Category Archives: Monetary Policy

An intuitive interpretation of factor models

Sinem Hacioglu Hoke and Kerem Tuzcuoglu

We economists want to have our cake and eat it. We have far more data series at our disposal now than ever before. But using all of them in regressions would lead to wild “over-fitting” – finding random correlations in the data rather than explaining the true underlying relationships. Researchers using large data sets have historically experienced this dilemma – you can either throw away some of the information and retain clean, interpretable models; or keep most of the information but lose interpretability. This trade-off is particularly frustrating in a policy environment where understanding the identified relationships is crucial. However, in a recent working paper we show how to sidestep this trade-off by estimating a factor model with intuitive results.

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Filed under Macroeconomics, Monetary Policy, New Methodologies

Should economists be more concerned about Artificial Intelligence?

Mauricio Armellini and Tim Pike.

This post highlights some of the possible economic implications of the so-called “Fourth Industrial Revolution” — whereby the use of new technologies and artificial intelligence (AI) threatens to transform entire industries and sectors. Some economists have argued that, like past technical change, this will not create large-scale unemployment, as labour gets reallocated. However, many technologists are less optimistic about the employment implications of AI.  In this blog post we argue that the potential for simultaneous and rapid disruption, coupled with the breadth of human functions that AI might replicate, may have profound implications for labour markets.  We conclude that economists should seriously consider the possibility that millions of people may be at risk of unemployment, should these technologies be widely adopted.

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Filed under International Economics, Macroeconomics, Monetary Policy

Do consumers respond in the same way to good and bad income surprises?

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.

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The surprise in monetary surprises: a tale of two shocks

Silvia Miranda-Agrippino.

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.

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Filed under Financial Markets, Macroeconomics, Monetary Policy

Bitesize: Has the FOMC increased its focus on foreign risks?

Dan Wales and Emil Iordanov.

Have FOMC discussions changed since the end of 2015? Are the committee more concerned about international risks now?

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Filed under Bitesize, International Economics, Macroeconomics, Monetary Policy

A cat, a hat and a simple measure of gobbledygook: How readable is your writing?

Jonathan Fullwood.

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.

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Why Unconventional Monetary Policy Works in Theory

Roger Farmer and Pawel Zabczyk.

Monetary Policy signpost

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.

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Filed under Financial Markets, Macroeconomics, Monetary Policy

The economic effects of globalisation: a view from two of the Bank’s Agents

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.

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Filed under International Economics, Macroeconomics, Monetary Policy

Central bank digital currency: the end of monetary policy as we know it?

Marilyne Tolle.

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.

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Filed under Banking, Currency, Monetary Policy

If Pate’s Grammar School set UK Monetary Policy…

Samuel Cole, Jack Sherer-Clarke, Oliver Wallbridge, Annabel Manley.

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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%).

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Filed under Guest Post, Macroeconomics, Monetary Policy