Exclusive: This MPC is not fit for purpose
The Bank of England committee missed the recession entirely. Rates were cut far too late
I arrived in the UK a short while back amid the chaos that only a few inches of snow and a little ice can bring. Lesson to be learned from this: get a decent forecasting model. Where have I heard that before?
Temperatures in Florida, where I am a snowbird, escaping from the cold of the north-east, have been unusually chilly. Key West had the coldest temperature ever recorded. There were widespread concerns over the orange crop, to such a degree that orange juice futures increased sharply, but then fell back as temperatures rose. Of particular interest was that it was so cold where I stay that the iguanas, which are not indigenous and have a bounty on their heads, were frozen into inactivity and were falling out of the trees. The mind boggles.
So, George Osborne, the Tory shadow chancellor, has obviously not taken heed of the advice I've been giving him in this column. He seems hell-bent on creating the Osborne Dip. In a speech on 14 January he announced that he would cut spending within 50 days of any election, well before any Budget. It strikes me as equivalent to a doctor determining a treatment without ever seeing the patient or knowing what was wrong with him or her.
I gather Osborne fully expects to be the most unpopular chancellor ever, within six months of being appointed. I don't doubt it. I am still waiting to hear which distinguished economists think that his plan to cut public spending in the depths of recession is a good idea.
Interestingly, in an interview in Tokyo this week, Dominique Strauss-Kahn, the head of the IMF, appeared to express his opposition to Osborne's plan for a doctrinaire cut in public spending. "The best indicator [for the exit timing] is private demand and employment . . . In most countries, growth is still supported by government policies. For as long as you do not have private demand strong enough to offset the need of public policy, you shouldn't exit." Compelling stuff, Mr Osborne.
The National Institute of Economic and Social Research has just forecast that the growth of output will prove to have been 0.3 per cent in the fourth quarter of 2009. This is important because, if so, it would mark the end of the longest postwar recession, which lasted six quarters. The fall in output for 2009 of 4.5 per cent is larger than in any year since 1921. Especially noteworthy is that the NIESR has now labelled the downturn a depression. This depression is worse in output terms, but not in relation to unemployment, than the Great Depression. For its sheer size and global reach, I now label it the Enormous Depression.
However, the first official announcement of output in the fourth quarter comes at the end of this month. This may well be a little below the NIESR estimate, given that manufacturing output turned out to be zero in November, and October was revised down.
Data from Germany compounded my worries about a double dip. Following a couple of positive quarters, German output has fallen back to zero growth. The worry is: then what?
And then one of the external members of the Bank of England's Monetary Policy Committee, Andrew Sentance, gave an interview that sent jitters through the markets, pushing the pound up when he unwisely suggested that growth had arrived and rate hikes were imminent. The first rule, for an MPC member, should be to do no harm. He was the one who throughout 2008 denied there was going to be a recession.
It is now my view that the MPC's days are numbered, certainly in terms of its remit and probably its membership. After the election we are going to have to reconsider who sets monetary policy. Here is why.
Creating an independent central bank in 1997 was a good idea and much comforted the markets. The idea of inflation targeting had much traction in academic literature and seemedlike it was worth a shot. The claim was that it would help bring macroeconomic stability and it seemed to have worked for a while, because inflation remained low for most of the next decade. But that was driven by cheap imports from China. When Tony Blair was asked recently in an interview at Columbia University what had driven the Great Moderation he replied, "Luck", and that seems about right.
It turns out that countries without an inflation target did just as well as those with one. And it didn't protect us from the greatest economic shock of our lifetimes.
It also helped to make it feel like everything was rosy, because all the attention was focused on the consumer price index (CPI) as a measure of inflation, which excluded the major variable that was increasing a lot -- house prices. If house prices had been included in the index, interest rates would have been a lot higher in 2006 and 2007, and that would have helped to prevent the bubble that followed. Symmetrically, including house prices now in the measure of inflation would make it clearer that we are in a deflationary period.
The MPC missed the recession entirely. Rates were cut too late and even in early September 2008, just days before the collapse of Lehman Brothers and the secret loans to RBS and HBOS, most of my MPC colleagues were concerned only about inflation and wage-price spirals. The recession was much deeper because of their failure to act. The MPC was asleep at the wheel. Its inability to communicate adequately what quantitative easing is supposed to do suggests it has learned little.
Targeting the CPI alone no longer has credibility and has to go. The US Federal Reserve has a much broader remit -- "to promote effectively the goals of maximum employment, stable prices and moderate long-term interest rates". I would advocate that something similar should be the remit for macro policy in the UK, not least because unemployment hurts much more than inflation. The last thing we need is for interest rates to rise any time soon. Inflation is going to jump in the short term because of the VAT increase, but will then fall back sharply.
This MPC is not fit for purpose and should be disbanded. The big question is what it should be replaced with. That is a subject to which I will be returning.
David Blanchflower is Bruce V Rauner Professor of Economics at Dartmouth College, New Hampshire, and the University of Stirling. He was a member of the MPC (2006-2009)