Using sectoral data to estimate the trend in aggregate wage growth

Tomas Key

Nominal wage growth has increased markedly in the UK in recent years, reaching levels that haven’t been seen for more than 20 years. Although growth has moderated a little in recent months, it remains significantly above its pre-pandemic level. An assessment of whether this strong rate of wage growth will persist is a key input to the monetary policy decision, given the important link between the cost of labour and firms’ pricing decisions. In this post, I will outline a new measure of the trend – or underlying – rate of wage growth which is estimated using data from many different sectors of the economy and which can help with this assessment.

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Selling England (no longer) by the pound: currency-mismatches and the dollarisation of UK exports

Marco Garofalo, Giovanni Rosso and Roger Vicquery

Most international trade is denominated in dominant currencies such as the US dollar. What explains the adoption of dominant currency pricing and what are its macroeconomic implications? In a recent paper, we explore a rare instance of transition in aggregate export invoicing patterns. In the aftermath of the depreciation that followed the Brexit referendum in 2016, UK exporters progressively shifted to invoicing most of their exports in dollars, rather than in pounds. This was driven by firms more exposed to currency mismatches, eg exporting in pounds but importing in dollars before the depreciation. As a result of this aggregate transition to dollar pricing, a dollar appreciation now depresses demand for UK exports by twice as much than before 2016.

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Quantifying the macroeconomic impact of geopolitical risk

Julian Reynolds

Policymakers and market participants consistently cite geopolitical developments as a key risk to the global economy and financial system. But how can one quantify the potential macroeconomic effects of these developments? Applying local projections to a popular metric of geopolitical risk, I show that geopolitical risk weighs on GDP in the central case and increases the severity of adverse outcomes. This impact appears much larger in emerging market economies (EMEs) than advanced economies (AEs). Geopolitical risk also pushes up inflation in both central case and adverse outcomes, implying that macroeconomic policymakers have to trade-off stabilising output versus inflation. Finally, I show that geopolitical risk may transmit to output and inflation via trade and uncertainty channels.

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Three facts about the rising number of UK business exits

Jelle Barkema, Maren Froemel and Sophie Piton

Record-high firm exits make headlines, but who are the firms going out of business? This post documents three facts about the rising number of corporations dissolving using granular data from Companies House and the Insolvency Service. We show that the increase in dissolutions that have already materialised reflected a catch-up following Covid and was concentrated among firms started during Covid. While these firms were small and had a limited macroeconomic impact, firms currently in the process of dissolving are larger. Their exit might therefore be more material from a macroeconomic perspective. We also discuss how the recent economic environment could contribute to further rises in dissolutions and particularly insolvencies in the future that could have more material macroeconomic impact.

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The transmission channels of geopolitical risk

Samuel Smith and Marco Pinchetti

Recent events in the Middle East, as well as Russia’s invasion of Ukraine, have sparked renewed interest in the consequences of geopolitical tensions for global economic developments. In this post, we argue that geopolitical risk (GPR) can transmit via two separate and intrinsically different channels: (i) a deflationary macro channel, and (ii) an inflationary energy channel. We then use a Bayesian vector autoregression (BVAR) framework to evaluate these channels empirically. Our estimates suggest that GPR shocks can place downward or upward pressure on advanced economy price levels depending on which of the two channels the shock propagates through.

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Forecasting UK inflation in the presence of large global shocks

Dario Bonciani and Johannes Fischer

The UK economy has been hit by significant terms-of-trade shocks, most notably the rise in energy prices following the Russian invasion of Ukraine. These shocks have created substantial and persistent inflationary pressure in many countries. Such upheavals bring increased uncertainty about the future, making macroeconomic forecasting more challenging. In this post, we assess the forecasting performance of a state of the art empirical model, of the type commonly employed in academic research and policy institutions. This model is not used to produce the Monetary Policy Committee’s (MPC’s) forecast but has been used periodically within the Bank of England including as a cross-check to the main forecast. Specifically, we assess its performance in predicting UK inflation out of-sample at key dates around the start of the war in Ukraine. The model performs well in forecasting short-term inflation, but it struggles to fully capture inflation persistence over the longer term.

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Beyond emissions: the interplay of macroprudential regulation and climate policy

Francesca Diluiso, Barbara Annicchiarico and Marco Carli

While climate change is often seen as a long-term concern, climate mitigation policies can have different short-term effects, since they affect the transmission mechanism of conventional macroeconomic shocks. In a new working paper, we show that cap-and-trade schemes lead to lower volatility in GDP and financial variables, and result in reduced welfare costs of the business cycle, when compared to the more widely known carbon taxes. As we find that these welfare differences are primarily driven by distortions in financial markets, we argue that countercyclical macroprudential regulation, even without any green-biased component, can effectively align the welfare performance of these policies and mitigate their short-run costs.

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Unifying monetary and macroprudential policy

Julia Giese, Michael McLeay, David Aikman and Sujit Kapadia

Central banks have been using a range of monetary policy and macroprudential tools to maintain monetary and financial stability. But when should monetary versus macroprudential tools be used and how should they be combined? Our recent paper develops a macroeconomic model to answer these questions. We find that two instruments are better than one. Used alone, interest rates can control inflation, but are ineffective for financial stability. Policymakers can do better by also deploying the countercyclical capital buffer, a tool that varies the amount of additional capital banks must set aside. The appropriate combination of tools can vary: both should tighten to counter a joint expansion of credit and activity, but move in opposite directions during an exuberance-driven credit boom.

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Profit margins and firm price growth: evidence from the Decision Maker Panel

Ivan Yotzov, Philip Bunn, Nicholas Bloom, Paul Mizen and Gregory Thwaites

Inflation in 2023 remains elevated across many advanced economies. Existing studies have considered the contribution of profits to persistently high inflation in the US, euro area and UK. To add to this debate, we recently asked firms in the Decision Maker Panel about their profit margins over the past year and their expectations for the year ahead. This post summarises the key findings from these new questions, and links them to recent trends in prices. Firms reported a squeeze in profit margins over the past year, on average, but they expect to rebuild margins over the next year. Firms expecting to increase margins also expect slightly higher price growth, suggesting that margin rebuilding could make some contribution to inflation persistence.

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Decoding the market for inflation risk

Saleem Bahaj, Robert Czech, Sitong Ding and Ricardo Reis

Few topics captivate our attention like the enigma of inflation. Understanding where the market thinks inflation is headed is crucial for policymakers, investors, and anyone who wants to keep their financial ducks in a row. And that’s where inflation swaps come into play. They are like the crystal ball of inflation expectations, allowing traders to hedge against inflation risk and giving us a peek into the minds of market participants. In a recent paper, we delve into this thriving market to uncover the who, what, and why behind the prices of these swaps to shed light on the dynamics of inflation expectations.

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