Britain: This Time Is Not Different
Adam Posen:
Inflation and Monetary Policy: T]he persistently above target CPI inflation the UK economy is experiencing is almost entirely due to the combination of the depreciation of Sterling prior to January 2009 and the increase in VAT in January 2010. As a committee, our forecast underestimated the size and particularly the persistence of these inflationary effects, and I accept my share of responsibility for that mistake. The lesson we need to take therefore is to update our estimates of transmission from external shocks going forward. That said, annual inflation in the UK as measured in the CPIY series, which excludes the price effect of indirect taxes, has been below target throughout this calendar year. Thus, if we allow for even just some exchange rate pressure upwards on prices over this period as well, underlying UK inflation has stayed well below target. Recognizing that fact has to be the starting point for our forecast.
This is not to dismiss the harmful impact of the past months of higher inflation on the vast majority of British citizens. British households do suffer.... What British households have suffered in this regard over the last year, however, is a decline in their purchasing power due to one-time factors that is neither amenable to reversal through monetary policy nor going to feed a more general rise in prices and wages. The MPC would only make things worse by making policy looking in the rear-view mirror, trying to make up for past mistakes, especially given the fact that the underlying trend inflation rate is below target....
Moreover, both the MPC and the British public should maintain some perspective on the size of our inflation forecast error given the magnitude of the shocks to which the UK economy has been subjected. That is not an excuse, but a reality check. I think both the Bank of England and the public gained an exaggerated confidence over the NICE decade of 1997-2007 about just how finely the MPC could both forecast and control inflation.... Given an appropriate degree of humility about our ability to forecast inflation, and the right mindset to keep looking forward by learning from past errors (rather than doing harm by trying to make up for them), how should we make our inflation forecast? To me, the right way to think about it is to consider what has happened to the UK and other similar economies when they have been in post-financial crisis situations like the one we are in now. As an already classic recent book (Reinhart and Rogoff (2010)) reminds us, economic policymakers as well as investors get into trouble when they arrogantly say “this time is different.” If anything, part of the reason the UK and other western economies got into the difficulties we have been in is because many of us assumed this time was different during the mid-2000s boom....
I would rather look at several cases, or even better try to draw conclusions statistically from a large sample, and try to take into account the specific conditions of the UK economy at present, than to just leap to conclusions from our current indicators or from comparison with one or two prior UK recessions... the last couple of UK recessions... came about due to monetary tightening, not as the result of a financial crisis, [and so]may be more different in nature from today‟s situation than other economies' post financial crisis experiences.... [I]f one plots the course of our current recovery versus that of the UK from recession in 1992 and that of Japan from its initial recession in 1993, one can discern no significant divergence between them.... [W]e all know what terrible things happened to Japan after 1993, and both credit and fiscal developments in the UK today look a lot more like Japan then than the UK at the same time.
