Wednesday, November 14, 2007
How dovish was that?
Posted by David Smith at 07:00 PM
Category: Thoughts and responses

A belated observation on the Bank of England's inflation report, which took most people by surprise with its dovishness. But it appears to have done the trick - 44 out of 51 economists surveyed by Reuters expect a rate cut by the end of the first quarter of 2008. Most expect another by the end of the second quarter.

Is a note of caution in order? Predictions of rate changes emanating from inflation reports do not always come true, most recently in August. Things change. There may also be a presentational difficulty if the Bank is cutting in the context of above-target inflation, which it expects in the first half of next year. That could argue for a very early cut - December - though I did not sense that. Anyway, it was dovish. Further analysis later. The report is here.

Comments

Hi David

You have to wonder why they didn't cut at the last meeting with such a dovish report. After all if we need a cut (or two or even three, as the report suggests), then why wait.

Also, it does seem to give a black mark to Merve for pushing/panicing (ie for voting for a rise in June), for the July rate increase. If they had waited for Sept report, NRock would have been known about (by the BOE anyway), and now we wouldn't be looking for such large reductions.


Posted by: kingofnowhere at November 15, 2007 07:43 AM

I’ve only seen the webcast but Mervyn seemed to be a man with a message. Quite often at the press conferences Mervyn is just playing a straight bat as he thinks things are fine or he’s trying to correct what he sees as the media running off on the wrong track. But this time he kept saying that they’re expecting growth to be low and inflation to be high some time in 2008. The message was: It’s going to be bad. When challenged he just said it’s not going to be catastrophically bad but implied it would be really pretty bad.

I don’t know. It could be spin. He did say there’s no timeframe, just that the incoming data would drive the decisions. He could be trying to talk down optimism from retailers, wage-setters and the housing market before the normally highly-inflationary first few months of the New Year.

I’m sure he’ll want to wait until Easter to see how things are - unless there’s a shock data point like the Dec. 2006 inflation that prompted the Jan. 2007 rate rise. I’ll be very surprised indeed if we see a rate cut in the first half of next year.

It was interesting how he asked Charlie Bean to speak much more than usually (and dismissed the need for Paul Tucker to say much). Was that a bit of grooming?

Mervyn looked pretty comfortable over Northern Rock.

Posted by: sandid at November 15, 2007 07:56 AM

I must say that this amuses me. We all know now the problems we have over debt and inflation (7.1% to middle income groups according to MoneyWeek) I can't help but laugh at this... I know its serious, but...

I suppose that if I was trying to destroy an economy then this is what I would do. Why not have interest rates at 0% Why not have hyper inflation as in the 1970's and as at present in Zimbabwe?

Posted by: Pete Balchin, Solicitor at November 15, 2007 11:22 AM

Agreed. We may be about to enter an era of hyperinflation - because of excessive money supply growth, increasing commodity prices driven by hydrocarbon depletion, rising Asian demand and the effects of drought and biofuels culture on food grain production ... etc. Unfortunately, central banks are stuck between a rock and hard place - they can't raise interest rates because of the level of public indebtedness.

Posted by: Boris at November 15, 2007 01:18 PM

Please don't corrupt this site by mentioning Money Week, or nonsense about middle-class inflation. If anybody's suffering now it is people on low incomes. As for hyperinflation, I suggest you look at the definition. Whether we're headed for a period of higher inflation is a matter of debate - the world has never had hyperinflation nor never will. Individual countries can have times of extreme currency debasement. Britain never has nor. I would say, ever will.

This may hark back to your earlier comment about broad money. You're new to the site but I've been through this a number of times. If broad money is linked to anything it should be money GDP. For over a decade now, broad money has increased at twice the rate of money GDP. Its velocity has declined sharply. It is not clear what it is telling us onnce you take into account the distortion involving the financial sector - which is worth reading up on - see speeches by, for example Paul Tucker, on the Bank's website

Posted by: David Smith at November 15, 2007 02:20 PM

“Please don't corrupt this site by mentioning Money Week, or nonsense about middle-class inflation. If anybody's suffering now it is people on low incomes”.

I’ve tried hard but I’m afraid I fail to see the relationship between any of my points and this comment.

“As for hyperinflation, I suggest you look at the definition.”

I’ve just googled it and the first entry I find is ‘In economics, hyperinflation is inflation that is "out of control," a condition in which prices increase rapidly as a currency loses its value. No precise definition of hyperinflation is universally accepted. One simple definition requires a monthly inflation rate of 20 or 30% or more. In informal usage the term is often applied to much lower rates.” There is no doubt that on this basis we are a long way from the ‘simple definition’. However, one could argue that we are not so far from the ‘informal usage’.

“Whether we're headed for a period of higher inflation is a matter of debate”.

Not much doubt about that, in my opinion.

“the world has never had hyperinflation nor never will”.

Perhaps.

“It is not clear what it [money supply] is telling us once you take into account the distortion involving the financial sector”.

“Taking the data from the 38 countries and plotting the inflation rate (CPI) versus the money supply growth rate shows a direct positive relationship, where the growth in the money supply explains roughly 70% of the variation in inflation.”

http://www.financialsense.com/Market/cpuplava/2007/1107.html
(Fig. 12).

How else would you interpret this relationship?

Posted by: Boris at November 15, 2007 03:48 PM

Boris,
You need to read a little bit more, both on this site and elsewhere, not just Google and then come straight back. My first response was, as should have been clear, to the comment before yours - I was killing two birds with one stone. As for the money supply, it is a lot more complicated than the superficial little piece you quote. Go and read up properly on it, and on hyperinflation. Philip Cagan's standard definition is price rises of more than 50% a month but Hungary in 1945-6 was 19,800% a month. I can recommend a rather good little book - The Rise and Fall of Monetarism, by David Smith, out of print but available in some libraries and some corners of the internet.

Posted by: David Smith at November 15, 2007 04:47 PM

"You need to read a little bit more, both on this site and elsewhere, not just Google and then come straight back."

Agreed. I know almost nothing about economics.

"As for the money supply, it is a lot more complicated than the superficial little piece you quote".

I have no doubt this is so. Nevertheless, data are data. Do you or do you not have an explanation for the statistically strong relationship between money supply growth and CPI shown by this data set? 'Go and read about it' is not an argument.

Posted by: Boris at November 15, 2007 05:17 PM

Yes, easy answer - it's not a serious exercise. You can't prove anything about the relationship between the money supply and inflation by taking one-year's data for lots of different countries and aggregating it on an unweighted basis to produce the desired result. So the four biggest European countries are in both the G7 and in "Europe". You need to look at it over time for individual countries, which is what I described earlier for the UK. Even this exercise shows that in every country the money supply grows by a multiple of inflation.

Posted by: David Smith at November 15, 2007 05:32 PM

Many thanks. That is a serious answer.

Posted by: Boris at November 15, 2007 05:37 PM

Hmmm ...

Posted by: David Smith at November 15, 2007 07:57 PM

"You need to look at it over time for individual countries".

How about this example, then?

http://br.endernet.org/~akrowne/econ/charts/postage_inflation-an.png

Here's the caption:

"This shows that inflation in terms of business costs (in specific, of the US Postal Service), M1 makes the best tracker of cost increases, not the CPI. The CPI began to depart from the reality of inflation on the streets in the early 80s (presumably, OER and other changes). The only time the USPS's costs significantly departed from M1 was during the energy crisis of the 70s/80s; after which the two series merged again. Then, in the mid-90s, catastrophic increases in costs (and M1) were averted only by dramatically lowering reserve requirements and sundry other purely-financial changes that all had the effect of liquifying the financial economy to get out of the early-90s economic funk."

Posted by: Boris at November 15, 2007 08:19 PM

Oh Boris, you are getting very wearing. I don't know whether you are a student but if you are you must irritate your teachers because all you do is Google, without doing any work. Quite what you are trying to prove with a relationship between US M1 and US postal costs I don't know. So here's your homework:

(a) What is the money supply?
b) What's the difference between broad money and narrow money?
(c) Is M1 a broad money measure or a narrow money measure?
(d) Is M4 in the UK a broad money measure or a narrow money measure?
(e) How much is narrow money growing in the UK at present -- is it 13-14%?

Take your time.

Posted by: David Smith at November 15, 2007 10:22 PM

We all know by now that you're not a fan of monetarism, but do you believe that the rate of inflation is completely independent of the growth of the money supply? Even if you don't believe in the equation of exchange, broad money growth (caused by credit fuelled spending) must have some impact on AD, and therefore, eventually, demand-pull inflationary pressure once the economy starts to run out of spare capacity.

Posted by: Nigel at November 15, 2007 10:28 PM

Of course money and credit growth are important, which is why we are all keen to assess the impact of the credit crisis. And I do believe the quantity theory identity - MV = PY holds (but that V can be unstable and unpredictable). My objection is to unthinking monetarism, which assumes causal relationships that aren't there, and which doesn't look at the composition of the money numbers.

Posted by: David Smith at November 15, 2007 10:46 PM

Casual monetarism is just absurd. Of course MV=PY, but the thing is in today's economy it is very hard to quantitfy these figures accuratly. It's almost impossible to quantify what the actual and relevant money supply is.

I think Greenspan has said somthing along those lines in his recent book (but I've nto read it, just going by his recent publicity talks he's been giving), about how the relationship between money supply and infation has brocken down and he is not quite sure why, and he puts it down to it being almost impossible to measure money suipply in the modern economy and not the fact that the relationship does not exist, it's jsut not possible to measure it any more.

Excuse my gin + tonic based writting, probably not as clear as it might be had I waited till tomorrow morning to get involved...

Posted by: James Trouble at November 19, 2007 01:24 AM

Do you really think that your dovish pandering to government stats will get you your lusted after seat on the MPC?

Ha Ha

Luckily all your predictions & faffle are now digitally recorded on the times website and here. They are going to be hysterical reading in ten years time.

As your domain name suggests, you truely are an economic suk.

Posted by: Ian Metzer at November 19, 2007 02:45 PM

And as your comment suggests, not only can't you spell but you haven't got a brain either. Sad little individual.

Posted by: David Smith at November 19, 2007 04:46 PM