Dissecting UK service inflation via a neural network Phillips curve

Marcus Buckmann, Galina Potjagailo and Philip Schnattinger

Understanding the origins of currently high inflation is a challenge, since the effects from a range of large shocks are layered on top of each other. The rise of UK service price inflation to up to 6.9% in April might potentially reflect external shocks propagating to a wider range of prices and into domestic price pressures. In this blog post we disentangle what might have contributed to the rise in service inflation in the UK using a neural network enhanced with some economic intuition. Our analysis suggests that much of the increase stems from spillovers from goods prices and input costs, a build-up of service inflation inertia and wage effects, and a pick-up in inflation expectations.

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Firm inflation perceptions and expectations: evidence from the Decision Maker Panel

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

Since late 2021, annual CPI inflation in the UK increased sharply. Alongside this increase, there was also a significant rise in firm and household short-term inflation expectations. In this post, we use data from the Decision Maker Panel (DMP), a UK-wide monthly business survey, to study whether there is an effect of CPI data releases on firms’ current inflation perceptions and year-ahead inflation expectations over the past four years. We find that on average firms’ perceptions of current CPI inflation have been close to the eventual outturn. Furthermore, one-year ahead own-price expectations respond significantly to CPI outturns, with the effects being particularly strong since the start of 2022.

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Did supply constraints tilt the Phillips Curve?

Ambrogio Cesa-Bianchi, Edward Hall, Marco Pinchetti and Julian Reynolds

The remarkable stability of US inflation dynamics in the pre-Covid era had led many to think that the Phillips Curve had flattened. However, the sharp rise in inflation that followed the Covid-19 pandemic ignited a debate on whether the Phillips Curve had steepened and, in particular, whether its slope depends on some particular macroeconomic conditions. Which are these conditions, though? In this post, we argue that one important candidate that could explain this kind of state-dependency in the slope of the Phillips Curve is global supply chain constraints. We propose a simple framework to account for this state-dependency, and conduct econometric analysis on US data which supports its implications – showing that inflation in the US is more responsive to slack when supply constraints are tighter.

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Does long-term unemployment affect inflation dynamics?

Vania Esady, Bradley Speigner and Boromeus Wanengkirtyo

The headline unemployment rate is one of the most widely used indicators of economic slack to measure the state of the business cycle. A large empirical literature on Phillips curve estimation has explored whether more general definitions of labour utilisation are more informative than this simple measure. In a new paper, we investigate whether the duration distribution of unemployment contains useful information for modelling inflation dynamics. More specifically, do short and long-term unemployment (by long-term unemployment we mean individuals who are unemployed for 27 weeks or longer) play separate roles in the Phillips curve?

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What can we learn about monetary policy transmission using international industry-panel data?

Sangyup Choi, Tim Willems and Seung Yong Yoo

How does monetary policy really affect the real economy? What kinds of firms or industries are more sensitive to changes in the stance of monetary policy, and through which exact channels? Despite advances in our understanding of the monetary transmission mechanism, existing studies have not reached a consensus regarding the exact mechanics of transmission. In a recently published Staff Working Paper, we aim to contribute to this understanding by analysing the impact of monetary policy on industry-level outcomes across a broad international industry-panel data set, exploiting the notion that different transmission channels are of varying degrees of importance to different industries.

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Tradable cost shocks and non-tradable inflation: real wages and spillovers

Ambrogio Cesa-Bianchi, Federico Di Pace, Aydan Dogan and Alex Haberis

The recent steep rise in energy prices led to a rise in the price of energy-intensive tradable goods, with inflationary pressures subsequently broadening into services in many economies. Because services are less traded and have little energy input some have suggested this broadening might indicate inflationary pressures becoming more persistent. In this post, we explore the issue through the lens of a stylised two-country model with a tradable and a non-tradable sector. It suggests that following an energy price shock: i) the broadening of inflation from goods to services need not imply more persistent inflationary pressure or changed longer-run expectations, but may reflect one-off adjustments via domestic labour markets; and ii) Inflationary pressures in non-tradable sectors can still have sizable international spillovers.

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The challenges of measuring financial conditions

Natalie Burr

The challenge of measuring financial conditions

Imagine you were tasked with thinking about how financial conditions have changed over a policy tightening cycle. Different economists would come to very different conclusions, and none would necessarily be wrong. Why? Because measuring financial conditions is challenging – for a variety of reasons. A financial conditions index (FCI) is a common solution, and its advantage lies in the disadvantage of the alternative: it is simpler than making a judgement across a range of individual variables. In this post, I propose one method to create a UK FCI. I find that financial conditions have tightened significantly over the past two years, coming from a period of accommodative conditions following Covid.

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Corporate insolvencies reaching record highs: a look under the hood

Jelle Barkema

How concerned should policymakers be as UK business insolvencies have soared to 60-year highs? This phenomenon has been extensively covered in the media; with media outlets attributing the record-breaking numbers to a ‘perfect storm’ of energy prices, supply-chain disruptions and the cost of living squeeze. Insolvencies are a popular measure of economic distress because they have implications for both the financial system and the real economy. For the financial system, an insolvency generally means creditors will incur losses. Insolvent firms will have to cease trading and lay off workers, which affects the real economy. In this blog post, I assess the evolution of corporate insolvencies over time, including the post-Covid surge to understand what these record numbers mean for the UK economy.

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Time-varying disagreement and monetary transmission

Vania Esady

In macroeconomic models, economic agents are often assumed to perfectly observe the current state, but in reality they have to infer current conditions (nowcast). Because of information costs, this is not always easy. Information costs are not observable in the data but they can be proxied. A good proxy is disagreement on a near-term forecast because significant disagreement indicates that it is difficult to observe current economic conditions – ie higher information frictions. If the ability to nowcast varies over time, this may affect agents’ ability to respond to various shocks, including monetary policy shocks. My recent paper shows that when disagreement is higher, contractionary monetary policy brings down inflation, at the cost of a greater fall in economic activity.

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Location, location, location? How UK housing preferences shifted during the pandemic

Martina Fazio and Gary Harper

During recessions, and indeed pandemics, housing prices usually fall. Yet between March 2020 and December 2021 (‘the pandemic’), housing prices grew in the UK, reaching at the time their highest growth rate in a decade. During this pandemic, many more people could work from home, which potentially influenced their housing choices. In a recent Financial Stability paper, we analyse how changes in peoples’ preferences might have played into house price growth. We find that about half the growth in housing prices was linked to shifts in preferences. This was mostly due to an increased premium paid for houses over flats, with changes in location preferences only contributing marginally. But other interventions and macroeconomic factors also affected housing price growth.

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