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Inside Economics

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This is a space for me to comment on Economics both in terms of the specific bits if economics, how the discipline works and the academic politics. I might also be tempted into talking about the economy!

CPI inflation July 2021: looking at the items.

Inflation Posted on Thu, August 19, 2021 17:55:48

The Headline CPI for July 2021 was 2.0%, down from 2.5%. I have analysed what underlies this in my NIESR Blog of August 18th. As I argued there, the drop was due to the monthly “spike” in inflation the previous July 2020 dropping out of the headline figure. The “new” monthly inflation in July was just below zero (-0.02%).

In this Blog I just want to look a little deeper at the item index level. The CPI is constructed of many items, and the ONS published 733 of these alongside the headline figure. Each item index is constructed from an average of over 100 price-quotes, to capture prices in different regions and types of shop. In the figure above, I have calculated the month on month (monthly) inflation for all of the 733 items available in June and July. These have been ranked by the level of inflation expressed as a %. The highest monthly item inflation rate was 14.8% for ROADSIDE RECOVERY SERVICE; the lowest was -22.3% for MOBILE PHONE APPLICATIONS. The arithmetic average was -0.28%, with median 0.02%.

Figure 1

We can also look at the same distribution in Histogram form. There is clearly a skewness in the distribution (there is a big tail on the left), a high variance and standard deviation (the coefficient of variation is 0.36, indicating the variance is over one third of the mean). In addition to the “fat tails” there is also a dense middle, which explains the high (excess) Kurtosis figure. All of these stats are in the shaded box in Figure 1.

Figure 2

The actual CPI figure published by the ONS is a weighted sum of the item inflation rates (item weights being expenditure weights), and includes the “centrally collected” items not included in the published list. The monthly CPI inflation was -0.02% (the ONS publishes this as 0% because inflation statistics are published to just one decimal place.

However, the unweighted distribution does tell us a lot about the almost zero inflation observed. The median items were DOOR HANDLE-PACK FOR ONE DOOR and PORTABLE SPEAKER, which both experienced exactly 0.02% inflation. Just under half of the items showed monthly inflation in the range -0.74% and +0.45%. (the 306 item tall column in Figure 2). The NIESR inflation tracker looks at all of the over 100k published individual price quotes underlying the 733 price indices each month. For July, over 80% of prices were the same as in June, with no change month on month. Indeed, 48 out of 733 item indices indicated 0% monthly inflation.

Overall, July was like any month in the sense that there is a wide variation in price changes month on month. Some prices rise a lot and some fall a lot. The proportion of individual prices remaining unchanged was a about the same as average (81%). Looking at the item indices, 50% had a change of zero or less, 50% were strictly positive. However, the negative skewness of the monthly item inflation figures gives a mean of -0.28%, which is an annualised rate of -3.36%. The median at 0.02% is an annualised rate of just 0.24%. Thee were a lot more big falls than big increases in the data.

If we look above the item level to the COICOP expenditure categories, shown in Figure 3, we can also see how there is a fairly even balance of prices going up and down, with Transport the being the big positive outlier reflecting big increases in motor fuel from June to July. However, in 7 out of 12 categories, the inflation was negative.

Figure 3: monthly Inflation by COICOP expenditure division

However, note that the the number of items does not reflect the expenditure shares. Some types of expenditure have lots of items. The main one is Division 01, FOOD AND NON-ALCOHOLIC BEVERAGES (FNAB). The ONS collects many more food items relative to overall expenditure share. One might therefore expect this to mean that the item average and was lower than the CPI figure (since division 01 FNAB had -0.34% inflation). This is indeed the case (average item inflation was -0.28% as opposed to CPI of -0.02%).

Pelagius: the first British author.

The meaning of Life Posted on Thu, May 28, 2020 15:45:46

“a natural sanctity in our minds…which favours honourable and upright actions and condemns wrong deeds…by a kind of inner law”

            Pelagius is the first British author for whom we have surviving literature. He was active in the period 390-420 and is well attested in contemporary sources: primarily Jerome and Augustine of Hippo, but also others. He is best known for giving his name to the “heresy” of Pelagianism.  His works are known both through the writings of his contemporary opponents and in surviving texts (although, as in most texts from this period, “authenticity” of any particular text is always an open question, since our earliest copies are from long after they were first written).   His date of birth and death are unknown. Birth would have been in the middle of the fourth century, 350-360. His date of death would be 419 or layer, at an unknown location (although Egypt seems a plausible possibility).

Christianity in Pelagius’s Britain.

            Christianity was well established in Roman Britain by the time of Pelagius.  Whilst the details of its earliest arrival in Britain are unknown to us,  there is a wealth of archaeological and historical evidence that indicates that by the fourth century there was a long-established Church in Britain with Bishops which were linked to the continental Churches. From the archaeological evidence, we have the Hinton St Mary Mosaic from a wealthy Roman villa dated to the early 4th Century, along with various Chi-rho iconography around Britain and the Sator Squares in Lancashire. From Pelagius’s own time we have the Church at Vindolanda. However, it is in the written text that we find many references to Christianity in Roman Britain.  Second century church fathers Tertullian and Origen wrote of Christian communities in Britain. In the fourth century, British Bishops attended the Council or Arles (314), and the Councils of Serdica (343) and Rimini (359).  We also have a letter to Flavius Sanctus, the Roman Governor of Rutupine (Richborough) from the middle of the 4th Century attesting to his Christianity.  Jerome writes about British pilgrims coming to Bethlehem in one of his letters which is contemporary with Pelagius .  Magnus Maximus was proclaimed Emperor in Britain and became effective ruler of Gaul and Britain in the period 383-8. He had a very orthodox view of Christianity and it was he who was behind the condemnation of the Priscillian heresy and first ever execution of a “heretic” (Priscillian), albeit under civil not church law (in fact the execution was opposed by St Martin and Ambrose who disagreed with the spilling of blood).[1]

            That Pelagius was British is stated by several contemporary sources.  He was obviously well educated and highly literate so almost certainly came from a high-ranking family.  Apart from patronage, there were at the time few paths to an education unless you were born into a well-off family. It is possible that he might have had an ecclesiastical education. He is also sometimes referred to as a lawyer, which may mean he was trained as such.  Jerome referred to him as being Irish (Scotti).  This is almost impossible. The establishment of Christianity and the Church in Ireland was to happen in the fifth century and knowledge of literate Latin would not have been available in Ireland in the late fourth century. Jerome’s comment was a put down, meaning that Pelagius was “beyond the pale” and his views were not to be taken seriously.  In fact St Patrick may well have been a contemporary of Pelagius, although born somewhat later. His Irish Mission is usually dated to the mid 5th Century and was certainly post-Roman.

Pelagius’s life.

At some time in the 380s, Pelagius made the journey from Britain to Rome. This was a common path for educated intellectual provincials in the western empire. His future critics Augustine and Jerome both made the journey from their home provinces to Rome in the late 4th Century.  There was lots of potential for giving classes to the sons and daughters of the wealthy. Also, wealthy families and individuals in Rome were keen to have Christian spiritual guides.  They sought advice on how to bring up children, how to behave and how to interpret the scriptures. These included Senatorial families who had converted to Christianity after the Edict of Thessalonica in 380 AD, when Emperor Theodosius I made Christianity the Empire’s state religion.   Whilst he might have started his career as a lawyer, by the 390s is described (by Jerome and Augustine at least) as a “Monk”. Pelagius made some very good connections whilst in Rome, including some of the same families who were connected to Jerome. The fact that he was criticised so extensively indicates that his message was popular and influential.  He also had several followers who were influential in their own right, and who became leading figures in the Pelagian controversy.  Indeed, it is sometimes difficult to disentangle what was said by Pelagius and what by his “followers”. Two of the most prominent of these were Celestius who was active in Africa and described by Augustine and Jerome as Pelagius’s pupil and Rufinus of Syria. Rufinus was based in Rome in the period 399-409 alongside Pelagius. 

When Alaric the Goth came to besiege Rome in 409, Pelagius fled along with many others. He went to Africa, via the land route of southern Italy, crossing the Mediterranean to Sicily and then on to what is now Algeria, where Augustine was the Bishop of Hippo. He arrived in Palestine sometime before 413, where he came into conflict with Jerome.  The ideas of Pelagius and his followers certainly had a popularity in many Christian communities.  This probably explains the strong response of parts of the Church against Celestius, Rufinus and eventually Pelagius himself.  Pelagius was charged with heresy at the synod of Diospolis in 415 before The Bishop of Jerusalem, John. He was acquitted after disassociating himself from some of the “extreme” views of Celestius. The African Bishops appealed to the Bishop of Rome to overturn the judgement, and a condemnation of Pelagius was issued by Bishop Innocent[2], who then died and his successor Bishop Zosimos reviewed the decision in 418 and replaced it with an ambiguous opinion.  The African Bishops then appealed to the Western Emperor Honorarius based in Ravenna and Zosimos finally condemned both Pelagius and Celestius in his 418 Epistula Tractoris. Having been condemned in the Western Church, the Eastern Church finally condemned “the opinions of Celestius” at the Council of Ephesus 431.  The decision of Zosimos in 418 was influenced by the emperor Honorius’s condemnation of Pelagius and riots in Rome by “Pelagians”. Pelagius, based in Palestine, attempted unsuccessfully to get Bishop John of Jerusalem to dissent from Zosimos and so he would have had to leave Palestine. Egypt is put forward as a possible ending location since the Bishops there might have been more sympathetic. He may well have died as early as 420, or possibly just kept a low profile and we hear nothing of him after that date.

The Writings of Pelagius.

What writings of Pelagius have survived? There are a series of 18 letters, or essays, on a variety of subjects, although some or most of these might be by his followers.  Of these, seven are more or less complete and others fragmentary. We also have the transcripts of Pelagius’s evidence given at the Synod of Diospolis. In some cases we know approximately when the letters were written. There is also a commentary on Paul’s letter to the Romans. In terms of style, Pelagius was a very clear and articulate writer with a direct style. This contrasts to the prolix, wordy and repetitive Augustine and the harangues of Jerome.   Even the venerable Bede recognised that although Augustine won the debate, Pelagius was the better writer.

The Letter to Demetrias, written in 413-14 is the best known of the letters and is almost certainly written by Pelagius himself . Demetrias was a 14 year old daughter of one of the elite families that had left Rome in 409 and who had decided to devote her life to virginity and to cancel a wedding that had been planned. The mother Juliana wrote to both Pelagius and Jerome to ask for their advice: both replies have survived. Pelagius’s letter is something of a tour de force and puts forward his theological views in a very clear and succinct manner. God made Man in his own image, free to act – “he left him free to make his own decisions” (Ecclesiasticus).  Pelagius says “”God wished to bestow on the rational creature the gift of doing good of his own free will…the capacity to do evil is also good – good I say because it makes the good part better by making it voluntary…not bound by necessity but free to decide for itself.”  Pelagius thought that there is an innate goodness in people: “a natural sanctity in our minds…which favours honourable and upright actions and condemns wrong deeds…by a kind of inner law”.  It was this inner law that enabled men to be righteous and pleasing to God even before Moses.  In particular, he quotes the Lord as saying of Job “there is none like him on earth, a man against whom there is no complaint, a true worshipper of God, keeping himself away from all evil”. Indeed, Pelagius holds up Job as an ideal example:

What a Man Job was! A man of the gospel before the gospel was known, a man of the apostles before their commands were uttered! A disciple of the apostles who, by opening up the hidden wealth of nature and bringing it out into the open, revealed by his own behaviour what all of us are capable of and has taught us how great is that treasure in the soul which we posses but fail to use and, because we refuse to display it, believe that we do not posses it either.”

How does the life and death of Christ alter things for Pelagius? He writes:

“…long before the arrival of our Lord and Saviour, some are reported to have lived holy and righteous lives. How much more possible must we believe that to be after the light of his coming, now that we have been instructed by the grace of his and reborn as better men. Purified and cleansed by his blood, encouraged by his example to pursue perfect righteousness, we ought surely to be better than those who lived before the time of the law, better even than those who lived under the law, since the Apostle says “For sin will have no dominion over you, since you are not under the law but under Grace” (Rom 6.14).

We can see that Pelagius had a positive view of human nature. We have an innate goodness in our nature. Whilst we are free to choose evil, we are also  we are also drawn towards the good and he old Testament provides examples of men viewed as righteous by God.

The argument with Augustine and Jerome.

            The argument with Augustine took some time to develop.  As we know from his autobiography, Augustin had converted to Christianity as an adult, very much inspired by Bishop Ambrose of Milan. He was very well acquainted with the “pagan” literature (philosophy) and had been a Manichean prior to becoming a Christian. The argument with Pelagius developed after 410 and played a part in the development of Augustin’s own world view. I do not seek to provide a detailed summary of Augustin’s views. However, there were two main planks involved in the debate with Pelagius. The first was his own idea of “original sin”.  The idea that humanity had suffered a fall from grace (been expelled from the Garden of Eden) was a core belief of both Christianity and Judaism.     Augustine took a much stronger view the fall of man meant that he was unable to live without sin unless there was Grace.  Secondly, since God was omnipotent and all knowing, this led him to believe in predestination: those who were to receive Grace were chosen from the beginning of time. Now of course, these views were very much flavour of the reformation a millennium after Augustine (both Luther and Calvin were inspired by him), but in the early 400s they were largely new and took to their logical conclusions some of the views found in St Pauls letters when combined with a well-articulated theology in terms of Gods omnipotence and omniscience.

            The central issue of the Pelagian debate was whether human nature was inherently sinful (Augustine) or had some innate goodness (Pelagius).  Pelagius believed that humans were able to choose good over evil even without Christianity, but with Christian faith and the grace of the holy spirit it was even more achievable and baptism could wash away any sins that we did commit.  I think it is best to see Pelagius as a moral teacher and motivator. He was shocked by the immorality he found in Rome and sought to stress that to be a good Christian you needed to behave in a moral manner.  Augustin was a Bishop of some authority and influence. Pelagius was at something of a disadvantage and destined to be outgunned by the Bishop of Hippo once Augustine had finally decided that the views of Pelagius contradicted his own views.

            Jerome, like Augustine, also had a pessimistic view of human nature. Furthermore, in siding with Augustine he was hoping to absolve himself from his own views as a young man. The Council of Constantinople in 381 had “completed” the council of Nicaea (which had adopted the consubstantiality of God the father and Jesus) by making the Holy Spirit part of the Holy Trinity, what then became a core Christian belief (as reflected in the verse it added to the original Nicene creed, which had not mentioned of the holy spirit).    Jerome had devoted much of his younger years to translating the works of the second century Church father Origen.  The concept of the Trinity was not part of Origen’s cosmology and so his works came to be viewed as heretical around the 400s. By association, Jerome came under suspicion and we can see fro his letters that he moved to distance himself from Origen.  Jerome needed to demonstrate his orthodoxy, and what better way than supporting Augustin against Pelagius.

            It is interesting to note that Pelagius and Jerome shared many views, and indeed some of Pelagius’s writings were later wrongly attributed to Jerome.  For example, they both encouraged virginity as an ideal state (and celibacy within Christian marriage). However, Jerome idealised mortification of the body and rejection of the worlds pleasures whereas Pelagius taught a more practical view that morality could be lived in normal life. There was also some personal beef between Jerome and Pelagius. Some of Pelagius’s followers trashed a monastery where Jerome was staying in Bethlehem and he had to flee for his life (on this, we only have his testimony however).

Pelagius the first British author.

In the end, Bishop Augustine prevailed and Pelagianism became the name of a heresy. From the perspective of modern Christians, I suspect the majority would side more with the optimistic Pelagius than with the deep pessimism of Augustine.  At the time, Pelagius was obviously a well respected and popular thinker. We know this because he had followers and both Augustine, Jerome and other opponents of “Pelagianism” first targeted his followers and only after the fall of Rome did they target Pelagius himself. Probably, once he left Rome he lost his network of influence amongst the powerful.

            However, Pelagius was the first British author whose writing survives.  He is an important figure of late antiquity who was well educated and who shows the strength of Christianity and Roman culture in late fourth century Britain. The next two authors who survive in Latin are St Patrick from later in the 5th Century and Gildas from the 6th century.  Whilst the theological debates Pelagius became involved in are of little relevance to life today, his optimistic view of human nature and the possibility of us being able to choose the right and moral path should still inspire us.

[1] Maximus himself died in battle in 388 with the eastern Emperor Theodosius at Save (modern day Croatia), ending his bid to become the Emperor of the west.

[2] In the Papal listing, he is known as Innocent 1st.

To “ise” or “ize”

other things, Uncategorised Posted on Sun, March 01, 2020 18:13:14

Just a quick note. I was chatting with colleagues about whether “realize”, “generalize” etc. are British spellings. Bill Gates and the Microsoft spell checker seem to think that these are “American” whilst “realise”, “generalise” are British. Also, various British media outlets also started to use the “ise” version as their default (starting with the Times in the early 90s, but now followed by other newspapers and the BBC). This has always puzzled me, as I have always used the “ize” spelling. “Nationalize”, “Optimize”, “Privatize” and so on.

The truth is that “ise” is un-American and almost 100% of US publications use “ize”. However, in Britain has been more complicated. In my family, the arbiter of correct spelling was the Oxford English Dictionary. When I look at my fathers 1951 OED edition, the only spelling of realize, generalize, nationalize etc. is the “ize” version. However, in current editions it states that whilst “ize” is preferred, “ise” is an alternative. The truth is that British English has always used both versions. However, if one looks at written British over the last few hundred years, for most of the time the “ize” was the most common usage and indeed still is. However, there was a brief 50 year period , from around 1875 to 1925 when “ise” became more common. The ratio of 2:1 held before 1840 and has held since 1950 (that is two “ize” for every “ise” for words such as realize and generalize). The situation was reversed for a very brief period 1900-1914 (two ise for every ize), but between 1840 and 1950, two were more equal (exact equality being in 1875 and 1925).

So, now in 2020 we have the odd position where in the media, the use of “ise” predominates, whereas in the wider corpus the “ize” has it by a large margin. The myth that “ize” is un-British is very common, even amongst my educated fellow Academics. I personally blame Bill Gates and Microsoft for perpetuating the myth that “ise” is the correct British spelling. In reality I will stick to viewing “ize” as the correct spelling and “ise” as a second rate alternative. Alas, journal editors do not always see it that way. When my paper on the generalized Taylor economy was published in the Economic Journal in 2012, they type set it as “”generalised”. Cambridge University Press has always been contrarian on this issue. I am sure that in the long-run the Times and the BBC will eventually come to their senses and realize that the good old British “ize” has it. The fact that it is the same as in American English is surely even better.

If you want to look at the usage of words and alternative spellings, the Google Ngram is a great place to start!

Prevarication and Procrastination

Monetary Policy Posted on Sun, June 24, 2018 19:27:47

Well, not much has happened in terms of interest rates since
my last post in November: interest rates still stuck at 0.5%. However, excellent news that Jonathan Haskell
is to join the committee. Well, there has been prevarication and
procrastination. Interest rates were set to rise, and then not. Mark Carney
continues to have a depressing effect on Sterling. His latest magisterial
intervention was the interview with Kamel Ahmed on the BBC on 19th
April. Prior to that expectations had
been gathering for a 0.25% increase in interest rates. In the interview he stressed the possibility
that increases might happen later rather than sooner. Sterling was then at
$1.43. After that interview, Sterling fell
and has continued to fall, reinforced by the May 9th MPC decision to
keep interest rates fixed. Sterling is now at $1.33. The “Blame Brexit” P.R. campaign has been
kept up. Of course, Brexit and weak
growth have had an effect on Sterling, but I would suggest that Carney’s
interventions have (as usual) talked down Sterling. Andrew Haldane voted for a rise in rates on
20th June (joining Saunders and McCafferty), leading to speculation in the press that maybe
there will be a rise in August.

When I contrast the lack of forward guidance and clarity in
what the MPC policy is, the contrast with the FED is complete. As early as
2014, the FOMC (the US equivalent of the MPC) had clearly laid out a plan. Raise interest rates, and then start to run
down the holdings of Treasuries accumulated under QE. The interest rate rises started in December
2015, with the rate hitting 2% in June this year, with the possibility of more
in the pipeline. The FOMC has regularly updated its policy statements on the
issue and indeed at the end of 2017 it has started to slowly unwind QE by
letting its holdings of treasuries and Mortgage backed securities decline. In contrast, the MPC has not issued a formal
statement on interest rate policy and unwinding QE.

History will not judge the Carney governorship kindly. However,
to look on the bright side, the Bank has started to talk about real interest
rates. Gertjan Vleighe gave a speech
talking about them last November. Excellent news. I am not sure I buy his idea that “low rates”
can be a normal state of the economy (the
example of world war two and the years just before and after has little
relevance for today). However, once you
accept the idea that the equilibrium real interest must be non-negative, it at
least puts a floor on sensible nominal rates (they should be no less than
inflation). Assuming inflation will be
on target, that would imply nominal
interest rates of at least 2%.

Also there is talk of Carney’s successor. Luckily the menopausal Broadbent has ruled
himself out. In my opinion, the idea of a Goldman Sachs alumnus as governor of
the Bank is not a good idea. There are
some excellent people for the job: Sir Charles Bean (Mervyn King’s number 2) to
name one. But why not go for a non-banking person. Kate Barker would make an excellent choice in
my opinion. She is a leading business economist and was on the MPC from 2001 to

At Last.

Monetary Policy Posted on Sun, November 12, 2017 09:47:05

I am in China at present, but the recent increase of the interest rate to 0.5% even made the news here. However, welcome as the increase is, all it does is to reverse the disastrous mistake of the post-Brexit cut of August 4th 2016. Let us recall the nonsense spoken by Carney at the time. Carney argued that Brexit would lead to job losses of 250,000 and that further interest rate cuts were in the pipeline, as was a further extension of QE. “There is a clear case for stimulus, and stimulus now, in order to have an effect when the economy really needs it,” he said. The result was a slump in Sterling. In the aftermath of the Brexit vote, sterling had fallen from around $1.45 to $1.30. After the Bank’s new policy it fell to $1.20 and below, to lows not seen since the 1980s. What happened after the recent reversal? Well, we see sterling back at its immediate post-Brexit level (todays rate is $1.32). And, recall that for most economists the post-Brexit world looks rather more dark than it did in mid-2016.

Since its August cut, there has been a largely successful public relations strategy of blaming all of the increase in inflation on Brexit. However, whilst Brexit played a role, the Banks own policy of easy money played only a slightly smaller role. I have not done the exact calculations or simulations, but as an off-the-cuff-Ball-park I would apportion “blame” for the increase in inflation about 60% to Brexit and 40% to the Bank of England. There has been a 3% increase in inflation since mid 2016. If the Bank had kept the interest rate unchanged at 0.5%, we would have now had inflation around 1.8%. The Bank’s post-Brexit cut and general loosening added another 1.2%.

So, the Bank has at last reversed the mistake. Will they start the path back to normal: long-run nominal rates equal to the target plus a real rate of 1-2% (i.e. nominal rates around 3-4%)? The next couple of meeting of the MPC are crucial here. Will common sense prevail, or will there be prevarication and procrastination?

A Tale of two Bankers: Carney the reckless and Haldane the wise.

Monetary Policy Posted on Thu, June 22, 2017 16:57:09

We have seen two recent pronouncements by leading Bank of
England MPC members: Governor Mark Carney at the Mansion house and Chief
economist Andrew Haldane in an interview with the Telegraph. But first, we have the very welcome announcement
that the new committee member replacing Kirsten Forbes is a real economist, Silvana
Tenreyro a Professor at the LSE. Just to explain why this is a welcome
appointment. The Chancellor is responsible
for the appointment, which is made through the cabinet office. Under George
Osborne we saw a shift in the type of person being appointed. Out went established academics like Mervyn
King, Charlie Bean, Martin Weale. In
came “city economists” from investment Banks.
Ben Broadbent (Goldman Sachs), Michael Saunders (Citi), Gertjan Vlieghe (Brevan Howard hedge fund). This is the first appointment under
Hammond. It is like for like: a serious
academic for a serious academic. However, I think we can heave a sigh of relief
that it is not another “city economist”.

I see two problems with appointing more than one city economist to the
MPC. There is the issue of regulatory capture. The Bank needs to be independent of the City. The
Bank has a regulatory role to maintain financial stability: since the
investment banks have been major sources of instability it is strange to have
their people at the top of the bank. The
Bank is supposed to be keeping inflation on target in the interest of the whole
nation. Its current policy of allowing
inflation to rise and failing to keep interest rates up with inflation (and
hence plunging the nation into financial repression) might be interpreted as
acting in the interests of the very investment banks and hedge funds from which
the MPC members have come. Now of course, city economists are perfectly capable of doing the right thing. Michael Saunders is one of the three who recently voted to raise rates: respect. However, perceptions matter and there is the possibility of a conflict of interest. The next
appointments will be a real signal, enabling Hammond (or his successor) to show
that the Osborne era is over and that the MPC and Bank of England needs to be independent
of the investment banks and the City. Mr
Osborne of course has since become part of the city, with his appointment in February
2017 as part time advisor to BlackRock, the world’s largest investment Bank.

Mark Carney
made what in my opinion was an amazingly reckless speech at the Mansion house.
Inflation is currently just short of 3%, the upper limit of the range. Three members of the MPC voted to raise
interest rates. The real implications of
having interest rates at 0.25% whilst inflation is 3% are really hitting home
to the public and politicians. Carney is
of course distracting us by blaming Brexit.
I opposed Brexit (as did nearly all economists), but it is rich for the
Bank of England to blame inflation on Brexit when the Bank has done nothing to
restrain inflation, which is its main job. Real interest rates have tumbled and
now stand well below minus 2. The Bank’s
own forecasts in mid 2016 predicted a rise in inflation to 2.8% by mid 2017. The surge in inflation was foreseen, but the
Bank did nothing. In fact, it made
matters worse by cutting interest rates by 25 Basis points post Brexit vote. A classic “Greenspan put” as seen in the run
up to the 2008 financial crash. Now, almost 12 months on, his Mansion house
speech was a loud and clear statement that “Now is not yet
the time” for interest
rates to rise. In effect, he is talking
down sterling at a moment when inflation may well break through the 3% barrier.
If it does go above 3%, I think that
Carney should be made to step down. Keeping
interest rates at near zero when inflation has risen by almost 3% is just
stoking up some huge problems and possibly another crash. The correct policy would have been to start
raising interest rates gently last year, with the aim of getting to a level of
the inflation target plus 1-2%: that is 3-4%. The US Fed is doing this. Unlike Carney, Janet Yellen is a serious
economist who understands these issues and has not spent time in an investment
bank or hedge fund.

Andrew Haldane
is a serious academic economist. In the recent Telegraph
interview, he said “might have to rise this year to nip inflation in the
bud and prevent a sharper jump in rates in future”. The
phrase “to Nip inflation in the bud” is a bit rich: the inflationary horse has
already bolted. Any bud nipping was due
last year. The MPC needs to look ahead.
Anyway, at least he is starting to think in the right way. More important is his statement “to prevent
sharper rises in the future”. Yes, keeping
rates so low can actually be a threat to the financial stability the Bank is supposed
to be maintaining. Sharp rises in the future are just what is required to
trigger a financial crash. Well said
Andy! Raising interest rates has become
not just an issue of avoiding financial repression and keeping to the Bank’s inflation
target, but also protecting the very stability of the financial system.

Carney on the line.

Monetary Policy Posted on Mon, May 15, 2017 15:19:08

Inflation is getting very close to the 3% upper limit and is well above the 2% target. This was not unexpected: it was indeed predicted by the Bank last year. As I argued last September (2016), interest rates should have been increased then in order to keep inflation closer to target in 2017. However, many forecasters predicted inflation might well rise above 3% in the next few months. For me IF inflation exceeds 3%, this will be a defining point in the recent history of monetary policy. It will demonstrate that Financial repression is the real policy of the MPC and inflation targeting is only secondary. If inflation crosses the 3% line, there is little excuse for Carney. He will blame Brexit. This has been a very successful diversion of attention away from the fact that the increase in inflation was easily avoidable in September last year. A modest rise in interest rates (maybe in line with inflation) would have been enough. The reason the Bank of England is responsible for setting the interest rate is that it is supposed to target inflation. If it is proving unwilling to do this, then its independence is really something we should all question. Blaming Brexit for a failure in monetary policy is a lame excuse.

So what would a sensible policy be? Simple. If we take the view that the real interest rate is 1%, the current nominal rate should be increased until it is equal to this 1% plus the inflation target of 2%: that is 3%. The long-run real rate might indeed be higher, indicating a long-run nominal rate at 4-4%. However, let us take things step by step…3% is at least in the ballpark.

Real Interest rates.

Monetary Policy Posted on Mon, February 27, 2017 22:06:36

Can there be an equilibrium real rate of interest that is
negative? In general, the answer is no. If we think of a steady-state where
consumption is constant, then because the household discounts the future, the
real rate of interest has to be strictly positive. The real interest rate corresponds to the
marginal product of capital. In a representative agent economy, a negative real
interest rate is possible as a transitory phenomenon, and would correspond to a
decumulation of capital indicating that the capital stock was too large and
hence the household would seek to reduce it by maintaining a high level of
consumption with possible dis-saving (consumption in excess of income). A
negative real interest rate would be a temporary phenomenon on the path to
steady-state: along the path, as the capital stock is reduced, the real
interest would get back into the positive territory. In the Ramsey model, a
very large initial capital stock yielding a negative marginal product would
result in a high level of consumption which fell over time, with

Matters are different in OLG models, which are not in
general dynamically efficient. In a simple exchange economy without production,
it is possible to get a negative real interest rate in equilibrium. If current consumption is cheaper than future
consumption, you need to give up more now to get less in the future. The key assumption needed is that there is no
storage or capital: one generation trades with another. Eggertson et al (2017)
have a model where people live for three periods: they have endowments middle
age and when old: they borrow when young.
Assuming that the endowment is largest in middle-age, consumption smoothing
indicates that they will borrow when young, and save when middle aged to
augment their retirement consumption (the old consume everything they
have). At any time, there are all three
generations living together. The middle aged at time t can only save for when
they are old in t+1 by lending to the young at time t, who will repay the old
at t+1. Here, the young demand loans
(consumption) from the middle aged; the middle aged lend to them so that next
period they get paid back and their old aged consumption is increased. The real interest rate here can be positive
or negative, depending on the balance between the supply and demand for loans.

In order to link this monetary policy, we need to introduce
nominal wages, nominal prices and a nominal interest rate. Making various
assumptions, Eggertsson et al show that there can exist “a unique, locally
determinate secular stagnation equilibrium”
(Proposition 1, page 21. Figures 4 just above the proposition make the essential
role of deflation clear).
However, the secular stagnation
equilibrium must have deflation: negative inflation. If inflation is positive,
then there will be full employment. This
is because the mechanism reducing output is the increase in real wages. So, in
a secular stagnation equilibrium, the nominal interest rate is at the ZLB (zero
lower bound), output is below full employment, inflation is negative and real
wages above their full employment level (due to downward rigidity). The actual real interest rate is positive
(equal to minus the deflation rate): it is a hypothetical real rate that is
negative (the real rate that would restore full employment). The ZLB does not lead to an equilibrium
negative real interest rate: it prevents the real interest rate from becoming
negative when inflation turns negative.

Have we observed
negative inflation? In the UK and the US just the occasional month in 2016 and
(depending on whether you use CPI or RPI) perhaps for a month or two at the
height of the crisis. Japan has had more
disinflation since the late 90s (disinflation “peaked” at just over -2% in
2009). The Eurozone is a mixed bag: the
aggregate inflation rate has mainly been strictly positive with a few
exceptions as in the UK and US. For
individual countries the story is more heterogeneous. So, if we look at the
major economies, there is no evidence of sustained disinflation that might give
rise to the high real rates required for Eggertsson Stagnation. In fact we find
the exact opposite. The ZLB is combined not with negative inflation, but
positive inflation. Rather than positive real rates, we find real rates are

This brings us to
the most important an obscure part of the paper: section 8, the model with over
100 equations. Here there are lots of
generations and capital is introduced. The key equations are buried in the
appendix: A81 and A82. The marginal productivity for capital A81 is the usual:
the marginal product of capital will be strictly positive. Then there is
A82. This is a little different: there
is a price of capital goods term. Greg Thwaites has developed a model of
falling real interest rates driven (in part) by the falling price of investment
goods. There has been a downward trend in the prices of investment goods
(relative to consumption goods), which means that savings leads to more
investment (but possibly lower investment expenditure). This can drive down the
marginal product of capital. However, in Thwaites model the real interest rate
may be low, but is always positive. So what is it in the Eggesrtsson model that
can give you their figure 7: secular stagnation with strictly positive
inflation (recall, this was impossible in the world of proposition1). I must
admit, that I have read the paper and am none the wiser about how this might be
possible. The paper just presents a
calibration and reports that this is what happens. Unlike the world of
proposition 1 there is no clear story or intuition.

I do not doubt that with sufficient
inventiveness a model with equilibrium negative real interest rates can be
constructed. But it would not be a basis for monetary policy. Monetary policy
needs to be based on robust models that have passed the test of time, not on
exotica. I will continue to believe that real interest rates should be strictly
positive in equilibrium.

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