The rise of Austrian Business Cycle theory (ABC)

“ABC is on the rise: trust me, i'm on it” The Filter^ 2006)

This post surveys how ABC has been treated in the mainstream media from the period of the “great moderation” through to around Summer 2010. (The reason for stopping here is because media coverage has become so widespread it would warrant a move from qualitative methods to more quantitative ones). Many of the examples used are not the result of retrospective research, for example on September 7th 2006 I posted a round up of increasing attention to ABC. The aim is to use archival sources to bridge the gap between ABC as a fringe school of thought, to becoming a widely discussed and publicly well known set of ideas.

It would be wrong to pretend that Austrian economics has become a widespread and recognised alternative to the Keynesian consensus, but it is important to note the dramatic and telling increase in exposure. We do need to be careful about over reaching. Therefore this paper does not rely on statements that can merely be interpreted through the lens of Austrian economics (and are thus “claimed” as Austrian). For example John Taylor wrote the following in the Wall Street Journal:

“A housing boom followed by a bust led to defaults, the implosion of mortgages and mortgage-related securities at financial institutions, and resulting financial turmoil… Monetary excesses were the main cause of the boom. The Fed held its target interest rate, especially in 2003-2005, well below known monetary guidelines that say what good policy should be based on historical experience… The greater the degree of monetary excess in a country, the larger was the housing boom”

Such an explanation seems highly compatible with the Austrian story, and is one of a number of similar examples (for example Anna Schwartz and Jeffrey Sachs could also be deemed to have relied upon “Austrian” explanations). However we will limit our survey to articles that require no interpretation, in other words articles that explicitly mention the Austrian school. And indeed we needn’t rely on a retroactive response to the financial crisis – there is evidence that the Austrian school provided advanced warning and that this was known amongst the mainstream media.

Consider for example three articles that appeared in The Economist in 2002, 2003 and 2005 (i.e. before the collapse of the subprime mortgage market in the summer of 2007, the bankruptcy of Lehman Brothers in September 2008, and the resulting global recession). Firstly, they suggest that ABC may become more common:

“the Austrian cycle may become more common again if, as this survey will argue, financial liberalisation has made bubbles in credit and investment more likely”

One year later they reiterate the benefits of understanding ABC

“perhaps it is a good time to dust down Austrian business-cycle theory… America displayed many of those [Austrian] features in the late 1990s. Faster productivity growth raised the natural rate of interest, but because inflation was low (and because Austrian economics had long been out of fashion) the Fed failed to lift interest rates by enough. Investment and borrowing boomed.” 

Then in June 2005 they correctly linked these prior warnings to the pending recession:

“No wonder that the Federal Reserve is starting, belatedly, to fret about house prices. By holding interest rates low for so long after equities crashed, the Fed hoped to inflate house prices. This prevented a deep recession, but it may have merely delayed the needed economic adjustment.”

When the structural problems within the economy began to manifest in 2006 three different newspapers directly invoked Austrian economics. Kaushik Das (an economist with SBI Capital Markets Ltd) wrote in the Financial Express:

“the Austrian Business Cycle theory can be very well applied to explain the current global as well as domestic financial imbalances”

According to John Dizzard, in the Financial Times,

“The Fed, with the encouragement and support of the political class, kept rates low so as continually to postpone financial busts over the past decade and a half… The Austrian analysis is probably the best one on hand to analyse the present bind of investors and central bankers”

And then The Economist, also:

“A more relevant model might be one based on the Austrian school of economics, developed in the late 19th century, when economic conditions were more akin to today's. In Austrian models the main result of excessively low interest rates is not inflation but over borrowing, an imbalance between saving and investment and a consequent misallocation of resources. That sounds like America today.”

Once history began to catch up with theory, a number of major broadsheet newspapers published opinion editorials that present ABC as the prime explanation of the crisis. George Bragues writing for The Financial Post ("Paulson's scheme", October 7th 2008) said,

"To the extent that this assessment has been made, it represents an important victory for a school of thought that has long hung on the margins of the economics discipline: the Austrian school of economics, whose most illustrious figures include the Nobel prize winning Friedrich von Hayek and Ludwig von Mises. Austrian economists hold that downturns are the inevitable aftermath of loose monetary policy, thus opposing explanations typically heard prior to the current crisis that attributed recessions to price shocks, underconsumption or central bank tightening of monetary policy"

Andrew Lilico wrote a Guardian column that provided an introduction to the Austrian school and the possible necessity for malinvestment to be liquidated.

John Authers in The Financial Times focused on Ludwig von Mises in particular,

“For von Mises, government is the danger, and is never justified in interfering with the market… For followers of von Mises, the expansive monetary and fiscal policy that has followed the crisis is wrong. They would advocate a drastic paring back in regulation and the removal of discretion from central banks. Presumably, as they hold that the market would not allow institutions to become too big to fail in the first place, they would support some kind of intervention to make the biggest banks smaller”

Dick Armey in the Wall Street Journal drew attention to FA Hayek,

“"Hayek, who famously debated Keynes in a series of articles after the release of "General Theory," gave what I believe to be the most devastating critique of government action to stimulate "aggregate demand." Hayek viewed the boom and bust of the business cycle as primarily a monetary phenomenon created by governments' artificial inflation of money and credit."

And in the New York Times, Kyle Crichton drew upon Hayek and modern proponents such as Peter Schiff,

“Austrian economists tend to emphasize a laissez-faire approach and entrepreneurship (not the most popular policies at this moment) and strict limits on money supply growth, usually by hitching the currency to the gold standard. While considered outside the mainstream, the Austrian School is far more respectable, counting in its ranks two Nobel Prize winners, Friedrich Hayek and James Buchanan. Peter Schiff of Euro Pacific Capital — an adviser to the libertarian presidential candidate Ron Paul and one of the most prominent doomsayers in the current collapse — also subscribes to its theories. Hayek is said to have successfully predicted the Great Depression and some Austrian School devotees are taking credit for calling this one. “The financial meltdown the economists of the Austrian School predicted has arrived,” Mr. Paul wrote in September, 11 days after Lehman Brothers filed for bankruptcy”

Indeed the influence and rise of Ron Paul has led to the previously unthinkable situation where the motto “End the Fed” appeared in the Financial Times,

“At marches and meetings against big government across the US, where some placards damn the president, others bear a catchy slogan: "End the Fed”… For Mr Paul and his allies, removing the Fed would end almost a century of rule over the economy by an undemocratic institution that has weakened the dollar and stoked inflation.”

It is telling to note that as part of the debate about how to respond to the financial crisis three of the UK’s most respected broadsheet newspapers – The Guardian, The Financial Times, and The Times published articles by prominent columnists discussing ABC and Austrian economics more generally. Writing in The Guardian, economics editor Larry Elliott (whilst not endorsing it) refers to the Austrian school as “clear and consistent.” Martin Wolf, the Financial Times’ chief economics commentator, said that he had sympathy with the Austrian view, pointing to the notion that “inflation-targeting is inherently destabilising; that fractional reserve banking creates unmanageable credit booms; and that the resulting global “malinvestment” explains the subsequent financial crash.” (see here for a rejoinder to Wolf's article). And finally, The Times’ Editor-at-large Anatole Kaletsky referred to the Austrian school as “seemingly common-sense” (albeit then concluding that “it makes no sense”!) (see here for a rejoinder to Kaletsky).

But the point remains that it is deemed worthy of dismissing, and thus discussing. There can be little doubt that exposure to Austrian ideas has increased. Indeed when I was first attempting to write opinion editorials I was advised not to use distinctly Austrian terms such as “malinvestment” since they were little known and signalled being an unorthodox concept. And yet The Economist now regularly uses the term as it has entered the popular lexicon (here and here).

The financial crisis put paid to a vast array of ventures, but Austrian economics has emerged all the stronger.

Addendum: Two more:

Taking von Mises to pieces, The Economist

A one-paragraph explanation of the Austrian theory of business cycles would run as follows. Interest rates are held at too low a level, creating a credit boom. Low financing costs persuade entrepreneurs to fund too many projects. Capital is misallocated into wasteful areas. When the bust comes the economy is stuck with the burden of excess capacity, which then takes years to clear up.

Jailed counterfeiters aren't a patch on the Bank of England, Jeff Randall, The Telegraph

The regulators are praying that the rest of us won’t notice. This is a high-wire act. As the economist Ludwig Von Mises noted, when the masses finally wake up, “a breakdown occurs”.

Risk - a few old thoughts

Cowen (1997) offers a version of the traditional Austrian theory that focuses on “risk” as distinct from “roundaboutness”. However this poses several problems. Firstly it runs the risk of misstating the original Austrian position – “roundaboutness” can not be easily summised as “chronological time”, and is really best thought of as whether a capital structure is more or less “elaborate”[1]. Cowen defines riskiness as “long-term, costly to reverse, high-yielding, and having returns highly sensitive to the arrival of new information” (Cowen 1997) and this also poses problems. It might seem reasonable to use basic finance theory to define risk as the inverse of returns, but when Cowen talks about “aggregate macroeconomic risk” the concept becomes highly dubious. Surely risk cannot be aggregated? Indeed instead of deciding upon the extent of their exposure to risk, entrepreneurs can only determine their exposure to different types of risk[2]. This begs the question: What sorts of risk do entrepreneurs engage in when credit conditions are loose? My suggestion is those that involve a more elaborate capital structure.

Moreover, we want to move away from characteristics of individual agents (such as risk preference) when trying to explain the so-called “cluster of errors” that arise during a cycle. Evans & Baxendale (2008a) highlights the heterogeneity of entrepreneurship, and we draw attention to the fact that an array of entrepreneurial plans will always exist[3]. If we assume reasonably efficient financial markets it is sensible to expect that the most profitable plans have a propensity to receive funding. Consequently during an inflationary boom there will be a systematic tendency for less profitable plans to find funding, and to come into fruition. Evans and Baxendale (2008a) therefore move away from representative agents to focus on marginal plans. Rather than deal with psychological explanations there are institutional reasons why the marginal plans will be prone to error.[4]

 


[1] Robert Miller has made an important discussion of buffer stocks. These might be defined as “resilience”. Indeed if we also label capital consumption as “extravagance” we have a three dimensional model to observe the Austrian cycle – resilience, elaborateness, and extravagance.

See Miller, R.C.B., 2010, “The role of ‘buffer stocks’ and commodities in an Austrian interpretation of the crisis” Paper presented at the Austrian Scholars Conference

[2] As a corollary an economic agent cannot be “risk averse”, they can only be “averse” to certain kinds of risk, but must also by definition have a corresponding penchant for other kinds of risk.

[3] This point is later echoed by Callahan & Horwitz (2010) “the ABC can be understood as assuming that actors have expectations that are to some degree heterogeneous”.

[4] Note that our knowledge assumptions here occupy a middle ground between omniscience and stupidity (see Evans 2014). This may seem sensible, but many economic studies imply that any deviations from the former leads to the latter.

NGDP growth falls to 1.9%, previous estimates downgraded

Today sees the release of the Second Estimate of the UK National Accounts, and thus the first chance to see NGDP data for the final quarter of 2015. Not only does it come in below 2% (using the quarter on same quarter of previous year measure) but previous estimates have been downgraded. The chart below shows NGDP growth from mid 2014 to now, with today's figures (in dark blue) relative to the estimates from Noovember 2015.

Coincidently, I have recently called for a ~2% NGDP growth target, and so I do not think this is bad per se. The problem is that the Bank of England had done a fairly effective job at returning NGDP to it's historic 4% rate (albeit without catching up on contractions in nominal income that ocurred during the great recession), and seemed committed to maintaining that. What we are seeing is NGDP falling below expectations, and this is highly concerning.

Update to The Kaleidic Guide to UK Monetary Policy

I've recently updated The Kaleidic Guide to UK Monetary Policy. The aim is to summarise some of the most important recent analysis and commentary on the economy, and weigh in on some important controversies. It is still very much a work in progress, and whilst I've attempted to provide a narrative structure some aspects may appear a little disjointed. You can download a PDF version, buy a hard copy, or even invite me to present it in person. But it's almost reached 300 pages!

2015 Q3 NGDP prediction market

 

Up until now we've used Inkling Markets as our prediction market provider, but they've recently been bought by Cultivate and will be offline from December. The finance questions for Cultivate will be run through a new website called Alphacast.

At the moment, members are unable to post their own questions. However, I've received some really helpful input from their technicians and one of their early trials will be a prediction market for UK NGDP. How cool is that! This is good timing because the Office for National Statistics release the second estimate of the National Accounts on Friday November 27th, and this will contain the first look at NGDP for Q3.

The question is: What will be the quarterly growth rate of NGDP for the UK economy for Q3 2015?

The market will only be running for a week, and as ever there's (relatively) large arbitrage opportunities early doors. So get trading!

Update: (27/11/15):

The correct answer is 3.4%.

Here's the Alphacast chart:

 

The Transmission Mechanism

I am yet to find the difinitive survey article that explains the transmission mechanism of monetary policy. I think there's 3 main reasons why it's proving elusive:

  1. There is no single transmission mechanism - hence it's always going to be complicated to present.
  2. There are big differences between US and UK monetarists.
  3. We've learnt new things about the transmission mechanism since 2008 but there's a pedagogical inertia that retains existing work.

A classic US textbook on monetary economics is Frederic Mishkin's "Economics of Money, Banking and Financial Markets". But look at the diagram below:

On first glance this is exactly the type of way to present such a tricky topic. It lays out several alternative channels, clarifies their background (i.e. presents credit view as slightly separate), and shows how they impact output. But it's not coherent. The key distinction between "interest rate" and "asset price" effects is flawed on the grounds that the interest rate matters because it's the price of bonds (i.e. an asset), whilst each of those asset price effects - whether it's the exchange rate, equity prices or credit markets - rely on interest rate changes (albeit the "cash flow" channel relies on nominal rather than real interest rate changes). This is why I struggled as an undergraduate - it's aint MECE.

I prefer this Mishkin article but it suffers from the same problem. Here's my attempt to summarise the transmission mechanism in terms of alternative schools of thought:

Not very helpful. One can also look at the Bank of England, and the ECB, but they leave out lots of important present-day channels. So help me out - where's the difinitive explanation of the transmission mechanism?

Low interest rates /= easy money

The impact of monetary expansion on nominal interest rates is unclear. The liquidity effect implies that in the short run they will fall. However the Fisher effect implies that in the long run they will rise. Whether the monetary expansion ultimately leads to a nominal interest rate that is higher or lower than the original rate depends on the relative strength of these effects. If the liquidity effect dominates the Fisher effect then expansionary policy will cause rates to fall. If the Fisher effect dominates the liquidity effect then the expansionary policy will cause rates to rise. (I'm neglecting several things, but I hope the above still makes sense).

This is important, because whether or not a low interest rate is a sign of expansionary monetary policy depends on inflation expectations.

Ben Southwood discusses a fascinating 1998 paper by Ellingsen and Soderstrom. From the abstract:

if monetary policy reveals information about economic developments, interest rates of all maturities move in the same direction in response to a policy innovation. If, on the other hand, monetary policy reveals information about the central bank's policy preferences, short and long interest rates move in opposite directions.

My interpreration of this is that when there is a policy surprise the Fisher effect dominates the liquidity effect. But this poses two really interesting questions:

1. Is there anything important about the surprise, other than its impact on inflation expectations?

2. Does this adhere to the Lucas critique?

Update: I've just seen that Samuel Hammond and Ben had a disagreement about what the paper implies about the liquidity and Fisher effects on Twitter. I would love to see a longer discussion.

Do Cantillon effects matter?

A couple of years ago there was a big blogosphere debate about Cantillon effects. It was prompted by Sheldon Richman's claim that:

Since Fed-created money reaches particular privileged interests before it filters through the economy, early recipients—banks, securities dealers, government contractors—have the benefit of increased purchasing power before prices rise.

Scott Sumner argued that "it makes very little difference how new money is injected" (see Sumner's follow up post here, see Robert Murphy's attempted resolution, and see Sumner's response.)

This debate struck me as a classic argument between comparative statics and market process theory. The process by which monetary expansion occurs will cause some prices to change. Whilst prices adjust, some groups will benefit and some will lose out. It seems uncontroversial to me.

Perhap's the problem is with immediately turning this into a debate as to whether "Cantillon effects" exist. We can think of them in two ways. The first is whether there's a wealth effect on the part of the early recipients of freshly created money. The second is the consequences of the relative price effect. Note that Sumner is challenging Sheldon's account of the former, whilst it is the latter is the really important contribution of Austrian monetary theory (i.e. the interplay between non-neutrality of money, relative price changes, and the capital structure).

Having read through the debate, I believe that the following statements are correct:

  • There is a perceived wealth effect for the specific first receivers (in other words the first receivers gain a consumer surplus from their mutually beneficial voluntary transaction. Mario Rizzo made this point here).
  • There is a wealth effect to some people across the economy as a whole

It is not necessarily the case that:

  • There is a wealth effect for the specific first receivers - because as Sumner points out, they are receiving the market rate for their asset.

I was prompted to look at that debate having read through a couple of old papers by Richard Wagner. One of them, (co-authored with Steve Daley), emphasises the relatiohip between the preferences of the recipients and the impact on relative prices:

"if money is injected at points where the recipients have particularly high demands for goods with relatively inelastic supply, those particular prices will rise further than they would under some alternative locus of monetary injection"

The other article is about Georg Simmel’s Philosophy of Money. Wagner argues that the essence of a Cantillon effect is that "the process of monetary injection will influence the concrete pattern of activities within a society". Whilst a comparative statics approach may dismiss the result as "mere distributional effects", Wagner argues that:

This dismissal arises out of a frame of reference where all that matters is the state of some aggregate economic variables. Yet the dynamic forces that are at work at shaping societies precisely work their way through those micro channels; the aggregate resultants are objects neither of choice nor of desire

In my "Choose your own financial crisis" I grappled with implied counterfactuals. I think a similar issue needs to be made explicit when discussing Cantillon effects. The question is: What is the implied counterfactual?

Bob Murphy was almost right to treat it as a semantic debate about what constitutes fiscal policy. The key point is that Austrian monetary economics rests on the far broader calculation debate. Cantillon effects are important not so much because of non-neutrality (i.e. a monetary reason), but because they disrupt the price mechanism. Incidently, I also think this is how to resolve Jeff Hummel's neglected criticism of ABC. He argues that Austrians have failed to clarify why they assume that monetary expansion should escalate. Whilst an ever increasing growth rate in the money supply will indeed lead to a necessary crash, why assume that a constant growth rate would inevitably escalate? I think the solution requires us to consider how new money is being spent, and the implication for economic calculation. Consider the government subsidies that went to Solyndra. There is no arithmetic reason to say that they should need to rise over time, but our understanding of the economic calculation debate tells us that it is unsustainable. The boom is unsustainable because it is an example of government intervention. Whether that should be considered monetary policy, or fiscal policy, is a separate issue. It's political economy.

M4 Lending and Divisia measures of the money supply

The last few years seems to have provided strong evidence that bank lending is not a pre-requisite for economic growth. Getting the banks to lend has been difficult, and yet the economy has been performing strongly. This is an important empirical contribution to a passionate theoretical debate.

The chart below shows two measures for M4 lending:

One possible explanation is de-leveraging - if individuals and companies are paying off debt we should expect lending to be subdued.

Another explanation is that lending is taking place outside of traditional channels. Perhaps the economic recovery has required lending, but not necessarily bank lending. Sources such as crowd funding, peer-to-peer lending or pay day loans have seemed to constitute a larger share of households access to finance (and has led to more regulatory attention to peer-to-peer lending. This economic activity should be captured in standard measures of broad money, so the argument isn't that the money supply is growing by more than official figures imply. However it is economically pertinent because:

1. It could show how changes in the composition of macroeconomic aggregates matters

2. It could show how financial innovation can reduce the demand for money (and thus increase velocity)

I'm not sure which of these avenues is most useful, and need to read more.

One interpretation is that broad money measures can mask a lot of important activity. This might lead to a greater focus on narrower measures (such as MA) or weighted measures such as Divisia. I have mentioned Divisia measures before, and here's a current look:

Whilst the growth rate for private non-financial corporations remains in the 12%-16% range, household Divisia has been steadily slowing. This is causing me to reduce the weight that I put on them - I felt that strong Divisia growth in 2013 was a sign of economic expansion, but NGDP growth tailed off (this is using series VTSR):


The interest rate should be almost 3% by now

Last year I made an estimate of the natural rate of interest, and I thought it was time to update it. Using the same methods the real neutral interest rate is currently 2.3%.

I also wanted to use this as an input to make a judgment about the monetary stance. To calculate the nominal neutral rate I used the GDP deflator (a quarterly measure of inflation expectations would be better, but I'm not aware of any). I then compared the implied nominal neutral rate with the actual nominal rate (given by Sterling Overnight Index Average, SONIA). The difference gives an indication of the monetary stance - a positive difference implies policy is too tight, a negative difference is too loose.

As of Q2 2015 the nominal neutral rate is 2.86%, and with an actual rate of 0.46% this provides a stance measure of -2.40%.

I'm holding off on providing too much interpretation until I'm more confident with the compilation method. Please contact me if you have any comments or queries. 

Note: If annual growth rates are used, the neutral rate is 1.9%:

This implies a stance of -2.43%:

Choose your own financial crisis

Do you remember those "Choose your own adventure" stories from your childhood? For some time I've intended to write one about the 2007-2008 financial crisis. I was recently invited to present a paper at the Workshop in Philosophy, Politics and Economics at George Mason University, and decided that this was the opportunity to start work on it.
It's called "Choose your own financial crisis", and here's the abstract:

On a recent trip to London you decided to visit the Bank of England museum, and played the infamous “Monetary Policy Balloon game”. In fact, you played it so well an alarm sounded and several men wearing black suits asked you to accompany them “upstairs”. You are told that the Governor, Mervyn King, has taken ill and they are looking for a stand-in. You have the high score, so they turned to you. The future of the British economy is in your hands. Academics, policymakers, the media and the general public will depend on YOU to do the right thing. But what is it? 

Many economists and economic commentators are critical of how the Bnak of England handled events, and seem to believe that things would have turned out different (and better), if only they had been in charge. For Austrian economists this presents an interesting dilemma - pervasive knowledge problems make monetary policy decisions almost impossible to get right, but surely decisions aren't all equally wrong? As a member of the IEA's Shadow Monetary Policy Committee this is something I grapple with on a monthly basis. 
The article is intended to be a bit of fun. You can download it here and I welcome comments and criticisms.
There is supposed to be a central plotline that mirrors actual events, so see if you can find it. I'm especially interested if any city economists have tried something similar. Thus far I'm staggered by the lack of explicit counterfactual reasoning and scenario analysis. But maybe I'm just oblivious.
In case you think this is a joke, I am serious about the methodological basis for this article. It is a genuine piece of economic research, building on an important tradition of counterfactual "historic fiction" and Austrian school attention to thought experiments and comparative analysis. For that reason I've also written a version that contains a methodological note.
Update: Just received this wonderfully relevant Mises quote courtesy of Solomon Stein:
It is vain to meditate what prices would have been if some of their determinants had been different. Such fantastic designs are no more sensible than whimsical speculations about what the course of history would have been if Napoleon had been killed in the battle of Arcole or if Lincoln had ordered Major Anderson to withdraw from Fort Sumter.
Human Action (1949 [1996], p. 395)
Ha!
Update 2: I've turned the paper into an app. Download it hee: http://financialcrisisapp.com/

We need to talk about Richard Murphy

Richard Murphy is a chartered accountant who has forged an impressive career campaigning for tax reform. He works tirelessly writing punchy blog posts and detailed policy reports. His basic point - that wealthy individuals and deliberately opaque companies find it too easy to evade and avoid HMRC - is surely correct.

I am not a socialist so I am uncomfortable with Murphy's implication that tax is good for its own sake. And I recognise that many experts have cast significant doubt on the validity of his calculations (to which Murphy has responded). Murphy is paid by trade unions, and he's good at what he does. I disagree with his political beliefs, but people like him are important voices in public debate.

I tend to defer to Murphy's judgment when it comes to accounting. But recently he has emerged as an economic commentator. As the self-styled originator of the concept of "People's Quantitative Easing" (PQE), and having been said to have influenced Jeremy Corbyn's economic platform, Murphy's profile has risen significantly. This concerns me greatly. I believe that PQE is economically illiterate and potentially very dangerous.*

I am an academic economist that specialises in monetary theory. I have no political loyalties and am generally sympathetic towards Jeremy Corbyn's character and motivations. But we need a reasoned debate about PQE, and one would think that the person claiming credit for creating it would be involved.

This article is not intended to provide a critique of PQE (although I've tried to explain my general opposition in the footnote). My issue now is Richard Murphy's hostility to open debate.

I was interested to watch Murphy's recent interview with Andrew Neil on the Daily Politics (permanent link):

In it, he makes the case for "modest amounts of inflation" and rests it on the fact that Mark Carney is currently failing to meet his 2% inflation target. (Note that Murphy is incorrect to say that Carney's inflation target is 2%. Inflation is not supposed to always be on target, but to meet that target "within a reasonable time period". Therefore technically Carney should be judged based on whether he is keeping inflation expectations at 2%, not on last months actual data. This seems like a pedantic distinction, and I'm sure I've glossed over the difference myself at times. But it's something that a supposed economic advisor should know).

This presents an interesting issue, because for much of 2011 inflation was well above 2%. 

Many economic commentators at the time were saying that this inflation was temporary, and driven by supply side factors. In such circumstances, tolerating inflation is a better option than the Bank of England raising interest rates to slow down the economy. In such circumstances the fact that real GDP growth was low may be more important than inflation being high. So I understand that there is a case for the Bank of England to increase QE (i.e. boost aggregate demand) in 2011.

Let me emphasise that the concern about PQE is that it would be used excessively, and in doing so would contribute to inflation. The whole issue is whether we can trust that PQE will not be abused. Murphy attempts to downplay this fear by claiming that he wants "modest" PQE, and that it's a good idea because inflation is under target. But if Murphy's reasons for advocating PQE circa 2015 are sincere, this implies that he did not think there was a case for PQE in 2011. My recollection is that he has been advocating PQE throughout this time period, even when inflation was above target. So this is a question I posed to him, on his blog, and our subsequent exchange:

Given that he's previously blocked me on Twitter, and deleted my comments, I am not surprised by how that exchange concluded. I am frustrated, because I believe that there's an inconsistency in his argument and he's unwilling to clarify it. And indeed he's even unwilling to permit a courteous discussion between commentators. For example "Bob" left the following reply to my comment:

But my response to that was deleted (here is a screenshot before it was deleted):

Maybe Bob was right. I was keen to hear his response.

So I am frustrated. But I am also annoyed because this is a serious issue and Murphy has a responsibility to engage with the economics community. Whilst he was a blogging accountant it was ok to disparage the whole of the economics profession as being deluded ideologues. As a heterodox economist myself, and critical of the neoclassical orthodoxy, I sympathised with him! But if he wants the attention that comes with being Corbyn's economic "guru" and the respect that comes with being an "academic" he needs to be intellectually mature.

This isn't about abuse or even civility. It's simply a refusal to engage in debate, and an attempt to shut down questions that are perceived to be challenging. Most of the economists I know would dismiss the likes of Richard Murphy as being self-evidently wrong. But when those of us who do try to engage with the sustance of the ideas get insulted, blocked and deleted, it is a real shame.

 


 

* One of the few things that macroeconomists actually agree on is that hyperinflation is the result of excessive money creation. This is as close to an empirical fact that macroeconomics can deliver - see David Romer's standard textbook, "Advanced Macroeconomics":

And we have a very strong understanding of the reasons why money creation can become excessive - when governments resort to the printing press to cover their fiscal ill-discipline. The catrostrophic monetary events of modern times (whether it's Weimar Germany, Yugoslavia, or Mugabe's Zimbabwe) happen when people become blase about the link between public spending and the money supply.

Back in 1997, when New Labour were keen to build their economic credibility, Gordon Brown made the Bank of England operationally independent. This was in line with a general trend in the 1980s and 1990s to separate fiscal policy and monetary policy, by outsourcing the latter to the central banks. When quantitative easing (QE) was initiated in 2009, economists like myself were concerned that it would weaken the independance of the Bank of England. In many ways the emergence of PQE as a potential tool is our worst nightmare, and reason enough to have opposed QE in the first place.

If you want more detail on how to understand monetary economics, I have written a textbook that explains it to non economists. Richard Murphy should read it.

 

NGDP growth in Q1 2015 was 4.3%

The preliminary estimate of Q1 2015 saw a disappointing real GDP growth rate of 0.3%. Whilst todays release of the second estimate hasn't revised it upwards, it has provided some better news. The second estimate provides the first look at NGDP figures, and the Q1 2015 rate is 4.3% (compared to last year). This constitutes a 0.9% rise from the previous quarter (up from 0.7%). This is further evidence that recent deflation is the result of positive supply shocks, rather than negative demand shocks.

Just to recap, this is UK NGDP over the last few years:

The Kaleidic Guide to UK Monetary Policy

For some time now I've been working on a guide to UK monetary policy. It is a 250+ slide powerpoint presentation that attempts to provide insight and commentary on key topics.

It remains a work in progress and I intend to update it annually. It provides an Austrian school perspective on some of the key policy debates of our times, and helps you to make sense of the economic landscape.

In addition to this, if you would like a live version please get in touch.

QE-a culpa

Recently I've been looking through some of the articles I've written about QE over the last few years. I spent much of the post financial crisis period learning about monetary theory and wondered about the extent to which this was reflected in my commentary. I feel that my understanding has increased significantly, and so I should reasses my previous claims.

I published several articles from 2009-2012 and benefitted from a general uncertainty that led to an increase in the demand for economic (and indeed Austrian economic) commentary. Most of the opportunities I had were not a result of my own expertise or reputation, but because I was representing a perspective that people wanted to hear. It has been an interesting intellectual journey to try to provide a mouthpiece for certain ideas, whilst also developing my own voice. 

Firstly, a bit of background and motivation. I've been accused of being too academic, too theoretical. However my primary aim is to prompt debate. It is not to simulate policy. Therefore I’m very resistant to the “don’t just stand there” mentality of a crisis. If I were a policy maker my instinct would probably be closer to action. As an academic my instinct is more contemplative. I have a natural tendency to think of longer term and unseen effects, and even if these are outweighed by the short term necessity for action, I still feel I’m doing an important public duty by pointing them out. If my audience were policymakers my message may well be different. But I consider my primary audience to be the educated layperson, and therefore my primary goal to provide a perspective that they may not already possess.

As I said in 2010,

my objective isn't to impress you by how clever I am. It's to participate in a conversation about economic theory and practice that all sides can learn something from. Therefore I don't see why I need to have provide[d] an alternative plan before jumping into the debate - if I convince you that fiscal stimuli very rarely achieve their objectives, you'll need to decide for yourself what the implications are. This reminds me of students that want "an answer". I'm sorry, but that's not my job. It's to provide new information that allows you to provide your own answers. I'm not trying to convince people that my "worldview" is correct, and that you should share it. I'm merely offering fragments of wisdom to allow you to cultivate your own.

I've read through all of the articles I've cited below, and picked out the money quotes. I've then categorised them and reflected on whether I stand by them (and whether I stand by them but for different reasons). You'll have to take my word that I've surveyed them honestly, and haven't simply ignored quotes that make me look bad. 

Introduction

I moved back to the UK to write up my PhD dissertation in 2006. My research focus at the time was the spread of the flat tax in Eastern Europe, but it seemed clear to me that there was an impending resurgance of Austrian business cycle theory. I've written elsewhere about whether Austrians predicted the financial crisis, and that's a hard question to answer. But it seemed clear that we were experiencing a central bank induced credit bubble and that a recession was on the horizon. And yet policymakers didn't seem concerned. With Toby Baxendale I began work trying to find an Austrian measure of the money supply. By 2008 it seemed obvious that a monetary boom had preceded a monetary contraction. But at the time, official measures hadn't revealed it.

I used the three charts below in a presentation on 8th November 2008. Broad money didn't show any problems:

Narrow money didn't show any problems:

And then there was the "Austrian" measure:

Given that the method of constructing the UK Austrian Money Supply has changed since then I was right to not draw too much emphasis to the warning signs at the time. But it signalled to me that us Austrians had something important to say and my confidence rose. Then, in January 2010, the Bank of England switched its conventional measure of broad money from M4 to M4ex, which stole a lot of my thunder:

Suddenly the value of the Austrian school switched from accurate forewarnings to the policy debate. In terms of QE, I think there's a narrow debate and a broad debate. The narrow debate is about whether QE will achieve it's stated aims and if this is broadly desirable given the current monetary regime. The broader debate is whether this "success" comes at the expense of unintended consequences (which may possibly be greater). Both of these debates rest on a firm understanding of what QE is, and how it differs from "conventional" monetary policy. Whe QE was first touted I had zero knowledge of the Japanese experiment. I'm happy with my contribution to clarifying what QE was, but perhaps focused too much on the broad, as opposed to narrow debate. Over time, this may be vindicated, because those broader concerns may becoming increasingly relevent. But in 2009 I was behind the curve in being able to make insightful commentary on that narrow debate.

Here are some of the key points I was trying to make:

1. QE is "merely" OMO

From the get go I was uneasy with the distinction between conventional monetary policy (cutting interest rates) and unconventional monetary policy (printing money to buy bonds - i.e. QE). Since QE is conducted via open market operations (OMO) it is more of a tweak to conventional monetary policy (i.e. targeting a quantity of reserves, rather than price/interest rate) than a replacement. In January 2009 Alistair Darling said,

  • “We are looking at a range of measures to support the economy, to support business and to help people. But nobody is talking about printing money.

 I don't think politicians should be allowed to deny that QE involves printing money and that central banks are routinely printing money. My response,

 

  • "QE isn't a different policy tool, it's an alternative way of using current policy. Whereas OMO means targeting a particular interest rate (and altering the money supply to hit it) QE means targeting a particular quantity of money (and ignoring the interest rate)" [see here]

 

As I put it in my 2009 Comment is Free article,

  • “1) QE is printing money; and 2) the printing press is already turned on.” [1]

In March 2009 I criticised a Financial Times video that attempted to explain QE because it:

  • “propogates the myth that this is fundamentally new policy - as if the Bank of England is only now being "inflationary", and "printing money".” [see here]

Tim Congdon has also made the point that QE is standard monetary policy for the situation we were in 

  • “He [Tim Congdon] challenges Gordon Brown's portrayal of his own role in the financial crisis, arguing that instead of the response being his ‘brainchild’ the then Prime Minister required a layman's briefing and did not grasp the orthodoxy of the policy for situations when nominal income is falling” [5]

Verdict: I stand by this. In fact, I think this is a strength of QE and should be why QE becomes even more conventional.

 

2. QE is one arm of the state financing the other

Stephanie Flanders confirmed that "printing money" is technically accurate, but defended QE:

  • “we can expect the Bank to buy a lot of gilts as part of this policy. Is that "printing money"? The politicians will say no. But any economist would say yes...
  • ... "When the Bank of England buys up gilts, one arm of the government is buying up debt owed by another arm of the government in exchange for money created by the central bank. Whether the gilt is brand new, or issued the day before, is quite simply irrelevant.”

I made this "two arms" debate in a 2009 article:

  • “despite the obfuscatory terminology, QE is nothing new. It is simply an exotic label for a discredited policy – one arm of government buying up the debt of another” [1]

Perhaps this was OTT. According to Flanders,

  • “That said, there are big practical differences between this policy and Zimbabwe-style money financing. The most important is that the Bank is choosing to buy gilts as a means to an end. It is not being forced to buy them because the government has nowhere else to go. –Also - and crucially - the Bank has every intention of unmonetizing the debt when the storm is past”

I was dismissive of the argument that QE isn't "printing money", and expressed concerns about public finance. I felt that Flanders' point rested on semantics and intentions, and the public finance considerations shouldn't be dismissed so easily

  • “Yes, the Bank of England is purchasing assets on the secondary market (not directly from the Treasury). Yes, the Bank has every intention to mop up this additional liquidity once the economy recovers, but "directness" and "intentions" are largely semantic.” [1]
  • “the Bank of England buying assets on the secondary market is essentially a gradation of the policy that Mugabe’s government has unleashed in Zimbabwe. One arm of government is buying up the debt of the other. We can pretend that those two arms are separate, but that illusion is becoming harder to maintain by the day.” [4]

And indeed the Bank of England has now became a major player in the UK debt market (from a Kaleidic post):


Verdict: I am glad I pointed out tangible downsides, but the jury is still out on the impact.

 

3. There is a risk of inflation

This is something many anti-QE commentators referred to, and we were wrong. We've not seen inflation anywhere near the scale we warned about. I said,

  • “The biggest danger of QE – one that no economist would deny – is the destructive inflation that it unleashes. We are asked to have confidence that our monetary authorities have both the omniscience to know when inflation will shoot upwards, and the benevolence to act in the public interest when this occurs” [1]

I then attempted to provide some evidence for this claim:

  • In February 2009 food price inflation rose to 9%, and factory gate inflation is at 3.1%, which might mitigate fears over deflation. We are in for another bout of inflation; another bubble is brewing. The party isn't over” [1]

The chart above shows CPI from 2004-2014 and in Feb 2009 I was warning about inflation. As you can see, it promply falls to around 1%. However, QE starts March 2009 - February 2010 which is the period in which CPI is in a trough. The consequence is that in 2010-2011 we see inflation rise to over 5%. So I could say "there's the inflation", and QE advocates could respond "it's hardly Zimbabwe!"

Indeed already by February 2010 I was saying:

  • "the inflation risk appears to be lower than first feared. Inflation expectations are contained, and yields remain low. Whether this can be maintained is another matter. The decision to cease QE indicates a concern that the inflation tiger is about to bite. Today's figures show a sharp rise, and we should not ignore the possibility that UK gilts are merely a new bubble." [3]

 And then in November 2010,

  • “monetarists are right to mock scaremongering about hyperinflation… CPI is above target (3.1%), but not to the extent that I (and others) feared… [But] We should also remember that inflation could manifest itself in asset price bubbles, for example in the gilt market or emerging markets” [4]

That said, I think I was successful at avoiding the claim that QE is a sign of loose monetary policy. Indeed:

  • “those who believe that low interest rates and a fast growing monetary base imply expansionary monetary policy make the same mistake that economists made during the Great Depression. Then, as now, they were actually signs of an inept central bank failing to offset a fall in the broader money supply.” [4]

Verdict: I was wrong, but shifting the argument slightly reveals the kernal of truth.

 

4. QE is hair of the dog monetary policy and generates malinvestment

If loose monetary policy caused the crisis how can loose monetary policy get us out? The hair of the dog argument is a convenient one to make, as I did in 2009:

  • “the Bank's solution is a larger dose of what caused the original disease.” [1]
  • “We are now seeing the inevitable hangover and are faced with choice – either to go through the painful but necessary recovery (a hangover) or simply to prolong the intoxication… QE is more hair of the dog.” [1]

This leads to a related idea that a liquidation is a necessary consequence of a boom. Once you accept an Austrian style boom then a recession is an inevitable and necessary consequence. In this 2009 article for Comment is Free article I reeled off some standard arguments:

  • “Over the last few years we have seen an unsustainable boom that has been financed through impoverishment. During this boom scarce capital has been squandered. Rather than use credit as a foundation for wealth-creation, it was erroneously treated as actual wealth, and consumed” [2]
  • “a decline in output is an important step towards production that more closely matches consumer demand. If GDP growth has been driven by bubble activity, a fall in GDP is therefore an inevitable and necessary stage of recovery.” [2]
  • “Genuine economic growth will only return if relative prices can adjust, malinvestment gets liquidated, and a correction is allowed to occur.” [2]
  • “the recession itself is a sign that markets are adjusting, and that entrepreneurs are engaging in the recalculation that is required to understand which plans were unprofitable and where capital should be reallocated. Allowing relative prices to adjust as quickly as possible, reducing labour market rigidities, and improving labour mobility will all help with this" [4]

Verdict: If the inflation argument is over simplified monetarism, then this is over simplified Austrianism. I totally neglected the distinction between a primary and secondary recession and ignored the possibility that such declines in output were unnecessary. 

However, by 2010 I was making a more distinct monetary equilibrium argument:

  • “There is a plausible free market argument to say that under certain institutional conditions (such as competitive banks and no moral hazard), increases in the money supply to offset changes in the demand for money would avoid adjustments having to take place through the notoriously ‘sticky’ real economy. In the same way that inflation creates real effects, so does a monetary deflation, and these effects are neither desirable nor necessary.” [4]
  • "A further argument that Austrian's might be interested in, is the distinction between an expansion in the money supply to offset an increase in the demand for money, and an expansion in the money supply as a means to stimulate aggregate demand." [see here].

 And in an IEA article published in March 2011 I was a lot clearer:

  • “Austrian economists are happy to acknowledge that under certain theoretical conditions QE can work as Congdon suggests – when the demand for money rises a corresponding increase in the supply can restore monetary equilibrium without forcing an adjustment to take place through prices and output” [5]
  • “the best hope for monetary policy was that it prevented the ‘primary recession’ caused by the bubble unwinding turning into a "secondary recession" that sucked in the whole economy.” [5]
  • just as the monetarist view is too rosy, the Rothbardian view is too pessimistic.” [5]

Verdict (2): I got there in the end

 

5. Unintended consequences of setting a precedent

In February 2010 I published a Guardian article that softened my critique of QE: 

  • “To judge whether it worked depends on what would have happened without QE, and economists typically lack the toolkit to engage in rigorous counterfactual analysis.” [3]
  • “Even if we understood better how the economy would look without the actual policy responses, determining whether they "worked" implies we understand the intentions of the primary decision-makers. Only then would we know if the actual outcomes match the intended consequences” [3]

 Part of the problem with QE is that it reuqires an exit strategy, and we entered it without having a clear one:

  • “The excess liquidity that QE creates will find its way into the real economy at some point – possibly after the economy has already begun to recover naturally – and this is why having an exit strategy is so important. Again, the more confidence markets have in the efficacy of such a strategy, the harder it is for QE to ‘work’, but doubts remain as to whether this can be navigated. Some argue that it’s simple to hike up interest paid on reserves, or possibly even confiscate such reserves when banks begin lending again. However, this overestimates the Bank of England’s ability to anticipate events.” [4]

 I also relegated the threat of inflation as a consideration but pointed out the following:

  • "the rules of the game have changed. The conditions under which QE would be rehabilitated aren't clear." [3]

A key issue is the danger it becomes semi-permanent. In a Management Today article, published January 2012:

  • 'The Bank of England’s policy rate has been historically low for some time now and this cannot continue indefinitely. The aim of low interest rates is to boost the economy by creating incentives to borrow money and invest. But higher capital requirements and policy uncertainty create counter forces that restrict bank lending. [7]
  • 'In these circumstances the purported "benefits" of low interest rates fail to materialise, but the costs certainly do. These include the lack of an incentive to save (and actually rebuild banks' balance sheets through voluntary lending), distortions to the capital structure of the economy (making white elephants like the HS2 line appear profitable) and the erosion of people's savings. [7]
  • 'The fact that real interest rates (the difference between inflation and the return you get on your savings accounts) is negative is a harmful confiscation of wealth. [7]
  • 'When interest rates are close to zero policymakers look to alternatives, and quantitative easing has emerged as their favoured tool. However grateful banks and the financial community are in general to have an injection of freshly-printed money, it’s not clear how much this is helping the real economy. The aim shouldn’t be to preserve the status quo, but to find ways to allow banks to fail without exposing the general public to the fall-out.' [7]

In November 2010 I said:

  • “the use of QE to boost aggregate demand (rather than prevent a liquidity meltdown) is a precedent” [see here]
  • “there can be a fine line between “stabilising MV (money supply multiplied by velocity)” and “boosting AD (aggregate demand)” [6]

Verdict: QE needs to be reformed and there's a real danger that it simply becomes another source of stimulus.

 

6. Back door bailouts

I try not to engage in banker bashing, but was unable to resist the temptation:

  • "banks have benefited. QE served as a bailout by the back door. By enlarging the scope of assets it buys, and printing money to fund them, this creates (alas perhaps literally) a get-out-of-jail-free card for profligate bankers." [3]
  • “Whilst many businesses have benefited from being able to issue more commercial paper (as the second Giles video points out), the main beneficiaries have been the banks. For very good reasons the Bank of England is not supposed to directly finance UK government debt. This is the cause of most hyperinflations, and is "one arm of the state directly financing another". But they are able to buy them on the secondary market. This makes a massive arbitrage opportunity for banks that buy up gilts and sell them on to the Bank” (see here)

Verdict: A bit crass.

What I should have done is emphasised the importance of liquidations in market corrections and the role of central banks at ditinguishing between liquidity and solvency crises. In 2010 I tried to make this point, arguing that a downside of QE is that it masks solvency problems:

  • "The original reason for having a lender of last resort was to provide emergency liquidity during a bank ‘panic’ and to help unwind unsound banks so that they wouldn’t pose a systemic risk. As time has passed since the first round of QE1 we have realised that it wasn’t merely a short-term liquidity problem, but a fundamental one of solvency. This cannot be cured with a quick gush from the monetary spigot, and direct bailouts merely obscure the distinction between liquidity and solvency problems further.” [4]

Perhaps this is too simplistic because they way in which QE is conducted can determine whether it's providing a Bagehot style penalty or a back door bailout. In March 2011 I said

  • "In a world where central banks exist, this is the mechanism by which we distinguish between the temporary illiquid to the fundamentally insolvent. And unlike QE it avoids a slew of unfavourable side effects, such as expanding the scope of the Bank of England (by redefining the types of assets and types of institutions they deal with); expanding their discretionary powers; generating regime uncertainty; increasing the upside risk of inflation; and placing epistemic burdens on policymakers that there is no hope they can shoulder.” [5]
  • “why can't the Bank of England simply fulfil its traditional role as being lender of last resort” [5]

Back then, I felt that the Bank of England should use discount window. Now, I believe QE could be used in a way that is better than a discount window.

 

Conclusion

In November 2010 I wrote a think piece for the Adam Smith Institute, and stand by the main argument:

  • “Policies like QE increase regime uncertainty and generate systemic instability. They have the potential to make matters worse, and ignore the fact that you cannot buy confidence. The Bank for International Settlements – one of the few organisations that foresaw large elements of the financial crisis – warns about the upside risk of continued low interest rates. Systemic misallocation of capital (including human capital) remains. Excessive risk-taking remains. Over-leveraged balance sheets remain. Volatile capital flows remain.”  [4]

However I argued that QE had run it's course

  • “There is an alternative to more QE.” [4]

Now, I believe that I should have explained what it is good for, and clarified what those alternatives are. The justification for QE was to prevent a collapse in commercial banks balance sheets and reduction in broad money growth. But the main reason for this problem was an exogenous policy shock, namely an increase in capital requirements.

 So, mea culpa:

  • I didn’t have a good grasp at to what was happening to the money supply at the time - broad money growth data was flawed
  • I was treating the ceteris as paribus, believing that if the problem was regulatory intervention the solution is to remove that intervention, rather than introduce new ones
  • Quibbling about how QE was conducted (and not having a clear alternative) was less important than generating liquidity
  • I placed too much weight on the long term, unintended consequences of QE

Then, my main policy sympathy would have been to implement Bagehot through discount window and keep provision of market liquidity separate

Now, however, I think that the problem was OMO being too narrow. If you have a “small number of counterparties” and a “small subset of “good” securities”, then a ““Bagehotian” case can still be made for occasional direct Fed lending”. However if OMO function well or are reformed (i.e. diversify the participants and diversify the assets) then that’s how Bagehot should be implemented. (See this George Selgin article for more).

I maintain that hair of the dog isn't effective monetary policy, and so the central bank should not be there handing out shots. But they do have a role in easing the hangover by handing out water. And given that they won't always know where it's needed, soak the market with liquidity and see where it goes.

Here's how I'd summarise the debate:

References:

  1. The semantics of printing money” The Guardian, March 2009 
  2. The unpalatable financial truth” The Guardian, March 2009 
  3. Has quantitative easing paid off?” The Guardian, February 2010
  4. The Threat of QE2”, Adam Smith Institute, November 2010
  5. Monetarists’ blind spot on quantitative easing” Institute of Economic Affairs, March 2011
  6. Forward thinking”, Money Marketing, May 2011
  7. "To QE Or Not To QE? The Market Has Spoken” Management Today, January 2012

 

Estimating the Productivity Norm Price Level for the UK

In George Selgin's classic book "Less than Zero" he advocates the concept of the "productivity norm". He argues that:

"the price level should be allowed to vary to reflect changes in goods' unit costs of production"(p.10)

A productivity norm exists when adjustments in the general price level follows the rule above, and has the following implications:

  • Changes in velocity would be offset by changes in the money supply such that nominal income is unchanged
  • Changes in productivity would be reflected by changes in the price level such that nominal income remains unchanged

Here is the chart from the book, showing the Actual and Productivity Norm Price Levels from 1948-1976:

There are several problems with attempting to replicate this for the UK. It may be that these problems are insurmountable, and it may be that my attempts to deal with those problems have created new ones. Still, this is a work in progress and I am looking for feedback.

The first issue is that the productivity norm rests on Total Factor Productivity. The best source of estimates for this come from the following ONS release:

These are only annual figures up to 2012 and supposed to be treated with caution. Given that I'm not careful with data anyway, I thought I'd use it. The chart below shows the results:

The method of calculation was simply:

What this shows is that productivity gains should have generated a benign deflation in 2003-2004, but also that policymakers should have allowed inflation to go higher during the 2008-2009 crisis than they did.

I also wanted to look at more reliable, and quarterly data, and therefore used Labour Productivity (I was bouyed by Scott Sumner's claim that the difference between Labour and TFP isn't all that important). The chart below shows the growth rates from 1997-2014 using the same method as above.

Once again we see several periods where positive inflation appears too hgh, with several points at which a productivity norm inflation rate would have been negative. It then spikes up significantly higher than actual CPI before coming into line more recently. Given that the productivity data is only available quarterly this doesn't incorporate the 0% CPI we have seen this month. Because I suspect this is the most interesting of the charts presented here, this will be the one that we update regularly in our data section.

Finally, my original goal was to do these calculations looking at levels. I used the following method for the first time period:

and this for each subsequent:

Here is the chart:

It is telling us something interesting, but I'm not sure if the narrative is supported strongly enough by the theory and methods employed.

Update to Private Investment series

In the data section of our website we have been providing an estimate of "Private Investment". The compilation was explained in this post and was simply the sum of "Business Investment" and "Private Sector Dwellings". In September 2014 the ONS announced major changes to the UK National Accounts, and they had a very large impact on the measures for Gross Fixed Capital Formation. As mentioned in a previous post, these revisions are big:
Here are the year-on-year growth rates (once again comparing 2013 with 2015 data, but this time with a difference colour scheme):
Now, the method is simply summing the following:
  • Business investment (NPEL)
  • Private sector dwellings (L636)
  • Private sector costs (L637)

And we contrast this with: 

  • General government (DLWF)

Here is the updated estimate:

The chart below shows the updated figures compared to using the 2013 methods:

As previously mentioned, the main difference is the stronger recovery in 2010. Note that we are using quarter on quarter (of same quarter of previous year) data. There is dramatic volatility with the private investment figure, showing -24.5% in Q2 2009 and +12.4 in Q4 2010. This may be the result of the way in which we are measuring growth. I tend to prefer QoQofY rather than QoQ because the latter tends to be more volatile, and the former shows the bigger picture. For example, here is a comparison of the two different growth rates for total Gross Fixed Capital Formation (i.e. investment):

These are the two measures published by the ONS. An alternative, however, is to annualise the data. Here is the chart showing Private vs. Government Investment with the quartely growth rate compared to an annualised one:

As you can see, the darker lines (quarterly growth) are less volatile than the lighter lines (annualised). This is the reason we opt for quarter on quarter (of same quarter of previous year) growth rates.

Natural interest rate estimates make the Daily Telegraph

Pete Spence has written an excellent article on natural interest rates in the Daily Telegraph. He says, 

The crisis came at an inconvenient time for policymakers. For the past two decades the so-called “natural rate” had been been trending downwards. This is the theoretical rate which best promotes growth and simultaneously keeps inflation in check. It has been a source of much debate among economists.

He goes on to cite the Kaleidic Economics estimates of the UK natural rate.

My intention is to update this on a regular basis and publish it on our Data page. It looks like there is some interest in this, and so I will focus efforts on providing it. This is great coverage, and especially encouraging that debate is moving in this direction.