Central banks and history: a troubled relationship

Barry Eichengreen

The Bank of England co-organised a ‘History and Policy Making Conference‘ in late 2020. This guest post by Barry Eichengreen, Professor of Economics and Political Science at the University of California Berkley, is based on material included in his keynote address at the conference.

Learning from history is hard. At central banks, it can be hard to draw policymakers’ attention to historical evidence. Even when historical analogies are at the forefront of their minds, the right analogies are not always applied in the right way. In fact, over-reliance on a small number of compelling historical case studies can lead to suboptimal decisions. Policymakers therefore need access to a wide portfolio of analogies. They must also cultivate an historical sensibility that is suspicious of simplification and alert to the differences – as well as the similarities – between ‘now’ and ‘then’.

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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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Slow recoveries, endogenous growth and macroprudential policy

Dario Bonciani, David Gauthier and Derrick Kanngiesser

Following the global financial crisis in 2008, central banks around the world introduced tighter banking regulations to increase the resilience of the financial sector and reduce the risks of severe financial disruptions during economic downturns. This fact has motivated a large body of literature to assess the role that macroprudential (MacroPru) policies play in mitigating the severity of recessions. One common finding is that the benefits of MacroPru are relatively minor within standard dynamic stochastic general equilibrium (DSGE) models. In a new paper, we show that MacroPru becomes significantly more important in a model that accounts for the long-term negative consequences of financial disruptions.

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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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When should policymakers reach for the history books? Some examples from the 20th century

Catherine R. Schenk

The Bank of England co-organised a ‘History and Policy Making Conference‘ in late 2020. This guest post by Catherine Schenk, Professor of Economic and Social History at the University of Oxford, is based on material included in her conference presentation.

Since the Great Financial Crisis started in 2007 there has been renewed interest in using the past as a basis for policy responses in the present, but how useful is history and how is it best used? Certainly, the old chestnut that ‘those who neglect the past are sure to repeat it’ is a valid warning, but how to select the appropriate historical examples and draw the right lessons is a more nuanced exercise that is explored in this post.

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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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What to expect when they’re expecting

Maren Froemel, Mike Joyce and Iryna Kaminska


During 2020 the MPC announced a further £450 billion of QE purchases, slightly more than the total amount of assets purchased over the preceding ten years, taking the target QE stock to £875 billion of gilt holdings and £20 billion of sterling investment-grade corporate bonds. We study the high-frequency reaction of gilt markets to these QE announcements in light of the surprises to market expectations of the future QE path. We find the yield reactions to be broadly consistent with news about the expected medium-term stock of QE. This is in line with recent commentary, which has focused on the ‘pace of purchases’, as a faster/slower pace translated into a larger/lower stock of expected purchases, and could capture the effects of the local supply channel. The reaction to news about purchase pace could also be potentially consistent with an impact on expected liquidity premia or expected policy rates.

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Uncertainty and voting in monetary policy committees

Alastair Firrell and Kate Reinold

The right stance for monetary policy is highly uncertain, and so it is no surprise that members of monetary policy committees – like the Bank of England’s Monetary Policy Committee (MPC) – regularly disagree about the best course of action. Asking a committee to decide allows different opinions to be aired and challenged, with a majority vote needed to determine policy. But how should we expect those disagreements and votes to change in periods of higher uncertainty? Should we expect more 9–0 unanimous votes? Or more 5–4 close contests? We address these questions in this post and find that the degree of disagreement is little changed in periods of high uncertainty, and nor are dissenting votes. There is, however, some difference in how voting decisions are formed when uncertain, with both individual and committee-wide views having less explanatory power for votes.

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