Battle of the exchange funds

Max Harris

This post contributes to our occasional series of guest posts by external researchers who have used the Bank of England’s archives for their work on subjects outside traditional central banking topics.

When Britain created the Exchange Equalisation Account (EEA) in 1932, its designers had little sense of the controversy that would ensue. The previous year, Britain had suspended gold convertibility, and the volatile capital flows that followed convinced officials that they needed a tool for managing the exchange rate. The EEA – originally a fund solely for foreign exchange interventions (its remit is broader now) – seemed not only necessary but eminently reasonable. To a world in the throes of depression, however, it looked like a means to weaken sterling and reap a competitive advantage. America responded by establishing the Exchange Stabilization Fund (ESF) in what many viewed as another escalation in the conflict that was tearing the international monetary system apart.

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Can sectoral supply shocks have aggregate demand consequences?

Ambrogio Cesa-Bianchi and Andrea Ferrero

Restrictions on activity to curb the spread of Covid-19 led to a shutdown of specific parts of the economy. These lockdown measures can be thought of as a shock that suddenly decreases the supply of affected sectors, which lowers output and increases their price. Guerrieri et al (2020) propose a theoretical model of ‘Keynesian supply shocks’ where a sectoral supply shock triggers knock-on effects on demand in other sectors which, if strong enough, can lead to a fall in aggregate prices and output – thus resembling an aggregate demand shock. In a recent paper, we provide empirical evidence supporting this hypothesis using pre-Covid data. Our results suggest a different way to look at the Covid crisis and business cycles in general.

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Household debt and consumption revisited

Philip Bunn and May Rostom

The academic literature finds that the build-up of household debt before the 2008 financial crisis is linked to weaker consumption afterwards. But there is wider debate over the mechanisms at play. One strand of literature emphasises debt overhang acting through the level of leverage. Others find it was over-optimism acting through leverage growth. In this post, we revisit our previous analysis on leverage and consumption in the UK using synthetic cohort analysis. The correlation between leverage measures and their link to other macroeconomic variables mean it’s challenging to tease out their effects. Yet we find that whilst both mechanisms played a role, there is evidence that debt overhang linked to a tighter credit constraints was the bigger driver.

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Monetary policy, sectoral comovement and the credit channel

Federico Di Pace and Christoph Görtz

There is ample evidence that a monetary policy tightening triggers a decline in consumer price inflation and a simultaneous contraction in investment and consumption (eg Erceg and Levin (2006) and Monacelli (2009)). However, in a standard two-sector New Keynesian model, consumption falls while investment increases in response to a monetary policy tightening. In a new paper, we propose a solution to this problem, known as the ‘comovement puzzle’. Guided by new empirical evidence on the relevance of frictions in credit provision, we show that adding these frictions to the standard model resolves the comovement puzzle. This has important policy implications because the degree of comovement between consumption and investment matters for the effectiveness of monetary policy.

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What do two million accounts tell us about the impact of Covid-19 on small businesses?

James Hurley, Sudipto Karmakar, Elena Markoska, Eryk Walczak and Danny Walker

Compass on old map

This post is the second of a series of posts about the Covid-19 pandemic and its impact on business activity.

Covid-19 led to a sharp reduction in economic activity in the UK. As the shock was playing out, small and medium-sized businesses (SMEs) were expected to be more exposed than larger businesses. But until now, we have not had the data to analyse the impact on SMEs. In a recent Staff Working Paper we use a new data set containing monthly information on the current accounts of two million UK SMEs. We show that the average SME saw a very large drop in turnover growth and that the crisis played out very differently for different types of SMEs. The youngest SMEs in consumer-facing sectors in Scotland and London were hit hardest.

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Unemployment risk, liquidity traps and monetary policy

Dario Bonciani and Joonseok Oh

The Global Financial Crisis in 2008 caused a significant and persistent increase in unemployment rates across major advanced economies. The worsening in labour market conditions increased uncertainty about job prospects, which potentially gave rise to precautionary savings, putting further downward pressure on real economic activity and prices. Moreover, in response to the severe drop in demand, central banks worldwide cut short-term nominal interest rates, which rapidly approached the zero lower bound (ZLB), where they remained for a prolonged time. In a recent paper, we show that committing to keep the interest rate at zero longer than implied by current macroeconomic conditions is particularly effective at easing contractions in demand in the presence of countercyclical unemployment risk and low interest rates.

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What types of businesses have used government support during the Covid-19 pandemic?

Will Banks, Sudipto Karmakar and Danny Walker

This post is the first of a series of posts about the Covid-19 pandemic and its impact on business activity.

During the pandemic, UK businesses have received unprecedented levels of government support, set to total 9% of GDP. This has mainly been through the Coronavirus Job Retention Scheme (CJRS), under which 1 in 3 employees have been furloughed, and the government-guaranteed loan schemes that were used by 1 in 4 businesses. Despite the scale of this support, little has been said about which businesses received it. In this post we combine data on loan scheme and CJRS usage with a data set on the characteristics of businesses. We find that small, relatively old and sophisticated, labour-intensive businesses in the sectors most vulnerable to the impacts of the pandemic are most likely to have received both types of support.

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Covid-19 briefing: working from home and worker productivity

John Lewis, Andrea Šiško and Misa Tanaka

The Covid pandemic has led to a large enforced shift towards working from home (WFH) as a result of ‘stay-at-home’ policies in many countries. This led to a resurgence in interest in, and new reignited discussion about, the consequences of greater WFH. In this briefing we review the literature on the impact of WFH on productivity. Across a very diverse literature the key lessons are: impacts depend on the nature of tasks, the share of WFH matters, and there is big difference between enforced versus voluntary WFH. And the caveats are important too: cost savings at the firm level don’t automatically translate into economy-wide productivity gains and evidence on long-run effects remains very scarce.

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The Real Effects of Zombie Lending in Europe

Belinda Tracey

‘Zombie lending’ occurs when a lender supports an otherwise insolvent borrower through forbearance measures such as repayment holidays and temporary interest-only loans. The phrase was first coined for Japan in the late 1990s, but more recently several authors have documented that zombie lending to European firms has been widespread following the sovereign debt crisis (see Acharya et al (2019), Adalet McGowan et al (2018), Banerjee and Hofmann (2020), Blattner et al (2018) and Schivardi et al (2017)). In a recent paper, I examine whether these lending practices contributed to the subsequent low output experienced by the euro area. My findings suggest that zombie lending had negative consequences for output, investment and productivity in the euro area over the period 2011 to 2014.

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Revisiting the New Keynesian policy paradoxes under QE

Dario Bonciani and Joonseok Oh

In the wake of the global financial crisis in 2008, nominal interest rates in the US and other advanced economies have approached the effective lower bound (ELB). This fact has motivated new research to understand, both theoretically and empirically, the impact of monetary policies when the nominal policy rate is at the ELB. In a new paper, we show that accounting for balance sheet policies (QE) can ease the constraints imposed by the ELB on monetary policy and resolve several paradoxical results arising in canonical New Keynesian models at the ELB. The ‘paradox of flexibility’, the ‘paradox of toil’ and the puzzle of excessively large fiscal multipliers are all resolved when QE is added to the model as policy tool.

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