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May 02, 2007
Mervyn King Reflects
The Financial Times records some thoughts from Bank of England Governor Mervyn King, reflecting on the Bank's performance over the past ten years:
He regards one of the Bank’s biggest achievements over the past 10 years as grasping early on the scale and significance of migrant labour from eastern Europe after the enlargement of the European Union in 2002.
“It’s our equivalent of [former US Federal Reserve chairman] Alan Greenspan [realising] the faster growth of output in the late 1990s was the result of faster productivity growth.”
He continued: “That was an absolutely correct judgment at the time and that’s what we have to do with every variable that we look at, work out why it’s growing faster or slower than it was before and not to use some rather mindless regression.”
What were those insights of which King is so proud? From the Telegraph:
Immigration from eastern Europe has helped keep inflation - and therefore interest rates - low, the Governor of the Bank of England Mervyn King said last night.
Speaking to business leaders at a dinner outside Bradford, Mr King praised globalisation as a way of increasing productivity and transferring new ideas, goods and services across borders.
In particular, he said immigration had reduced wage inflation in Britain: "If the increased demand for labour generates its own supply in the form of migrant labour then the link between demand and prices is broken, or at least altered. Indeed, in an economy that can call on unlimited supplies of migrant labour, the concept of the output gap is meaningless."
The output gap is a measure used by economists to see how much spare capacity is left in an economy.
"Increasing productivity and transferring new ideas" is certainly equivalent to the Greenspan insight. But on the output gap bit, a better comparison is to Federal Reserve Bank of Dallas President Richard Fisher:
One key capacity factor is the labor pool. There is a shibboleth known as the Phillips curve, which posits that beyond a certain point too much employment ignites demand for greater pay, with eventual inflationary consequences for the entire economy...
How can economists quantify with such precision what the U.S. can produce with existing labor and capital when we don’t know the full extent of the global labor pool we can access? Or the totality of the financial and intellectual capital that can be drawn on to produce what we produce?
As long as we are able to hold back the devil of protectionism and keep open international capital markets and remain an open economy, how can we calculate an “output gap” without knowing the present capacity of, say, the Chinese and Indian economies? How can we fashion a Phillips curve without imputing the behavioral patterns of foreign labor pools? How can we formulate a regression analysis to capture what competition from all these new sources does to incentivize American management?
Until we are able to do so, we can only surmise what globalization does to the gearing of the U.S. economy, and we must continue driving monetary policy by qualitative assessment as we work to perfect our quantitative tool kit. At least that is my view.
And, apparently, Governor King's view as well. Back to the FT:
“The secret of good policy is to try and think through what are the economics of the shocks hitting the economy at present,” he says. “That in a nutshell is my philosophy of how you should do policy. Don’t rely on regressions from the past.”
OK, but I'm not sure I would recommend entirely forgetting those recessions from the past either, lest we find ourselves repeating their lessons.
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