An estimate of the UK’s natural rate of interest

Mike Goldby, Lien Laureys and Kate Reinold.

The natural rate of interest is usually defined as the one prevailing when economic activity is at potential and inflation is low and stable. As this has a very similar flavour to the monetary policy objective of many central banks, it is interesting to policymakers. The natural rate is unobservable and needs to be estimated. In this post, we show an estimate derived from a standard macroeconomic model which suggests that the (real) natural rate fell very sharply during the financial crisis, perhaps to as low as -6%, and that, despite a marked recovery since 2012, it remains around zero. Continue reading “An estimate of the UK’s natural rate of interest” →

Inequality: reframing the debate, reforming institutions and rooting out rent-seeking

Marilyne Tolle.

Inequality sits near the top of Western politicians’ agendas and exercises the minds of academic economists and policymakers alike. While attention to the living standards of the poorest is warranted, I argue that the current focus on inequality is misplaced for two reasons: first, because inequality of outcome is of second-order economic importance compared to improving absolute living standards; and second, because it shifts attention away from tackling the inefficiencies caused by rent-seeking. Addressing these via institutional reforms would foster growth, raise the living standards of the poorest, and, as a by-product, reduce inequality.

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Helicopter money: setting the tale straight

Author: Fergus Cumming.

When Friedman famously conjured up images of banknotes fluttering from helicopters in 1969, perhaps he knew he was about to inspire decades of sky-bound puns and policies in the name of deflation avoidance. Helicopter money goes beyond standard fiscal and monetary policy by boosting economic activity using money created by the central bank – money that does not have to be paid back. To its modern advocates, the tale is one of blue-sky thinking that could avert the next recession. But is this just pie in the sky? This post discusses why such a policy is different to quantitative easing, why it is unlikely to have much impact relative to conventional fiscal measures and the pitfalls associated with pursuing it.
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UK mortgage rates: born in the USA?

Authors: Gareth Anderson and Matt Roberts-Sklar.

UK mortgage rates play an important role in the transmission mechanism of monetary policy, but are they home-grown? UK swap rates are a key component in determining UK mortgage rates. And UK swap rates are highly correlated with those in the US. Putting these pieces together, we show that UK mortgage rates increase by around 50bp on average in response to a 100bp increase in US swaps. This highlights one important channel through which global financial spillovers affect small open economies such as the UK.

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Are mortgages like potatoes? Unintended consequences in a world of many constraints

Authors: Renzo Corrias and Tobias Neumann.

When banks are subject to both a leverage and a risk-weighted constraint they may violate a fundamental law of economics: that of demand. In our theoretical model, some banks constrained by the leverage ratio react to an increase in capital requirements by investing more in the asset. This so-called ‘Giffen’ behaviour is very counterintuitive. One would assume the opposite to be the case: higher capital requirements should discourage lending. In our theoretical model, Giffen behaviour is likely to occur for firms that hold predominantly low-risk weighted asset and are therefore bound by the leverage ratio. The real-world equivalent in the context of mortgages would be building societies and, in the future, ring-fenced banks.
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Drivers of long-term global interest rates – can changes in desired savings and investment explain the fall?

Authors: Lukasz Rachel and Thomas Smith.

In this post we show how various secular trends – demographics, inequality and the emerging market savings glut – raised desired savings at the global level and put downward pressure on real rates. We also show how desired investment could have fallen due to the decline in the relative price of capital goods, lower public investment and a rise in the spread between risk-free rates and the return on capital. Together we think these secular trends can account for 300bps of the historic decline in the global real rate. Moreover, we think these secular trends are likely to persist. This suggests the global neutral rate, which acts as an anchor for individual countries’ equilibrium rates in the long-term, will remain low, perhaps around 1%. Continue reading “Drivers of long-term global interest rates – can changes in desired savings and investment explain the fall?” →

Drivers of long-term global interest rates – can weaker growth explain the fall?

Authors: Lukasz Rachel and Thomas Smith.

Long-term real interest rates have fallen substantially over the past thirty years. The co-movement in real rates across both advanced and emerging economies suggests a common driver is at work – the global neutral rate may have fallen. In this two-part blog post we attempt to identify which secular trends could have driven such a fall. In Part 1 we highlight how weaker expectations for global trend growth can account for around 100bps of the 450bps fall in real rates since the 1980s. But this effect seems to mainly apply to the post-crisis period – suggesting other factors are responsible for the protracted decline before the crisis.
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Are firms ever going to empty their war chests?

Katie Farrant and Magda Rutkowska

UK private non-financial corporations (PNFCs) consistently ran a financial surplus between 2002 and 2013. They now hold around £1.8 trillion of financial assets, including £0.5 trillion of cash. This has attracted attention from policymakers and the media. Should we expect companies to spend these assets to finance investment? The MPC considers this to be possible (see e.g. the February 2015 Inflation Report). Many agree, calling on companies to spend their ‘cash hoards’ (see e.g. these articles in the Telegraph and the FT). Here, we explain why we think companies are unlikely to run down their assets significantly. This does not mean that they will not invest; rather, they will not necessarily finance investment through liquidating assets.

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Human capital depreciation during unemployment – does it matter for monetary policy?

Lien Laureys

In many countries the great recession that followed the financial crisis led to sharp rises in not only the rate, but also the duration of unemployment. These were bad in themselves, but many were further worried that because lengthy unemployment spells are thought to erode workers’ human capital, productive potential would be damaged. The question I ask is whether this should affect the conduct of monetary policy. The short answer is no. But it may still be a question worth exploring further.

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Five facts about buy-to-let

Philippe Bracke

Buy-to-Let (BTL) investors are taking on an increasingly relevant role in the UK housing market. In this post, I present some initial findings from my ongoing research on BTL. I use data from the England and Wales Land Registry and the Zoopla web portal to find properties that are advertised for rent shortly after being bought. I show that: 1) BTL investors prefer (a) London and (b) flats; 2) BTL investors are more likely to pay cash; 3) BTL transactions are faster; 4) BTL investors buy at a discount; and 5) BTL discounts are larger for (a) Northern regions and (b) big properties.

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