The US Federal Reserve has led the way in running a highly accommodative monetary policy and, unlike the Bank of England, it is still doing quantitative easing. Both have rates close to zero although the Fed has continued to make it clear it will keep them that way for ages – so-called “forward guidance”.
There was some confusion over how long rates would be kept at zero, given differing comments from members of the Federal Open Market Committee.
This was made clearer in the recently published minutes of its meeting of December 11-12 at which voting and non-voting members expressed their views on when rates would or should be raised. One said 2013; three said 2014; 13 said 2014 and one said 2016. So not for a while.
Note also that the lone dissenting hawk on the committee, Jeffrey Lacker, is no longer a voting member in 2013 and is replaced by two well-known doves, Charles Evans, Governor of the Chicago Fed, and Eric Rosengren, my boss at the Boston Fed, where I am a visiting scholar. So the new, 2013 committee looks likely to be even more dovish than the 2012 version.
A good plan
The Fed made it clear in these minutes that it currently anticipates this exceptionally low federal funds rate will be appropriate “at least as long as the unemployment rate remains above 6.5 per cent; inflation between one and two years ahead is projected to be no more than a half percentage point above the committee’s 2 per cent longer-run goal, and longer-term inflation expectations continue to be well anchored”.
In determining how long to maintain a highly accommodative stance on monetary policy, the committee is not simply going to be boxed in by a narrow measure and “will also consider other information, including additional measures of labour market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments”. So the Fed is targeting unemployment. Good plan.
That brings us to the Bank of England, which is stuck with a remit where it is supposed to keep consumer price index inflation at 2 per cent, but shouldn’t because of one-off and external factors such as VAT, tuition-fee and oil-price rises. The inflation nutters have thankfully been ignored because of the costs to the economy in terms of jobs and growth of higher rates that would be needed to dampen inflation.
The Bank’s incoming Governor, Mark Carney, has expressed an interest in both forward guidance and nominal gross domestic product targeting (NGDP).
The first is a good idea; the second isn’t because the Bank is then faced with the major practical problem of frequent and large data revisions, which make it totally impractical.
Capable Carney, who apparently doesn’t suffer fools gladly, has used forward guidance during his term as Governor of the Canadian central bank, when he was a committee of one, and this is a sensible measure the Bank of England’s monetary policy committee (MPC) should adopt. Rates need to remain at 0.5 per cent or lower, at least through 2015.
Few, if any, commentators have noted the practical difficulties of targeting NGDP, which unlike inflation or unemployment is heavily revised.
I contacted the Office for National Statistics (ONS), which was kind enough to provide quarterly data for me from 2008 on both nominal and real GDP revisions. Real GDP, of course, is just NGDP with a price deflator.
The table above reports, for the first time, the first published estimates of the two as well as the most recent revised estimate as of June 2012, along with the scale of the revision.
The revisions to quarterly NGDP can be big, averaging 0.25 percentage points a quarter and ranging in size from +0.5 to -1.5 a quarter.
The table reveals a major problem that the ONS has in identifying turning points and in particular the start of the recession in the first and second quarters of 2008, although it took a while before we knew it.
There was a real GDP revision between the first and latest round of -1.11 percentage points, along with a nominal GDP revision over the same period of minus 0.94 percentage points, so the majority of the real GDP revision can be explained by the nominal revision.
For the technical among you, this occurs mainly because Her Majesty’s Revenue & Customs’ profits data, which takes time to collect, were added in Blue Book 2011 but were not available in full for Blue Book 2010.
Profits came in lower than expected as the economy went into recession. The third quarter of 2008 looks similar with an even bigger revision to NGDP, but there are periods when the relationship appears not to hold, like the second quarter of 2009, where a real GDP revision of plus 0.63 percentage points comes off a nominal GDP revision of minus 0.55.
It makes no sense for the Bank of England to target a variable that is subject to such large and frequent revisions, which are greatest at turning points such as occurred in the spring of 2008. In contrast, unemployment was already climbing steadily from the start of 2008 and picked up at the turn.
So a data revision comes out one morning, and immediately the MPC has to meet to issue a statement about everything it said and did last week. Personally, I would just adopt the Fed’s unemployment target of 6.5 per cent with the same other broad language about inflation and expectations. As Slasher Osborne has said so many times: “We are all in this together.”
Mr Carney had better get busy quickly as the big drum roll he received when he was appointed means there are high expectations that are going to be almost impossible for him to fulfil – and if they aren’t, the press will be all over him.
At the very least, much-needed personnel and other changes are hopefully already in train at Threadneedle Street. The UK economy Mr Carney is going to inherit is going to be in pretty bad shape. Let’s hope he is a miracle worker. The King is dead. Long live the king.
The author is a former member of the Bank of England's Monetary Policy Committee