If you put this question to most economists at the tail end of 2008, they would have said “around the time Lehman Brothers collapsed”. The last Inflation Report of the year showed things flat in Q2, and then that first bad quarter in 15 years in 2008Q3. However, the latest data from the ONS suggests it got far worse far earlier. Around the beginning of the 2008 the economy started contracting, reaching a pace of 1% per year by Q”. That is a fierce recession, even without all that language about “breaking the buck”, and the extraordinary spike in credit spreads (they were merely “elevated”). What were the MPC thinking in early 2008? Here is the fan chart of where they thought things were in February that year – when the economy was flatlining, and about to start shrinking really quickly: That’s how they thought the world looked – set for a mild slowdown. And how did they act (kudos to the Bank for how it publishes data, by the way)? A rather mild response? Put it this way: imagine what we would be demanding of Carney, right now, if the economy was slowing at a pace of 0.7% per quarter. Blithely, the May 08 minutes report that the financial markets expect rates to be around where they are:
“Expectations of policy rates, derived from financial markets, in the United Kingdom, United States and euro area had increased during the month. Expectations of Bank Rate twelve months ahead had fallen back early in April, but had then increased later in the month. That left forward rates implying a little under half a percentage point reduction in Bank Rate during the next twelve months. “
This is then followed by this gem
Several factors appeared to have contributed to the rise in interest rate expectations. Some market contacts had put it down to news on the outlook for demand being less weak than expected, especially in the United States. Another plausible explanation for the increase in rate expectations internationally was the further rise in oil prices and a growing appreciation of central banks’ determination to control inflation
Central banks control inflation, determinedly, by keeping nominal spending at such a level that inflation cannot get out of control. In the middle of 2008, financial markets were impressed by the central banks’ determination to do just that. The minutes go on to observe that the various surveys pointed to output growth slowing. Not a contraction, just a bit less growth. And the minutes have time to record two pieces of influence on the CPI that the MPC can do nothing about: the way something from 12 months before was about to drop out (“The effect of last year’s cuts in retail gas and electricity tariffs”) and some upcoming rises in energy prices. Note that these were discussed in terms of how they would boost CPI, and maybe influence those dangerous inflation expectations, which various surveys said could be unhelpful (i.e. high). That these cost shocks damage real incomes don’t get talked about much.
It would be unfair to see these minutes as evidence of disastrous thinking: the MPC can indeed see a slowdown of sorts. But they are balanced, and the Committee continuously reasserts the need to convince the public of its anti-inflationary determination. This was a decisive reason not to cut rates. Only Blanchflower saw absolutely no risk to easing.
What is disturbing is that the Eight were right and Blachflower wrong – in terms of the remit they had. Given the CPI-at-2% remit, you needed to see serious risks of CPI going well below 2% in order to argue for easing. Blanchflower was being a hero, but a hero in another cause – the secondary one of stopping the UK economy from imploding.
FlipChartRick and Chris Dillow each have interesting posts on how the economy was in difficulties/not exactly partying long before we were treated to the sight of Lehman employees carting their stuff out of the office. In my crude terminology, they look at real rather than nominal things: the existence of working poor, of higher numbers of self employed people, an inability to produce good jobs, alongside longer term technological/secular stagnation arguments in the background. I think a longer examination of 2008 might produce a more straightforward analysis. We had a monetary framework that forced at least 8 intelligent people, during a quarter of sharp contraction, to argue for some merit in keeping nominal interest rates some 5% higher than the rate of nominal growth. No wonder household incomes started collapsing around then (chart to follow):
Tim Harford has an excellent column on how macro economists can’t get it right. Forecasts are difficult, and some of this story has to be about why neither the MPC nor the markets was screaming Fire! at a time when the economy was falling hard. But a whole lot of blame for what appears to be a structural drop in household prosperity has to be aimed at a monetary policy remit that actually encouraged the MPC to be “balanced” at such a time.