Yet more Tory economic stupidity

I don’t want to make a habit of defending Yvette Cooper, whom I’ve always thought of as the poor man’s Ruth Kelly. But for Iain Dale to accuse her of economic illiteracy is rather like Ann Widdecombe calling her ugly.
Ms Cooper says:

We have never had a policy of targeting the pound. Our policy has been to target inflation.

To which Iain replies:

Last time I looked at the laws of economics they told me that a weak currency means the price of imports goes up, which leads to higher prices, therefore higher inflation.

But there ain’t no law about it.
If exporters price to market - that is, accept the prices prevailing in their target market - a weaker pound will lead not to higher prices but rather to a squeeze upon exporters‘ profit margins.
A similar thing can happen if buyers have monopsony power. Tesco (say) might have sufficient power over some of its foreign suppliers to resist any price rise.
But even if this isn’t the case, inflation only rises relative to what would otherwise happen. It doesn‘t necessarily rise relative to its past level.
This point matters if sterling falls because of the weakness of the economy. In such an event, it’s quite likely that weak demand will have more effect in depressing inflation than the fall in sterling will have in raising inflation.
All this is a way of explaining the chart. It shows that big changes in sterling have little impact upon inflation (I’ve put both on the same axis to highlight this fact). For example, sterling’s fall when we left the ERM did not lead to higher inflation. Nor did its rise in 1997-98 lead to lower inflation.
So, Ms Cooper is quite right to be relaxed about the weakness of the pound (for now at any rate), and Iain is wrong to suggest it will lead to higher inflation.
This continues a pattern for Tory commentators’ attacks upon Labour’s economic policies to be just plain stupid.
Which is odd, because there is much that has been genuinely wrong about these policies.

Comments

[Bob B]

Absolutely. All this relates back to the complete policy muddle the Conservatives got themselves into in government in the second half of the 1980s when they couldn't make up their minds as to whether they wanted lower interest rates for a more competitive exchange rate to put Sterling into the exchange rate mechanism (ERM) with an advantage or higher interest rates to curb inflation.

In the end, we ended up with an unsustainable boom which collapsed in 1989 with resurgent inflation and huge hikes in interest rates to curb inflation. Sterling then got forced out of the ERM in September 1992.

The trouble is that too many Conservatives are effing ignorant about economics or don't understand the subject or passionately believe that politics trumps economics anyway.

This is absolutely mainstream economics but many overlook it:

"policy makers in open economies face a macroeconomic trilemma. Typically they are confronted with three typically desirable, yet contradictory objectives:

(1) to stabilize the exchange rate;
(2) to enjoy free international capital mobility;
(3) to engage in monetary policy orientated towards domestic goals.

Because only two out of the three objectives can be mutually consistent, policymakers must decide which one to give up. This is the trilemma."
http://elsa.berkeley.edu/~obstfeld/ost12.pdf

Ever since Tinbergen's classic: On The Theory of Economic Policy (1952), mainstream literate economists have appreciated that each policy target needs its own policy instrument:
http://www.garfield.library.upenn.edu/classics1986/A1986C401200001.pdf

[Kardinal Birkutzki]

Hang on: I thought there was no run on the pound.

[Iain Dale]

Your entire thesis is based on this sentence: "If exporters price to market". If is a big word. Most exporters price according to cost. If the market cannot take the resultant price, the exporter won't sell. You would have a point if I was an exporter who exported a widget to the US at $10, but decided to sell it to Rwanda for $1. It just doesn't happen. If it did, and the US importer then found out about it, you can imagine the consequence.

[Planeshift]

Good Iain, your here.

Wikkipedia's bio of Yvette Cooper (http://en.wikipedia.org/wiki/Yvette_Cooper) claims the following:

"She studied at Balliol College, Oxford where she was awarded a BA in PPE (the same degree as her husband's). She was awarded a Kennedy Scholarship in 1991 to Harvard University and finished her studies with a MSc in Economics at the LSE."

Do you think somebody with an Msc in economics might just know a little bit about economics?

Do you think its a bit stupid to accuse her of "economic illiteracy", when you yourself don't have a degree in economics (again - wikkipedia)?

[Shuggy]

"You would have a point if..."

He DOES have a point. It's this one: "But there ain’t no law about it". A weak currency may lead to higher inflation - on the other hand it may not. Depends on a number of variables - general level of demand, the elasticity of demand for imports, stuff like that. The point is THERE IS NO LAW. Not difficult really, is it? Hole, shovel, stop digging.

[Bob B]

Recommended reading for George Osborne and others who mistakenly think Herr Steinbrück was doing them a political favour:

Complacency rules as time slips away
By Wolfgang Münchau
FT: 15 December 2008
http://ft.onet.pl/1,18620,druk.html

Btw Iain: I notice you make no attempt to rebutt the issues raised in my post above here.

[Shuggy]

I mean you got a graph with a big wavy line on it and everything and yet you STILL go ahead with the, "You would have a point if..." line? What on earth are you doing to yourself?

[Bob B]

In case the Conservatives haven't noticed:

"British voters have continued to swing behind Gordon Brown as he struggles to steer the country through the global financial crisis, according to a new poll for The Independent on Sunday.

"David Cameron's double-digit lead has been whittled down to a single point in the space of a month, despite the first significant criticisms last week of the Prime Minister's £20bn 'fiscal stimulus' rescue plan."
http://www.independent.co.uk/news/uk/politics/labour-cuts-tories-poll-lead-to-a-single-point-1066096.html

I'm getting a distinct impression of increasingly desperate measures being deployed in an effort to regain a lead in the polls.

[Innocent Abroad]

This post may be unique. I will defend Iain Dale (I have the flu, so my judgment may be impaired).

Possession of an MSc in Economics does not imply competence in the subject, nor does absence of one constitute grounds for inferring incompetence (Keynes, for example, read maths).

[Bob B]

"Possession of an MSc in Economics does not imply competence in the subject, nor does absence of one constitute grounds for inferring incompetence (Keynes, for example, read maths)"

Fine but that just evades the substantive economic analysis - and the issues put in my post at the top of the thread.

[dearieme]

So the pound in our pocket has not been devalued? Yippee.

[Bob B]

"So the pound in our pocket has not been devalued? Yippee."

But no one - no one - is claiming that. The policy issue at stake is whether Yvette Cooper is correct to say it's bad policy to prop up the Pound.

The Conservatives got us all into a terrible mess in the 1980s from trying to manipulate the Pound exchange rate so I don't think we want to repeat those mistakes again.

After the Euro was launched at end 1999, the Pound was very strong versus the Euro and the government and BoE came under much political pressure at that time to do something to weaken the Pound - which was wisely resisted.

By its remit from Parliament, the BoE Monetary Policy Committee sets base interest rates to target the inflation rate as measured by the CPI since February 2004. In so far as movements in import prices impact on predictions for the CPI downstream, the BoE takes that into account in making its decisions about interest rates.

[Shuggy]

"I will defend Iain Dale"

Ah but why would you do this to yourself? Dale says he's looked at the 'laws of economics' and declared Cooper to be an ignoramus for not knowing about the law that declares a depreciation in the currency leads to inflation. There IS NO SUCH LAW as the squiggly line above shows. It squiggles quite a lot. Dale didn't even have to read that much - he could have just looked at said squiggly line and decided he had made a bit of a tit of himself and kept quiet about it. Instead he popped into the comments and said, "You would have a point if..." There is no IF! This is borderline insanity - and defending him on this point is frankly a bit mental. Pull yourself together man! Lemsip - and plenty of press-ups: that'll sort you out.

[Peter]

Innocent Abroad says:
"Possession of an MSc in Economics does not imply competence in the subject, nor does absence of one constitute grounds for inferring incompetence (Keynes, for example, read maths)."

- Presumably, (s)he means something like that possession of an MSc in Economics does not ENTAIL competence in the subject. When the person in question (ie. Cooper) has been taught economics (and presumably been pretty good at it, so as to get her Kennedy Scholarship) at Oxford and Harvard, that looks pretty shakey. I mean ... who's the counter-example? I can't think of a single Oxford and Harvard educated economist who isn't competent.

But anyway, that Cooper has studied economics and Dale has not, even if it doesn't *entail* that Cooper is right, it certainly gives us great reason to be suspicious of Dale's analysis. Great reason for us to believe he'd make a huge balls up of the entire thing, in fact.

[Bob B]

I've become increasingly alarmed at the extent of economic illiteracy among avowed Conservatives.

[cityunslicker]

in the Uk's economic circumstances it is VERY likely that a weaker pound will lead to higher inflation.

Unless the economy REALLY collapses.

If you disagree, please look at the inflation figures out today - really holding up better than the BOE may think.

Cooper cannot eat her cake and have it (this is the right way round, pedantic I know). Either we get a weak pound and inflation - in which case we need higher rates (2% or more would be my view) or we don't because the economy has collapsed.

This is not a good place to be for Cooper and Dale is broadly correct.

Also, Chris, above a post about the importance of accurate statistics you use a graph of RPIX, which is one of the most politically abused compliation of stats that the ONS produce.

[Bob B]

"in the Uk's economic circumstances it is VERY likely that a weaker pound will lead to higher inflation."

All very curious. According to this report in today's news on the BBC website:

"Hard to believe though it may seem, inflation is set to tumble below 1% in the second half of next year."
http://news.bbc.co.uk/1/hi/business/7786022.stm

With the inflation rate predicted to fall that far below the target rate of 2 per cent, it's little wonder there are rumours that the BoE may be soon setting interest rates towards zero per cent.

[cityunslicker]

And closer reading Bob will show you food prices rocketing, the oil bubble is distorting the picture.

Also, the BOE is not very good at predictions; hence King having to write this letter.

+ The currency crisis just started so will take a few months to get going through the economy. No more small traders buying from China that is for sure. Note too that the inflation rate fell less than expected.

Not curious at all. Just a different view to the BBC, who peston apart, are frankly useless at economic reporting.

[Bob B]

Ho hum. Never mind the UK inflation rate dropping below 1 per cent next year.

By a curious coincidence, Robert Peston, the BBC Business editor, is saying on his blog today (Wednesday) that the US Federal Reserve Bank and the Bank of England now regard deflation - that's negative inflation or falling prices - as the looming threat:
http://www.bbc.co.uk/blogs/thereporters/robertpeston/

Peston has a useful link to an article by Martin Wolf on deflation in Wednesday's Financial Times - I take it that Martin Wolf is among the acceptable commentators on economic affairs ! I'm looking forward to reading his forthcoming book: Fixing Global Finance (Yale UP, January 2009) before Gordon Brown and Alistair Darling get taken off to the gallows.

Peston is also saying that the Bank of England is preparing to possibly follow the FED in cutting base interest rates here towards zero per cent.

Illuminating interview with Sir Victor Blank, chairman of Lloyds TSB, on the BBCR4 1 o'clock news today. Amongst other things on responsibility for the current crisis, he was saying that some of the things some investment banks have been doing is "unforgivable".

But then Warren Buffett did warn us all about the hazards of derivatives back in 2003:
http://news.bbc.co.uk/2/hi/business/2817995.stm

[Tom Addison]

Surely if you're going to talk about inflation you need to at least mention the money supply, Friedman must be spinning in his grave reading this....although he can't....'cause hes dead.

R.I.P, Milton Friedman and Apollo Creed.

[Bob B]

"Surely if you're going to talk about inflation you need to at least mention the money supply, Friedman must be spinning in his grave reading this."

The IMF wrote the obituary on Monetarism over a decade ago:

"...instability of monetary demand, especially in the context of supply shocks and declines in potential output growth, complicated the task of monetary authorities. As a result, during the 1980s most central banks – with some notable exceptions – either abandoned or downplayed the role of monetary targets".
IMF World Economic Outlook, October 1996, p.106.

More insightful stuff about asset price bubbles in Wednesday's FT: Sushil Wadhwani on: Why policymakers should have known better:

" . . Over the past decade, while the bubbles were emerging, it was frequently argued that central bankers have neither more information nor greater expertise in valuing an asset than private market participants. This was often one of the primary explanations for why central banks were not attempting to 'lean against the wind' with respect to emerging bubbles.

"As I argue in my recent National Institute article, had central banks raised interest rates by more than was justified by a fixed-horizon inflation target while house prices were rising above most conventional valuation measures, it is likely that the size of the eventual bubble would have been smaller. At least as importantly, because of the fear of being seen as ‘market-unfriendly’, fiscal and regulatory policy did not lean against the wind either. Our economies would plausibly have exhibited greater stability if tax policy were used in an anti-bubble fashion (eg a counter-cyclical land tax) and if regulatory policy were more activist (eg a ceiling on loan-value ratios) and contra-cyclical (eg time-varying bank capital requirements). . ."
http://www.ft.com/cms/s/0/dadc438a-cb84-11dd-ba02-000077b07658.html?nclick_check=1

[Glenn]

Iain does it again?

"Most exporters price according to cost." No most businesses will price according to what the customer will pay and will subsequently sell if there is sufficient profit in it (but occsasionally, some suppliers sell at a very low margin or even a loss).

"If the market cannot take the resultant price, the exporter won't sell." Not necessarily - some businesses will sell at a reduced price and make a loss if they have enough reserves to push competitors out of business and can achieve a relative monopoly.

"You would have a point if I was an exporter who exported a widget to the US at $10, but decided to sell it to Rwanda for $1. It just doesn't happen. If it did, and the US importer then found out about it, you can imagine the consequence." it depends what the competition was like - if the US importer could switch to another supplier, then they would. Its the competitive market working.

As per Chris's response - there's several dynamic changes occuring. OK the pound can buy less, but then demand has decreased which means prices are lowered. The exporter to the UK takes the hit on their profits.

The prospective problem is not inflation, but the threat of deflation in the next year or two. A bit of inflation would be useful right now.

[Ruchika]

Interest rates, crude and thus inflation has gone down big time across world. More is expected to happen. People are also talking of deflation. Good time to invest in stock market?

[Diogenes]

interesting that you point out "Tory" stupidity(whatever that might mean)- don't they call themselves the Conservative Party, so why resort to 18thc name-calling?

However, have you ever thought of engaging with the beguiling Leftish policy nostra of Richard Murphy - who makes these examples of stupidity seem positively lucid? See flr example, his recent attack on economics.