Battle of the ex-MPC members: Blanchflower vs Sentance

On the off chance that none of you have been following twitter recently, there has been something of a running disagreement (not quite a spat, but certainly not a friendly discussion) between two former members of the Bank of England’s Monetary Policy Committee (the group of learned people that, among other things, set the Bank of England’s base rate). Specifically, Danny Blanchflower and Andrew Sentance have been airing their widely different opinions regarding the state of the UK economy, and its recovery (or lack thereof) since 2008/2009. (See, for example, Blanchflower’s tweet in response to Sentance – there are plenty of others, although they do verge on the childish at times.)

By way of background, it’s helpful to note that during their time on the MPC, Blanchflower was noted as an inflation “dove” (i.e. someone who is not overly concerned with inflation as long as it was at extreme levels), whereas Sentance was one of the most “hawkish” (the opposite of a dove – i.e. someone who is concerned about inflation as (practically) the be-all-and-end-all) members.

This difference of opinion regarding the importance of inflation seems to have spilled over into their interpretation of the UK economy’s performance since 2008/2009. Blanchflower views the UK’s “recovery” since 2008/2009 as pitiful, and makes the (valid) point that it has taken over 60 months for the UK to return to its pre-2008 GDP level. Indeed, he uses the graph below to indicate that it has been the lengthiest recovery for over 100 years – each line represents the progression of GDP during each recession and recovery since 1920. The line representing the 2008-2013 recovery takes almost 12 months more than the next lengthiest recovery (1973-1976) to return to pre-recession levels, appearing to support Blanchflower’s claim. (In fact, Blanchflower makes the claim that it has been the lengthiest recovery for over 300 years, although the data to substantiate this claim have not yet been presented).

The picture is even more striking when looking at GDP per capita. Due to increases in population over time, the length of a recovery in terms of GDP per capita is increased relative to looking at GDP on its own. The graph below shows the difference between GDP per capita and its peak for each of the fours most recent recessions that were presented in the previous above. Due to limitations in the data available from the ONS, the series in the graph below are calculated using the ONS’ quarterly GDP data and their annual population data (assuming that quarterly population changes within a year are minimal).

Nonetheless, the implications of the graph are clear – it took even longer for GDP per capita to return to its pre-2008 level than was the case for just GDP: 7 years for GDP per capita versus about 5 a bit years for GDP on its own. Moreover, the difference between the current recovery and the next most lengthy is 13 quarters – i.e. just over 3 years.

GDP per capita

So, then, it appears as though Blanchflower is correct in terms of the length of the recovery. It is difficult to see how Sentance can disagree with Blanchflower on this issue.

Another matter is the reason for the lengthy recovery, but that’s for another blog post!

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Why would the UK move away from inflation-targeting?

Today’s announcement that the Corbyn Labour party is planning to examine to what extent the Bank of England’s inflation target might be modified to take into account factors other than inflation provides a good opportunity to reflect on what inflation-targeting itself has achieved and why the UK might move to a different monetary regime.

(By way of background, although the Bank of England is “instrument independent” – that is, the BoE gets to choose how it achieves its target – the target itself is set by the government – i.e. the BoE is “goal dependent”. Hence, in the event that a Corbyn government is elected, they would have the power to change the measure that the BoE targeted.)

Although one of the main reasons for Corbyn’s decision to re-examine inflation targeting appears to have been due to actual inflation having missed the BoE’s target on a consistent basis in recent years (CPI has been below the 2% +/- 1% band much more often that not recently), it can be argued that this “accuracy metric” is not the most important criterion by which to measure the success of inflation targeting.

Indeed, the main purpose of inflation targeting is to anchor people’s expectations regarding what level of inflation will prevail. As such, the most important metric by which inflation targeting should be measured is the extent to which people’s expectations regarding what the prevailing rate of inflation will be have converged to the level of inflation that has been set as the target.  To that end, both Capistran & Ramos-Francia and Gurkaynak et al. demonstrate that targeting inflation leads to a decrease in the range of people’s inflation expectations.

In other words, the fact that a target might have been missed does not matter in-and-of-itself. Instead, missing an inflation target only matters insofar as consistently missing the target would affect people’s expectations of inflation. Thus far, there have not been any signs that people’s expectations regarding future inflation have been affected by the Bank of England missing its target.

Hence, at least one of the motivations regarding a potential move away from inflation-targeting is likely to be flawed. However, that is not to say that the other targets that have been proposed – such as targeting nominal GDP growth, or increasing the level of inflation targeted to, say, 4% per year – would lead to run-away inflation. Indeed, there are some economists that advocate moving entirely to a nominal GDP target would have the benefit of promoting growth (particularly when interest rates are close to the zero lower bound) as well as still preventing anchoring inflation expectations (see, for example, here).

The one word of caution that needs noting is that a nominal GDP target is less transparent than inflation – how will the general public be able to translate a target for nominal GDP into a target for inflation? How will they be able to know what inflation is likely to be when all they have is a nominal GDP target? Hence, it seems likely that a nominal GDP target won’t be sufficient on its own, but instead needs to be accompanied by an explicit inflation target (i.e. a dual target). That seems a much more transparent and easily-accessible policy, particularly given that the main aim in all of this is to anchor people’s expectations.