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10 Dec 2014
BoE's McCafferty: Monetary policy in an uncertain economy
FXStreet (London) - Speaking at the Institute of Directors, Bank of England Monetary Policy Committee member Ian McCafferty defended his stance in voting for a rate hike in August-November MPC meetings. However, he stressed that his comments today reflect his thinking up to the November Inflation Report and not necessarily December.
McCafferty suggests that uncertainties about the sustainability of domestic demand … have resurfaced. But although “latest evidence from output surveys suggests that some … momentum is waning in some sectors, these surveys remain consistent with healthy growth rates in the vicinity of 0.6 percent – 0.7 percent in the current and coming quarters”.
He goes on to say that “considerable though uncertainties are on the demand side, they are small compared with those concerning supply”. He focuses on four questions on supply:
1. McCafferty notes that “business surveys suggest that companies are operating at close to ‘normal’ levels of capacity utilisation”. But he suggests that the degree of slack in the labour market is a “more complex concept”, requiring an assessment of equilibrium levels of unemployment, participation and hours, which cannot be observed directly. He considers that “recent weaker data on participation may well be telling us that the recent upward trend is coming to an end at a somewhat lower level than previously thought”.
2. How quickly is slack being absorbed? McCafferty notes that this depends on economic growth – growth will need to remain no faster than its average rate in coming years for slack to be absorbed less quickly. While he finds that “plausible” he warns that if growth ends up being slightly higher that could “materially change the date by which slack would be fully absorbed.” In his view, “we may well see the economy return to full capacity somewhat earlier than implied by our central forecast in the November Inflation Report”.
3. What are pay measures telling us? McCafferty explains that “here too policy makers have had to grapple with heightened uncertainty, relating to the interpretation of divergences in pay measures”. “The main puzzle has been the recent weakness of average weekly earnings which has been at odds with the strength of the survey indicators”. But he notes that survey measures have reasonably good leading indicator properties, and that the most recent private sector pay data suggest a pickup, so he concludes that “domestic pricing pressures may be less dormant than we think, and might surprise us faster than we expect”.
4. How far should current low inflation influence our policy decisions? McCafferty argues that there are “some good reasons to justify looking through the recent sharp fall of inflation, at least partially.” He explains that policy has to be forward looking. That the source of the weakness in inflation is largely external reflecting “falling food and energy prices, as well as the 10 percent appreciation of sterling”. That “there is little evidence of … disinflationary second round effects emerging”. And that, when looking through current levels of inflation “it is not only the current level of spare capacity that is important. Whether that spare capacity is diminishing or growing, and whether that output gap moves from negative to positive over the forecast horizon, are also important considerations”.
McCafferty suggests that uncertainties about the sustainability of domestic demand … have resurfaced. But although “latest evidence from output surveys suggests that some … momentum is waning in some sectors, these surveys remain consistent with healthy growth rates in the vicinity of 0.6 percent – 0.7 percent in the current and coming quarters”.
He goes on to say that “considerable though uncertainties are on the demand side, they are small compared with those concerning supply”. He focuses on four questions on supply:
1. McCafferty notes that “business surveys suggest that companies are operating at close to ‘normal’ levels of capacity utilisation”. But he suggests that the degree of slack in the labour market is a “more complex concept”, requiring an assessment of equilibrium levels of unemployment, participation and hours, which cannot be observed directly. He considers that “recent weaker data on participation may well be telling us that the recent upward trend is coming to an end at a somewhat lower level than previously thought”.
2. How quickly is slack being absorbed? McCafferty notes that this depends on economic growth – growth will need to remain no faster than its average rate in coming years for slack to be absorbed less quickly. While he finds that “plausible” he warns that if growth ends up being slightly higher that could “materially change the date by which slack would be fully absorbed.” In his view, “we may well see the economy return to full capacity somewhat earlier than implied by our central forecast in the November Inflation Report”.
3. What are pay measures telling us? McCafferty explains that “here too policy makers have had to grapple with heightened uncertainty, relating to the interpretation of divergences in pay measures”. “The main puzzle has been the recent weakness of average weekly earnings which has been at odds with the strength of the survey indicators”. But he notes that survey measures have reasonably good leading indicator properties, and that the most recent private sector pay data suggest a pickup, so he concludes that “domestic pricing pressures may be less dormant than we think, and might surprise us faster than we expect”.
4. How far should current low inflation influence our policy decisions? McCafferty argues that there are “some good reasons to justify looking through the recent sharp fall of inflation, at least partially.” He explains that policy has to be forward looking. That the source of the weakness in inflation is largely external reflecting “falling food and energy prices, as well as the 10 percent appreciation of sterling”. That “there is little evidence of … disinflationary second round effects emerging”. And that, when looking through current levels of inflation “it is not only the current level of spare capacity that is important. Whether that spare capacity is diminishing or growing, and whether that output gap moves from negative to positive over the forecast horizon, are also important considerations”.