On the one hand, there is a danger that the current high level of inflation becomes embedded in wage and price setting behaviour, imparting greater persistence to the upside deviation of inflation from target in the coming years. On the other hand, the squeeze on real household incomes coming from higher energy and goods prices threatens to weigh heavily on demand, activity and employment, potentially adding to the undershoot of the inflation target forecast by the MPC at a three-year horizon. As has been emphasised in recent Bank communication, the MPC seeks to follow the narrow path between these two risks, while returning inflation to its 2% target in a sustainable manner. [5] The weight attached to the risks on either side of this narrow path will vary across people and through time, evolving as new economic data are published and analysed. The recent discussion of UK monetary policy – and the absence of unanimity in MPC votes – should be understood in that light. In today’s talk, I aim to flesh out the framework established in the MPC’s recent forecasts and reports for assessing how to identify and follow this narrow path. [6] These forecasts and reports represent the ‘best collective judgement’ of the MPC as a whole. But I will also take this opportunity to flag where I differ from that ‘best collective judgement’.
Of course – as I have explored in previous talks (Pill, 2022) – assessing how supportive any particular stance of monetary policy will prove is difficult, since it relies on conceptually and empirically uncertain measures of neutral benchmarks for policy, such as the natural rate of interest or R-star. 9. On Tuesday, the ONS published an unemployment rate for March 2022 of 3.5% (single month basis) (‘Labour market overview’, Office for National Statistics  ). 10. Private sector regular average weekly earnings (AWE) growth increased to 4.8% in Q1, while annual whole economy AWE growth was 7.0% (‘Labour market overview’, Office for National Statistics ). In part, the difference between these two indicators reflects the strength of bonuses in the data, which – despite adding to household income – are not ongoing costs to firms. 11. Of course, that means the assumption of stable energy prices has not proved very accurate in the recent past. But commodity prices are hard to forecast, and the random walk forecast has performed as well as alternatives over most periods. In particular, there is scant evidence that the path of commodity prices embodied in market futures pricing has outperformed the random walk assumption. 12. See Broadbent (2022). 13. See the discussion of a Brexit ‘doppelganger’ model reflected in Chart 1 of my MPC colleague Catherine Mann’s recent speech (Mann, 2022). 14. See Nickell (2005). 15. See the discussion of labour market trends and long Covid reflected in Figure 6 of my MPC colleague Michael Saunders’ recent speech (Saunders, 2022).