In an article
in the Independent today, I argue that it is about time the Bank of
England changed UK interest rates. But they should go down, not up.
The essence of the argument is there remains a significant risk that
we have substantial deficient demand. Even if the probability of this
is below 50%, if it is true the costs of it persisting far outweigh
the costs of some mild inflation overshooting.
One point I do not consider in the article are the implications for
nominal GDP (NGDP) targeting. Here is the picture.
I use nominal GDP per head, because that is robust to changes in
migration flows, which for the UK have been important and variable.
The serious arguments are for a levels target, so I’ve drawn in a
reference path for 4.25% growth. That is a combination of 2% output
price inflation and 2.25% real growth per head, the latter being the
1955-2008 average rate.
If the Bank of England had adopted a NGDP target, as many have
recommended,
the MPC would be tearing their collective hair out right now trying
to stimulate the economy. There would be zero talk of interest rate
increases. So there seem to be just two possibilities. Either
NGDP targeting is nuts, or monetary policy has slowly gone off the
rails by focusing on CPI inflation alone.
Time will tell. But
if the possibility that the UK could really grow quite fast right now
without inflation getting out of control turns out to be true (and
the argument I make in the Independent is just that there is a
non-trivial possibility that it might be true), what will history
say? I suspect they will talk about Goodhart’s
law,
which says “when
a measure becomes a target, it ceases to be a good measure”.
Targeting inflation and ignoring output seemed like a good idea,
because of what is called the divine coincidence. I talked about this
in what I think is one of my better posts.
Goodhart’s law applied to this case says CPI inflation ceases to be a good indicator of
both the state of the economy and maybe also the costs of inflation
when you try using it as a target.
