Samuel Cole, Jack Sherer-Clarke, Oliver Wallbridge, Annabel Manley.
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%).
Like in most advanced economies, output fell significantly in the UK in the aftermath of the financial crisis. There is an ongoing debate on to what extent this fall could be explained by output having grown above its sustainable level; in other words, was there a positive output gap before the crisis? I argue that using financial market indicators in addition to more traditional macroeconomic variables to explain output fluctuations helps in constructing a consistent real-time narrative of a positive pre-crisis output gap in the UK.
Potential supply matters! If an economy is producing less output than it could, then there are resources that are being wasted. And when these resources are human – that is unemployment – this carries an additional social cost. But why, specifically, should it matter for an inflation-targeting central bank? Presumably, because it is a good indicator of inflationary pressure! The trouble is that there are good reasons to think that this is not actually the case. And economic theory suggests there is a much better measure of inflationary pressure we can use.