Comments: Bank has to find the tipping point

From where I'm sitting, four rate hikes in 9 months appear to have done very little to slow leading demand-side indicators, but the MPC may have a different view of course. They could also be concerned about the fact that it seems the US is almost certainly going into recession within the next 2 quarters.

Posted by Minh at May 13, 2007 10:24 AM

To say that the UK could have experienced a Japan-like 'lost decade' is a bit misleading. Japan's bust was a result of over-inflated house prices which then collapsed, helping expose the frailties of the banking system. Japan's deflation has been a symptom of insufficient demand.

It's difficult to argue that the UK has suffered from such a problem. The UK's (and the US's) low inflation episodes have been a product of falling goods prices from Asia - a positive supply 'shock'. Policymakers have clearly prioritized short-term stability in inflation over longer-term stability. By accommodating the supply shock (lowering interest rates to keep inflation on target), we now really do face the possibility of a Japan-type bust.

I know this kind of thing is always easier to detect in hindsight. But C'mon David - quit being a cheerleader for the UK economy and admit the flaws which are obvious to everybody else.

Posted by Sell Everything at May 13, 2007 03:52 PM

I'm not quite sure you understood the point. What would have happened from the mid-1990s if policy had been geared to preventing house prices rising by more than, say, average earnings? Interest rates would have been substantially higher, growth slower and general inflation would have been negative for significant periods. I'm not saying this did happen, I'm saying what could have happened. If you're familiar with the Japanese story you'll know that the bursting of the bubble economy (shares and commercial property being much more important in that than house prices) was followed by a series of monetary and fiscal policy errors - policy being tightened too soon or kept too tight too long.

I'm not uncritical about the British economy, there are structural weaknesses and competitive shortcomings. But the record on growth, inflation and employment over the past 13-14 years has been the best in very many decades. Indeed, it is hard to identify a more successful sequence. Those who do not recognise this either have no sense of history or are obsessed with just one bit of the economy - the housing market.

Posted by David Smith at May 13, 2007 08:01 PM

It's too early to judge how bad a housing market collapse will be if it happens. So it's hard to know if the property boom will have been 'worth it' or not.

Although it's fair to say that it's wrong to be obsessed by the housing market, it now accounts for over half our wealth, which is pretty scary. I also think that a great deal of recent general economic success has come from consumer spending, which has been underpinned by the wealth effects of housing.

It would be silly to target house prices as part of policy. However, the housing bubble is excessive and could have been mitigated if: the mistaken switch from rpi(x) to cpi hadn't occured, lending standards for mortgages hadn't been so lax, and fiscal policy hadn't been so loose.

Posted by labarte at May 14, 2007 12:14 AM

I'm with labarte. It's difficult to look at the UK economy without focussing on housing given its central role over the last decade. It would be like analysing trends in the US in the late 1990s and ignoring the stock market.

I agree there's much we can champion: the successful labour market policies of the Conservative and Labour governments; the drive to open up markets and encourage competition; and, so far, the success of inflation targeting.

I just think it might be complacent to believe we've cracked the problems which have dogged the UK economy for decades (this is where my sense of history comes in...) Policymakers thought they had solved Britain's economic problems in the 1960s with the Phillips curve. The 1970s proved them wrong. They believed the same in the 1980s when they started targeting monetary aggregates. The late 1980s/early 1990s proved them wrong again. It seems to me that we've fallen into the same trap with inflation targeting. Goodhart's law springs to mind:

`Any observed statistical regularity will tend to collapse once pressure is placed upon it for control purposes.'

Targeting inflation in a narrow band might not be sufficient to guarantee broader economic stability. The most obvious reason is that it distorts the relationship between asset prices and other prices. And I'm not alone on this one. There's a growing consensus in the academic community that central bankers should target broader economic stability, rather than simply stability in prices.

Posted by Sell Everything at May 14, 2007 01:11 PM

The problem with general stability is that it is too vague and means different things to different people. That is why inflation-targeting has been so popular wordwide and is favoured by the vast majority of current and former MPC members. The record in the UK has been better than anybody could reasonably have expected when targeting was introduced. As Mervyn King pointed out recently, the combined growth-inflation performance has gone from being something like the worst in the G7 to the best. Nobody in the 1960s thought they'd cracked Britain's economic problems, hence the ill-fated experiment with economic planning.

A few other points:

1. The switch from RPIX to CPI was, I agree, a mistake, giving rise to thousands of silly comments about fiddled figures. But I can't detect a rate decision that would have been different if the change had not been made. If you can, I'd be interested.

2. Goodhart's law does not really apply. Inflation figures are much more straightforward than the broad money data to which he was referring. The issues about inflation figures are those of coverage and technical construction.

3. Housing is typically half of all household wealth.

4. I agree about loose fiscal policy.

Posted by David Smith at May 14, 2007 01:51 PM

Hi David

Why do you think Hips will slow the market down? From my prospective, all it will do is at as a restriction on supply, and therefore push prices up.

Posted by kingofnowhere at May 14, 2007 01:57 PM

Dear David,
Research in progress (I hope to have more on this within the forthcoming months) suggests that switching from RPIX targeting to CPI targetting has made NO difference to the way interest rates are set (we economists/econometricians call this lack of a structural break in the MPC's reaction function).
Fresh research for the US, please see

suggests a stable relationship between M0 and output (which is NOT the case for other measures of money). The research is very useful because it covers some 150 years; this period is long enough to detect a "near" true relationship between money and output. Very unlikely that results would be different for the UK.

Posted by Costas Milas at May 14, 2007 04:31 PM

Very interesting research.

Re: HIPs - I agree it could go either way, though I don't think activity and prices can go in opposite directions for long.

Posted by David Smith at May 14, 2007 05:04 PM

As for so many people focusing on house prices, I would say rightfully so. I think a great many people would agree that house prices in this country is a damaging factor that is both economically divisive and socially stagnating. It reduces opportunity for social mobility and is a demotivating factor for people, especially young graduates, wanting to 'work hard and get ahead' yet seeing only a future of high debt and foiled aspirations.

There are other factors besides interest rates in determing house prices though, such as the private sector being allowed to consume swathes of council housing (begun by the Conservatives and continued by New Labour), the lack of housing stock created by the government, the change in the amount financial institutions loan for mortages in ratio to incomes, and more second home owners...By the way, didn't Gordon Brown say something in 1997 like, 'I will not allow house prices to get out of control'?

Posted by Walt at May 14, 2007 07:07 PM
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