Once upon a time in the future: strategic foresight in central banks

Julia Giese and Jacqueline Koay

We live in an era of rapid change, complexity and uncertainty. Over recent years, severe global shocks have been frequent, with profound implications for our economy and financial system. Yet such shocks are impossible to forecast with any precision as they are not extrapolations of past relationships. Our economy and financial system are subject to longer-running trends such as technological advances, demographics, geopolitical shifts and climate change which can be blown off course or altered in unexpected ways. Where forecasts are bound to fail, strategic foresight tools can help as they are a means for practitioners to understand the dynamics of change (and how this could impact the economy and financial stability) by imagining different futures and telling stories around how trends might interact to give rise to unforeseen shocks.

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GIV us some credit: estimating the macroeconomic effects of credit supply shocks

Sam Christie and Aniruddha Rajan

Sudden contractions in credit supply can trigger and amplify recessions – a reality made painfully clear by the 2008 global financial crisis (GFC). However, quantifying these real economic effects is challenging. In this post, we demonstrate a novel way to do so using Granular Instrumental Variables (GIV), focusing on the UK mortgage market. The core idea is that we can exploit the market’s concentration to build up exogenous fluctuations in aggregate credit supply from idiosyncratic lender-specific shocks. Using our GIV, we find evidence that contractionary mortgage supply shocks can have quantitatively significant effects on the macroeconomy, causing persistent decreases in output, consumption, and investment, alongside increases in unemployment.

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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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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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30+ year mortgages – are these the new norm? What does this mean for financial stability?

James Waddell and Meghna Shrestha

An increasing number of households in the UK are opting for longer-term mortgages, with the share of borrowers taking out new mortgages with terms 30 years or longer tripling since 2005. But who are these households, why have they done so, and what could this imply for financial stability?

This blog presents some analysis to answer these questions, and focuses on three potential risk channels which could affect financial stability. These can be broadly classified into: (i) lending into old age; (ii) increased leverage; and (iii) higher debt persistence. We judge the risks associated with longer-term mortgages are limited and are mitigated by existing Financial Policy Committee (FPC) and Financial Conduct Authority (FCA) policies, which limit risky lending both at the borrower level and in aggregate.

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‘No one length fits all’ – haircuts in the repo market

Miruna-Daniela Ivan, Joshua Lillis, Eduardo Maqui and Carlos Cañon Salazar

Funding markets are crucial for healthy and active financial institutions, and consequently for everyone in the economy. The repurchase agreement (repo) market plays a key role in bank and non-bank financial institutions’ (NBFIs’) daily activities by facilitating short-term financing and risk hedging. In this post, we use novel Securities Financing Transaction Regulation (SFTR) data to highlight new, and corroborate previous, stylised repo haircut facts.

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The link between mortgage debt servicing burdens and arrears: is there a critical threshold?

Nuri Khayal and Jonathan Loke

Many households in the UK have seen their mortgage payments go up since mortgage rates started to increase in 2022. In the current environment of higher rates, the question of how much a household can comfortably spend on their mortgage payments before getting into financial distress is particularly relevant. This blog shows that households which spend a larger share of their income on mortgage payments are at a higher risk of being in arrears. But in contrast to pre-existing work on the subject, we do not find evidence of a critical threshold after which the risk increases much more sharply. These findings imply that changes in the indebtedness across the whole mortgagor population, not just the tail, matter for financial stability.

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Three facts about the rising number of UK business exits

Jelle Barkema, Maren Froemel and Sophie Piton

Record-high firm exits make headlines, but who are the firms going out of business? This post documents three facts about the rising number of corporations dissolving using granular data from Companies House and the Insolvency Service. We show that the increase in dissolutions that have already materialised reflected a catch-up following Covid and was concentrated among firms started during Covid. While these firms were small and had a limited macroeconomic impact, firms currently in the process of dissolving are larger. Their exit might therefore be more material from a macroeconomic perspective. We also discuss how the recent economic environment could contribute to further rises in dissolutions and particularly insolvencies in the future that could have more material macroeconomic impact.

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Stressed or in distress? How best to measure corporate vulnerability

Alice Crundwell, William Bennett and Will Banks

Accurate measures of the number of firms at risk of failure are becoming increasingly important for policymakers, as corporate insolvencies are continuing to rise and interest rates are expected to remain higher than over much of the past decade. The share of vulnerable firms is often assessed by looking at debt-servicing ability via the interest coverage ratio (ICR) – companies’ earnings before tax and interest divided by their interest expense. But several other factors are also associated with a higher probability of firm failure. This post will explore the merits of looking at a combination of financial indicators of corporate distress to better measure the share of firms at risk of failure and the associated level of debt at risk.

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Bias, fairness, and other ethical dimensions in artificial intelligence

Kathleen Blake

Artificial intelligence (AI) is an increasingly important feature of the financial system with firms expecting the use of AI and machine learning to increase by 3.5 times over the next three years. The impact of bias, fairness, and other ethical considerations are principally associated with conduct and consumer protection. But as set out in DP5/22, AI may create or amplify financial stability and monetary stability risks. I argue that biased data or unethical algorithms could exacerbate financial stability risks, as well as conduct risks.

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