The London Business School with Gower Publishing: Forecast Release: EARNINGS AND UNEMPLOYMENT IN THE CAR INDUSTRY: THE BEST AND WORST OF BRITISH INDUSTRY

The Chancellor has described the cost in terms of lost output and higher unemployment of getting inflation down as ‘well worth paying’. Yet the trade-off so far is a miserable 1.25 per cent off the underlying rate of growth of earnings for an unemployment increase approaching 600,000, some 2–3 per cent off the underlying rate of inflation for a 3 per cent drop in GDP and a 7 per cent fall in manufacturing output. The question is clear: why is it that in the UK we seem to have to pay such a high price in terms of lost output and higher unemployment to make only modest progress on reducing wage and price inflation? One possible answer is in terms of the NAIRU; another stems from the way in which we measure retail price inflation. Using the example of the car industry as a backdrop, we examine the relationship between unemployment and inflation and ask whether there is a role for government to play in improving the trade-off. Our conclusion is that the present non-interventionist stance is probably appropriate but that the government should be doing more to educate both sides of the wage bargain - a challenge picked up by the Prime Minister in his recent speech to the CBI. This is especially appropriate at the present time, because price inflation is falling but wage inflation is lagging behind. It is not a cut in real wages that is required but an equi-proportionate deceleration in both wages and prices. By joining the ERM, we will ultimately obtain German rates of inflation; low wage settlements would both shorten the time-scale and reduce the unemployment cost of convergence.     

THE 1990-91 WAGE ROUND

The 1990-91 pay round could hardly have started against a less propitious background. Retail price inflation -still the principal target for wage negotiators despite its unreliability as a measure of inflation -is at 10 per cent and rising. The shock to oil prices will boost prices and add to wage demands -the natural desire to seek recompense in higher wages will be little impressed by the economist's argument that it is not possible to offset the real income shock to oil consumers by raising nominal incomes. And while cost pressures are pushing up prices, almost every other factor is working in the opposite direction. Domestic demand is at last responding to high interest rates, while the recovery in the pound has worsened UK competitiveness by 10 per cent since the start of the year and this is now taking its toll of exports, hitherto the only buoyant component of demand. The CBZ is warning forcibly that recession is beckoning. How will wages respond to a situation where a backward-looking view points to higher settlements but a forward-looking view indicates the need for wage moderation?     

Can Germany save itself from negative rates?

• German inflation looks set to rise in response to diminishing slack in the economy. But this will be a mixed blessing for those in Germany hit by negative policy rates and ECB asset purchases. Higher German inflation may eliminate the need for further ECB policy action, but it is unlikely to trigger imminent rate hikes. As a result, the rise in inflation will merely lower real interest rates for German savers.
• Structural cross‐country differences mean that the ECB is better able to hit its inflation target when the peripheral economies rather than Germany are the region's growth engine. A key reason for this is that the German Phillips curve is flat by Eurozone standards, meaning that policymakers need to work hard to generate sufficient inflation in Germany to offset sustained weakness elsewhere.
• Despite this, there is evidence to suggest that the tightening labour market is beginning to push German wage growth higher. And if productivity growth remains subdued, this will lead to faster unit labour cost growth.
• While firms could respond by lowering their margins, the strength of household spending suggests that firms may be more inclined than in the past to pass on higher costs to consumers.
• In all, we expect German inflation to rise more sharply than elsewhere to around 2% in 2017, meaning that the ECB will not unveil further unconventional policy support. But it would take much sharper rises in German wage growth and inflation than in our baseline forecast to prompt the ECB to bring forward interest rate rises.

     

The Narrow Band Option for Mr. Lamont

The dilemma facing Mr. Lamont as he prepares his first Budget is the conflict between the need to keep interest rates high to maintain the commitment to sterling's ERM band and the wish to reduce interest rates to ease the severe recession in the domestic economy. In large part, this conflict is intrinsic to the government's aim to bring down UK inflation to German levels through membership of the ERM: the process of reducing inflation is always painful and costly in terms of lost output and higher unemployment. But the dilemma is made worse by the uncertainties over future policy direction, reflected in the differential between UK and German interest rates. German monetary policy is set to remain tight to hold in check the inflationary pressures that might otherwise arise from German unification. Against this background success in reducing UK interest rates will depend on the government's success in establishing the credibility of its anti-inflation policy and of its ERM commitment. An expansionary Budget aimed at easing the recession would undermine this credibility, and remove the scope for additional interest rate reductions. An abandonment of the ERM commitment would signal the accommodation of inflation, and condemn the UK to continuing high inflation and interest rates. We argue in this Viewpoint that the best course open to the Chancellor is to adopt a broadly neutral Budget stance, and to strengthen the ERM commitment by moving to a narrow band for sterling within the ERM. This should enable the Chancellor to reduce UK interest rates again at around the time of the Budget and lay the basis for further subsequent cuts.     

The London Business School with Gower Publishing

The current economic outlook is dominated by fears of continued industrial unrest and uncertainty regarding wage increases. The key issues for output and expenditure will be the outcome of the almost inevitable conflict between the monetary objectives and wage inflation. The most recent indicators provide some evidence of the type of problems the economy will face during 1979. The figures for industrial output and consumption suggest that, by end of 1978, the growth of output was slowing down and the figures for wholesale and retail prices suggest that inflation was picking up. Adherence to the monetary targets is already, on a short-term basis, requiring little or no growth in the real money supply and accompanying high interest rates. The latest official longer-term indicators also point to a slowdown in domestic demand.
Inflation would probably have increased by now had it not been for the recent tight monetary policy and the resulting stability of the exchange rate. We have earlier argued that earnings increases of about 12% will be consistent with the current financial background. But earnings increases of 15% or more will put extreme pressure on the company sector and would bring into sharp focus the choice between finanacing wage increases and letting the exchange rate fall with resulting higher inflation rates: or holding the monetary targets and accepting the short-term consequences for output and unemployment.     

The monetary policy dilemma: Will interest rates have to rise?

UK interest rates are now at their lowest level for more than two decades, and the government is hoping that interest rates can be kept at a low and sustainable level comparable to the 1960s. Indeed, some commentators are calling for still lower interest rates to offset the risk that the £12bn tax increases and cuts in government spending that will come into effect in the next financial year will lead to stagnant consumer spending and a stalled recovery. Against this must be weighed the risk that the recent very good run of inflation figures will prove temporary. Both headline and underlying inflation will be pushed up by indirect tax increases and there is the possibility that wages will follow too, as employees seek to maintain their living standards in a tightening labour market. That risk would point to a much more cautious monetary policy stance and the possibility that the government may need to raise rates from their present level if it is to achieve its inflation objective. The Chancellor faces a clear dilemma. In this Viewpoint, we assess the evidence available to guide him in his decisions and draw out the implications for the future path of interest rates.     

Monetary policy regimes and the term structure of interest rates

US monetary policy is investigated using a regime-switching no-arbitrage term structure model that relies on inflation, output, and the short interest rate as factors. The model is complemented with a set of assumptions that allow the dynamics of the private sector to be separated from monetary policy. The monetary policy regimes cannot be estimated if the yield curve is ignored during estimation. Counterfactual analysis evaluates importance of regimes in policy and shocks for the great moderation. The low-volatility regime of exogenous shocks plays an important role. Monetary policy contributes by trading off asymmetric responses of output and inflation under different regimes.     

Economic Outlook 1991–1995: The London Business School with Gower Publishing: Forecast Release: THE CHANCELLOR'S ECONOMIC ADVICE

Within the last month the Chancellor has made two important speeches on macroeconomic policy. The first, to Surrey businessmen in June, pledged the UK to the French route to a ‘virtuous circle of low inflation, rising competitiveness and increasing market share’; the second, in July to the European Policy Forum, vigorously defended his present policy against the alternatives, which he dismissed as ‘illusory or destined to fail’, of devaluation or cutting interest rates. On both occasions Mr. Lamont placed the permanent conquest of inflation at the centre of his policy, arguing that holding sterling at its present central parity of DM 2.95 is the only way to achieve this objective. In his view the consequence of any of the alternative proposals would be ‘either higher interest rates, higher inflation, or most likely both’. In this Forecast Release we consider these claims and the economic advice on which it is based. On the latter we would surmise that the thrust of the advice which Mr. Lamont is receiving is that he has the opportunity to deliver a sustainably low inflation rate and that this requires a stable pound within the ERM. The alternatives involve a sterling devaluation which, no matter how obtained, would obstruct the goal of permanently low inflation in return for only transient benefits on output and unemployment. But the price of defeating inflation has been high and is not yet fully paid. Moreover the goalposts have been moved: to reach the French position on competitiveness, which underpins their gains in market share and which has taken the best part of a deeade to achieve, requires a still better inflation performance on the part of the UK and while this is being achieved, adjustment costs will persist. It is partly in defence of his own policies and partly in an attempt to moderate the already-high adjustment costs that Mr. Lamont has adopted a more combative stance. His advice is that to compete with Europe, we cannot award ourselves pay increases far in excess of European levels, indeed we need a period of below-average pay rises.     

A New Keynesian model with staggered price and wage setting under learning

This paper provides a study of the implications for economic dynamics when the central bank sets its nominal interest rate target in response to variations in wage inflation. I provide results on the existence, uniqueness, and stability under learning of rational expectations equilibrium for alternative specifications of the manner in which monetary policy responds to economic shocks when nominal rigidities are present. Monopolistically competitive producers set prices via staggered price contracts, and households set nominal wages in the same fashion. In this setting, the conditions for determinacy and learnability of rational expectations equilibrium differ from a model where only prices are sticky. I find that when the central bank responds to wage and price inflation and to the output gap, a Taylor principle for wage and price inflation arises that is related to stability under learning dynamics. In other words, a moderate reaction of the interest rate to wage inflation helps to avoid instability under learning and indeterminacy.     

Do unions redistribute income from capital to labour? Union density and wage shares since 1960

The income distribution between capital and labour is understudied within industrial relations. This article investigates the relationship between union density, taken as an indicator of the bargaining power of unions, and the wage share of national income in 16 advanced capitalist economies since 1960. It is shown that overall there is a positive relationship between union density and the wage share, as one would expect. But the relationship is weak or non‐existent in the Nordic countries, and in some specifications in Germany and Anglo‐Saxon countries, and overall it is weak in the 1980s and early 1990s. The article discusses the differences between countries in relationship to the literature on corporatism and wage moderation, and the decreasing effect over time with reference to increased global competition and conservatism of monetary policy from about 1980 on, increasing unions' incentives for wage moderation policies.     

Dealing with a liquidity trap when government debt matters: Optimal time-consistent monetary and fiscal policy

How does the need to preserve government debt sustainability affect the optimal monetary and fiscal policy response to a liquidity trap? To provide an answer, we employ a small stochastic New Keynesian model with a zero bound on nominal interest rates and characterize optimal time-consistent stabilization policies. We focus on two policy tools, the short-term nominal interest rate and debt-financed government spending. The optimal policy response to a liquidity trap critically depends on the prevailing debt burden. While the optimal amount of government spending is decreasing in the level of outstanding government debt, future monetary policy is becoming more accommodative, triggering a change in private sector expectations that helps to dampen the fall in output and inflation at the outset of the liquidity trap.     

The 1997 Election: Can an Improving Economy Secure a Fifth Tory Term?

The current government is in deep electoral trouble. Nothing is certain in politics, but it still seems very likely the Tories will be defeated by New Labour this spring. Yet the economy is in fine shape – inflation and interest rates are at historically low levels, economic growth is proceeding at a respectable rate, and unemployment continues to fall. Why won’t the electorate reward the government? In this article Simon Price argues that the Tories lost their reputation for economic competence in 1992 and this has swayed the public’s opinion.     

ELUSIVE PERSISTENCE: WAGE AND PRICE RIGIDITIES,THE NEW KEYNESIAN PHILLIPS CURVE AND INFLATION DYNAMICS

Abstract We review the main New Keynesian inflation equations that have arisen as a result of aggregation from individual firms' price rigidities. We find that, on the whole, they cannot account for inflation persistence, a key feature of the empirical dynamics of inflation, and with important policy implications. The only exceptions seem to be when indexation is allowed in price setting or when price stickiness is combined with wage rigidity and staggering.     

Around the world with Irving Fisher

This paper aims to show why Irving Fisher's own data on interest rates and inflation in New York, London, Paris, Berlin, Calcutta, and Tokyo during 1825–1927 suggested to him that nominal interest rates adjusted neither quickly nor fully to changes in inflation, not even in the long run. In Fisher's data, interest rates evolve less rapidly than inflation and change less than inflation over time. Even so, the “Fisher effect” is commonly defined as a point-for-point effect of inflation on nominal interest rates rather than what Fisher actually found: a persistent negative effect of increased inflation on real interest rates.     

'Social Partnership' not for Export

Sweden was once held up as a model welfare state for Britain to emulate. But Swedes are having doubts. Lately Austria has been offered as a model for the achievement of low unemployment and little inflation through wage regulation by incomes policy. An Austrian and a British observer appraise the argument with differing degrees of scepticism.     

The First Unified Budget What Should Mr. Clarke Do?

Mr. Clarke has the distinction of presenting the first Unified Budget, an innovation introduced by his predecessor. He does so against a subdued inflation outlook and a recovery from recession that has been proceeding since the first half of last year. But he is also aware that there are risks to this favourable outlook: European recession may slow growth, and there is the worry that underlying inflation may breach the Government's 4 per cent ceiling. III this Viewpoint, we argue that the Chancellor should go further that his predecessor in curbing public borrowing, aiming for a reduction of sonic £4-5bn; this fiscal contraction could be accompanied by a further 0.5 per cent reduction in interest rates, or more if the recovery shows signs of faltering. A rebalancing of monetary and fiscal policy in this way reduces the risks associated with a high level of public borrowing, can help in reducing the excessive level of consumption (private and public) in the UK economy, and offers the best means of maintaining a competitive exchange rate without inflation. A curious feature of the first Unified Budget is that, having moved tax decisions to the autumn, the Chancellor appears to have ruled out further government spending cuts beyond those agreed by the Cabinet before the summer: with more favourable inflation arid the public sector pay limit, there would seem to be scope for a further reduction in the Control Total. On the revenue side, the Chancellor should seek to raise revenues in such a way that does not adversely affect incentives. Here he has several options: to extend the VAT net; to eliminate income tax allowances or reduce them to the 20p rate of tax; or to introduce new user charges. There is also the opportunity, one year on from the UK's exit from the ERM, to restate the basis for a sustainable macroeconomic framework. This should include a rebalancing of monetary and fiscal policy, and a move to enhance the powers of the Bank of England but with parliamentary accountability.     

Impacts of Monetary, Fiscal and Exchange Rate Policies on Output in China: A Var Approach

Applying the VAR model and using the interest rate as a monetary policy variable, we find that in the long run, output in China responds negatively to a shock to the interest rate, the real exchange rate, government debt, or the inflation rate, and it reacts positively to a shock to government deficits or lagged own output. When real M2 is chosen as a monetary policy variable, long-term output in China responds positively to a shock to real M2 or lagged own output, and it reacts negatively to a shock to the real exchange rate, government debt, or government deficits. Its response to a shock to the inflation rate is negative when government debt is used and is positive when government deficits are considered. In the short run, fiscal policy is more important than monetary policy in three out of four cases. In the long run, monetary policy is more influential than fiscal policy in three out of four cases. Therefore, the government may consider conducting monetary and fiscal policies differently in the short run and long run. The government needs to be cautious in pursuing deficit spending as its long-term impacts depend on the monetary variable employed. The policy of maintaining a relatively stable exchange rate is appropriate as the depreciation of the Yuan may hurt the economy in the short run.JEL Classifications: E5, F4, H6     

Interest rate movements and US consumers’ inflation forecast errors: is there a link?

The Fisher effect maintains that movements in short-term interest rates largely reflect changes in expected inflation. Since expected inflation is subject to error, we ask whether interest rates move in response to over- and under-predictions of inflation. In answering, we measure expected inflation by the consumers’ forecast of inflation derived from the Michigan Surveys of Consumers (MSC). Our findings for 1978–2013 indicate that the MSC inflation forecasts were unbiased, efficient, and directionally accurate. For 1978–2007, (i) interest rates moved downward (upward) in response to MSC over-predictions (under-predictions) of inflation, and (ii) MSC inflation forecast errors had directional predictability for interest rates. However, no link between interest rate movements and MSC inflation forecast errors is detected for 2008–2013 when monetary policy kept short-term interest rates unusually low.     

我国灵活动态金融状况指数构建与应用研究

鉴于目前研究缺乏灵活动态性,本文从通胀控制目标出发,引进MI-TVP-SV-VAR模型,选取5个金融变量,估计其每一期的灵活动态权重,构建我国灵活动态金融状况指数,并分析它对通胀率的预测能力。经验分析结果表明利率和房价的权重相对较大,反映出货币政策依然倚重于价格型传导渠道;FCI与通货膨胀有很高的相关性,且领先通胀1~7个月,能够很好地预测通胀。建议政府定期构建我国灵活动态金融状况指数并应用于通货膨胀预测。     

How low can U go?

• ? Although there is growing evidence that wage growth is building in response to low and falling unemployment in the advanced economies, there is scope for unemployment rates to fall further without triggering a pay surge.
• ? For a start, current unemployment rates in comparison to past cyclical troughs overstate the tightness of labour markets. Demographic trends associated with the ageing ‘baby boomer’ bulge have pushed down the headline unemployment rate – unemployment rates among older workers are lower than those of younger cohorts. And in a historical context, Europe still has a large pool of involuntary part‐timers.
• ? In addition, rising participation rates mean that demographics are less of a constraint on employment growth than widely assumed. In both 2017 and 2018, had it not been for increased activity rates (mainly for older cohorts), unemployment would have had to fall more sharply to accommodate the same employment increase. We expect rising participation rates to continue to act as a pressure valve for the labour market.
• ? Finally, unemployment rates were generally far lower during the 1950s and 1960s than now. If wages stay low relative to productivity, as was the case during that prior era, employment growth may remain strong, with unemployment falling further. In the post‐war era, low wages were partly a function of a grand bargain in which policy‐makers provided full employment in return for low wage growth.
• ? There is evidence to suggest that many post‐crisis workers have opted for the security of their existing full‐time job and its associated benefits despite lower wage growth, rather than change job and potentially earn more; the rise of the ‘gig economy’ has led some workers to value what they already have more. Put another way, the non‐accelerating inflation rate of unemployment (NAIRU) has fallen. So, the role of labour market tightness in pushing wage growth higher may continue to surprise to the downside.