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Monetary policy in the face of large supply shocks

Presentation at Resolution Foundation event hosting MPC Member Silvana Tenreyro's valedictory speech.

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Silvana Tenreyro
External member of the Monetary Policy Committee
Monetary policy in the
face of large supply shocks
Resolution Foundation & Society of
Professional Economists, London
• Two enormous shocks hit the economy:
• The pandemic and its aftershocks;
• War in Ukraine: increase in energy and other commodity prices.
• Both were global shocks that affected everyone.
• But effects have differed across countries.
Once-in-a-generation shocks
Real household consumption
Notes: Indexed as 2019 Q4 = 100.
Sources: Bureau of Economic Analysis, Eurostat, Office for National Statistics and Bank calculations.
CPI retail energy prices and CPI inflation
Notes: CPI inflation for the UK and euro area; PCE inflation for the US.
Sources: Bureau of Economic Analysis, Eurostat, Office for National Statistics and Bank calculations.
-20
0
20
40
60
80
100
-20
0
20
40
60
80
100
Jan 21 Jul 21 Jan 22 Jul 22 Jan 23
Per cent
Electricity, gas & other fuels inflation
UK
US
EA
0
2
4
6
8
10
12
0
2
4
6
8
10
12
Jan 21 Jul 21 Jan 22 Jul 22 Jan 23
Per cent
Headline inflation
UK
EA
US
UK headline inflation during energy price shocks
Notes: Dates refer to month of peak in inflation. Headline inflation measured as RPI inflation in 1975 and 1980; CPI inflation in 2011 and 2022.
Source: Office for National Statistics and Bank calculations.
0
5
10
15
20
25
30
0
5
10
15
20
25
30
-24 -16 -8 0 8 16 24 32
Aug 1975
May 1980
Oct 2022
Sep 2011
Per cent
Months from peak

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Monetary policy in the face of large supply shocks

  • 2. Silvana Tenreyro External member of the Monetary Policy Committee Monetary policy in the face of large supply shocks Resolution Foundation & Society of Professional Economists, London
  • 3. • Two enormous shocks hit the economy: • The pandemic and its aftershocks; • War in Ukraine: increase in energy and other commodity prices. • Both were global shocks that affected everyone. • But effects have differed across countries. Once-in-a-generation shocks
  • 4. Real household consumption Notes: Indexed as 2019 Q4 = 100. Sources: Bureau of Economic Analysis, Eurostat, Office for National Statistics and Bank calculations.
  • 5. CPI retail energy prices and CPI inflation Notes: CPI inflation for the UK and euro area; PCE inflation for the US. Sources: Bureau of Economic Analysis, Eurostat, Office for National Statistics and Bank calculations. -20 0 20 40 60 80 100 -20 0 20 40 60 80 100 Jan 21 Jul 21 Jan 22 Jul 22 Jan 23 Per cent Electricity, gas & other fuels inflation UK US EA 0 2 4 6 8 10 12 0 2 4 6 8 10 12 Jan 21 Jul 21 Jan 22 Jul 22 Jan 23 Per cent Headline inflation UK EA US
  • 6. UK headline inflation during energy price shocks Notes: Dates refer to month of peak in inflation. Headline inflation measured as RPI inflation in 1975 and 1980; CPI inflation in 2011 and 2022. Source: Office for National Statistics and Bank calculations. 0 5 10 15 20 25 30 0 5 10 15 20 25 30 -24 -16 -8 0 8 16 24 32 Aug 1975 May 1980 Oct 2022 Sep 2011 Per cent Months from peak
  • 7. Financial-market measures of inflation compensation Notes: Data to June 27. Source: Bloomberg Finance L.P.
  • 8. Household and firm inflation expectations • Academic understanding of expectations formation remains limited. • How does monetary policy affect expectations? • Significant effects on inflation. • More limited (if any) direct effects of rates/QE on inflation expectations. • Households and firms often respond in the ‘wrong’ direction. • Other determinants • Households and firms sensitive to energy and food. • Outside the control of monetary policy. See ‘Monetary policy in the face of supply shocks: the role of inflation expectations’ by Bandera, Barnes, Chavaz, Tenreyro and von dem Berge (2023).
  • 9. • Fan charts emphasise uncertainty about the shocks that will arise, the structure of the economy, and about policy effects. • In contrast to the medium-term forecast, forecast misses in the short-term often have smaller policy implications. • MPC forecasts are conditional; not a prediction of the absolute probabilities of different outturns occurring. Forecasting and models
  • 10. CPI goods price inflation and producer price inflation Notes: The PPI series has been mean and variance adjusted to match the CPI series. Source: Office for National Statistics and Bank calculations.
  • 11. Counterfactual policy experiment Notes: Policy effect calculated as the difference between market rate and constant rate inflation forecasts in the MPC’s November 2022 Monetary Policy Report, linearly scaled to the size needed to bring inflation to 2% in 2024 Q1. Sources: Bank of England and Bank calculations. Scenario • MPC had raised rates much faster to 7% by mid-2022 and to around 9½% this year. • Scenario constructed to have inflation close to 2% in early 2024, rather than late 2024. • Would have needed 4pp higher unemployment and significant inflation undershoot in late 2024.
  • 12. 1. Redouble efforts to explain the remit and the UK’s flexible inflation targeting framework. 2. Use multiple scenarios to explain policy decisions (de-emphasising central forecasts). 3. Consider publishing individual views or paths on future policy. Central bank communications
  • 13. • Two enormous global shocks – the pandemic and the war in Ukraine. • Have led to high inflation. • Differential effects across regions. • No shortcuts to establishing or maintaining credibility. • Comes from the inflation-targeting framework. • Long history of the central bank fulfilling its remit. • MPC forecasts are uncertain, conditional, and judgement-based. • Central banks should continue to innovate on public communications. Key Points
  • 15. Wifi