In my presentation to the Bank of England advocating the adoption of NGDP as an intermediate target, I added at the last moment the following slide near the beginning of the talk:
- UK macroeconomic performance since 2010 has been disastrous, both in comparison to previous recoveries and to the US.
- I have not seen any remotely persuasive ‘structural’ reasons why this has to be so, but there are some fairly obvious policy related explanations. (Austerity + ZLB + a string of cost-push shocks.)
- For a policy mistake of this magnitude, it seems unlikely that either fiscal or monetary policy bears sole responsibility. It also seems sensible to ask to what extent the macropolicy regime caused or enabled this mistake.
Understandably this was just a little provocative to an audience of Bank of England economists and some MPC members.
Is this an example of the Rogoff-Krugman dilemma in how to confront policymakers? I suppose I could have said instead that it was mostly fiscal policy’s fault, and that the Bank had done a reasonable job in difficult circumstances, but I just thought they might tweak things a little bit. But if I had done so, this would have been an argument for something like forward guidance, not a more radical change like NGDP targets.
However Bank economists were right to be provoked, because the slide conflates two things: the weak recovery everywhere, and how the UK has performed relative to the US. I should have ignored the latter. As I have previously noted, the difference in productivity growth between the UK and US is substantial, and unlikely to be down to just labour hoarding. Although that post and others have speculated about what is behind that difference (see also below), in truth no one really knows. As a result, using relative UK/US GDP growth performance in a simplistic way to criticise policy is too easy.
That said, I do think that macropolicy has been better in the US than the UK. In terms of monetary policy, I would note the following:
- The US was quicker to recognise the severity of the crisis and reduce interest rates
- In spring 2011 the UK came close to raising interest rates, while the US did not.
- The US introduced forward guidance that countenanced exceeding the inflation target, whereas the UK has yet to do so. (The fact that actual UK inflation has generally exceeded 2% misses the point, because the idea should be to raise inflation expectations as long as unemployment remains high.)
- Bernanke has recently been explicit that US austerity means that monetary policy may not be able to meet its goals. Either UK policymakers do not believe that to be true, or they are keeping very quiet about it.
None of these are huge differences. I have argued that the lack of a dual mandate in the UK has been an important contributory factor behind the first three points above, which was the idea behind my last bullet point on the slide, but which rather got lost in debating the second. But perhaps the more basic point, which I should have focused on, is that in both countries the intended output inflation trade-off in this recovery has been wrong. In terms of decisions within the context of their respective mandates, I’m not sure either committee has done better than the other.
So that is one example where the Bank’s criticism would lead me to improve my argument. Another point that I perhaps should have tackled head on is the idea that the UK’s problems start and end with its banks (rather than the Bank). The story goes something like this. UK banks, unlike US banks, remain undercapitalised, and undercapitalised banks are very reluctant to lend. In additional small and medium sized firms are more reliant on bank finance in the UK than in the US. This might help explain the UK’s poor productivity performance. So far this is believable, although the survey evidence on why firms fail to invest is not that supportive. The argument then goes that if banks are the problem, then changing bank behaviour (rather than raising inflation expectations) is also the solution, and policies like the UK’s FLS are unconventional but appropriate. To put the same point another way, it is the effective interest differential between short rates and bank lending rates that is the problem, and not the zero lower bound.
Unfortunately changing bank behaviour has proved rather difficult. In that situation, it is not the case that the only remedy is to tackle the cause. For example, although fiscal expansion is second best to lower nominal interest rates, when we are at the ZLB it can largely eliminate the impact of incorrect real rates on output with relatively low costs in terms of distortions. Equally expanding demand could offset the impact of risk averse banks on the economy as a whole. Indeed it might even encourage these banks to think rather more optimistically about their loan book.
Those are two specific issues. What about the general reaction to my proposal for establishing a path for NGDP as an intermediate target for policy? On the idea of raising inflation to raise output, this visit reinforced my impression that once you spend a lot of time in central banks, you become infected with the strange belief that while it is quite easy to get inflation expectations to increase, subsequently reducing these higher expectations is much more difficult. I would love to see the evidence or model on which that idea is based. But more generally I think the Bank’s reaction to NGDP targets goes back to where this post started.
My impression from this and other evidence is that the Bank has a form of what I have called ZLB denial: it thinks it can still do its job with unconventional monetary policy. That in turn must imply that it bears responsibility for intended outcomes, and here I get mixed messages about the output inflation trade-off it is aiming for: maybe it is optimal because the UK output gap is pretty small (but what about all those unemployed and underemployed?), or maybe it is because the inflation target is primary. But either way I get the impression that the Bank thinks that it has done reasonably well in difficult circumstances. With these beliefs, the case for radical change seems underwhelming.