Dr InflationDove or: How I Learned to Stop Worrying and Love the Bank of England

January 20th, 2010 by The Parallax Brief

The Parallax Brief has found himself increasingly exasperated with the inflation hawks who have used the recent jump in inflation to 2.9% to holler in panic that these near record lows are harbinger of an impending Weimar-style wage-price death spiral. They themselves admit that inflationary pressures will ease after the first quarter, yet still pen these articles.

But in addition to this, the Parallax Brief also believes that even if inflation did increase to four or five percent, it wouldn’t be anything to worry about. Indeed, after some hunting around this morning, he discovered an article from Scott Sumner, professor of economics at Bentley University, which argued that inflation at 5% may be optimum, citing Australia as an exemplar:

Interestingly, I know of only one country that stayed away from the ever lower inflation obsession of the major central banks. The Bank of Australia. Australia had about 4% inflation in their GDP deflator and 7.4% NGDP growth between 2000:2 and 2008:2. With a much higher inflation and NGDP trend rate going into the crisis, they we able to avoid the zero interest rate bound. And by the way, for those who think nominal shocks don’t explain real events like the recent recession, Australia was the only major developed economy to avoid a recession last year. Indeed they haven’t had one since 1991. They are called ‘the lucky country,” but I have argued that their culture lacks our puritanical obsession with inflation.

That makes sense. And, indeed, if Britain did have inflation at around 4%, it would certainly do more to help our debt situation than at 1 or 2%.

So why on earth the trembling knees from the hawks on the right?

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Categories [ Economics and Finance, UK Politics ]

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Deflating the Great Inflation Scare

January 20th, 2010 by The Parallax Brief

John Redwood MP (Con, Wokingham) joined the Great Inflation Scare yesterday, posting a blog, ominously titled “Inflation Soars”:

“December’s inflation figure was as bad as I feared – and that’s before the force of higher VAT kicks in in January.

The Consumer Price Index, the government’s preferred measure, rose by 2.9%, just a whisker below the level where the Bank of England has to write a letter of apology and explanation to the Chancellor. The Retail Price Index (including mortgages) rose to 2.4%, whilst the RPI excluding housing hit an alarming 3.8%.

The Monetary Policy Committee has a lot of explaining to do.

[...]

Their defence will be twofold. They say inflation will come down again after a further rise in the first quarter of this year. That is likely to be true unless there is another devaluation and a further difficult surge in the price of commodities and fuel.”

This encapsulates the Parallax Brief’s objections to the inflation hawks. Mr. Redwood fumes about inflation, but it is actually near post-war lows; he then admits later in the very same article that inflationary pressures will probably ease after the first quarter. But still he pens a blog entry front loaded with language like, “inflation soars”, “[the figures were] as bad as I feared,” and “[the MPC] has a lot of explaining to do”. Amazing!

And Iain Martin, the deputy editor of the Wall Street Journal Europe, did exactly the same yesterday on his blog, admitting that the Bank of England — which, the Parallax Brief would like to remind his readers, is an independent institution — was probably right to say the figures were nothing to worry about, but then going on the claim that inflation as it stands could lead to a resurgence of militant trade unionism. Astonishing!

Inflation is only 2.9%, a figure that almost every single government between the war and 1993 would have killed for. Second, these hawks actually admit themselves that inflationary pressures are likely to ease in the second quarter.

Yet here they are whipping up support for the idea that we should be panicked about a non-existent threat that, even if it did exist, might not even be a threat, as opposed to, say, concentrating on real problems that actually exist now.

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Categories [ Economics and Finance, UK Politics ]

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An Inflated Danger

January 19th, 2010 by The Parallax Brief

The inflation hawks are starting to get silly. Indeed, the Parallax Brief is reminded of the Simpsons character, Helen Lovejoy, the pious, gossipy wife of Springfield’s reverend, who screams “What about the children?! Won’t somebody please think of the children!?” everytime the town faces an issue such as sex education or the presence of a burlesque dancing club.

All the economy has to do is show that it isn’t deflating like it’s 1875 and the hawks are trembling at the knees screaming “What about the inflation?! Won’t somebody please think about the inflation?!”

So, when figures released today showed that CPI inflation had risen unexpectedly sharply in December to 2.9%, the hawks were bound to get vocal.

Guido Fawkes basically advises his readers to run for the hills: “Get your wheelbarrows out, stock up on gold and baked beans. Here comes inflation…”

While Iain Martin, the deputy editor of the Wall Street Journal Europe, let fear grab his imagination and conjure from its darkest recesses an imaginary troop of nouveau Arthur Scargills and Jack Joneses who militantly round 2.9% inflation for a month up to 5% for a year, and negotiate from there, apparently oblivious to the labour market situation, but precipitating a wage-price death spiral:

“But imagine you are the head of a team of trade union negotiators anywhere in Britain right now. You will just have clocked that inflation is 2.9% and rounded it up mentally to 3%. Your members will see it on the news and clock it, too. They’ll wonder if these economists and experts — the one’s who mostly missed the crash — know what they’re talking about when they say it’s just a blip. Indeed, if many of their previous predictions are anything to go by then it’ll be at 4% or 5% before the year is out.”

My God! Inflation could even bring back union militancy. Won’t anyone think of the children?

The jump in inflation was, as always, the result of several factors, but this time several of those factors are quite unique and conspired to make December special. First, oil prices were incredibly low last year, and their recovery to USD70-80 per barrel was bound to impact on food costs. Second, the economy has just started to recover, showing its first signs of growth in a long time, compared to the incredibly depressed situation last year. In short, prices are bouncing back from a low base. Meantime, the core figure is bound to have been affected because the devaluation of sterling had not yet fully filtered through into the economy.

But even if inflation did move higher, so what? Aren’t these right wing inflation hawks often the same people who boast loudest about the triumph of Margaret Thatcher’s economic liberalisation? Yet, inflation in her tenure was never lower than 4.5%, and was as high on the day of her resignation speech to parliament as it was when she first took office — 10%, a number that would surely turn the arch-Thatcherite inflation hawks into quivering blancmanges.

Who’da thunk it? Inflation at 10% didn’t signal the end of civilisation and scenes reminiscent of the Wiemar Republic?

Obviously, it would be unpleasant to be forced to choose between recovery and jobs and inflation. And it is also true that if inflation rises too much, economic recovery will slow whether the Bank of England raises rates or not, because the market will effectively do it for them by increasing the yields on gilts.

But isn’t it more important to worry about the economic issue we currently face than decide we must crush the recovery and force hundreds of thousands out of work just to deal with an imaginary threat that most economists and the (independent) Bank of England tells us isn’t even a threat? And should we really be worrying now with inflation at post-war historic lows?

The Parallax Brief confidently predicts that inflation will climb over 3% next month as the rise in VAT comes into effect.

But he’s still not worried. A sluggish recovery, high unemployment and post-election reductions in government spending are bound to act as a drag on inflation.

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Categories [ Economics and Finance, UK Politics ]

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The Bank of England Must Keep the Printing Presses Rolling

December 22nd, 2009 by The Parallax Brief

The Right have been wailing since the start of the Bank of England’s and the Federal Reserve’s quantitative easing programs — essentially printing money to purchase assets, mostly government bonds — that the additional money this brings into circulation will inevitably lead to inflation, or, in their hyperbolic vernacular, hyper-inflation.

It seems to make sense: if the Bank of England keeps the printing presses hot, and creates huge quantities of cash, a far greater volume of cash will be chasing the same goods, reducing the value of cash, and increasing the value of goods. Inflation must follow.

But the creation of money doesn’t work like that: the monetary base is not measured by just the volume of cash in circulation, but by much by a much broader term that also includes money available for use — from, for instance, traveller’s cheques and in current accounts — as well as that which isn’t, that in term deposits, in funds, in the REPO activities of financial institutions, etc.

According to monetarists, such as the feted Nobel Laureate Milton Friedman, inspiration for Ronald Reagan’s and Margaret Thatcher’s economic policy, this broader measure of the volume of money in an economy, M3 money, is vital for assessing inflation risk and projecting economic outlook. Mr. Friedman, for instance, argued that the great depression was essentially a monetary phenomenon, caused by a vast contraction of money supply as banks stopped handing out credit to repair savaged loan portfolios and balance sheets, and the Federal Reserve raised interest rates to maintain the dollar’s gold peg.

It shouldn’t come as a shock, therefore, that M3 money across the world is in fact contracting, despite quantitative easing programs. Ambrose Evans-Pritchard of the Telegraph has the goods:

Professor Charles Goodhart, a former top official at the Bank of England now at the London School of Economics, said policymakers have neglected the flashing danger signal of the monetary data.

“What has happened to all the monetarists? Growth in money holdings and lending has plummeted. Thirty, or 40, years ago they would have been forewarning doom and destruction at this juncture, and casting anathemas at the authorities,” he wrote in a consultant report for Morgan Stanley.

[...]

Reconstructed data shows that M3 shrank at an annual rate of 7.2pc in the three months to November. Bank loans have fallen from $7.1 trillion (£4.4 trillion) to $6.75 trillion since the end of May.

[...]

Banks are tightening credit for two reasons: losses from the crisis, and tougher capital adequacy rules imposed by regulators. Mr Congdon said it is bizarre that the European Central Bank (ECB) seems unwilling to take steps to prevent a monetary implosion in these circumstances.

It seems bizarre, therefore, to hear those on the Right, especially those of a libertarian bent, howling that inflation is on the way when the money supply is actually contracting. Especially as many of those were at the vanguard of the monetarist movement in the late 70s in the UK and US.

Perhaps they pick and choose monetary policy to suit their political prejudices: monetarism in the late 70s and early 80s, the Austrian School now?

Whatever the reason, there is no reason at present to succumb to their inflation fear-mongering.

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Where’s the Deflation? And Will it be Bad if we Find it?

November 18th, 2009 by The Parallax Brief

Guido wants to know today “Where’s the Deflation?” because figures recently released show inflation back on the uptick. He also makes an argument that deflation isn’t very bad because “history shows that there have been times of increasing prosperity that coincided with deflation,” that “Deflation happened several times in the nineteenth century,” and, of course, the hoary point that “pensioners know that their standard of living would have improved” had deflation set in.

It is important to debunk the idea that deflation wouldn’t be that bad.

Deflation increases the real burden of debt — something that would be disastrous given current levels of debt in the UK — while providing powerful incentives for consumers to hold off on purchases — why would you buy now when it’ll be cheaper next month? — adding a further drag on economic performance. Japan’s lost decade went missing as a result of deflation. The privations of the Great Depression were brought forth by massive debt-deflation.

Of course, pensioners would see the real value of their pensions increase, but economic policy is not made to satisfy one specific interest group at the great expense of all others — as I’m sure Guido agrees when he discusses matters of pension reform.

Guido’s embrace of deflation might be the most unpopular economic decision since King… no, hang on, hasn’t that line been used before somewhere?

The Parallax Brief knows that conspiracy theories about shadowy groups deciding to introduce QE to prop up gilts and bail out Brown (and no doubt to further the new world order) are far more interesting than mundane reality, but is it too much to ask that Guido might consider the simple explanation that deflation was avoided because of the (independent) Bank of England’s super loose monetary policy?

A better question to ask, given the number of conservative and libertarian commentators droning on about Mugabenomics and Wiemar II, might be “Where’s the hyperinflation?”

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Categories [ Economics and Finance, UK Politics ]

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Blanchflower Favours Higher Inflation

October 21st, 2009 by The Parallax Brief

David Blanchflower, the professor of economics at Dartmouth College, New Hampshire and former (outspoken) member of the Bank of England’s Monetary Policy Committee (MPC), has drawn the ire of the right for a New Statesmen article in which he argues that inflation might be the spoon full of sugar that helps the medicine go down for the British economy.

“Moderate inflation would lift people out of negative housing equity. A few years of inflation of roughly 5 per cent or so would be very attractive right now. Maintain the monetary stimulus and if necessary expand it further for the foreseeable future, and keep the fiscal stimulus going. Too much is better than too little. And, for goodness’ sake, don’t start paying back the public debt until we are well out of recession.”

This passage so infuriated the highly respected (and, the Parallax Brief admits, usually superb) blog on the libertarian Adam Smith Institute that it was posted with no analysis — as if its content was self evidently outlandish — under the headline, “Blanchflower Blather”.

The Parallax Brief often disagrees with libertarian views but can at least understand them. On this matter, however, he’s at a loss. What exactly is so bad about inflation?

The main objections tend to be that it discourages investment; that it is a tax on the poor as prices on essentials rise, eating into ever larger chunks of their wages; that it destroys wealth; and that it tends to self-reinforce — the argument that once the pandora’s box of inflation has been opened, it proves increasingly difficult, and economically ever more painful, the tackle its evils.

But these issues don’t particularly apply to the level of inflation Blanchflower is proposing, or at least shouldn’t be of concern now.

First, it is true that in the economic Somme that was the stagflation of the late seventies and early eighties, inflation shackled the economy. But inflation was running well into double figures, and, as Blanchflower points out, at levels like 5%, it wouldn’t be too difficult for investors and savers to inflation-proof themselves.

And besides, given the subsequent successes of both Fed Chief Paul Volker’s and the Margaret Thatcher government’s inflation-targeting monetarist formulae for setting interest rates, it seems reasonable to assume that the MPC would have the tools now to target inflation at 5% with little concern that it would lose control.

Second, and more important, deflation is a far larger concern. Deflation increases the real burden of wealth — something that would be disastrous given current levels of debt in the UK — while providing powerful incentives for consumers to hold off on purchases — why would you buy now when it’ll be cheaper next month? — adding a further drag on economic performance. Japan’s lost decade went missing as a result of deflation. The privations of the Great Depression were brought forth by massive debt-deflation.

Given deflation is clearly the far greater evil, and remains a clear and present danger in the current environment, hand-wringing about the dangers of inflation seems rather like finding a Mars bar during a famine and fretting about getting fat.

Blanchflower is right: not only is inflation not worth worrying about, it would actually serve a useful purpose in the next several years by reducing Britain’s debt burden.

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