Read this and make notes, then I can skip some of the boring bits on inflation...

 

DAVID SMITH | ECONOMIC OUTLOOK

Should we move the Bank’s inflation target to 3%?

David Smith

Saturday August 26 2023, 6.00pm, The Sunday Times

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An epic battle has been under way for more than 18 months. Some say it is being fought with the wrong weapons, others that the outcome is not for us to determine but depends on international factors. Still, it continues. The battle is to get inflation back down to its official target of 2 per cent.

While inflation has fallen from its peak of 11.1 per cent last October to 6.8 per cent last month, there is a bigger journey to get from here to 2 per cent than that achieved so far. There is nervousness in government about where we go from here — particularly around next month’s figures, which will determine by how much state pensions and other benefits go up next April. Household energy bills are heading in the right direction, but petrol prices are rising again.

Meanwhile, the collateral damage from fighting inflation with higher interest rates — which can now be seen in the housing and labour markets and will spread elsewhere — is building.

The latest “flash” purchasing managers’ survey, published a few days ago, dropped well below the key 50 level and was headlined “UK private sector output falls at fastest rate since January 2021”. That month, to remind you, marks the start of the third Covid lockdown, when monthly GDP fell by nearly 3 per cent. Other countries are seeing a similar impact.

Is the battle worth the fight? Why do we have an inflation target, and why does it have to be 2 per cent? Would it make much difference if it were higher, say 3 or 4 per cent, if it meant less interest rate pain?

This debate has been running for a long time but remains hot. A few days ago, Jason Furman, former head of the White House Council of Economic Advisers, wrote in The Wall Street Journal that the Federal Reserve, the US central bank, should lift its target from 2 to 3 per cent when it next reviews its strategy.

“Whatever considerations led policy- makers to conclude that 2 per cent was the right number in the 1990s would lead them to consider something higher, like 3 per cent, today,” he wrote.

A bit of history might be useful. The UK came to have an inflation target by accident just over 30 years ago. When the pound was forced out of the European exchange rate mechanism (ERM) on “Black” Wednesday in September 1992, the central plank of the government’s economic policy was removed.

In its place, an inflation target was introduced. Legend has it that the process was helped by a couple of economists from New Zealand on secondment at the Treasury. Three years earlier, New Zealand had pioneered an inflation target — and an independent central bank got the job of meeting it.

The UK target, for inflation to be kept in a 1 to 4 per cent range, paved the way for the Bank of England to be made independent in 1997. Its target was 2.5 per cent for a measure known as RPIX: the retail price index excluding mortgage interest payments. This was chosen instead of plain RPI because, otherwise, the Bank would have been targeting a measure that mechanically went higher every time interest rates were increased.

Things became simpler with the shift to a CPI (consumer prices index) target in the early 2000s. The target was reduced from 2.5 to 2 per cent, reflecting the fact that, over time, RPIX inflation was about half a percentage point higher than CPI inflation. That 2 per cent also became the consensus figure among central banks, though the UK target is set by the government, as since 1992.

Why, despite the current difficulties, think about changing the target? After all, and this may surprise you, in the first 25 years of Bank independence, until the spring of last year, CPI inflation averaged exactly 2 per cent — bang on target. The very high inflation of the past year or so has tarnished the record, so the average since 1997 now stands at 2.4 per cent. Disappointing, but not disastrous.

For economists such as Furman, one of the strongest arguments for a higher target is that, while it seems a distant prospect now, few expected we would enter a long period with official interest rates at zero, or close to it, when 2 per cent became the inflation target; stimulating their economies meant central banks had to resort to quantitative easing (QE) and other unconventional measures. It is easy to forget now that two years ago, before it embarked on the current run of raising rates sharply, the Bank was busy putting negative interest rates into its policy toolkit. A higher target would give central banks more leeway, and more ability to cut rates when necessary, without even thinking of negative rates.

There is another argument, which in the case of the UK is more compelling. It is that, in spite of the record of the past quarter of a century, I am not sure that 2 per cent ever became the natural or “normal” rate of inflation in the UK.

I say this because if you look at inflation over the first 25 years of independence, when the rate averaged 2 per cent, goods price inflation was a low 1.1 per cent, while service sector inflation, a better measure of domestically generated price pressures, averaged 3.3 per cent. Goods prices were held down by the China effect and the initial price-reducing impact of the internet — factors that have faded in importance. Neither prevented goods price inflation from surging over the past 18 months, alongside food and energy.

There is another piece of evidence, from the Office for National Statistics. In new research, it has produced data for what it calls “that part of inflation which is common to all goods and services in the index”. It can thus be considered, says the ONS, “the general underlying trend or core inflation rate across the whole economy”. It has calculated this trend or core inflation rate from January 2002 until last month — so a period of more than 20 years — and the average over that period is 2.75 per cent, which is closer to 3 per cent than 2 per cent.

Shifting to a 3 per cent inflation target would have costs. For the government, it would imply a higher debt interest bill and increased costs in the long term for uprating state pensions and benefits.

For everybody else, it would mean a higher price level. Under a 2 per cent inflation target, if achieved, prices rise by 22 per cent over ten years; with 3 per cent, it would be nearly 35 per cent. The 2 per cent target was chosen because it was a rate that did not interfere with business and consumer decisions; firms and individuals would not always be trying to beat inflation. That might also be true at 3 per cent, but it might not.

Perhaps most difficult would be the adjustment to a higher target, which could not be achieved without a loss of credibility and could not be tried until inflation has subsided a lot more, probably to 2 per cent, at least for a while. In this respect, moving the goalposts would not help us out of the present difficulties. But it might make such difficulties less likely in future.

Interesting article about the Irish growth story from FT

Don't forget you can access the FT yourself. Quite a long read but good detail about the importance of different factors that lead to FDI into a country, plus some useful information about a mooted international tax treaty that could be helpful in essays. Be selective in what you carry from this:

Ireland seeks to lure life science investment despite corporate tax rise 

Dublin believes that the country’s skill base will attract pharma and medical companies 

Jamie Smyth in Dublin 

A surge in life sciences investment that helped make Ireland the EU’s top performing economy in the past two years will continue despite a rise in the corporate tax rate to 15 per cent, the country’s investment chief said. Michael Lohan said Ireland was poised to win several big investments from pharmaceutical and medical device companies attracted to the country’s blend of tax incentives, political stability, skilled workforce and EU membership. 

 “As uncertainty continues around the globe, Ireland’s certainty has become more attractive. People are seeking those islands of tranquillity, and Ireland is one of those,” Lohan, chief executive of the country’s foreign investment authority IDA Ireland, told the Financial Times.

 The number of people employed in life sciences in Ireland has surged by 80 per cent to almost 100,000 over the past decade on the back of almost $15bn in capital investment in the sector. Last year a record 301,475 people worked at multinationals, which paid 86 per cent of all corporate taxes received in the country of 5mn people. 

 Ireland has built its record as being one of the EU’s largest FDI recipients on its attractive headline corporate tax rate of 12.5 per cent, but Lohan is the confident that the rise to 15 per cent in January for all companies that generate $750mn or more in annual revenues is “not making a marked difference in terms of investment decisions”. But as countries such as the US pursue a “reshoring” manufacturing policy and consider tax incentives for pharma companies, analysts and investors warn that the wider OECD-led shake-up of corporate tax rules, as well as housing and energy shortages, could dent Dublin’s ability to attract multinationals. 

 “The key challenge for Ireland is addressing infrastructure constraints and other bottlenecks such as housing which are raising the costs for foreign investors,” said Conall Mac Coille, economist at Davy, a Dublin stockbroker. A downturn in the technology sector that is spurring job losses at Meta, X (formerly Twitter) and Accenture, all of which have operations in Ireland, has added to concerns about its competitiveness. 

 A second tranche of tax reforms called Pillar One, which are being overseen by the Paris-based OECD, would result in a portion of taxable profits generated by large multinationals being reassigned from Ireland to other markets. The change reflects how modern businesses can make profits in foreign markets without necessarily having a physical presence there. 

 Brad Setser, a senior fellow at the Council on Foreign Relations in Washington, said that the Pillar One reforms, and uncertainty over whether the US and other countries will implement the agreement, were the main threats to Ireland. 

 The OECD is hoping that the measure can come into force in 2025 but a failure by Washington to sign up to a global agreement, which looks likely as many Republicans in Congress remain opposed to it, could create trade tensions and complicate FDI decisions for US multinationals, Setser said. 

 For now, most investors are playing down the risks, suggesting that access to skills and support services in Ireland are more important than tax reforms. Mac Coille also noted that Ireland would maintain a corporate tax advantage over its rivals, including the UK, which in April raised its rate from 19 to 25 per cent. European OECD countries levy an average corporate rate of 21.5 per cent, according to the Tax Foundation think-tank.

 Ireland-based life science companies have tripled R&D spending, as they undertake higher value activities including manufacturing of complex biologic medicines. Since December the pace of investment has picked up, with Eli Lilly, Pfizer and AstraZeneca ploughing more than $2bn into manufacturing plants in Ireland, which is one of the world’s largest exporters of medicines. 

 Japanese drugmaker Takeda made its first investment in Ireland a quarter of a century ago when corporate tax was 10 per cent. It now employs 1,000 people and last year opened the country’s first cell therapy manufacturing plant. “People and talent are key. The academic institutions are really important,” said Shane Ryan, general manager Ireland at Takeda. 

 Ireland has the highest level of per capita Stem (science, technology, engineering and maths) graduates in the EU, according to Ireland’s government statistics office. Ireland’s EU membership is another factor because it provides access to a broader European workforce, said Ryan, adding that Takeda employs 43 nationalities across its four Irish sites. 

 Takeda is one of several life sciences companies which collaborate with Ireland’s National Institute for Bioprocessing Research and Training (Nibrt), an academic centre that provides training and research aimed at expanding the biopharma manufacturing industry. Almost 5,000 people train at the centre every year, including staff from the FDA and other global regulators.

 Matt Moran, director of BioPharmaChem Ireland, an industry group, said that Nibrt highlighted the benefits of close collaboration between pro-enterprise Irish governments, academia and industry. “Compliance and regulation is very good. Many of these plants are approved by the US Food and Drug Administration,” Moran said.

 Initial Irish investments by Pfizer and Bristol Myers Squibb more than a half century ago encouraged other multinationals to follow, he said. Ireland is now a manufacturing centre for some of the world’s top-selling drugs, including Merck’s cancer therapy Keytruda and Pfizer’s Covid-19 vaccine. 

 Moran said that competition for life sciences investment from the US was becoming more intense following a US push to “reshore” manufacturing, a key plank of President Joe Biden’s economic programme. “Ireland was a bit of a no-brainer [for new investment]. Now companies look at US states as well — so we just need to be better,” Moran said. 

 The pharmaceutical industry is focusing on the resilience of supply chains following recent disruptions caused by the pandemic and a spate of drug shortages linked to manufacturing problems in India and the US.  The IDA said this trend was benefiting Ireland, which manufactures everything from drug ingredients to tablets and more complex biological medicines. 

 Dublin’s decision to keep its borders open and facilitate exports of life-saving drugs while competitors erected trade barriers during the coronavirus pandemic helped the IDA win two life science investments initially destined for the US and China, the agency said. “We have benefited from the more conservative approach to managing the supply chain,” said Rory Mullen, head of biopharma and food at the IDA. “Covid has changed that decision-making process.” 

 Additional reporting by Emma Agyemang

Supply-side - planning applications & infrastructure (Sam Dimitriu)

 

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A Boring Story about Infrastructure Planning

How our inflexible planning system can discourages cheaper, greener changes

SAM DUMITRIU AUG 23

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The Lower Thames Crossing is a vital road project necessary to relieve extreme congestion at the Dartford Tunnel. It is also the most expensive project on National Highways’ books by a long way. And at a cost of £8.2bn-£9bn, it is more than ten times more expensive than longer and deeper road tunnels being built elsewhere in the world. In fact, the Lower Thames Crossing’s planning application alone costs more than twice as much as it cost Norway to actually build the world’s longest road tunnel. 

Now of course, Norway’s geology is extremely favourable for tunnelling, yet this comparison isn’t tunnelling under the Thames versus tunnelling under Norway’s hard rock. It is applying for planning permission to tunnel under the Thames versus actually tunnelling in Norway.

It goes without saying that any measures that can reduce the cost of the Lower Thames Crossing would be extremely welcome. The good news is that one has been identified by one of the project’s contractors. Instead, as was originally planned, of using two expensive tunnel boring machines starting at the north then tunnelling south side-by-side, National Highways is now proposing to use a single tunnel boring machine moving from north to south and then looping back.

A Tunnel Boring Machine used in Switzerland. These are big bits of kit.

Tunnel boring machines are extremely expensive and can cost tens of millions of pounds. Building them is energy intensive too. National Highways estimates that using one tunnel boring machine instead of two would “result in a saving of approximately 38,000 tonnes of carbon.” The equivalent of taking almost 30,000 cars off the road for a year.

In theory, two tunnel boring machines can do twice the work as one so it should mean a time saving. Yet, National Highway has found that using just one would actually allow the project to start earlier as fewer temporary works need to be built before tunnelling can start, which means that using one machine will take the same amount of time overall as using two.

Greener and cheaper, without taking longer, what’s not to like? In an ideal world, the planning system would be flexible and responsive to any change that kept project costs down while delivering environmental benefits.

Yet the Planning Inspectorate have told National Highway to:

“provide a tabulated addendum to the ES [Environmental Statement], reviewing the construction effects changes consequent on the possible effect of changing from the use of 2 tunnel boring machines (TBMs) to 1 TBM. The duration of works and the effects experienced by receptors should be expressly considered. Effects and conclusion changes (if any) should be tabulated for each component of the Environmental Statement (ES) analysis.”

In layman’s terms, you need to do a bunch more paperwork before we’re convinced that using one tunnel boring machine instead of two is no worse for the environment. 

The savings from using one machine instead of two are significant. More than enough to cover the cost of carrying out any additional studies as well as any additional billable hours for National Highways’ already well-remunerated consultants and lawyers. Yet not all engineering changes will generate such large cost savings. There will be times when a bright engineer has identified a cheaper and greener way of working, but the additional cost savings will be eaten away by legal fees and the risk of slowing the entire project down to carry out new environmental studies.

In the case of the tunnel boring machines, there’s a legal issue over whether or not using one instead of two counts as a material change or not. National Highways argue it doesn’t. National Highways position has been that its lengthy assessments already include the use of a single TBM in its “reasonable worst case” scenario which has been assessed. Yet, change or not, it’d be hard to argue that the environmental impacts, and the cost, of using one less machine are anything but overwhelmingly positive.

There’s a simple fix to cut through this red tape. To save time, money, and the environment, reform the Nationally Significant Infrastructure Project process to automatically approve any project amendment that has a clear positive or neutral environmental impact. The kind of flexibility which National Highways is seeking should be promoted, instead of having further impediments erected. 

My students know I am very sceptical of monetary policy as enacted since 2010...

 and here's why; do be critical of this article rather than accepting it wholesale, and try to grasp the limitations of monetary policy rather than rejecting it outright:

Mindlessly printing money has ruined Britain’s economy and politics. We must return to sanity

The scale of quantitative easing since 2009 is scarcely believable, and the results simply catastrophic

DANIEL HANNAN19 August 2023 • 7:53pm

We should be wary of catch-all solutions. Campaigners who claim that every trouble would be addressed by their particular remedy – a land tax, say, or changes to the school curriculum, or some form of alternative energy – are generally monomaniacs. Modern government is a messy business, involving difficult trade-offs. All the easy stuff has already been done.

So I am not going to make exaggerated claims about monetary policy. I will instead say this. A surprising number of apparently unrelated problems – the decline in living standards, the rise in house prices, the widening gap between those who own assets and those who don’t, the fact that we are close to being overtaken in real GDP per head by South Korea, the sense of generational unfairness, the doctors’ strike, even the way in which government departments spray money around on woke campaigns – have been exacerbated by one policy.

That policy was not demanded by the population at large or voted through by Parliament. It was decreed, rather, by the Bank of England in response to the 2008 financial crisis. Starting in March 2009, our central bank, in common with others around the world, began to print money on a scale that would have embarrassed a 1970s Latin American junta.

They called it “quantitative easing” and, while people were aware of it, few realised how radical and transformative it would be.

Until then, the Bank of England’s tool for stimulating economic activity was lowering interest rates, but that tactic had been exhausted. Indeed, it seems to me to be partly because the Bank of England had kept rates so low for so long that the crash happened in the way it did. 

In March 2009, the base rate was 0.5 per cent, leaving little room for further cuts. So the Bank of England, determined to blow at least some air back into the bubble, began magicking up money.

“Inflation is caused by too much money chasing after too few goods,” said Milton Friedman. But the impact of QE was not immediate. The extra pounds called into existence were not loaded onto pallets and driven around the country. They were used to recapitalise banks and fund bond purchases. Their inflationary effect was thus delayed.

Emboldened by their apparent ability to get away with it, central banks kept going. A response that had been intended as a one-off reaction to a global emergency effectively became a standard policy tool. Financiers, who enjoyed first access to all the new moolah, became addicted to it. Each new injection of QE seemingly had less effect. The highs became shorter, the cold turkey scarier.

Then, in 2020, just when QE was scheduled to be wound up, the pandemic hit. Naturally, the Bank of England – with the tacit support of many politicians, who preferred the long-term pain of money printing to the sharp shock of spending cuts – responded with yet more QE. 

The numbers are almost literally unbelievable. As a result of the Bank of England’s actions since March 2009, the amount of money in circulation has increased by more than 50 per cent. Hundreds of billions have been added to the pool since 2020.

This time there was no getting away from the consequences. The money might as well have been loaded on to pallets, in the sense that it enabled banks to buy bonds with money that was then handed out through furlough payments, business grants and other benefits.

As Gertjan Vlieghe, a then member of the Bank of England’s Monetary Policy Committee, put in in April 2020: “If we were the central bank of the Weimar Republic or Zimbabwe, the mechanical transactions on our balance sheet would be similar to what is actually happening in the UK right now.” It was an extraordinary admission even if, as he added, the difference is that the Bank of England was not being told what to do by the government. 

What does all this mean? Most obviously, it means that Britain feels poorer. As the pound drops in value, so the country begins to compare unfavourably with the wealth of nations elsewhere. But these effects are not felt evenly. People whose wealth is mainly in money – that is, people who live on their salaries – have been much more badly hit than people who own houses, stocks or other hard assets. 

Those whose savings were in cash have been subjected to a swingeing tax. The debasement of the pound means that their bank accounts have lost their value, but so has the government’s debt. Inflation shifts wealth from private savers to the state.

Money-printing is also, to my mind, the proximate cause of the public-sector strikes. When trade unions complain that their members’ salaries have fallen, they are not wrong. But they helped bring the problem about by insisting on the longest possible lockdown, thus prolonging QE.

To give in to the strikers would be to dole out more of the medicine that sickened the patient. Excessive state spending is the cause of the problem, not the solution, and Rishi Sunak knows it.

But I fear he is in the minority. Another malign consequence of QE was to destroy our sense of value. When we read of hundreds of billions of pounds being spent on lockdowns, we can’t understand why our own pet cause shouldn’t have a few hundred million. 

Civil servants are especially guilty of this failing, throwing the new-minted money at their favourite projects. Despite the talk of cuts, taxpayers are funding 10,000 jobs in “Equality, Diversity and Inclusion” (EDI) at an annual cost of £557 million a year. That is on top of the £150 million worth of paid days spent sending officials on training courses covering EDI, race, sexuality and unconscious bias.

Billions more go on quangos which are, so to speak, indirectly woke: the Quality Assurance Agency – which checks on university course standards – demanding “decolonisation”; the Arts Council tying grants to an agenda linked to a campaign that backs “unlearning whiteness”; and so on.

We don’t usually think of identity politics as a consequence of loose money. But, according to a report by Conservative Way Forward which totted up the figures, woke grants cost taxpayers £7  billion a year – £19 million a day. That is the kind of money that governments spend when they are not forced to live within their means. Without the cash, identity politics would struggle to get off the ground.

Is it possible to turn monetary policy into a popular cause? Maybe. The surprise winner of Argentina’s primary elections last week, Javier Milei, bases much of his appeal on sound money and spending cuts. The shock-haired economist, who describes himself as an anarcho-capitalist and has named his English mastiffs after economists Milton Friedman, Murray Rothbard and Robert Lucas, has a real shot at becoming president in November.

In most countries, politicians who talk about restoring the gold standard or ending fractional reserve banking are regarded as cranks. But not in Argentina, where inflation is running at more than 100 per cent.

We are not ready for a British Milei – things are not yet that bad here. But we can, in a more modest way, turn sound money into a vote-winning issue. Last month I co-signed a letter to the Chancellor of the Exchequer organised by a new lobby group, the Honest Money Initiative. 

We are not asking for full-fat Austrian economics, complete with ending fractional reserve banking (though if you want to understand what is wrong with the current system, I recommend the new film Ex Nihilo: The Truth About Money, released a couple of weeks ago by the Cobden Centre, and free to watch online).

No, all we want is to tweak the rules governing the Bank of England, removing its right to print unlimited quantities of cash and giving it a statutory responsibility to preserve the value of the pound. What could be more moderate? What could be more Tory? Come to think of it, what could be more popular?

A useful article explaining that Beyonce & Taylor Swift don't cause inflation...

 

Can superstars like Beyoncé or Taylor Swift spur inflation?

Some economists think that tours by big acts drive up the consumer-price index

image: getty images

Jul 25th 2023

The sworn enemies of Europe’s central bankers include Vladimir Putin, covid-19 and, apparently, Beyoncé. All three have recently been blamed for hot inflation, but the American singer seems an unlikely macroeconomic force. Hotel prices surged in Sweden when 46,000 fans flocked to the capital, Stockholm, for the pop star’s tour in May. The country’s consumer-price index hit 9.7% that month, higher than expected. “Beyoncé is responsible,” declared one local economist, as though he had caught her red-handed. Do superstar tours really spur inflation?

In most cases, probably not. Inflation is calculated by comparing the prices of a basket of goods, rather than measuring sudden price rises in one sector, such as hotels. Britain’s consumer-price index, for example, includes almost 750 goods and services. Concerts, theatre and cinema have a weight of less than 0.8% in the basket. Countrywide inflation therefore rarely jumps as a result of a single event, unless it is on an enormous scale. Fans of Taylor Swift, another pop giant, are projected to spend around $600m on tickets for her current tour of America—but the country’s consumers spent almost $7trn over an equivalent period last year. Tours are big business, but not that big.

Nor should price rises in entertainment contaminate other goods or services and make them more expensive. Pricier hotels may even be offset by falling costs elsewhere. To afford eye-wateringly expensive tickets (up to $899 for Ms Swift’s American tour), some fans will skimp on other treats, bringing down demand—and in theory prices—for those goods for a short time.

For small countries, things may be different. They could see a small, temporary bump in inflation as a result of a huge tour, reckons Tony Yates, an economist formerly at the Bank of England. In Singapore, a city state of around 5.6m people, Ms Swift is putting on six shows—her only dates in South-East Asia. In theory around 6% of the population could attend. (The country’s education minister recently refused to grant children an ad hoc school holiday for the tour, in case it “fuelled further inflation”.) In reality, thousands of Swifties are flying in from across the region, bringing a jolt of new demand and cash. That could throttle the supply of hotels, pushing up prices enough to cause a small bump in inflation. Locals may dip into savings, too, spending money intended for the future. That could also push up prices.

Even then, any effect would be short lived. When die-hard fans depart, prices will fall; hotels cannot charge Swiftian rates year-round. The inflation rate may look correspondingly lower the following month. This means tours are probably not something central bankers should bother responding to, says Mr Yates.

The price of seeing big acts perform has always been high. Jenny Lind, a soprano who toured America in the 1850s, flogged tickets at $6 a pop. Adjusting for inflation, that is around $230 today. The average cost to see Ms Swift is $254. But today acts visit fewer small venues and play to bigger crowds. One reason is the competition to stage bigger and better shows. Perhaps that is why Ms Swift has opted to perform her only South-East Asia dates in Singapore. Carting sets around is riskier and more expensive than playing multiple times at the same venue, if the demand is there. Coldplay and Harry Styles, two other big pop acts, are taking a similar approach. The economics of touring may be changing—but that need not worry most central bankers.