The yield curve is an important barometer of market sentiment and reflects interest rate expectations as well as different risk premia. In this post, we show how changes in demand for UK government bonds, also called gilts, may affect the shape of the yield curve. We find that demand shocks have persistent local effects on the yield curve, in particular at longer maturities and during volatile market conditions. These findings therefore indicate that investors in longer-term gilts tend to be less price-sensitive. Moreover, we find that demand shocks for one bond transmit to neighbouring bonds, while the transmission to other bonds declines with the difference in the residual maturity.
According to conventional wisdom, a currency area benefits from internal labour mobility. If independent stabilisation policies are unavailable, the argument goes, factor mobility helps regions respond to shocks. Reasonable as it sounds, few attempts have been made to test this intuition in state-of-the-art macroeconomic models. In a recent Staff Working Paper (also available here), we build a DSGE model of a currency area with internal migration to go through the maths. So does the old intuition hold up? The short answer, we think, is yes. Internal labour mobility eases the burden on monetary policy by reducing regional labour markets imbalances. But policymakers can improve welfare by putting greater weight on unemployment. Effectively, interregional migration justifies a somewhat higher ‘lambda’.
Carlo Favero, Sebastian Vismara and Iryna Kaminska
The slope of the yield curve has decreased in the US and the UK over the last few years (Chart 1). This development is attracting significant attention, because the yield curve slope (i.e. the difference between longer term government bond yields and shorter term government bond yields) is a popular business cycle indicator, and a fall of longer term yields below shorter term yields (i.e. an ‘inversion’ of the yield curve) has historically been considered as a powerful signal of recessions, particularly in the US.
Thomas Mathae, Stephen Millard, Tairi Room, Ladislav Wintr and Robert Wyszynski
How do firms respond to shocks? Do they first change the hours worked by their employees? Or the number of employees? Or wages? Or a combination? Does the shock matter? And the firm’s country? One way of answering these questions is to ask the managers within firms themselves. And this is exactly what the Wage Dynamics Network did, surveying firms in 25 European countries. Our research used this survey to answer these questions. We found that in response to negative shocks firms were most likely to reduce employment, then wages and then hours, regardless of the source of the shock. But, in response to positive shocks, firms were most likely to raise wages, then employment and then hours.
Cristiano Cantore, Filippo Ferroni and Miguel León-Ledesma.
How do monetary policy shocks affect the distribution of income between workers and owners of capital? Do workers benefit relatively more when policy changes? Tackling this question empirically requires technical econometric methods, but we are able to show that the share of output allocated to wages (the labor share) temporarily increases following a positive shock to the interest rate. This means that the slice of the pie enjoyed by those whose earnings are mostly made up of wages increases at the expense of profits and capital income. Strikingly, this redistribution channel that shows up in the data runs precisely in the opposite direction to the predictions of standard New Keynesian models commonly used to study the effects of monetary policy.
As the UK economy went into recession in 2008, the Monetary Policy Committee responded with a 400 basis point reduction in Bank Rate between October 2008 and March 2009. Although this easing lessened the impact of the recession across the whole economy, its cash-flow effect would have initially benefited some households more than others. Those holding large debt contracts with repayments closely linked to policy rates immediately received substantial boosts to their disposable income. Cheaper mortgage repayments meant more pounds in peoples’ pockets, and this supported both spending and employment in 2009. In this article I explore one element of the monetary transmission mechanism that works through cash-flow effects associated with the mortgage market, and show that it can vary across both time and space.
Kristina Bluwstein, Michal Brzoza-Brzezina, Paolo Gelain and Marcin Kolasa.
Mortgages matter. For the individual, borrowing to buy a house can be the biggest debt decision of a lifetime. For the economy, mortgages make up a large fraction of total debt and are a main driver of the financial cycle. Mortgage debt exceeds 80% of UK household debt (see Figure 1), so it is important to understand mortgage market trends, how they link to the macroeconomy and the implications for monetary policy. This post uses a novel model to do just that. In particular, it introduces a rich description of the housing sector into an otherwise standard ‘DSGE’ Model. It focusses on the role of fixed rate mortgages, the mortgage cycle, and how they affect monetary policy transmission.
David Bholat, Nida Broughton, Janna Ter Meer and Eryk Walczak
Clear communications are important for central banks at a time when their responsibilities have increased but trust in public institutions has declined. Using an online experiment with a representative sample of the UK population, our recent paper measured how differently styled summaries of the Inflation Report impacted public comprehension and trust in its policy messages. We find that a new ‘Visual Summary’ of the Inflation Report, which makes use of graphics and simpler language, increases understanding of policy messages. And making more changes using insights from behavioural science can further increase public understanding. These changes also somewhat increase people’s trust in the information. Continue reading “Simply is best: enhancing trust and understanding of central banks through better communications”→
Last May, the Bank organised an economic history workshop at the St Clere Estate, home of former governor Montagu Norman. In this guest post, one of the speakers David Kynaston, visiting Professor at Kingston University, reflects on more than three centuries of Bank history…
It was a huge honour to be asked by Mervyn King to write a history of the Bank. The eventual book, Till Time’s Last Sand, was published last autumn. It covers 1694 to 2013 and is based heavily on the Bank’s own archive. Fitting more than 300 years of history into a single volume was a difficult task, and condensing that into a short blog post is harder still. Here I will try to bring out a handful of key lessons from my research into the Bank’s history that might be useful for the policymakers, economists and other interested observers of today – and their successors…