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exiges

Andrew Sentance Speaks..

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http://www.bankofengland.co.uk/publications/news/2011/009.htm

Full speech: http://www.bankofengland.co.uk/publications/speeches/2011/speech472.pdf

In a speech to the Institute of Economic Affairs ‘State of the Economy Conference’ in London, Andrew Sentance – External Member of the Monetary Policy Committee – discusses the outlook for inflation in the United Kingdom, explains why he thinks that inflationary pressure is greater than suggested by the MPC’s latest Inflation Report forecasts and why higher interest rates are now needed.

Andrew Sentance begins by asking: “Why has inflation turned out persistently above target, despite the widespread expectation that it would be pushed down by the financial crisis and the global recession?” The answer, he argues, is that “…too much faith is being put on the impact of a large ‘output gap’ pushing down on inflation and not enough weight has been put on the upward pressure from the global environment and the exchange rate”.

Andrew Sentance goes on to explain why he thinks that the ‘output gap’ has not dampened inflation as much as is commonly thought. First, he suggests that the degree of spare capacity created by the recent recession is less than might have been expected given the experience of previous recessions. He says: “In both the early 1980s and early 1990s recessions, the unemployment rate rose to over 10%.... By contrast, the current unemployment rate is still below 8%, and it should drop back gradually as the recovery proceeds”. Consequently, he indicates, pay pressures during this recovery are now beginning to build. Second, in making pricing decisions, businesses look not just at the level of demand, but at its growth rate, and he notes that “...domestic demand in the UK economy has bounced back strongly following the recession in both real and nominal terms”. Third, he argues that the ‘pricing climate’ is more complicated than a simple view based on measure of the ‘output gap’ would suggest. In comparing the current recovery with those following the early 1980s and 1990s recessions, he says: “Businesses appear to have taken a stronger signal from the stimulatory policy and its impact on demand growth, and looked through what they might reasonably have expected to be a temporary shortfall in demand. The danger of this is, of course, that businesses come to expect higher inflation on an ongoing basis and the higher rate of inflation becomes deeply ingrained.”

Fourth, and most importantly, Andrew Sentance says that in an open economy like the UK the ‘output gap’ model of inflation pays insufficient attention to the global forces shaping UK inflation. “A key driver behind the upward pressure on prices in global markets has been strong global economic growth, particularly driven by Asia and other emerging markets”, he says. Moreover, “Forecasts of future global growth are now being revised up again…”. Dr Sentance concludes that “...global inflationary pressures look set to continue and with them above-target UK inflation”.

Finally, Andrew Sentance considers the role of the exchange rate, and the appropriate response of monetary policy to global inflationary pressure. He says that: “...the recent fall in the external value of the pound between 2007 and 2009 is probably the largest depreciation we have experienced in a relatively short period over the past two centuries – with the exception of the departure from the Gold Standard in the early 1930s.” And, he argues, while some depreciation of the exchange rate is a helpful boost to export demand, “…there must be a concern that we have let the pound fall much further than this rebalancing requires”. He concludes by saying that, while the exchange rate should clearly not become the centrepiece of UK monetary policy, the value of sterling “...needs to be one of the key areas of focus for the MPC as we seek to steer ourselves out of the current phase of high inflation”. A modest appreciation of sterling, he argues, “…would mitigate the impact of global inflationary pressures in the short term and help to steer inflation back to the target over the medium term”.

Edited by exiges

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Again we come back to the Bank’s asymmetric policy.

Sentance shows the following chart which separates goods inflation from services inflation:

sentance170211.gif

He makes the point that if there is a supposedly large output gap, why have we not seen services inflation (which is mainly domestically driven and is not much influenced by international factors) dip much lower?

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Good points. I've always questioned mervs magical spare capacity and it's good that at least someone from the MPC acknowledges the ability they have to influence the exchange rate and therefore imported inflation.

Just a shame he is going in May.

Edited by Pent Up

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Give it 12 months and he'll be arguing why it was 'unexpected' that the Chinese economy collapsed in a heap and why they're having to slash real rates again to fight deflation from rapidly falling commodity prices.

:lol:

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Give it 12 months and he'll be arguing why it was 'unexpected' that the Chinese economy collapsed in a heap and why they're having to slash real rates again to fight deflation from rapidly falling commodity prices.

...except it won’t be unexpected. It will be because the authorities around the globe are having to tighten monetary and fiscal policy.

The same thing happened in 1937, when easy money and government stimulus had pushed up commodity prices (which of course for some time had been the aim). Eventually they had to put on the brakes and this sent the US back into recession (it became known as ‘Roosevelt’s Recession’, and also as ‘Depression II’).

In case anyone thinks that what we’re witnessing now is unprecedented, here’s a House of Commons exchange from 12 April 1937 (courtesy Hansard):

Mr. De la Bère

asked the Chancellor of the Exchequer (1) whether it is the intention of the Government to keep money cheap by various methods and at the same time to attempt to curb speculation; (2) whether he can give some assurance to the House that the Government's finance policy, which tends to make cheap money for speculators in commodities, will not entail a rise in the price of food for the people and the cost of living?

Lieut.-Colonel Colville

My hon. Friend appears to misapprehend the purpose of the Government's policy; cheap money is not an object in itself, but a means adopted for securing the improvement of trade activity and employment. My right hon. Friend is satisfied that the policy actually followed has given a maximum stimulus to economic recovery in the United Kingdom and the Empire with a minimum of undesirable repercussions. I cannot make any statement as to the future, since the measures to be taken at any time will depend on the course of events, but I can assure my hon. Friend that my right hon. Friend the Chancellor of the Exchequer will continue to follow developments with close attention as he has hitherto done.

And again on 20 April:

Major Stourton

asked the Chancellor of the Exchequer whether he is aware that the present cheap rates for money are increasing the price of materials and adding to the cost of rearmament; and whether, in order that the general taxpayer may not suffer on balance, he will re-examine the effects of artificially cheap money causing a rise in the commodity index number?

Lieut.-Colonel Colville

I would refer my hon. and gallant Friend to the reply which I gave to the hon. Member for Evesham (Mr. De la Bère) on 12th April.

Major Stourton

asked the Chancellor of the Exchequer whether, in view of the fact that the wholesale commodity sterling price index is to-day 7 per cent. higher than the index for the whole period 1844 to 1913, he will take precautionary steps to ward off a repetition of the calamities which have hitherto followed high commodity prices causing over-production and diminished consumption owing to the reduced real purchasing power of wages, salaries, and fixed incomes?

Lieut.-Colonel Colville

My right hon. Friend has the situation constantly under observation, but he is unable to agree with the interpretation of price movements suggested in my hon. and gallant Friend's question. He does not think that increased production involving increased employment and so increased demand can be regarded as undesirable at the present time.

Major Stourton

Is my right hon. and gallant Friend aware that the principal cause of the rise in commodity prices is speculation due to cheap money?

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He makes the point that if there is a supposedly large output gap, why have we not seen services inflation (which is mainly domestically driven and is not much influenced by international factors) dip much lower?

They don't know how to measure the output gap properly, it is highly questionable to include permanently loss making facilities/divisions in the output gap as they are liable to get axed particularly if the economy is slightly sickly.

They have poor understanding of real world microeconomics and how you run a company, in the good times companies might tolerate loss making facilities as they need the whole product portfolio and profits across the product range are good.

Example below created from some former clients or their competitors in the food and drinks industry, it applies to most of the industry, it could almost be a stereotype for the industry (I used to work for one of the strategy consultancies).

There is a phenomenon where companies with say 5+ plants in the UK, will have some older facilities (dating from 1950-1960s) that have not received major investment in the last 25 years and it is not viable to significantly invest in them in the future (poor location, high local labour cost, inability to expand...), they typically make 1 or 2 types of products, are not that efficient and have limited operating hours as there is relatively fixed demand for their products. The products the plants make are not big sellers overall but are the leaders in niche area and allows the firms to claim #1 position, firms need to retain the products to stop competitors expanding their overall sales and becoming more efficient due to scale. The plants are loss making but they keep them going during the good times as they could afford it overall and didn't want bad publicity, but times change and the production is shifted to other profitable plants which receive new investments and only take on 1/3 of the number of employees at the new site that were employed at the old site for the same amount of production.

This is surprisingly common and has happened to at least 14 plants in the last 3-4 years, the "spare" capacity is rapidly going up in smoke and they seem not to be noticing. They may also have counted the difference between 24/7 operation (which wasn't happening or had never happened) and the real operating hours of a plant as spare capacity too, unfortunately for the BoE the economics of the real world firms don't look like that.

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Major Stourton

asked the Chancellor of the Exchequer whether, in view of the fact that the wholesale commodity sterling price index is to-day 7 per cent. higher than the index for the whole period 1844 to 1913, he will take precautionary steps to ward off a repetition of the calamities which have hitherto followed high commodity prices causing over-production and diminished consumption owing to the reduced real purchasing power of wages, salaries, and fixed incomes

Wow 7% inflation over 25 years...how did they manage! Just goes to show how crazy things have been over the past 60 years

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They don't know how to measure the output gap properly, it is highly questionable to include permanently loss making facilities/divisions in the output gap as they are liable to get axed particularly if the economy is slightly sickly.

Yap - quite a bit of capacities have been permanently lost (those empty shops/factories). Beyond that, I can see little 'output gap' in useful things in the economy.

( OK - many unemployed. However, is an unemployed ex-mortgage advisor who does not retrain a 'spare capacity' ?)

I think the best way of looking at output gap is looking at manufacturer / shops margins - they have not come down much (e.g. Home Retail group / Argos, still

rums at close to 40% gross margin - no sign of desperation there for sure).

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...

Example below created from some former clients or their competitors in the food and drinks industry, it applies to most of the industry, it could almost be a stereotype for the industry (I used to work for one of the strategy consultancies).

There is a phenomenon where companies with say 5+ plants in the UK, will have some older facilities (dating from 1950-1960s) that have not received major investment in the last 25 years and it is not viable to significantly invest in them in the future (poor location, high local labour cost, inability to expand...), they typically make 1 or 2 types of products, are not that efficient and have limited operating hours as there is relatively fixed demand for their products. The products the plants make are not big sellers overall but are the leaders in niche area and allows the firms to claim #1 position, firms need to retain the products to stop competitors expanding their overall sales and becoming more efficient due to scale. The plants are loss making but they keep them going during the good times as they could afford it overall and didn't want bad publicity, but times change and the production is shifted to other profitable plants which receive new investments and only take on 1/3 of the number of employees at the new site that were employed at the old site for the same amount of production.

This is surprisingly common and has happened to at least 14 plants in the last 3-4 years, the "spare" capacity is rapidly going up in smoke and they seem not to be noticing. They may also have counted the difference between 24/7 operation (which wasn't happening or had never happened) and the real operating hours of a plant as spare capacity too, unfortunately for the BoE the economics of the real world firms don't look like that.

Babycham or Stowells per chance?

I might have worked for Constellation :)

Edited by se7ensport

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  • 312 Brexit, House prices and Summer 2020

    1. 1. Including the effects Brexit, where do you think average UK house prices will be relative to now in June 2020?


      • down 5% +
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