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Saturday 2nd September 2017
Hi Friend,
Michael Saunders ... A Hawk in the Park ...
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Michael Saunders was in Cardiff this week. The external member of the Bank of England MPC explained why he is voting for a rate rise. He had done so in June and August this year, voting for an increase of 25 basis points.
"Beyond my limits of tolerance" the term used. A reference to the policy trade off between above target inflation and the output gap. Inflation is above target. The output gap is evaporating as the economy reaches full employment. The time is right, to raise rates now to preempt the need for higher rate rises in the months and years to come. It is a familiar refrain, shared on the MPC by Ian McCafferty.
The problem is to explain the ephemeral. How do we measure the output gap and capacity? Central bankers pine for the period when the Taylor rule was dominant. A simple monetary policy reaction function, tracking base rates in relation to inflation and the output gap. The output gap simply measured as GDP actual, in relation to the long term trend rate of growth. The model was blown away in the great recession. The perceived output gap was blown off scale by the large and significant slow down in the economy.
To follow the Taylor rule implicitly, negative real rates would have had to be determined at scale to allow the model to run. Dangerous and impractical, the option emerged, to acclaim the substitution effect of QE. The spurious proposition that £1 billion of QE money spent would equate to a one basis point blip in base rates was proffered by Adam Posen and others. £425 billion of gilts bought somehow would offset the restrictions of the real rate floor to balance policy. It was nonsense of course.
So here we are trapped on Planet ZIRP. Rates on the floor, mispricing capital. The magnetic compass spinning without end, as bankers search for the elusive measure of the output gap and measures of capacity. I have always been fascinated by the concept of capacity restrictions in £2 trillion economy. Running a business, we understood all to well the concept of capacity with a two shift system. Limits to capital could be swayed by overtime working, week-end working or in severe cases the introduction of a three shift system. When the balance of supply and demand was under threat, fixed capital was flexed until additional investment could be made. Fixed capital is not so "fixed" after all.
In the wider economy, economists struggle to define and determine the concept and measurement of capacity. Why bother? The labour market offered the best option. The meandering NAIRU and the flawed Phillips Curve betray the aspirations of accuracy. Remember when 7% unemployment rate would be the trigger for forward guidance and the first rate rise?
In the UK and the USA we struggle to understand why a "u" rate of 4.5% and below is failing to deliver a rise in earnings and the support of real earnings. Michael Saunders, the hawk in the park, (He was speaking at the Park Plaza Hotel in Cardiff) had difficulty in explaining the concept of capacity as a policy counterpoint to the idea of inflation above target.
It is difficult. The Taylor rule is dead. The quest for a measure of capacity is difficult to define and measure. It is time to consign "capacity", the meandering NAIRU, the failing Phillips curve to the dustbin of economic thought, along with the J curve and the devaluation solution.
Maybe it is time to accept that life on Planet ZIRP is the issue. One day we will realise, low rates are the problem. ZIRP is the missing link in the Phillips curve trade off. The hawk in the Park is right! It is time to raise rates and escape from Planet ZIRP ...
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Too many notes ...
The Prime Minister was in Japan this week. Theresa May confessed she had never done "Karaoke". Running through the fields of wheat, is all we can pin on the Lady of Number Ten for the moment. David Davis was left in charge of negotiations with the EU! Liam Fox tried to help out, accusing Barnier of Blackmail over the demands for money to start the ball rolling on trade. "Bills must be paid, before talks about trade" the mantra, the trade trio fail to grasp the basics of the deal.
Davis appears remarkably relaxed about the whole process. "Too many notes" Emperor Leopold II would declaim Mozart's Marriage of Figaro. "You have shown us something quite new today but is simply has too many notes". No such criticism could be leveled at the Secretary of State for Exiting the EU. Barnier appears to be quite confused about the "Ask" as part of the process. David Davis has shown "nothing new" and has no notes on the table to share. What exactly is the UK proposition?
Plans for his "new form of trade" were dashed this week. Proposals for an "innovative" and "unprecedented" approach to border controls removing the need for customs checks between the UK and the UK were abandoned. The plan had been met by bafflement and scepticism from business either side of the Channel. It simply cannot work. Neither can the UK approach to Europe. Access to the single market, inside the customs union free to negotiate trade deals with the rest of the world fails to satisfy the basic "rules of origin" required for free trade function.
Davis may argue the EU deal is essential to the world economy, globalization and trade. Michel Barnier is not convinced. The world looks on in bewilderment about the lack of progress ...
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| West Wing WTF ... The President speaks for himself...
The President was in Houston this week. Seeing for himself first hand the problems facing the people of Texas. Well not really. A briefing in an aircraft hanger safe in the dry zone would convince few of the risks undertaken by the Air Force One team. "Texas is heeling fast" tweeted the president. The typo was rescinded within the hour. Well just under two actually.
Something strange is happening to the US constitution. The separation of powers is attracting an additional rift. The founding fathers supported the isolation of the executive, the legislative and the judiciary each supporting the rule of law. The administration is dividing into the executive branch and the President. "The President speaks for himself" explained Rex Tillerson following the Charlottesville comments last week.
The President speaks and Tweets for himself, we just get on with the job the explanation. General John Kelly has executed a military coup of sorts within the White House. Steve Bannon banished, Gorka long gone. The Alt Right eliminated. The military have their say on Afghanistan. Transgenders will stay until policy is evaluated. Mad Dog Mattis proffers peace in the peninsula as Trump rants about his fire and fury solution.
Battles are looming in Congress about the budget, tax cuts and the debt ceiling. The President speaks for himself and fewer and fewer are listening. Trump fired his long term events organiser George Gigicos this week. Trump walked into the Pheonix rally, into a room half empty. Poor organisation by George or too many notes singing the old tunes from the podium?
That's all from the West Wing Whisky Tango Foxtrot this week. It has been a chaotic week, make that six weeks. The President continues to attack the Attorney General, the leader of the Republican Party, the leader of the house and the GOP as a whole. Tensions between John Kelly and Trump are rising, Gary Cohn and others have been openly critical ... bubbling nicely ... something has to give and soon ...
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| | | | | Don't
Miss the Economics Conference on the 13th October. Our theme is the
Economics of Greater Manchester. We will be talking about the Inclusive
Growth Challenge, Balancing the Books and the Sectors Driving Growth in
the City Region! Another Great Conference in the pro-manchester series . We have a great line up of speakers to be announced this week. Book Now Don't Miss Out ... |
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John
That's all for this week. A bit geeky perhaps, sorry about that!
Have a great week-end ...
John
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