Tony Yates thinks there should be no more [sic] fiscal stimulus in the UK, because inflation is above target. As inflation is above target, there is no need to stimulate demand. Tony accepts that in principle at the ZLB fiscal stimulus can be a useful expansionary instrument, but in the UK at the moment it is not required.
So here is a table of CPI inflation in a few countries.
CPI Inflation rates (source: OECD Economic Outlook)
|
| 2007 | 2008 | 2009 | 2010 | 2011 | 2012 | 2013 | 2014 |
| United Kingdom | 2.3 | 3.6 | 2.2 | 3.3 | 4.5 | 2.8 | 2.8 | 2.4 |
| United States | 2.9 | 3.8 | -0.3 | 1.6 | 3.1 | 2.1 | 1.6 | 1.9 |
| Euro area | 2.1 | 3.3 | 0.3 | 1.6 | 2.7 | 2.5 | 1.5 | 1.2 |
The inflation target in the UK is 2%. So not only is there no case for any stimulus going forward, it also looks like the UK managed to completely avoid any recession in 2008/9! The US also had a small boom in 2011, and who knows why people in the Eurozone feel so depressed?
OK, this is a cheap point, but a valid one nevertheless: CPI inflation is a pretty hopeless indicator of the output gap when inflation is low. Other inflation measures do a bit better: here is the GDP deflator at basic prices.
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| UK Inflation: source ONS |
Some of the low growth in the GDP deflator is because of low inflation in the government consumption deflator, and we know this is difficult to measure. However I’m not trying to argue that one index is better than another. Instead I just want to make the point that at low levels of inflation, inflation itself becomes a very unreliable measure of the output gap. This is true not just in the UK, as the IMF recently pointed out.
One reason why UK inflation has not fallen further is UK labour productivity, which I have discussed before. Now if the decline in UK productivity growth was an irreversible supply side phenomenon then you could indeed argue that the current UK output gap was small (but not zero - see below), but is this remotely plausible?
Here is a chart of (logged) UK GDP since 1950. [1] I’ve added a trend line not because I believe productivity growth is always constant, but just so the following point becomes clearer. GDP growth does sometimes fall sharply: in 1980, and in 1990. But both these occasions were demand induced recessions. To argue that 2008/9 is different means that something quite extraordinary and unprecedented has happened. Now maybe that is possible, but given the costs of being wrong about this, we have to be pretty certain of your story to base policy on it.
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| UK GDP, logged. Source - see [1] |
So let us look at something we can measure with reasonable accuracy: unemployment.
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| UK Unemployment Rate: ONS |
The increase in unemployment since 2008/9 is modest given the output fall - productivity again - but it is not small. I have heard no one argue that this increase in unemployment represents an increase in the NAIRU or natural rate. To the extent that low real wage growth has encouraged substitution from capital to labour, unemployment underestimates the extent of the output gap. (If unemployment continues to fall at the same rate it has over the last year - a rate the Employment Minister describesas encouraging - we should see a return to pre-recession levels sometime after 2025.)
So it seems to me that we are sitting in a freezing house, but because the thermostat says it is still warm, its occupants are trying to convince themselves that they are not really feeling cold, and the last thing they want to do is turn up the heat. (I admit not the best of analogies for the UK right now.) Just because we build models in which inflation always responds in a predictable and linear way to the output gap, does not mean that the real world behaves in the same way.
[1] I’ve spliced the recent ONS data revision from 1998 on to a time series from Lawrence H. Officer and Samuel H. Williamson, 'What Was the U.K. GDP Then?' MeasuringWorth, 2012.
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