Unifying monetary and macroprudential policy

Julia Giese, Michael McLeay, David Aikman and Sujit Kapadia

Central banks have been using a range of monetary policy and macroprudential tools to maintain monetary and financial stability. But when should monetary versus macroprudential tools be used and how should they be combined? Our recent paper develops a macroeconomic model to answer these questions. We find that two instruments are better than one. Used alone, interest rates can control inflation, but are ineffective for financial stability. Policymakers can do better by also deploying the countercyclical capital buffer, a tool that varies the amount of additional capital banks must set aside. The appropriate combination of tools can vary: both should tighten to counter a joint expansion of credit and activity, but move in opposite directions during an exuberance-driven credit boom.

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Can data science capture key insights in news articles?

Itua Etiobhio, Riyad Khan and Steve Blaxland

The volume of information available to supervisors from public sources has grown enormously over the past few years, including unstructured text data from traditional news outlets, news aggregators, and social media. This presents an opportunity to leverage the power of data science techniques to gain valuable insights. By utilising sophisticated analytical tools, can supervisors identify hidden patterns, detect emerging events and gauge public sentiment to better understand risks to the safety and soundness of banks and insurance firms? This article explores how data science could support central bank supervisors to discover significant events, capture public trends and ultimately enable more effective supervision.

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Has the import price shock been worse in the UK or euro area?

Josh Martin and Julian Reynolds

How much have higher import prices increased consumer prices in the UK and euro area? This post explores this question using a framework grounded in some fundamental economic and national accounting concepts. Starting with the GDP price, we adjust for relative import and export prices to arrive at a consumer prices measure – this gives us a sense of the impact of import prices and the terms of trade shock on consumer price inflation. For the euro area, aggregating imports across member countries, which includes trade between members, risks overstating total imports and thus the effect on inflation. Using supplementary data to resolve this issue, we find that the euro area terms of trade shock has been larger than the UK’s.

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Central clearing and the functioning of government bond markets

Yuliya Baranova, Eleanor Holbrook, David MacDonald, William Rawstorne, Nicholas Vause and Georgia Waddington

The functioning of major government bond and related repo markets has deteriorated on several occasions in recent years as trading demand has overwhelmed dealers’ intermediation capacity. Seeking a remedy, Duffie (2020) proposes a study of the costs and benefits of a clearing mandate in these markets. Such a policy could boost dealers’ intermediation capacity by allowing more of their trades to be netted, thereby reducing their balance sheet exposures and capital requirements. In a recent staff working paper, we estimate the effects of comprehensive central clearing of cash gilt and gilt repo trades on UK dealer balance sheets during one particular stress episode. This post summarises those quantitative results and discusses qualitatively other costs and benefits of broader central clearing.

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The transmission of macroprudential policy in the tails

Álvaro Fernández-Gallardo, Simon Lloyd and Ed Manuel

Since the 2007–09 Global Financial Crisis, central banks have developed a range of macroprudential policies (‘macropru’) to address fault lines in the financial system. A key aim of macropru is to reduce ‘left-tail risks‘ – ie, minimise the probability and severity of future economic crises. However, building this resilience could influence other parts of the GDP-growth distribution and so may not always be costless. In our Working Paper, we gauge these potential costs and benefits by estimating the effects of macropru on the entire GDP-growth distribution, and explore its transmission channels. We find that macropru is effective at reducing the variance of GDP growth, and that it does so by reducing the probability and severity of excessive credit booms.

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Profit margins and firm price growth: evidence from the Decision Maker Panel

Ivan Yotzov, Philip Bunn, Nicholas Bloom, Paul Mizen and Gregory Thwaites

Inflation in 2023 remains elevated across many advanced economies. Existing studies have considered the contribution of profits to persistently high inflation in the US, euro area and UK. To add to this debate, we recently asked firms in the Decision Maker Panel about their profit margins over the past year and their expectations for the year ahead. This post summarises the key findings from these new questions, and links them to recent trends in prices. Firms reported a squeeze in profit margins over the past year, on average, but they expect to rebuild margins over the next year. Firms expecting to increase margins also expect slightly higher price growth, suggesting that margin rebuilding could make some contribution to inflation persistence.

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Decoding the market for inflation risk

Saleem Bahaj, Robert Czech, Sitong Ding and Ricardo Reis

Few topics captivate our attention like the enigma of inflation. Understanding where the market thinks inflation is headed is crucial for policymakers, investors, and anyone who wants to keep their financial ducks in a row. And that’s where inflation swaps come into play. They are like the crystal ball of inflation expectations, allowing traders to hedge against inflation risk and giving us a peek into the minds of market participants. In a recent paper, we delve into this thriving market to uncover the who, what, and why behind the prices of these swaps to shed light on the dynamics of inflation expectations.

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Leveraged and inverse ETFs – the exotic side of exchange-traded funds

Julian Oakland

Exchange-traded funds (ETFs) are supposed to be simple and straightforward, and for the most part they are, but one group punches well above its weight when it comes to market impact. In this post, I show that leveraged and inverse (L&I) ETFs generate rebalancing flows that: (1) are always in the same direction of the underlying market move; (2) grow significantly with both increasing and inverse leverage; and (3) must be transacted towards the end of the trading day. These features give rebalancing flows the potential to amplify market moves when markets are at their most vulnerable. L&I ETFs do not currently pose a risk to UK financial stability, but this could change if they grow in popularity.

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Profits in a time of inflation: some insights from recent and past energy shocks in the UK

Sophie Piton, Ivan Yotzov and Ed Manuel

How have profits behaved in this context of sustained level of inflation? In part, the answer depends on how ‘profits’ are defined. Some broad measures suggest increasing profits, but conflate market and non-market sector dynamics and omit important corporate costs. We construct an alternative measure of corporate profits to capture UK firm earnings in excess of all production costs. This measure has been declining since the start of 2022, consistent with evidence from historical energy shocks. This decline has not been uniform across firms, however: firms with higher market power have been better able to increase their margins; others have experienced large declines.

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How do firms pass energy and food costs through the supply chain

Hela Mrabet and Jack Page

The rise in commodity prices after Russia’s invasion of Ukraine had a direct and noticeable impact on consumers’ bills for energy and food. But firms also felt the brunt of higher costs. How did firms pass on these cost shocks through the supply chain and all the way onto consumer prices? How much and how quickly can firms pass through such large cost shocks? In this blog post, we combine information from Supply-Use tables with a rich industry-level data set on input and output price indices to shed light on these questions.

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