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)

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.