Philip Bunn, Jeanne Le Roux, Kate Reinold and Paolo Surico.
If you unexpectedly received £1000 of extra income this year, how much of it would you spend? All? Half? None? Now, by how much would you cut your spending if it had been an unexpected fall in income? Standard economic theory (for example the ‘permanent income hypothesis’) suggests that your answers should be symmetric. But there are good reasons to think that they might not be, for example in the face of limits on borrowing or uncertainty about future income. That is backed up by new survey evidence, which finds that an unanticipated fall in income leads to consumption changes which are significantly larger than the consumption changes associated with an income rise of the same size.
Empirical identification of the effects of monetary policy requires isolating exogenous shifts in the policy instrument that are distinct from the systematic response of the central bank to actual or foreseen changes in the economic outlook. Because the same tools are used to both induce changes in the economy, and to react to them, distinguishing between cause and effect is a far from trivial matter. One popular way is to use surprises in financial markets to proxy for the shock. In a recent paper, we argue that markets are not able to distinguish the shocks from the systematic component of policy if their forecasts do not align with those of the central bank. We thus develop a new measure of monetary shocks, based on market surprises but free of anticipatory effects and unpredictable by past information.
Dan Wales and Emil Iordanov.
Have FOMC discussions changed since the end of 2015? Are the committee more concerned about international risks now?
Sometimes the obvious questions are the hardest to answer. In this post I ask how much of what the Bank and the financial industry in general write can actually be read by a broad audience. Based on my findings, I suggest that both must try harder if claims of accessibility are to be meaningful.
Roger Farmer and Pawel Zabczyk.
In a discussion at the Brookings Institution, Ben Bernanke quipped that ‘the problem with Quantitative Easing is that it works in practice, but it doesn’t work in theory’. Bernanke was referring to Wallace Neutrality – a famous result from monetary theory which asserts that the size and composition of the central bank balance sheet has no effect on inflation or employment. In a new working paper we bridge the gap between practice and theory, and we show how, by intervening in asset markets, a central bank can influence both. In our model, that intervention will unambiguously improve economic outcomes. In essence, central banks can use open market operations and trades in risky assets to insure those unable to insure themselves.
Will Holman and Tim Pike.
The openness of the UK economy — measured by international trade and labour flows — has increased substantially in the past twenty years (Charts 1 (a) and (b)). In this post we explore three structural changes to the economy arising from globalisation that we have observed daily in our visits to companies around the UK. These are increases in: (a) openness of product markets; (b) access for UK businesses to overseas labour; and (c) outsourcing of non-core activities to lower-wage economies. There is a long-running debate whether globalisation of markets has weakened the link between domestic factors, such as the amount of domestic slack (spare capacity among UK-based firms and workers), and inflationary pressures. In our view, these structural changes have provided an additional source of slack in product and labour markets that has borne down on UK inflation in recent years. Looking to the future, the vote on 23rd June to leave the EU might affect the pace of change of these forces, making future trends uncertain.
Central banks (CBs) have long issued paper currency. The development of Bitcoin and other private digital currencies has provided them with the technological means to issue their own digital currency. But should they?
Addressing this question is part of the Bank’s Research Agenda. In this post I sketch out how a CB digital currency – call it CBcoin – might affect the monetary and banking systems – setting aside other important and complex systemic implications that range from prudential regulation and financial stability to technology, operational and financial conduct.
I argue that taken to its most extreme conclusion, CBcoin issuance could have far-reaching consequences for commercial and central banking – divorcing payments from private bank deposits and even putting an end to banks’ ability to create money. By redefining the architecture of payment systems, CBcoin could thus challenge fractional reserve banking and reshape the conduct of monetary policy.
Samuel Cole, Jack Sherer-Clarke, Oliver Wallbridge, Annabel Manley.
Each year, the Bank of England organises the Target 2.0 competition for A-level economics students. In this guest post, the winning team at March’s national final from Pate’s Grammar School explain what they would do if they were the MPC…
We decided as a team to hold the Bank Rate at 0.5% and to maintain asset purchases at £375bn. In our view it is not yet time to tighten monetary policy. Though we believe the output gap is small, the economy is yet to reach escape velocity and the Wicksellian natural rate of interest is likely to remain depressed. We are more optimistic on potential supply than other economists and think oil prices will stay low. As such, we predicted that inflation will only reach 1.7% in 2018Q1 compared to the MPC’s median forecast in February of around 2.1% (which has since fallen to 1.9%).
Seeing into the future is always difficult. But in the world of macroeconomics, just trying to look at the past can be a challenge. Official estimates of economic growth in the UK are regularly revised, so forecasts for growth over the next year have to be made on the basis of an ever-changing report card for the previous year. This post tackles some of the most common questions about UK GDP revisions, a topic close to the heart of many users of the UK’s National Accounts. Are the initial estimates of growth biased? Can you predict revisions? Does UK data get revised more than other countries? And which parts of early estimates of GDP should be approached with caution?
James Purchase and Nick Constantine.
In 1995, Fischer Black, an economist whose ground-breaking work in financial theory helped revolutionise options trading, confidently stated that “the nominal short rate cannot be negative.” Twenty years later this assumption looks questionable: one quarter of world GDP now comes from countries with negative central bank policy rates. Practitioners have been forced to update their models accordingly, in many cases introducing greater complexity. But this shift is not just academic. Models allowing for a wider distribution of future rates require market participants to hedge against greater uncertainty. We argue that this hedging contributed to the volatility in global rates in early 2015, but that derivatives can also play an important role in facilitating monetary policy transmission at negative rates.