A few years ago Capital Economics made a strong case that the UK output gap — or how much slack there is in the economy — was being grossly under estimated by one and all. Their note prompted a spirited debate about the importance of output gaps in ascertaining correct monetary and fiscal policy.
Well, a similar case is now being made for the Eurozone by David Mackie and team at JP Morgan.
It’s an absolutely fascinating note, which argues above all that the ECB and the European Commission are wrong to think that the Euro area output gap is modest or that the growing unemployment rate is structural, given there is so little wage pressure in the region. Read more
As a reminder, the big unknown about the US labour market is the extent to which the demographic-adjusted decline in the labour force participation rate has been caused by cyclical vs structural trends. And in addition to the decline in the unemployment rate, a few other economic indicators suggest the potential for a near-term increase in wages.
From a note by Paul Ashworth of Capital Economics: Read more
Here’s a rough sketch of the variables influencing US inflation, which has been remarkably low for two years running:
1) The remaining labour market slack, including a staggering and resilient long-term unemployment problem. The amount of slack remains tough to know given the difficulty of measuring the cyclical vs secular components of the fall in the labour force participation rate. Much more on this later.
2) The output gap. This isn’t a well-defined idea, we know, but few people would argue that the US economy is producing at potential. The US economic recovery does appear to have accelerated in the final two quarters of last year (the December jobs report notwithstanding), and the conditions for growth look better than they have in years. If the nascent acceleration proves sustainable, then the labour market may well tighten up and push wages higher. Obviously this is related to the first point about labour market slack, and plenty of caveats are needed given the head-fakes of the last four winters. Read more
As Mark Carney outlined at Wednesday’s press conference for the BoE inflation report, much-awaited ‘forward guidance’ will be linked to unemployment falling through the 7 per cent level. But it will also in some sense be related to the committee’s evaluation of how much slack there is in the economy.
Or rather, they’re linking rates to unemployment (targeting, in everyone else’s book) because they can’t explicitly target slack. Read more
Let’s look at the latest from the UK’s Office for Budget Responsibility (our emphasis):
The combination of more robust employment and much weaker GDP growth than we expected together create a significant ‘productivity puzzle’. Output per hour is much weaker than in previous cycles and than in our June 2010 forecast. Several explanations for the puzzle have been put forward and although we believe that some of the weakness of productivity relative to the pre-crisis trend is likely to be a temporary phenomenon, we also assume that a significant proportion of the hit is likely to be permanent or long-lasting. Read more
Capital Economics put out a cracker of a note on UK output this week. It’s taken us a while to get through it but we wanted to do it justice. Here’s the key extract:
‘Supply pessimists’ point to high inflation and growing employment as evidence of a small output gap. But inflation was pushed up by temporary factors and has eased recently, while domestically generated inflation has remained low.
From HSBC’s Global Macro Economics team on Thursday:
Matters are being made worse because the world’s savers would rather buy Treasuries than global goods. Read more
Can prolonged periods of negative real interest rates ever be good for economies in a globalised world?
Anders Aslund, senior fellow of the Peterson Institute for International Economics, argues no. Read more
FT Alphaville loves data mysteries — and there’s something particularly ironic about fourth-quarter UK productivity data not being, erm, produced on time.
Anyway, the UK’s Office for National Statistics said earlier this week that the Q4 productivity numbers scheduled for Wednesday would be delayed until April 7 because of “data quality issues.” Read more
We posted this chart from the San Fran Fed (via Mark Thoma) in yesterday’s further reading list, but it’s worth a second look:
For the commute home, or while worrying about what Friday may bring,
- ‘What if the stock market was a bond?’ Read more
James Bullard delivered an interesting, chart-rich speech on inflation, QE2 and global output gaps on Thursday. (And yes, ‘interesting’ is all subjective.)
The now non-voting St Louis Fed President was a strong advocate of QE2 as a way to reverse alleged deflationary pressures. FT Alphaville noted in December that Bullard was keen to suggest that QE2 was just hunky-dory, impacting on key indicators as predicted. Read more
… is the title of the 1973 album from ‘prog rockers’ Genesis, and it also sums up the UK’s inflation problem, according to Bank of England hawk, Andrew Sentance.
In a speech at the Institute of Economic Affairs ‘State of the Economy’ conference on Thursday, the Monetary Policy Committee member says the value of the pound needs to be a key area of focus (not neglect) for the UK’s central bank, if it is to have any hope of mitigating the impact of global inflationary pressures. Read more
Citigroup’s Michael Saunders and Ann O’Kelly, on this week’s Bank of England rate decision:
We expect that the MPC will leave rates on hold at the upcoming [February 10] meeting. However, we believe it may well be a much closer call than many expect, and there is a decent chance that the MPC will tighten policy. If it does decide to tighten, a 25bp hike is the most likely option, with little chance of either a 50bp hike or an early reversal of QE… Read more
It’s no secret we at FT Alphaville ♥ John Kemp.
And we output gaps. Or at least, certain policymakers’ over-reliance on them. Read more
As Nicolas Sarkozy has noticed, worries about global inflation have picked up in the first weeks of 2011.
And according to two notes out on Monday this is not just down to rising commodity prices; there is also a lack of spare capacity that is being reflected in rising core inflation and increased expectations. Read more
Maybe there’s not so much to this Beveridge Curve business after all.
As we’ve written previously, many economists and other observers have been discussing in recent months the rather large and persistent gap between job openings and the high unemployment rate, which was much higher than you would expect given the previous empirical relationship between the two. Read more
Britain is on track to have the fastest economic expansion in the first half of this year of any of the world’s large industrialised economies, bar that of Canada, according to a forecast from the Organisation for Economic Co-operation and Development, the FT reports. According to the think-tank, UK output is likely to expand at an annualised rate of 2 per cent in the first quarter and at an annualised rate of 3.1 per cent in the second quarter of 2010.
. . . the risks to the Committee’s central view of a gradual recovery of output remain to the downside.
That’s Bank of England governor Mervyn King testifying to the UK Treasury Committee about the February inflation report. The output gap has become something of a catchphrase for Monetary Policy Committee members at the BoE, and for some Federal Reserve board members too. Read more
Thursday’s FT has an interview with the Bank of England’s executive director for markets, Paul Fisher, on the subjects of quantitative easing, inflation, deflation, the output gap, money supply, and the UK economy in general.
The whole thing makes for worthwhile reading for QE-watchers, but we’ve provided some excerpts of the most salient points below. Read more
Here’s further evidence that the Fed is somewhat split on the output gap theory and the amount of ‘slack’ in the US economy — and by extension, the inflation and deflation risks that face it.
Slack occurs when the output gap is a negative number — when the economy is below its full potential. In traditional economic theory, that implies deflationary risks as companies cut prices and jobs to deal with the spare capacity. A high deflation risk would imply continued low interest rates — and perhaps liquidity ops — from the US central bank. Read more
Reuters columnist Rolfe Winkler points us to a recent speech and presentation by Fed governor James Bullard.
The speech, Winkler says, is a direct refutation of economist Paul Krugman‘s ideas that inflation, potentially triggered by extremely low interest rates and unconventional monetary policy, is not a threat so long as there’s a large amount of `slack’ in the US economy. Slack occurs when the output gap is a negative number — when the economy is below its full potential — and in traditional economic theory implies deflationary risks as companies cut prices and jobs to deal with the spare capacity. Read more
The French are lazy.
Germans are efficient. Read more
Goldman Sachs is putting an end to the deflation vs inflation debate, once and for all!
In a 30-page research note out on Wednesday, the bank comes down firmly on the side of (moderate) deflation in the near-term. Read more
Here’s an interesting little chart from BofA Merrill Lynch.
Economy watchers should by now be familiar with the concept of the output gap – a measure of the amount of ‘slack’ in the economy; the bigger the output gap, the greater the amount of spare capacity. Read more
So where’s the deflation which Bank of England governor Mervyn King is so desperate to avoid?
The UK’s rate of inflation is slowing — but it’s certainly not nearing deflation levels. The Consumer Prices Index annual inflation rate was 1.6 per cent in August, down from 1.8 per cent in July, and its lowest since January 2005. Expectations, however, were for a 1.4 per cent year-on-year rate. Read more