As documented recently by my MPC colleague Steve Nickell,9 retailers’ margins were compressed in the years around the turn of the century. Since then, they seem to have crushed their costs through measures delivering rapid productivity growth. In part, that appears to have been achieved by disintermediating wholesale distributors, whose margins have continued to fall (Chart 15). At a macro level, the effect was, for a period, to open up a gap between producer output price inflation and retail goods price inflation (Chart 16). In other words, for a while some structural changes in the distribution sector reduced the feed through of demand pressures into retail price inflation. Looking ahead, one downside risk to the MPC’s central projection is that we cannot rule out that this process has further to go. The current conjuncture and policy Monetary regime change, labour market reform, financial innovation, the technological revolution, globalisation – it is a heady combination, which unavoidably adds to the challenge of discriminating between cyclical and structural influences when forming a view on the macroeconomic outlook. But it is equally unavoidable that policymakers must try to do just that. That brings me to the current conjuncture and so to policy. My own take at present is as follows. In my judgment, there is, on balance, most likely a degree of excess demand in the economy. Surveys suggest above-average capacity utilisation.
The policy debate – inside and outside the Bank – has recently refocused on the possibility of some other changes in the way our economy functions. Less than 18 months ago, the Bank’s interest rate was just 3.5%, essentially because the MPC wanted to stimulate private sector domestic spending to offset the effects on aggregate demand of weak net trade, given adverse developments in the world economy. As global conditions recovered, and with a pick up in public sector spending, we were able gradually to withdraw much of that stimulus during 2004 in a series of steps which were widely anticipated and understood across the financial and real economy (Chart 2). With the slack in the economy being absorbed, attention shifted to gauging the degree of demand pressures and their implications for the inflation outlook. In particular, on the basis of some simple statistical relationships, a question has been posed about whether there has been some change in the extent to which demand pressures feed through into wages and prices. Most notably, as discussed in the Bank’s February Inflation Report, the steady falls in unemployment over recent years have not been accompanied by a rising rate of earnings growth (Chart 3). These issues obtained some prominence towards the end of last year when, despite apparently buoyant demand, inflation on the CPI measure fell to 1.1%.