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gruffydd

A Gap In The Output Gap - Inflation Targeting Crisis Rocks Britain

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http://ftalphaville.ft.com/blog/2009/07/22...the-output-gap/

'...That’s basically a tacit admission by the BoE that the output gap may not be as wide as it thought. And it’s something of a big deal since the output gap is a rather large factor in the central bank’s inflation targeting.'

PS. There are some interesting comments at the bottom...e.g...

legovernchips Jul 22 14:34

I think you have something there. Paul Krugman realised about 2 months ago that much of the US productivity out performance of the last decade was the result of "output" from financial services.

Much of that is of dubious intrinsic worth - look at all the mortgages that were sold. If you take out turnover of that sort the GDP path becomes very different.

WEB Jul 22 14:30

How about: The historic trend growth rate of the UK economy was consistently overestimated as it was based on unsustainable bubbles in Finance, Property, Construction and associated Services. Cut the historic trend rate by 30% and see where we are - no output gap (yet), a permanent structural deficit and no possibility of negative inflation on a measure that isn't distorted by 0.5% interest rates.

Edited by gruffydd

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http://ftalphaville.ft.com/blog/2009/07/22...the-output-gap/

'...That’s basically a tacit admission by the BoE that the output gap may not be as wide as it thought. And it’s something of a big deal since the output gap is a rather large factor in the central bank’s inflation targeting.'

It's a big deal for pretty much everything :o

Output gap smaller than expected -> we're entering an era of lower (or no) growth compared to the previously expected "long-term" average growth rate of the economy.

Edit: I'm not persuaded that it's the bubbles, since we've had bubbles and busts for a very long time and the trend growth rate takes them into account. Who'd be brave enough to claim we'll never have another bubble to artifically boost growth for a while? No, I think this one's based on structural changes such as resource depletion and globalisation and the limits of debt-based money systems.

Edited by huw

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It sure is. Pretty astonishing stuff - well done to FTAlphaville for highlighting this.

It's certainly interesting to see policy-maker opinion moving towards what's essentially an uber-bearish position (i.e. that we won't be returning to "normality").

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Output gap smaller than expected -> we're entering an era of lower (or no) growth compared to the previously expected "long-term" average growth rate of the economy.

But surely that depends on which side of the gap has been estimated incorrectly? If potential capacity is being revised downwards then that would hold true, but if the utilised capacity is being revised upwards then surely that means that the recessionary impact has been overstated?

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But surely that depends on which side of the gap has been estimated incorrectly? If potential capacity is being revised downwards then that would hold true, but if the utilised capacity is being revised upwards then surely that means ..,,,,,

Basically this is saying if you strip out the meaningless part of the economy ie a large chunk of financial services, then actually the economy is smaller than they thought - thus more prone to inflation as the money supply is bigger relative to GDP.

Edited by mikelivingstone

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Basically this is saying if you strip out the meaningless part of the economy ie a large chunk of financial services, then actually the economy is smaller than they thought - thus more prone to inflation as the money supply is bigger relative to GDP.

yeah, but within the fiscal prudent cycle, all will balance.

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The key point, though, is that if the rate of loss of potential supply is variable, the MPC may not be in a position, for some time to come, to form a reliable view on the inflation outlook on the basis of its assessments of current and future output. It is hard to see how, in such circumstances, the central bank’s commitment to inflation targeting could continue to serve as an anchor for inflation expectations.

So, the MPC may have no idea what is going to happen, and now that people know that, they could do stuff that will make the situation even more unpredictable, volatile and dangerous?

Lovely.

edit: quote tags

Edited by Timm

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So, the MPC may have no idea what is going to happen, and now that people know that, they could do stuff that will make the situation even more unpredictable, volatile and dangerous?

And we pay the MPC what for this genius? Mystic Merv is on what £300k a year?

Good job his pay isn't performance related.

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The dipshits at the Bankrupt of England have been poullting the economy for so long, measuring the wrong things for so long and running the economy into the ground for so long with high costs inflated by low interest rates that they are actually clueless to how much damage they have caused.

Companies are continiuing to shelve staff, not becjust becuase of the downturn but because of the BOE policy of maintaining high costs - it is still profitable (or even more so) to shift production abroad, to locations, morever, that have good prospects for the next decades.

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I don't see how this matters in the slightest bit. Britain gets ripped on for having it's economy based on financials but financials are the future and the way forward.

We should not go back to manufacturing we should expand our financial side of the economy or risk being left behind in the next global boom. Clean energy is the other thing we could heavily invest in and other knowledge economies.

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But surely that depends on which side of the gap has been estimated incorrectly? If potential capacity is being revised downwards then that would hold true, but if the utilised capacity is being revised upwards then surely that means that the recessionary impact has been overstated?

Potential capacity needs to be revised down.

With every business that goes bust, every factory that closes, every now excess machine flogged off cheap, every worker made redundant wealth creating capacity falls.

Even for those businesses that survive many will be so financially, and perhaps even more importantly psychologically damaged, by the experiences of 2008-10 that they will not be able or willing to increase capacity afterwards.

We are seeing a permanent reduction in wealth creating capacity.

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I don't see how this matters in the slightest bit. Britain gets ripped on for having it's economy based on financials but financials are the future and the way forward.

We should not go back to manufacturing we should expand our financial side of the economy or risk being left behind in the next global boom. Clean energy is the other thing we could heavily invest in and other knowledge economies.

I'm not sure if you are being ironic or not?

:blink:

There's over 500 people on the Isle of Wight who are able to to explain the benefits of working in the clean energy field.

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I don't see how this matters in the slightest bit. Britain gets ripped on for having it's economy based on financials but financials are the future and the way forward.

We should not go back to manufacturing we should expand our financial side of the economy or risk being left behind in the next global boom. Clean energy is the other thing we could heavily invest in and other knowledge economies.

I like your sense of humour! :lol:

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But surely that depends on which side of the gap has been estimated incorrectly? If potential capacity is being revised downwards then that would hold true, but if the utilised capacity is being revised upwards then surely that means that the recessionary impact has been overstated?

From the quoted MPC minutes:

Another potential factor that could explain the resilience of inflation was that the supply potential of the economy may be lower than assumed. Economies that had had significant financial crises in the past seemed to have suffered large and persistent supply contractions. The Committee had already assumed in its May Inflation Report projections that the growth of potential supply was likely to weaken considerably. But it was impossible to judge the scale and timing of any effects from the current financial crisis and the recession on the UK supply side with any precision.

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