The minutes of June’s Monetary Policy Committee (MPC) meeting were published this morning. They were rather more dovish than the markets had expected and raised the prospect of a further round of quantitative easing. The relevant quote was: “It was possible that further asset purchases might become warranted if the downside risks to medium-term inflation materialised.”
Once again, my good friend Adam Posen voted for a further £50bn of asset purchases. It is increasingly looking like he is on the right side of this one. The two misguided inflation hawks — the chief economist, Spencer Dale, and Martin Weale — voted for a 25 basis-point increase. They know not what they do, honestly.
The majority on the MPC is right to worry more about growth than inflation right now. This week, there was more evidence that George Osborne’s nightmare scenario of zero or even negative growth is unfolding before our eyes. The Confederation of British Industry’s Industrial Trends Survey for June, published yesterday, was not encouraging.
The drop in the output expectations index from May’s 20 to 13, the lowest figure since December last year, added to other recent evidence suggesting that the previously strong manufacturing recovery is disappearing. The slowing economy is also holding back tax receipts that, according to data released this week, were up only 3 per cent in April and May together.
The monthly public-sector borrowing figure of £17.4bn was a little below last May’s figure of £18.5bn. But, in the first two months of the fiscal year together, borrowing totalled £27.4bn, compared to last year’s £25.9bn.
Jonathan Loynes at Capital Economics has pointed out that, although it is early days yet, at this rate, borrowing will overshoot the Office for Budget Responsibility’s Budget forecast of £122bn by almost £30bn. Loynes argues: “Overall, the public finances figures provide a clear warning that the weakness of the economy could derail the government’s deficit-reduction plans and will add fuel to the debate over whether it should scale back the size and speed of the fiscal tightening.” Hence, the concern of the majority on the MPC that more stimulus may be needed.
This afternoon’s Opposition Day Debate in the House of Commons on the anniversary of Osborne’s first Budget makes the case for the government to “adopt a more balanced deficit plan which, alongside tough decisions on tax and spending cuts, puts jobs first and will be a better way to get the deficit down over the longer term and avoid long-term damage to the economy”. There is a realistic alternative (Tiara).
Of particular interest was how the MPC’s newest addition, Ben Broadbent, voted at his first meeting. It turns out he voted along with the majority: for no change.
While he was at Goldman Sachs, Broadbent was the co-author of an article written with Kevin Daly that advocated the macroeconomic benefits of an “expansionary fiscal contraction”. This is the idea that Larry Summers dubbed as “oxymoronic”. The empirical evidence suggests that such a policy has never worked without being accompanied by a big loosening of monetary policy. Given that there seems to be a contractionary fiscal contraction going on, Broadbent was always likely to vote for a stimulative monetary policy as his Plan B. Plus, I understand that he is pals with Osborne’s chief economist, Rupert Harrison, who would no doubt be most unhappy if he voted for a rate rise.
I gave a speech last week at a conference in London where I said that there are few things that Osborne, Mervyn King, Alistair Darling and Blanchflower would agree on right now other than that interest rates shouldn’t rise any time soon. The next speaker after me was Lord Lamont, who kindly came up to me afterwards and said that he agreed on my comments on the need to keep monetary policy loose.
I recall being told by Steve Nickell, whom I replaced on the MPC, that it was a good idea to wait for two or three meetings before doing much, so you could work out which way was up. This was great advice. I remember, though, that Andrew Sentance, in his first meeting in 2006, voted in the minority along with Tim Besley, who was attending his second meeting for a rate rise in a 7-2 decision for no change.
One of my ex-colleagues on the MPC commented to me at the time that it was interesting that the only two members of the MPC who believed the August inflation and growth forecasts were the ones who weren’t there when they were being constructed.
Over the past few weeks, there were three speeches by MPC members that were of particular interest. Sir Mervyn’s Mansion House speech didn’t say much of note, other than that Osborne, who presumably had approved his knighthood, couldn’t do anything wrong and should keep on going slashing and burning the economy. His comment on fiscal policy was interesting. “Of course, there can always be differences of judgement about the overall stance of policy but to change the broad policy mix would make little sense.” Maybe Merv still doesn’t realise that he is the likely fall guy when the coalition’s economic ship hits the rocks.
The external MPC member Martin Weale made a speech in London, in which he argued that bank rate should be raised now, even though inflation is likely to fall sharply as the temporary factors drop out. There is no evidence of any second-round effects from wages; consumer confidence is at levels only seen previously in the depths of the great recession and growth is anaemic — all before austerity hits. Weale argued that:
The case for a rise can be put quite simply. An early increase in bank rate makes it more likely that the inflation target can be met in two to three years time because it allows for greater subsequent flexibility. If inflationary pressures subsequently prove more severe than the central part of our forecast suggests, then it will be a help to have started to raise interest rates earlier. But if they prove less strong then subsequent increases can be slower than would otherwise be the case. Indeed, if the economy is extremely weak, interest rates can be reduced again.
What a load of tosh. An increase now would slow the economy at a time when the economy has stagnated. Raising rates now only to have to reduce them in the future would be a major policy mistake. There is no empirical support whatever for Weale’s claim in the June minutes that: “A small increase in bank rate would afford the committee greater subsequent flexibility in responding to possible future developments.” Weale is taking over Sentance’s mantle as the MPC’s resident clown.
Fortunately, there are some sane voices on the MPC. I was much encouraged to read the excellent speech by my old friend and colleague Paul Fisher at the Global Borrowers and Investors Forum in London on 21 June. Paul made it clear that he is especially worried about risks to the downside.
Over the past couple of years, the challenge has been dealing with a succession of real changes in relative prices (via negative supply side shocks) which have pushed up on prices whilst depressing demand and output. That is extremely uncomfortable for everybody. But there was, and is, no easy way for monetary policy to deal with the impact of such shocks. In our current projections there are very major risks to either side of the central case. On one side, higher inflation expectations could become entrenched making it very costly for the MPC to subsequently bring inflation back to target. On the other side, the economy could be much weaker than we expect pushing down on inflation and risking deflation. Recovering to the target from that could be even harder (at least in my personal view).
Phew, Fisher gets it but Weale and Dale sadly don’t. At least Sir Mervyn continues to vote the right way (along with Posen, Broadbent Tucker, Bean, Fisher and Miles). I am grateful for small mercies.
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