Posts Tagged ‘deflation’

19 May

Defending the Bank of England

Posted by freethinkingeconomist in Uncategorized. Tagged: , , .

It is looking pretty dicey for the Bank and it’s inflation-fighting reputation.  Read Jeremy Warner (Does the inflation target actually mean anything any more?) and above all the point made clear in Simon Ward’s post yesterday (UK CPI inflation 3 percentage points above BoE year-ago forecast).  Here is a graph from last year’s May Inflation Report:

One quick observation: the prediction was based on 125bn of QE.  We have had 75bn more than that, which must have had some effect on inflation (though as I droned on in Credit Where It’s Due, the mechanisms are rather wobbly and demand-dependent).

Another is: how on earth did they make such a prediction when they knew VAT would be returning? Did they simply miss it out? the April CPIY index stands at 112.8, which is 2.1 points above the April 09 level of 110.7, or almost exactly 2 per cent higher.   This would put the forecast error down to 1 per cent.  But if it WAS CPI without tax which they were forecasting, they didn’t tell us.  I see a straight mistake.

A third observation is that Britain’s inflation is a bit of an exception within Europe.  See the charts from Wolf’s (rather boilerplate) post today:

A final observation (coz I have to go to lunch) is this: if the Bank has made a mistake, I would rather it made this one than the other one.  Reading Chris Giles today about what this means for you and me, it comes down to this: it makes living standards go down, but it may help make the budget deficit lower.   And so far households are not expecting it to last.  In other words, a one off transfer, lightening the biggest problem (government debt) and making all of us fairly evenly contribute to the problem.

This crisis needs measures OF THAT SORT to get the country back in balance: lower government debt, lower living standards.   (We could also do with being more competitive, which this doesn’t help, but weak sterling manages that).  Though I look like a hubristic fool to some (even though I stand by my points about Base Effects), actual deflation to such an indebted country suffering from insufficient demand may have been worse.

Lunchtime!

17 Mar

Oh sterling doommongers, where are ye?

Posted by freethinkingeconomist in Economics, Politics. Tagged: , , , , .

Remember those hazy days at the beginning of March? It was obvious, innit: a hung parliament spells doom to the pound.  Since then, the possibility of a hung parliament has remained just as strong (see Betfair)

and yet the Pound is up.  From the $1.50 level to $1.54.  Nothing spectacular: just enough to confirm my hunch that this is not “tories down, sell the pound’.     The sort of dumb stuff that Tory newspapers were and are desperate to believe.

Although FT Alphaville have every reason to pick on him, it was not just Jim Rogers.  Every saloon bar economist thinks that you can go from 1. not remembering what the UK produces (read Policy Exchange’s recent report on manufacturing) to 2. assuming the pound should fall.

Why is the pound up?  Perhaps the unemployment figures – stronger economy, stronger finances, safer gilts (gilts are also up today).  Perhaps the mildly hawkish BOE minutes. It is not likely to be eurozone strength: they have weaker prices than since the Euro was brought in.    Nor inflation in the US, which is still kinda missing.   Though if the UK is going to outgrow both these it might be good for the pound, it might just as easily translate into even more export weakness, more QE, and the other direction.

Unsurprisingly, though dismayingly for armchair political pundits determined to use their rules of thumb to dictate messages linking the Pound to Political Weakness, I think the direction of sterling is something to do with economics.  I have no idea where it is going, but don’t think it will be much to do with the latest gossip about Liberal Conservative alliances, no matter how well informed.

25 Feb

You can tell things are going downhill when ….

Posted by freethinkingeconomist in Economics. Tagged: , , , .

Jeremy Warner of the Telegraph is berating the heir-presumptive of the ECB, Axel Weber, for being anti-inflation:

Yet it is plainly better to be attempting to choke off an inflationary boom than to be in a Depression wondering how to get out. In a deflationary debt spiral, monetary policy becomes almost wholly impotent. However low rates go, people will still be keener to pay down debt than invest and consume. The risks of Depression are therefore much worse than those of inflation.

To be fair, I overreacted to his previous Stagflation post, where he admits that inflation is unlikely and deflation would be worse.  But for someone on the Telegraph to hint that pushing the inflation target out to 4% may be a lesser evil is pretty amazing.

And the FT is now doing a Double Dip Watch.  The link is very useful indeed.  And sad news: Krishna Gua, the excellent US monetary correspondent, is leaving for the Fed.

Sterling is down 2c today on the investment figures that Chris discussed.

Another straw in the wind is the way that UBS has warned of the consequences of more savage cutting.   See this from Ed Conway’s blog:

Taking too sharp an axe to the deficit  would “endanger tax revenues, Britain’s sovereign rating, the recovery of the banking sector and the UK labour market,” the strongly-worded report argues. With confidence in British policymaking gone, the pound would risk plunging to $1.05 against the dollar and slumping beyond parity for the first time against the euro

Everyone seems to agree now that the pace of recovery, and not the scale of the deficit, is the real problem.  See this on Stephanie Flanders’ blog.  Talking of the Man with a Shovel, she says:

On the basis of his testimony – and that of other members of the Monetary Policy Committee (MPC) - it is the state of the recovery that is clearly their major concern. We heard several times that “risks to the Committee’s central view of a gradual recovery of output remain to the downside”. Subtitle: we’re not out of the woods yet. Britain’s banks, households and government all need to get their balance sheets in order over the next few years, and bring down their stock of debt. That has long been a reason to expect a weak recovery. But, as King and his colleagues noted, the weakness of the recovery in the eurozone gives us another one.

This reminds me of the punchline to Slash and Grow (October 2009):

If the next British government proceeds upon the basis of deficit reduction before growth, it risks achieving neither.

I’m not claiming a toldyouso here: for most of the intervening few months, I was relatively bullish.   It is only since this around this time on 6th Feb I have thought the double-dip the biggest worry.  I don’t think economics is really about predictions as such; more tracing out consequences if X or Y happens.  And coming up with ideas for what to do: hence the column today.

16 Feb

I’ve been waiting for this: the price index drops. Innumerate right winger shouts ‘Inflation!’

Posted by freethinkingeconomist in Economics. Tagged: , , , .

Guido is SO confused on this one.  Because he seems not to understand how annual inflation figures are created, he presents the first fall in the index as proof that INFLATION is settling in.  Proving my prediction in a post a few weeks back:

How the Right will be screaming ‘Inflation’ as we go into deflation.

So what figures have come out?  Here is a graph of the CPI index:

In fact, when you use CPIY – which is I think the CPI without tax effects – you get this startling picture:

CPIY inflation has fallen from 2.7% to 1.9% in this month.

So Guido the Innumerate screams Inflation!! and his trolls all say Aye Aye sir.  As the price index drops.

UPDATE:  Hooray!  I knew the Telegraph still has what it takes.  Jeremy Warner calls ‘There’s not much sign of deflation in these latest numbers’. Um, how about the tax adjusted price being 2 points lower in January?  BUT I also ought to point out seasonal effects I had not clocked the first time (foolishly); January is on average 0.5-0.9 pips lower than December, for obvious reasons.  Still, the fact that it was lower by 0.2, despite VAT rising, is a strong indication for me that CPI inflation is scarcely a threat.

16 Feb

Letter in the FT

Posted by freethinkingeconomist in Economics. Tagged: , , .

I’ve got a letter in the FT here.   It is about whether deflation is such a spiffing idea, as Edward Gottesman the day before had asserted.  After pointing out some factual errors, the conclusion I make is fairly predictable:

His greatest error is to imply that savings are necessarily virtuous, and spending necessarily vicious. Everything depends on the economic context. Keynes showed in theory, and the Great Depression in practice, how low savings can cause incomes to plummet. Deflation encourages people to put off their spending, thereby exacerbating a cyclical downswing, and causing huge wastage of economic and human potential. It is the last thing we need right now.

9 Feb

Greece, money printing, immigration and inequality

Posted by freethinkingeconomist in Economics. Tagged: , , , , , , , .

Back to prose economics. . . particularly after a colleague devastatingly mentioned the Peter Lilley precedent . . . it is a slippery slope.  And those kind people mentioning this blog in the same sentences as Dillow probably want more economics.  If I was as good or diligent as Dillow, I would try somehow to link all the items in this title together.

Greece. First: how interesting what Barroso has said about the consequences of sending money to the PIGS:

Mr Barroso points to the anomaly that countries such as Greece, Ireland and Portugal, which have benefited in the past 20 years from tens of billions of euros in EU regional aid, are in a worse situation than ever in terms of relative competitiveness.

It seems similar to a theme explored in the discussion about Alison Wolf’s excellent paper.  Read that paper and you might not be so confused.  Sending a lot of money can help, but it can also just boost demand pressures and make a place within the same currency area less competitive in its private sector activities, so that it finds it HARDER to stand on its own two feet.

Charles Wyplosz has listed many facts and myths about the Greece situation.  I particularly noted this:

Myth No.5: Contagion, already under way, would be destructive. . . Fact No.5: The real worry is the banking system. Some European banks hold part of the Greek debt and, if still saddled with unrecognized losses from the subprime crisis, some might become bankrupt

and

Fact No.8: Greece, along with Spain, Portugal and Ireland suffer from a loss of competitiveness due to continuing higher inflation. This partly explains their widening current account deficits until the crisis. Yet, the budget deficits are unrelated to this evolution.

Not all Tories are deniers.  Paul Sagar praises Hague, and boils it down nicely:

Outrageous as it sounds, forget about the economy. The most important thing David Cameron must do over the next 5 years is defy his own grass roots and continue to stick to the science. If the Tories plunge into climate denialism, then we really are in trouble.

The Economist argues for not worrying about inflation:

This is a dangerous time for the global economy. Policymakers seem to be overestimating the return to stability. I’d say the argument for forgetting about inflation entirely until we see two quarters of core inflation at or above a 3% annual rate is quite strong.

I agree; the risk I have in mind is that politicians call “mission accomplished” too soon.  Against the context of deflationary risk, this extraordinary suggestion for the printing of a permanent Etrillion does not seem so daft.

Get your social statistics here.  Hat tip Chris Cook.

I continue to rate John Redwood, despite his use of a totally misleading analogy in dismissing AV.  IF AV is so daft, why do Conservatives use it for selecting their candidates, eh?

First gilt auction since the end of QE.  FT Alphaville detect some signs of slightly higher yields.  But they blame some of this on Labour’s latest recovery in the polls.

Demos are pushing hard for wealth taxes.  I have not read the rest … apparently it argues for how important inequality is.

Good to see the Spectator taking aim at the consistent myth of the numbers bandied around for Iraq War deaths.  As the ClimateHate discussions show us, you don’t strengthen your argument by exaggerating beyond reason: you merely end up having your integrity doubted.  As one of the commenters puts it:

The independent (well left wing anti war, actually) Iraq Body Count puts the deaths at 100,000.
This is bad enough, so it beats me my people have to lie about it.

8 Jan

Quote of the day 8 Jan 2010

Posted by freethinkingeconomist in Economics. Tagged: , , .

On Japan, their new finance minister, and the mistakes we hope the UK won’t copy (from FT leader):

the Japanese conundrum was caused by timid conservatism. Right now, a risk averse stance is to be bold. One must hope that Mr Kan, a deficit dove and deflation hawk, follows his instincts – and does so bravely.

Of course, any such analogies with Japan actually rely on the idea that our economy is like Japan’s.  But incipient signs of real inflation (i.e. not just base effect) might give the lie to this comparison.

17 Dec

Lifting up the inflation debate

Posted by freethinkingeconomist in Uncategorized. Tagged: , , , , .

When people talk about inflation and QE, the variety of responses range across a number of dimensions.  It’s not just inflation, although at some point in the stereotypical Spectator discussion, some fool always mentions Wheelbarrows, and Weimar.  (Try to avoid being stuck next to him in a saloon bar).  But in that discussion Mark Bathgate makes a good-ish point:

QE has lowered government borrowing costs, this year.   By 75bps, which might come down to £10-12bn or so – a lot of money. Not by 200bps, whatever some investment manager says.   And so it may get more expensive to borrow when QE ends – and more likely when it is reversed.

So what is QE then?  Well, since losses by the APF (the Asset Purchase Facility, which actually holds these bonds) are indemnified by the government, it is a future government that pays for that £10bn. In other words, it is fiscal policy.  It allows lower fiscal constraints today in return for higher fiscal costs tomorrow. £10bn possibly being lent by a future government to a present one.   Let’s be honest – it may be a Labour government borrowing off a Conservative one.

But this transfer is only likely if there is inflation, because without inflation, there will not be losses on the gilt portfolio for a future Tory administration to pay for.  If there is no extra inflation, there will be profits, because the Bank borrows at 0.5%, and lends at 4%.   Currently, the Bank is making rich returns. No fiscal problem there – just profit from the deflation and panic.

What if there is inflation, like the Spectator chaps seem to so earnestly hope for (and John Redwood, see posts passim)?  Well, the APF loses money, perhaps a lot.   Up to £50bn on the current portfolio, I reckon, if we get 6% inflation rapidly (though that is really unlikely).  Does this make our fiscal burden even worse?

Um, not really.  Remember how our revenues collapsed over 2008-9 (link to award winning publication)?  This was because it was (a) a recession and (b) a nominal GDP recession.  High inflation and growth wipes away debts, inflates revenues – and makes the government far better equipped to raise the funds to pay a bill like £50bn.   So, in an important way, QE is a useful fiscal hedge. If it works and we get booming NGDP growth, the Bank loses, the Government gains, and the Government pays the Bank.  If not, vice versa; the profits from the gilt purchases may help make deflation bearable.

I do not normally read all of Edmund Conway’s stuff, but his discussion of the inflation and QE issues is top notch.  Unlike some rightwing blowhards, he seems to understand (like Chris)  that QE does not lead to inflation without some intervening stage of higher output.  People do not read that the Bank has swapped some money for gilts and then just go out and mark their prices up; they wait for some customers. So first output rises, then prices and output – that at least is my hope.

Conway also explains how high inflation does not produce the same trade off for the UK Gov as it did in the 1970s – a point I made in A Balancing Act when calling for more index-linked debt.

I don’t understand his views about “getting on with fiscal consolidation asap”.  Wait until the private sector can take the strain, or you just do a Japan (see Koo post), is my view.  But the article discussing government tradeoffs is good thoughtful stuff. It identifies that high inflation can only really happen if the government wills it.  Hyperinflation is a fiscal phenomenon.  At the least, monetary and fiscal easing can shock a depressed economy out of low expectations – a point that Eggertsson makes in his discussion of the Great Depression.

On that subject, we are still a long way from the level of debate about inflation you find in the US.  If you have time, enjoy the discussion between Scott Sumner and Kling, and then Kling’s answer.  Both are right wing, hating fiscal stimulus, but Sumner is convinced that the Fed can order high NGDP growth, and Kling is not.  It is about the demand and supply of money in their world – as Simon Ward, UK’s answer to them, attests.

I am closer to Eggertsson, and Conway.  Inflation can only really be made to happen if the government wills it,  the people believe the government wills it and the economy gets near its output limits.  Unlike the Speccie crowd, I could imagine deflation coming next year, and the government having to consider it as a policy.  It has its costs, as Conway points out. But so does a decade of stagnation and high debts.  There aren’t easy choices.

17 Dec

Base effect: or, why the Right will be screaming “inflation!!” even as we go into deflation

Posted by freethinkingeconomist in Economics. Tagged: , , , , , .

I am not saying it is going to happen – deflation that is.  But some elements of the near future are predictable, and that is because of Base Effects.

The headline inflation rate* is, quite simply, the difference between this month’s index and the index 12 months before.

P (t)/P (t-1)   – 1

One part of this equation, P(t-1) is known.  We know where the CPI index was in Dec 2008, up to Nov 2009.    P(t) is something we can guess reasonably well – it moves up a bit each month, with some predictable contributions (e.g. fuel, the upcomingVAT hike).   Here is how the monthly index has changed in the last few months:

You can see the deflation of the beginning of the year clearly, and the oil-induced hikes of mid 2008.

So, given that we know where the base (i.e. P(t-1)) is going to move in the next few months, we can make a reasonable guess as to where inflation will be on a headline basis.  First, let us assume that CPI goes up by about 2% per year, like this.

So, even if inflation sticks robustly to its steady path, the economically-illiterate will shout ‘inflation nation‘.

In fact, (and this is the nightmare scenario), we could even get shouts of inflation as we set off into a round of deflation. Because of base effects, and the VAT rise bumping up inflation, a weakening economy might well still co-exist with those headlines.  This scenario imagines the VAT rise to 17.5 putting the price index up less than 2 points between January and May next year, and then a weak economy (VAT rise, fiscal cutting) bringing deflation:

Is Mark Bathgate of the Spectator correct when he says “David Cameron’s comments in his conference speech that printing money was the wrong solution to the UK’s debt problems and risked inflation are looking increasingly prescient.”  No.   We have printed £200bn, tripling the monetary base, and yet even with the VAT rising effects I describe above we are heading for 3% inflation.   Over 2 years, even with the biggest run up in commodity prices since the 1970s, the two year rate of inflation will be 5.6%, or 2.8% per year.

Repeat after me.  Inflation Is Not The Problem**.

And this is serious, because if the right medicine is more stimulus/more QE, then voices like the Spectator or John Redwood can perhaps stop it from happening.

*I’m sticking to CPI right now, and have no time to discuss different indices, etc.  RPI has mortgage payments.  RPIX does not, but has elements of housing costs that are related to house prices via depreciation.  Look up our “politics of inflation” paper if you are interested.

**As an economist, I reserve the right to add Yet.   Can we make inflation?  Yes.  Will we?  If we have an impossible Fiscal situation, then yes.  What will bring us an impossible fiscal situation?  Lack of growth.  What will cause that?  Lots of things – but one of them might be worrying about inflation.

3 Nov

If you want to compare Japan to Keynesian-future Britain . . .

Posted by freethinkingeconomist in Economics. Tagged: , , , , , , .

. . . my spreadsheet for playing with GDP levels has been updated. UPDATE ON UPDATED NEWS: THE UPLOAD SEEMS TO HAVE FAILED.  WILL DO THIS TOMORROW PM.  SORRY.

SECOND UPDATE: NOW IT’S THERE.  Please have a play.

Now you can add your own scenarios, play with them.   If you can be bothered, compare the last two, called “Japan without the exports” and “Grow fast, deal with debt later”.   The difference in terms of GDP is the equivalent of having a lost decade or not. It is what I am referring to in the last paragraph of my piece on Comment Is Free today.

I would like to pass on my thanks to Paul on LibCon and Chris on Stumbling and Mumbling for mentioning my paper – it gets it noticed by the intelligent readers I know they have.  Chris, as expected, has more research than me, and backs up the intuition that devaluation is not the answer to everything:

For one thing, there are long lags between exchange rate moves and export performance. During these lags, FX markets will question whether sterling is helping, and might therefore sell pound even more.  Also, many exporters respond to a lower exchange rate by raising prices more than expanding sales. And even if sales do rise, many UK exports have a high import content – think of all the imported raw materials and components – which mitigates the effect on growth.

He is also too modest to mention his earlier posts that really took apart the “sterling crisis” warnings of George Osborne. Osborne warned a year ago of such a crisis, and by July was clearly wrong.  It raises an interesting problem: there is no one model of what determines a currency rate.  Osborne last November implied – not unsurprisingly – that having inflationary finance, unsustainable deficits, that sort of thing, weakens currencies.  But so too – as Chris points out – does having smaller deficits and lower interest rates.   The two models conflict.  You can ****up the pound by having huge deficits or by having tiny deficits. He seems to have proposed both mechanisms in the last year.

So a strategy to grow through devaluation – but with no assurance (a) that devaluation will be achieved and (b) that it will produce the very necessary export surge.    And if it did produce growth, the pound might soar like it did from 1996 . . . .

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