Bank of England Inflation Report May 2009

Higher inflation is inevitableProfessor David BlanchflowerDartmouth, Stirling, NBER, IZA,The New Statesman and Bloomberg

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22Financial collapse 3The world economy was hit by a once in a 100years financial shock a Taleb black swan

Geithner this week at Dartmouth said thatmost of what feels bad about the American economy today is the aftershock of the crisis.we were on the edge of a catastrophic collapse....we looked into the abyss.we were at the cliff edge

Bernanke worries about the death spiral

The scale of the shock has been under-estimated

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Alistair Darling

5Vince Cable: UK Secretary of State for Business, 25 May 2011 6The thing that worries me more than anything else [is that] we really haven't engaged with the real depths and seriousness of the financial crash. I was very impressed with that Warren Buffett metaphor that asset-backed mortgage lending was the atomic bomb, and that there are hydrogen bombs out there.

I just don't think that collectively governments have got to grips with this at all. So another huge bomb could go off, sooner rather than later? It's not imminent. But you can see this happening.66Where we are (1) 7The central problem over the last decade was thatrisk was under-priced, hence that price must rise.

This is a negative productivity shock

Most of the recent rise in inflation is transitorydue to oil and commodity price increases and in theUK a rise in VAT and a depreciation of the currency

The spreading sovereign debt crisis in Europe is amajor problem especially as the ECB is fighting non-existent inflation.77Annual inflation rates (%) May 2011 8Euro area 2.7Netherlands2.4EU 27 3.2Norway1.6Austria 3.7 Portugal3.7Belgium 3.1Spain3.4Denmark 3.1Sweden1.7Finland 3.4UK4.5France 2.2Germany 2.4Greece 3.1Ireland 1.2 Italy 3.0

Source: Eurostat, June 16th 201188Where we are (2) 9 The evidence from around the world is that growth is slowing and the recovery will be protracted

This is no time to remove the fiscal stimulus

The US deficit needs to paid off within 10-15 years is the view of Geithner and Bernanke

Tax cuts look like a good idea especially to firms to stimulate investment and employment.

Greece has big structural problems and will default

99Ease of Doing Business, 2011 10Singapore100. GuyanaHong King101. GuatemalaNew Zealand102. Sri LankaUK103. Papua New GuineaUSA104. EthiopiaDenmark105. YemenCanada106. ParaguayNorway107. BangladeshIreland108. Marshall islands Australia109. Greece

Source: United Nations Doing business Project www.doingbusiness.org/rankings 1010Greece 11 Greece suffers from endemic tax evasion and a poor tax collection infrastructure

It has parochial patronage policies, corruption and big delays in courts dealing with tax disputes

It ranks 149th in ease of starting a business and 153rd in ease of registering property

Providing more highly priced debt to an over-indebted country is kicking the can down the road

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The Exhibition Industry 13Prior to last year, the largest single year decline ever recorded by the U. S. exhibition industry was 3.1%... and that was in 2008.

The 12.5% decline recorded in 2009 and reported in this, the 2010 CEIR Exhibition Industry Index Report (CEIR Index), is four times greater than the downturn the industry experienced in 2008.

CEIR president Carrie Freeman Parsons

Source: The Center for Exhibition Industry Research (www.ceir.org) 1313Exhibition Industry Decline Tracks GDP Fall But is Bigger 14

Source: The Center for Exhibition Industry Research (www.ceir.org) The CEIR Index Report. An analysis of the 2009 Exhibition Industry and Future Outlook

1414Exhibition Industry Decline 15

Source: The Center for Exhibition Industry Research (www.ceir.org) The CEIR Index Report. An analysis of the 2009 Exhibition Industry and Future Outlook

1515Real GDP by industry and % changes in value added 16 2008 2009Gross Domestic Product 0.0 2.6Total private industries 0.7 3.0Construction 5.715.6Total Manufacturing 4.8 8.6Durable goods 1.012.7Transportation and warehousing 0.813.0Arts, entertainment, recreation, accommodation, & food services 4.6 8.7Government 2.1 0.8Private goods producing industries 4.2 6.4Private services producing industries 0.4 2.1

Source: Economic report of the President, February 2011, Table B131616QE and slowing growth prospects 17The likelihood of QE in the US has risen. Rateswill remain low for an extended period

The point of competitive QE is to 1) raise assetprices and 2) depreciate the currency.

The latest MPC minutes show that QE is backon the table in the UK and private sector assetpurchases likely but not possible in the USA .

The UK market yield curve predicts interestrates wont rise until mid 2012

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Source: Financial Times, June 26th 2011FOMC reduced growth forecasts 19 2011 20122013Change in GDP 2.7-2.93.3-3.73.5-4.2 April projection3.1-3.33.5-4.23.5-4.3Unemployment rate8.6-8.97.8-8.27.0-7.5 April projection8.4-8.77.6-7.96.8-7.2

Inflation2.3-2.51.5-2.01.5-2.0 April projection2.1-2.81.2-2.01.4-2.0

Core Inflation1.5-1.81.4-2.01.4-2.0 April projection1.3-1.61.3-1.81.4-2.0

Source: Federal Reserve Board of Governors, June 21-22 FOMC meeting economic projections1919Oil price 20 Oil price has fallen to approximately $90 a barrel

Driven by US releasing 30m barrels from strategic reserve. The UK, Japan, Germany, France, Spain and Italy also contributed.

Done to prevent short term supply disruptions, particularly from Libya, that 'could damage the economy and threaten the global economic recovery'

The fall in the oil price will push down on inflation and help growth. Deflation worries persist.

2020Inflation vs Deflation 21 If there is hyper-inflation we know what to do

Inflating the debt away looks attractive especially where there have been large declines in house prices such as the USA, Ireland, Spain and the UK.

At some point interest rates need to rise to normal levels so when the next shock arrives they can be cut

Moves by the ECB to raise rates as in July 2008 even though Euro Area was already in recession and quickly reversed is likely a major policy error.

2121Wage Inflation 22 After the oil price hikes of the 1970s unions were able to obtain very large wage increases not least because of the rapid increase in unionization rates

Union density has fallen sharply. Globalization has weakened workers bargaining power. Wage growth is benign around the world. There is no evidence of second-round effects.

Central banks should react to an oil shock when wages dont rise by loosening monetary policy.

2222Annual % change in hourly labor costs Q12011 23Euro area 2.6Netherlands2.6EU 27 2.7Norway4.4Austria 3.0 Portugal0.8Belgium 3.5Spain1.9Denmark 3.2Sweden1.6Finland 2.3UK2.1France 3.8Germany 2.9Greece-6.8Ireland-2.2 Italy 2.8

Source: Eurostat, June 20th 20112323Difficulty paying bills most of the time 24 March 2011 May 2010Belgium 7 6Denmark 3 2France14 8Germany 5 5Greece3522Ireland18 8Italy13 8Netherlands 3 4Portugal1912Spain14 9Sweden 2 1UK10 6

242425 Financial crisis a major failure of macroeconomics The state of macro is good

(IMF Chief economist Olivier Blanchard, The state of macro, NBER WP14259, August 2008)

Over the last three decades, macroeconomic theory and the practice of macroeconomics by economists have changed for the better. Macroeconomics is now firmly grounded in the principles of economic theory

(V. V. Chari and P. Kehoe (2006), Modern macroeconomics in practice: how theory is shaping policy, Journal of Economic Perspectives, Fall, pp. 328)

26Nobel Laureate Robert Solow (2008)The other possible defence of modern macro is that, however special it may seem, it is justified empirically. This too strikes me as a delusion. In fact modern macro has been notable for paying very little rigorous attention to data.

I am left with the feeling that there is nothing in the empirical performance of these models that could come close to overcoming a modest scepticism. And more certainly, there is nothing to justify reliance on them for serious policy analysisRobert Solow (2008), Journal of Economic Perspectives, 22(1), Winter, pp. 243-249.August 2008. GDP projection based on market interest rate expectations includes no financial sector

27May 2011 GDP projection based on market interest rate expectations and 200 billion asset purchases still includes no financial sector

28May 2011 CPI inflation projection based on market interest rate expectations and 200 billion asset purchases

29The Great Recession 30 Growth comes from bank lend or government spend.

There is no believable evidence that fiscal retrenchment in a recession works e.g. Canada.

Austerity failed in Portugal, Ireland, Greece and the UK

Animal spirits are a major problem in many countries

The recovery looks to be highly interest rate sensitive

Consumer confidence and retail sales in the UK have collapsed and growth has been revised down not up.

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ConclusionThere does remain a major risk of deflation, especially if growth disappoints. There is little evidence of second-round effects and inflation expectations remain anchored.

Deflation would be much worse than inflation.

Expansionary fiscal contractions are oxymoronic andare not working. U-turns are coming.

Interest rates will remain low for a long time

Monetary policy will remain loose for several years andI certainly dont rule out more QE.

323232EndThank you

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