smartphone.

 

 

 

The Jackson Hole symposium should embace lower inflation

Later this week the world’s central banks will gather at the economics symposium of the US Kansas Federal Reserve at Jackson Hole in Wyoming. The description can be found below.

The 2017 Economic Symposium, “Fostering a Dynamic Global Economy,” will take place Aug. 24-26, 2017.  (The program will be available at 6 p.m., MT, Aug. 24, 2017).

It is appropriate that they do not yet know the program as the world’s central bankers find themselves at a variety of crossroads which they are approaching from different directions. It is also true that after all their expansionary monetary policy and “masters ( and mistresses) of the universe” activities over the last decade or so they now approach one of the most difficult decisions which is how to exit these programs. For some this will simply mean a slowing of the expansion. This all looks very different to when a speech on Forward Guidance was eagerly lapped up by a receptive audience and quickly became policy in many countries. After all Open Mouth Operations make a central banker feel both loved and important as we all hang on every word. Oh and there is a clear irony in the title of “Fostering a Dynamic Global Economy” for a group of people whose propping up of many zombie banks has led to anything but. That is of course assuming anyone knows what the phrase means in practice!

The inflation issue

The issue here is highlighted by this from Bloomberg today.

The world’s top central bankers head to Jackson Hole amid growing unease about low inflation.

Of course central bankers and those in the media subject to their brainwashing program may think this but the ordinary worker and consumer will be relieved. Should any of the central bankers suffer from stomach problems no doubt they will be delighted to discover this from CNBC.

Hikma Pharmaceuticals Plc’s U.S. subsidiary has raised the price of a common diarrhea drug by more than 400 percent and is charging more for five other medicines as well, the Financial Times reported on Sunday……The average wholesale price of a 60 ml bottle of liquid Atropine-Diphenoxylate, a common diarrhea drug also known as Lomotil, went from about $16 a bottle to $84, the FT reported.

Central banker heaven apparently and what needs looking into in my opinion is the clear examples of price gouging we see from time to time. Also more mundane products are seeing price rises. From Mining.com last week.

The iron ore price is now trading up a whopping 43% from its 2017 lows struck just two months ago.

According to Yuan Talks the Dalian futures contract rose 6.6% today before price limits kicked in. It is not alone as the Nikkei Asian Review points out.

Three-month zinc futures were at their highest level in 10 years, at about $3,100 per ton, rising 26% over the same period.
Aluminum also rose 10% over the same period.

So as well as raising a smile on the face of the heads of the central banks of Canada and Australia there are hints of some commodity inflation about. This provides a counterpoint to the concerns about low inflation which in the Euro area and the US is not that far below especially when we allow for the margin of error.

Does QE lead to inflation?

Some care is needed here as of course we have seen waves of asset price inflation across a wide range of countries. But of course the statistical policy across most of the world is to avoid measuring that in consumer inflation. Then it can be presented as growth which for some it is but not for example for first time buyers. However one of the building blocks of economics 101 is that QE ( Quantitative Easing) leads to inflation. Yet the enormous programs in the US and the ongoing one in the Euro area have not got consumer inflation back to target and the leader of the pack in this regard Japan has 0% inflation. After all the money involved has it simply led to price shifts? That is especially awkward for Ivory Tower theorists as they are not supposed to be able to happen with ~0% inflation so I guess they sent their spouse out to fill up the car as the petrol/diesel price fell.

More deeply whilst the initial effect of QE should have some inflationary implications is there something in it such as the support of a zombie business culture that means inflation the fades. It could of course be something outside of the monetary environment such as changing demographics involving ageing populations. Perhaps it was those two factors which broke the Phillips Curve.

As to future prospects there are two issues at play. The US Federal Reserve will start next month on an exit road which I remember suggesting for the Bank of England in City-AM some 4 years ago. If you do not want QE to become a permanent feature of the economic landscape you have to start somewhere. The issue for the ECB is getting more complex mostly driven by the fiscal conservatism of Germany which means that a supply crunch is looming as it faces the prospect of running out of German bonds to buy.

Currency Wars

There are two specific dangers here which relate to timing ( during thin summer markets) and the fact that markets hang on every central banking word. Eyes will be on the Euro because it has been strong in 2017 and in particular since mid April when it did not quite touch 93 on its effective ( trade-weighted) index as opposed to the 98.7 the ECB calculated it at on Friday. It has put another squeeze on the poor battered UK Pound £ but of more international seriousness is yet another example of a problem for economics 101 as interest-rate rises should have the US Dollar rising. Of course there is a timing issue as the US Dollar previously rose anticipating this and maybe more, but from the point of Mario Draghi and the ECB there is the fear that cutting the rate of QE further might make the Euro rally even more. Although one might note that in spite of the swings and roundabouts along the way the Euro at 98.7 is not far away from where it all began.

The Bank of Japan is also facing a yen rallying against the US Dollar and this morning it briefly rose into the 108s versus the US Dollar. Whilst it is lower than this time last year the trend seemed to change a few months back and the Yen has been stronger again.

Comment

It is hard not to have a wry smile at a group of people who via Forward Guidance and Open Mouth Operations have encouraged markets to hang on their every word now trying to downplay this. If you create junkies then you face the choice between cold turkey or a gradual wind down. Even worse you face the prospect of still feeding addiction number one when a need for number two arises as sooner or later an economic slow down will be along. Or creating fears about low inflation when the “lost decades” of Japan has shown that the world does not in fact end.

If we move onto the concept of a total eclipse then I am jealous of those in the United States today. From Scientific American.

Someone said that it is like suddenly being in some sort of CGI of another world or maybe like a drug-induced hallucination that feels (and is) totally real.

No they have not switched to central banking analysis but if the excellent BBC 4 documentary ”  do we really need the moon?” is any guide we should enjoy solar eclipses whilst we still have them. Meanwhile of course there is Bonnie Tyler.

I don’t know what to do and I’m always in the dark
We’re living in a powder keg and giving off sparks.

 

 

 

 

The problems facing inflation targets

Today I wish to discuss something which if it was a plant we would call a hardy perennial. No I do not mean Greece although of course there has been another “deal” which extends the austerity that was originally supposed to end in 2020 to 2060 in a clear example along the lines of To Infinity! And Beyond! Nor do I mean the Bank of Japan which has announced it will continue to chomp away on Japanese assets. What I mean is central bankers and members of the establishment who conclude that an inflation target of 2% per annum is not enough and it needs to be raised. The latest example has come from the chair of the US Federal Reserve Janet Yellen. From Reuters.

Years of tepid economic recovery have Fed Chair Janet Yellen and other central bankers considering what was once unthinkable: abandoning decades-long efforts to hold inflation down and allowing price expectations to creep up.

I am not sure if the author has not been keeping up with current events or has been drinking the Kool Aid because since early 2012 the US Federal Reserve has been trying to get inflation up to its 2% per annum target. It managed it for the grand sum of one month earlier this year before it started slip sliding away again. Indeed for a while the inflation target was raised to 2.5% which achieved precisely nothing which is why the change has mostly been forgotten. From December 2012.

inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee’s 2 percent longer-run goal,

Of course the Bank of Japan has been trying to raise inflation pretty much since the lost decade(s) began. Anyway here is Reuters again on the current thinking of Janet Yellen.

In remarks on Wednesday, Yellen called an emerging debate over raising global inflation targets “one of the most important questions facing monetary policy,” as central bankers grapple with an economic rut in which low growth, low interest rates and weak price and wage increases reinforce each other.

There is a clear problem with that paragraph as this week’s UK data has reminded us “weak price” increases boosted both retail sales and consumption via the way they boosted real wages. The rationale as expressed below is that we are expected to be none too bright.

The aim would be a change of households’ and businesses’ psychology, convincing them that prices would rise fast enough in the future that they would be better off borrowing and spending more today……..Raising that target to 3 or even 4 percent as some economists have suggested would shift the outlook of firms in particular, allowing them to charge more for goods and pay more for labor without the fear that a central bank would step on the brakes.

They are relying on us being unable to spot that the extra money buys less. Oh and after the utter failure of central bank Forward Guidance particularly in the UK you have my permission to laugh at the Ivory Tower style idea that before they do things consumers and businesses stop to wonder what Mark Carney or Janet Yellen might think or do next!

The theme here is along the lines set out by this speech from John Williams of the San Francisco Fed last September.

The most direct attack on low r-star would be for central banks to pursue a somewhat higher inflation target. This would imply a higher average level of interest rates and thereby give monetary policy more room to maneuver. The logic of this approach argues that a 1 percentage point increase in the inflation target would offset the deleterious effects of an equal-sized decline in r-star.

In John’s Ivory Tower there is a natural rate of interest called r-star.

Meanwhile in the real world

Whilst I am a big fan of Earth Wind and Fire I caution against using their lyrics too literally for policy action.

Take a ride in the sky
On our ship, fantasize
All your dreams will come true right away

You see if we actually look at the real world there is an issue that in spite of all the monetary easing of the credit crunch era we have not seen the consumer inflation that central bankers were both planning and hoping for. The Federal Reserve raised its inflation target as described above in December 2012 because it was expecting “More,More, More” but it never arrived. For today I will ignore the fact that inflation did appear in asset markets such as house prices because so many consumer inflation measures follow the advice “look away now” to that issue.

If we move to the current situation and ignore the currency conflicted UK we see that there is a danger for central bankers but hope for the rest of us that inflationary pressure is fading. A sign of that has come from Eurostat this morning.

Euro area annual inflation was 1.4% in May 2017, down from 1.9% in April.

Tucked away in the detail was the fact that energy costs fell by 1.2% on the month reducing the annual rise to 4.5% from the much higher levels seen so far in 2017. As we look at a price for Brent Crude Oil of US $47 per barrel we see that if that should remain there then more of this can be expected as 2017 progresses. That is of course an “if” but OPEC does seem to have lost at least some of its pricing power.

Actually today’s data posed yet another problem for the assumptions of central bankers and the inhabitants of Ivory Towers. We have been seeing am improvement in the Euro area economy as 2016 moved in 2017 so we should be seeing higher wage increases according to economics 101. From Eurostat.

In the euro area, wages & salaries per hour worked grew by 1.4%…., in the first quarter of 2017 compared with the same quarter of the previous year. In the fourth quarter of 2016, the annual change was +1.6%

What if our intrepid theorists managed to push inflation higher and wages did not rise? A bit like the calamity the Bank of England ignored back in 2010/11. As an aside a particular sign that the world has seen a shift in its axis is the number from Spain which for those unaware is seeing a burst of economic growth. Yet annual wage growth is the roundest number of all at 0%.

Comment

Much has changed in the credit crunch era but it would appear that central bankers are at best tone-deaf to the noise. We have seen rises in inflation target as one was hidden in the UK switch to CPI from RPI ( ~0.5% per annum) and the US had a temporary one as discussed above and a more permanent one when it switched from the CPI to PCE measure back in 2000 ( ~ 0.3% per annum). I do not see advocates of higher inflation target claiming these were a success so we can only assume there are hoping we will not spot them.

The reality is quite simple the logical response to where we are now would be to reduce inflation targets rather than raise them. Another route which would have mostly similar effects would be to put house prices in the various consumer inflation measures.

Oh and something I thought I would keep for the end. have you spotted how the US Federal Reserve sets its own targets? I wonder how that would work in the era of the Donald?!

Music for traders

My twitter feed has been quite busy with suggestions of songs for traders. All suggestions welcome.

 

My suggestions for the McDonnell Review of Bank of England policy and mandate

The last 24 hours or so has seen several suggestions appear in response to the request by the Shadow Chancellor of the Exchequer John McDonnell for a review of the Bank of England’s remit on the 18th of October last year. So our first impression is that it is not only monetary policy which operates with a lag! Perhaps it is economists too.

However the mandate of the Bank of England is very important and mostly unknown to the public it has been shifting in recent times as the primacy of the inflation target where the Consumer Price Index is supposed to rise at 2% per annum has been reduced. Successive changes have brought in a sentence which poses its own problems.

Subject to that, to support the economic policy of Her Majesty’s Government, including its objectives for growth and employment.

I have two issues with this. The first is that it is rather wishy-washy and the second is that I am in the camp who believe that most of the post credit crunch Bank of England policy has been to deliver the second objective and not the first.

My suggestions are different

The two suggestions I have seen over the past 24 hours from Tony Yates and Gabriel Sterne both come from people who worked at the Bank of England and can be classified as insiders to both the Bank and its way of thinking and to the UK establishment.I note that two members of the review team ( David Blanchflower and Adam Posen) are what I would describe as Bank of England insiders too. With respect to them and their views what is needed is some outsider thinking as most people reading this will recognise that if things were going so well we would not be where we are.

Also there has been debate on this issue – as so often in the modern era on Twitter with advantages of timing but of course only 140 characters – which has headed in the direction of a rise in the inflation target. For example Tony Yates suggested this.

Inflation target: a rise in the inflation target, to something like 4%, the level to be reviewed by some third party body, i.e. not BoE, not HMT, and to take effect 2-3 years after getting inflation back to the old target. This being the surest way to minimise future trips to the zero bound. Level to be reviewed every 5 years.

The online debate saw Dame Kate Barker ( ex Bank of England ) suggest that she would in time prefer a 3% inflation target. So the insider view is for a higher target whereas I would change it but my changes would be in the direction of (mostly) tightening it as I will explain below. Let us not be like the Bank of Canada which after pointing out there are grounds for a lower inflation target seems set to ignore them and head the other way.

The Inflation Target

If we look back in time we see that the inflation target of 2% per annum actually arrived by fluke as it “seemed right” rather than being the result of a fundamental econometric study. Also my contention is that the UK inflation infrastructure saw a loosening back in the period 2002/03 when the Consumer Price Index replaced the Retail Price Index. This was for two reasons of which the first is that the gap these days between CPI and RPI is now of the order of 1% whereas the target changed only by 0.5%.

Also secondly I would argue that what we saw pre credit crunch was an asset bubble and the change from CPI to RPI took out the asset measure (house prices) some five years or so earlier. It was supposed to be put back in but that got “forgotten”. Actually Europe is on the road to putting it back in (although their methodology is flawed) and we should do the same. Our perspective of consumer inflation would change if we properly measured it via introducing a house price influence.

In general the influence here would be to raise the level of measured inflation and would for example change the view right now of where we are. Of course the action would be in reverse on the rarer occasions when UK house prices fall.

Just to be clear I have spent quite some time at the Royal Statistical Society (RSS) debating these issues and am aware that there is a theoretical inconsistency in including house prices in a consumer inflation measure. However the debate there pretty much accepts this now as the theoretically consistent approach has again failed with the shambles that trying to use rents as a measure of house/asset prices has been. To this end I would direct people towards the Household Inflation Index developed by Jill Leyland and John Austin at the RSS which is an improvement on what we currently have in my view. No inflation measure is perfect but some are more equal than others to coin a phrase.

Accountability

This is a something I have been advancing for over five years now so let me state my proposal from September 2010.

Also I have a further thought and it does indicate quite a change. As the role of the Monetary Policy Committee has changed and expanded more than could have been forecast when it was introduced in 1997  there need to be new checks and balances on its power. My suggestion for a change is that MPC members should stand for election as they are currently much more powerful than many of our elected representatives.

Let me add to this that such a case is in my view even stronger should you decide to follow the suggestions you have already received. A further increase in the power of the Bank of England requires more democratic accountability or we will make the same mistake as the Euro area did when it appointed technocrats. Democracy has to be complete or it fails.

One area where I agree with the proposals you have received is that the number of external members needs to be increased from the current 4. If it was raised to 5 as Gabriel Sterne suggests then they would be in a theoretical majority albeit a tenuous one in practice and if they were elected they would also have a mandate. This gets ever more necessary as the power of the Bank of England increases and is especially important were you decided to give it (more) fiscal power as Tony Yates suggests. I say more because QE (Quantitative Easing) has already influenced fiscal policy.

This move would also return some independence to the Bank of England. As it stands it is subject to the critique that it is not independent at all and I have argued this and believe it. Giving the external members a majority and subjecting them to election would change this for the better.

Alternative Targets

As the issue of nominal GDP (Gross Domestic Product) targets has been raised elsewhere I agree with the proposals I have seen that it would be a mistake. The revisions to GDP growth make that case rather eloquently. One would often be chasing a mirage.

Forward Guidance

This has become one of the worst four-letter words which can be applied to monetary policy which is that it has become a joke. So let us put it out of its misery and end it.

Foreign Exchange Reserves

The position here needs clarifying as I have read in the past that both the Bank of England and the government could use the reserves and now note this from the UK Government website.

Specific prior authority from Treasury Ministers is required for intervention designed to influence sterling exchange rates using the EEA, or for EEA participation in concerted intervention in support of any other currency

This needs clarity as in a crisis situation the idea of the Bank of England raising interest-rates in response in the way we have seen in Africa,Russia and Ukraine but not controlling foreign exchange reserves use seems to be a case for “order, counter-order, disorder” to me.

Conclusion

This is in essence my case and your will find on this website a lot more detail and information on the issues discussed. Also I wish to make it clear that these suggestions are for all political parties as I run a non-partisan operation. I have contacted the Chancellor of the Exchequer in the past on economic issues but for no other reason than he was and indeed is the Chancellor. In the same way I contacted the Portuguese government as the Euro crisis built up. Should either of them give me the courtesy of a reply I will let you know. I would also be more than happy to discuss my views on this issue with any of the other political parties.

We also have a situation where economic policy across the world is run more and more by central bankers as elected politicians retreat from it. This has clearly been evident in the Euro area where the European Central Bank has at times dictated to governments. So we are on a more dangerous road than many might think in my opinion and adding some democracy to the Bank of England would be a way of reversing the trend away from accountability.

Also my thoughts are open to reply and comment on here as you will find that readers come up with some good ideas which returns me to my point that we need to move on from what can look like a cosy insiders club. If that was going so well we would not be where we are.