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August 29, 2012



Its hardly a silver bullet but I think it has more going for it than you seem to imply. Official public targets, which are actually believed, might be more useful than a series of policies that achieve an implicit target. A credible target will mean that the BoE ends up actually doing very little, because all the agents behave as if NGDP will expand at their target rate. See: http://www.themoneyillusion.com/?p=15868

The other thing is if you have an NGDP level target specifically, rather than an NGDP growth target, then you can also credibly commit to adjust for any nominal shock pre-emptively, thus making the shocks themselves less likely and less extreme.


"Official public targets, which are actually believed..."
This begs the question: will the mere announcement of an NGDP target be believed? The public might think - insofar as it gives the matter any thought at all - "The Bank has missed its inflation target, so why should we believe its NGDP target?"
If such expectations mechanisms don't work, NGDP targets will work only insofar as they give the Bank even more leeway to use more QE, or other monetary expansions. But such policies are of dubious efficacy. Which is why I say looser fiscal policy is less of a faff.

Nick Rowe

Chris: "- the coefficient on inflation is less than one. This means that if inflation rises, the real interest rate falls and monetary policy (by that measure) loosens. This is inconsistent with inflation targeting."

It is also, *if you take it at face value*, inconsistent with inflation not exploding into hyperinflation or hyperdeflation. That's because it is inconsistent with the Howitt/Taylor principle (normally called the Taylor principle, but Peter Howitt said it first).

(And it's also roughly the same in Canada, which successfully targets 2% inflation.)

Here's the resolution of the paradox: suppose we lived in a world where expected inflation remained exactly at 2% because the central bank's commitment to the 2% inflation target was credible. (That's a good assumption for the good times). That would mean that all fluctuations in actual inflation would be perceived as temporary and would have no impact on expected inflation. That would mean that if actual inflation increased by (say) 1 ppt, the central bank needs only increase the nominal interest rate by (say) 0.5 ppt to increase the real interest rate and bring inflation down again. So an econometrician observing such a world would find a coefficient of less than one. But expected inflation is kept stable by an implicit threat to raise interest rates more than one-for-one if expected inflation every deviated from the 2% target. Because the threat is credible, it never needs be carried out.

Chuck Norris wins again, without even moving a muscle! Expected inflation is too terrified to move away from 2%.

"But this owes more to the massive adverse demand shock that it does to pig-headed inflation targeting."

Careful now. Can we really talk about "demand shocks" without specifying what it is that the central bank is holding constant, or supposed to be holding constant? "It wasn't me pressing down on the gas pedal officer; it was this downhill stretch of road that caused my car to break the speed limit!"


@ Nick Rowe. That's a beautiful point in theory. But is it true in practice? 2 things suggest not:
1. Gilt market inflation expectations have frequently moved away from 2% pa since 1997. If the target were credible, they'd not have done so.
2. Households have often expected 2%+ inflation.


What Central Bank?
The dismal performance of the last 5 years and the transfer of wealth from savers/pensioners to the rich through QE/ZIRP is a proof that the independence of the BoE must be removed.

They have been incapable to do anything well besides shoring up their pension fund with index linked gilts and transferring wealth for the rich.

Hopefully the next goverment or the market will soon prove how useless our BoE MPC board is.

They have used QE as a permanent solution which is a mistake and a debasement of the £. Time to stop this experiment now.

Nick Rowe

Chris; Wot? You want it to work in practice too?? Asking a bit much, aren't you?

The trouble with all those simple rules (like Taylor rules) is that they implicitly assume the natural rate is a constant (or is some white noise process about which the central bank has no information). And that the only information the bank can look at is: its own past mistakes (deviations of inflation from target); the output gap (which is just another measure of its own past mistakes, and the real time estimates of the most recent output gap is very often a long way off final revised estimates of past output gaps). If the Bank's real time estimates of the natural rate change over time, and are correlated with recent inflation due to supply shocks or mistakes, almost anything can happen with the estimated coefficients in a simple Taylor-like Rule.

There is a better way to test whether or not the BoE was really targeting inflation (I did it once for the BoC). Assume the BoE is targeting 2% inflation at a 2-year horizon (that's what it was supposed to be doing, IIRC?). Then all deviations of inflation from the 2% target should be uncorrelated with anything and everything that was in the BoE's information set at a 2 year lag. (It's an immediate implication of the assumption of rational expectations by the BoE -- the orthogonality of forecast errors with respect to the information set). Zero structural assumptions needed at all.

If you do find a "significant" (statistically and economically) correlation, it means either: the BoE was making systematic mistakes; or the BoE was really targeting something else (and you can figure out what that something else was by repeating the procedure for other plausible targets).


Nick, the Bank have been annoyingly inconsistent about the target horizon. They have used the deviation of the CPI rate from 2% at the two or three year horizon to justify shifts changes. They have been all over the shop since 2008 on the two year horizon, per this post: http://uneconomical.wordpress.com/2012/08/11/monetary-policy-stance-under-inflation-targeting/

Chris: it does seem correct that inflation targeting should approximate an NGDP target if IT is done properly, as the BoE did up to 2007; others have done posts on how Sweden/Poland/Israel have had good NGDP outcomes under inflation targeting. I'd be happy enough if the BoE did IT properly and set policy to try to reduce the output gap by targeting higher inflation. Right now they are targeting sub-2% inflation forever.


«the transfer of wealth from savers/pensioners to the rich through QE/ZIRP»

Oh no! It is quite the opposite. QE/ZIRP has been designed to keep asset prices up, and to deliver tax-free capital gains to savers and pensioners, most importantly to those with real property. Because property owners cannot have both high capital gains and high interest rates, and much prefer high capital gains as they taxed much less or not at all.

The real objectives of the BoE and government have been neither NGDP nor inflation, and they have been:

* Keep real property prices up, at any cost. Because a collapse in property prices would be politically and financially too painful. 70% of voters have speculated on property and around 25% of them have negative equity. Their banks have those loans on the books.

* Limit demand for oil consumption, as UK oil production collapses and the UK has to import ever more oil just as other countries struggle to produce more oil. The usual graph is:

The plan seems to be to protect at any cost the living standards of rentiers (real property owners but also financial property owners like many savers and pensioners), by cutting savagely the living standards of workers (and pensioners) who don't own real or financial property.

My estimate is that the goal is to cut the living standards of workers by 3-5% a year for several years, by way of declining nominal wages thanks to continuing recession and immigration from poor countries, and of rising inflation thanks to letting the pound fall further.

These are very popular policies! Most middle aged and older voters (especially female voters, which are critical to electoral success) feel they have secure jobs and that they have made so much tax-free money from speculating on real property that they want it to continue forever, and they don't care about property-less working people, who are largely male and young and poor.

To give an idea of the sums at play (medians would have been more useful):

«In 2001, the average price of a house was £121,769 and the average salary was £16,557, according to the National Housing Federation. A decade on, the typical price of a property is 94% higher at £236,518, while average wages are up 29% to £21,330,»

Someone who bought an everage house 10 years ago has been given by long term government policy a pure rent (no value added, pure income transfer from someone else) of £125k, or around £10k a year tax-free. For those who bought a 200k house which is now floating towards 400k it was £20k a year tax-free pure rent extraction every year for 10 years.

Middle and upper class older and retired Daily Mail and Telegraph readers, many of them retired, or the New Labour "aspirational" middle aged voters want only two things: higher house prices for themselves and lower wages for everybody else, and the coalition programme is all about delivering both of those.

In the past it was much easier because booming oil exports from 1982 to 2007 allowed various governments and the BoE to run wildly asset-inflationary policies without suffering dire consequences in other areas, and now the UK is a net oil importer and increasingly so.

Also now the ratio between average house price and average wage is over 10 (TEN TIMES), up from around the usual 2-3 just 20-30 years ago, and the whole scheme has become unsustainable, because the 70% of voters who are rabid rentiers cannot live off the work of the 30% who are not.

Massive income "transfer" schemes can work when a small minority (e.g. the top 10%) is living of a large majority (e.g. the middle and bottom 90%), not when a significant majority (the top and middle 70%) want to live off a smaller minority (the poorest 30%).

But the well-advised people with major property are liquidating their UK based investments in what has become a massive government run asset price pump-and-dump scheme, to reinvest in higher growth countries or those better provided with natural resources; as Jim Rogers said without oil exports keeping the balance of payment the right way the UK does not have much else.


«if the BoE did IT properly and set policy to try to reduce the output gap by targeting higher inflation. Right now they are targeting sub-2% inflation forever.»

The Bank like many other central banks and government policies seem to be targeting whatever "inflation" index correlates with earned incomes to keep that low, and whatever index correlates with cost of living to keep that high, all the while boosting asset prices as much as possible.

As Greenspan has often repeated, the key to prosperity (of his sponsors) is massive balance sheet capital gains for property owners, trickling down one day to the parasitic workers who deservedly earn little.

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