Yesterday brought a set piece speech from the Governor of the Bank of England via a virtual broadcast to the Resolution Foundation. There was much to consider including a statement of where he thinks we are in economic terms.
The economic impact of Covid has in aggregate been very large. We expect that by the end of the first
quarter, UK GDP will still be around 12% below its level at the end of 2019, a huge shortfall.
As it is rarely put like this let me point again that this is a decline of depressionary size and in fact of a Great Depression. Hopefully it will be short but as we stand we do not know that.
Rather curiously for a man with his foot pressed down hard on the monetary pedal we did get a section on inflation dangers.
Firms in the DMP estimated that Covid has increased average unit costs by around 7% in the second and third quarters of last year. They expected this impact to reduce to 5% by the second quarter of this year, with a more
persistent negative impact of 2%. All of this reflects new costs – for PPE, screens etc., and the impact on
costs from social distancing reducing capacity. ( DMP = Decision Maker Panel)
Do not fear though as the productivity fairy is deployed to avoid any inflationary consequences. This is rather curious because in the next section we get told we have not had much of it for years and maybe decades.
A Lost Decade?
I give the Governor credit for at least addressing this issue.
First, the UK has experienced a fall in the average rate of growth, reflecting slower growth in potential supply capacity. Chart 3 illustrates the four-quarter GDP growth rate since 2000. It is apparent that the average growth rate
has fallen from around 2.5% in the years before the global financial crisis, to around 1.5% in the period
immediately prior to the Covid pandemic.
There is a consequence of this and as you can see the productivity fairy which turned up so conveniently in the section above had been missing for many years.
Chart 4 shows the same timeline for aggregate labour productivity per hour over the last twenty years. Again, the story is not encouraging. Another way of representing this, is to note that the level of activity in the UK following the global financial crisis is significantly below its level at
the equivalent stage following the 1930s Depression.
Regular readers will be familiar with these issues and one follows pretty directly from the other although some care is needed as the labour market is involved. The productivity hit has a good feature which is that pre Covid the UK employment situation was strong. But also a poor one which has been the fact that real wages have not achieved pre pandemic levels. Just for clarity I have reported the recent average earnings figures to the Office for Statistics Regulation for those wondering about the figures which claim we are in the middle of a wages boom right now.
Oh and there is no mention at all of the fact that the fall in both economic growth and productivity comes in a period where monetary policy has been fully deployed by the Bank of England.
What next for policy?
It is quite revealing that we start with something more relevant for fiscal than monetary policy these days.
First, we will continue to execute the announced programme of asset purchases, which we expect to be completed by around the end of 2021.
If we look at the difference between the amount completed ( ~£760 billion) and the present target ( £875 billion) then if we changed today the pace would be about two-thirds of what it is now. That may be awkward if bond yields continue upwards but this gets ignored.
Next we move onto what I can only call an oxymoron squared. This is because “Forward Guidance” almost immediately became one of the clearest oxymorons of our time so cannot be an important piece.
Second, we have in place an important piece of forward guidance
As you can see they will loosen policy with the speed of Usain Bolt and will tighten it by contrast in the form of definitely maybe.
“If the outlook for inflation weakens the Committee stands ready to take whatever additional action is
necessary to achieve its remit. The Committee does not intend to tighten monetary policy at least until there
is clear evidence that significant progress is being made in eliminating spare capacity and achieving the 2%
inflation target sustainably”.
Or maybe not as you see “spare capacity” is out old friend the “output gap” in another guise. As you can make it up to be almost any number you want ( remember how the 7% unemployment rate morphed into a 4.5% estimate) it means they have no intention of tightening policy in spite of this bit.
with a rapid recovery later this year
The grounds are being tilled for possible inflation trouble as we see another deflector shield being polished.
And in this context it is encouraging that measures of inflation expectations have remained relatively stable in the UK, despite the seismic shocks and unprecedented policy response we’ve experienced over the past year.
This is the new central banking standard where they use inflation expectations as a reason to do nothing. Actually inflation expectations have been rising but I do not expect them to let that bother them.
This area has been one where the Bank of England has scored several own goals. For example at one extreme we have had Silvana Tenreyro constructing quite a fantasy world about the impact of negative interest-rates in the Euro area. Also there have been several occasions when people have thought and in some cases feared they were due imminently. It is yet another reason to describe Forward Guidance as an oxymoron.
Here is the new description and yes “toolbox” is another new phase from the central banking zoom calls.
We have been quite clear these toolkit decisions should not be interpreted as a signal about the future path of monetary policy. We decided to ask the banks to make preparations within the next six months, in case we need to use negative interest rates to provide further support.
If you think about it seeing as we first had negative interest-rates over a decade ago ( some mortgage rates went negative as Bank Rate was cut to 0.5%) this is quite a confession of incompetence.
Governor Bailey must have been pleased to leave the Financial Conduct Authority. I am sure he was too important to be a user of the toilets where the dirty protests took place. But there was the report on the London and Capital Finance scandal which pointed the blame in his direction. In some ways even worse was his campaign to reduce overdraft interest-rates which managed to double them!
As Governor in some ways he has had it easy as all he had to do was copy moves made elsewhere by lowering interest-rates and doing lots of QE. Now it gets harder as the recovery hopes would suggest a winding down of the support except they have pre commited in several areas. Also they have completely ignored the fact that monetary policy takes 18/24 months to work. It means that they have abandoned past knowledge and gambled.
Also there is a familiar assymetry. The Bank of England is not slow in coming forward when it feels it can claim some success however dubious But the period of slower economic growth does coincide with its own interventions. For someone like me worried about the effect of Zombie companies being given ever more blood transfusions there is another issue. Can new companies not get past the Zombies meaning they have driven this?
although business investment did recover from a low base following the global financial crisis, it too was weak in the period prior to the Covid pandemic.