Stable gilts and stable prices: assessing the Bank of England’s response to the LDI crisis

Nicolò Bandera and Jacob Stevens

How should the central bank conduct asset purchases to restore market functioning without causing higher inflation? The Bank of England was faced with this question during the 2022 gilt crisis, when it undertook gilt purchases on financial stability grounds while inflation was above 10%. These financial stability asset purchases could have counteracted the monetary policy stance by easing financial conditions at a time when monetary policy was tightening them. Did a trade-off between price and financial stability arise? In our Staff Working Paper, we find the asset purchases stabilised gilt markets without materially affecting the monetary policy stance. This was only possible because the intervention was temporary; highly persistent asset purchases would have created tension between price and financial stability.

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Zero-day options and financial market vulnerability

Bowen Xiao

Zero-day options have exploded in popularity in recent years, accounting for approximately half of S&P 500’s total options volume, a ten-fold increase from just 5% in 2016. Their flexibility, low premia and underlying leverage appeal to all market participants ranging from conservative investors hedging against intraday market volatility to aggressive traders speculating for quick profit generation. The rapid rise of zero-day options and the memory of a market stress episode known as ‘Volmageddon‘ raises concerns that zero-day options could lead to a similar event. There are differing views among participants on the perceived risks of zero-day options. This post aims to provide a balanced overview.

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Adaptation is to mitigation what Robin is to Batman

Jenny Clark and Theresa Löber

The UK’s climate continues to change, getting wetter and warmer, with extremes becoming ever more pronounced. Even if we limit global warming to 1.5°C above pre-industrial levels, experts warn that we’ll see the number and severity of extreme weather events increase further. Without adaptation, we will see more property, infrastructure and agriculture damaged or destroyed, with devastating consequences to households, communities and businesses – as well as increasing risks to economic and financial stability. To date there has been relatively more focus on mitigation and the transition to net zero than on adaptation and addressing physical risk, across both government and the private sector. Adaptation is mitigation’s sidekick, we need them to consistently work together to achieve better outcomes. Much like Batman and Robin.

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Weathering the storm: the economic impact of floods and the role of adaptation

Rebecca Mari and Matteo Ficarra.

Floods are the most costly natural disaster in Europe. In the UK, they account for around GBP1.4 billion in annual losses. Yet, evidence on the macroeconomic implications is inconclusive. GDP often shows a puzzling delayed response, and prices can be pushed in opposite directions. Using a novel county level data set for England for the years 1998–2021, we estimate the impact of flooding on output and inflation at the sector level. Sectors react heterogeneously to floods, which explains well aggregate evidence. Prices respond in sectors related to both headline and core inflation, which has crucial implications for monetary policy. We further show that investing in flood defences mitigates the economic burden of floods by strongly reducing the risk of flooding.

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Staying afloat: the impact of flooding on UK firms

Benjamin Crampton, Rupert-Hu Gilman and Rebecca Mari.

With climate change set to increase the frequency and intensity of flooding in the UK, it is important to deepen our understanding of the potential microeconomic impacts that may propagate into the macroeconomy. We integrate firm-level corporate records, with Ordnance Survey business-premise address information and publicly available flood maps to investigate two questions. First, what characteristics of firms are associated to the historical exposure and current risk of flooding; and second, what is the impact of flood events on corporate outcomes. We find significant sectoral, spatial and structural heterogeneity among firms in their risk and exposure to flooding. Larger firms are more likely to locate in flood zones, while small and medium-sized enterprises (SMEs) and natural-resource-related industries have historically been impacted most heavily.

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The heterogenous effects of carbon pricing: macro and micro evidence

Ambrogio Cesa-Bianchi, Alex Haberis, Federico Di Pace and Brendan Berthold

To achieve the Paris Agreement objectives, governments around the world are introducing a range of climate change mitigation policies. Cap-and-trade schemes, such as the EU Emissions Trading System (EU ETS), which set limits on the emissions of greenhouse gases and allow their price to be determined by market forces, are an important part of the policy mix. In this post, we discuss the findings of our recent research into the impact of changes in carbon prices in the EU ETS on inflation and output, focusing on how the emissions intensity of output – the quantity of CO2 emissions per unit of GDP – affects the response. Understanding these economic impacts is important for the Bank’s core objectives for monetary and financial stability.

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Some implications of climate policy for monetary policy

Francesca Diluiso, Boromeus Wanengkirtyo and Jenny Chan.

This post examines key aspects of climate mitigation policies that could matter for monetary policy, using insights from structural climate macroeconomic models (Environmental Dynamic Stochastic General Equilibrium). Three main findings emerge: first, mitigation policies – like carbon pricing – can be a direct source of shocks, creating potential trade-offs for monetary policy (Carney (2017)). Second, the degree to which these policies are anticipated affects their macroeconomic impacts. Third, different climate policies may alter the transmission of conventional business-cycle shocks, therefore affecting the calibration of optimal monetary policy. We focus on the 3–5 year horizon, abstracting from longer-run considerations and changing trends such as interactions with the zero lower bound, the natural interest rate, or transitional effects on productivity and output.

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Climate and monetary policy series

Boromeus Wanengkirtyo, Francesca Diluiso, Rebecca Mari, Jenny Chan, Ambrogio Cesa-Bianchi and Alex Haberis.

Climate change is becoming increasingly important for monetary policy as the world transitions into greener economies and climate change’s physical impacts become more prominent. This is complementary, but distinct to, examining how climate change affects financial stability risks (Carney (2015)). This series of posts highlights how climate change can affect key economic variables such as output and inflation, and thereby the conduct of monetary policy. Climate change and climate policies represent another set of economic shocks and structural changes to monitor, so that monetary policy can meet its objectives.

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