Monetary Policy in Turbulent Times
Andrew Sentance
External Member
Monetary Policy Committee
Harrodian School, Barnes
3rd February 2011
Outline
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The end of the “great stability”
Influence of global growth and inflation trends on
the UK economy
Globalisation and the effectiveness of monetary
policy
Current UK monetary policy issues
UK economic growth, 2005-2010
GDP growth, percentage change on previous quarter
2
1
0
-1
-2
-3
2005
2006
Source: Office for National Statistics.
2007
2008
2009
2010
UK inflation has been stubbornly high
Percentage change, year on year
6
RPIX
5
CPI
4
3
2
1
0
2005
2006
Source: Office for National Statistics.
2007
2008
2009
2010
UK, US and Euro Area inflation rates
Annual percentage increase in consumer prices
2003-07 Average
4
2008 - 10 Average
Dec 2010
3
2
1
0
UK
Source: Office for National Statistics, Thomson Datastream.
US
Euro Area
Inflation has exceeded forecasts
Annual percentage increase in consumer prices
February 2009 forecast
August 2009 forecast
Actual CPI inflation
May 2009 forecast
November 2009 forecast
6
5
4
3
2
1
0
2007
2008
Source: Bank of England and Office for National Statistics.
2009
2010
The end of the “great stability”

2008/9 Financial Crisis and Recession

Inflation has been high


Simple “output gap” model not operating as
expected
Key lies in understanding how global economy has
affected UK growth, inflation and monetary policy
World trade and global GDP growth
Percentage change on previous year
15
World GDP growth
World trade growth
10
5
0
-5
-10
-15
2000
Source: IMF.
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
The “new global economy”
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Integration of China, India and other low-cost
producers into global economic system
Financial liberalisation and globalisation
Globalisation pressures extend from trade and direct
investment to labour and capital markets
Rapid transmission of global shocks
Demand spillovers and global inflation trends affect
national growth/inflation trade-off
Global monetary conditions are a powerful influence,
and a potential source of economic volatility
GDP growth in the world economy
Average percentage change on previous years; GDP at constant prices
7
Developing countries
6
OECD countries
5
4
3
2
1
0
1970s
Source: IMF, OECD.
1980s
1990s
2000s
Source: IMF, October 2010 World Economic Outlook
South Africa
Turkey
Australia
United States
Italy
India
Brazil
France
Canada
United Kingdom
Mexico
European Union
Indonesia
Argentina
Korea
Japan
Russia
Germany
China
Saudi Arabia
G20 current account balances
Percent of GDP
30
2005-2007 average
2008-2010 average
25
20
15
10
5
0
-5
-10
Global energy and commodity prices
2000 =100
700
350
S&P GSCI agriculture and
livestock index (RHS)
600
300
S&P GSCI industrial metals
index (RHS)
500
250
Brent crude (LHS)
400
200
300
150
200
100
100
50
0
2000
2001
2002
Source: Thompson Datastream.
2003
2004
2005
2006
2007
2008
2009
2010
0
2011
Global impact on UK demand & inflation

Import prices

Demand conditions
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Exports
Business confidence and investment
Financial markets
Global pricing climate
CPI inflation and import prices
Percentage increase on previous year
CPI Inflation
20
Goods Import Price
Inflation
15
10
5
0
-5
-10
2000
2001
2002
Source: Office for National Statistics.
2003
2004
2005
2006
2007
2008
2009
2010
UK trade as percentage of GDP
Exports plus imports as % of GDP, current prices
65%
60%
55%
50%
45%
40%
35%
30%
1960
1965
1970
Source: Office for National Statistics.
1975
1980
1985
1990
1995
2000
2005
2010
World economic growth since 2000
Annual GDP growth rate, percent
6
Average 2000-08
5
4
3
2
1
0
-1
2000
2001
2002
2003
2004
2005
Note: 2010 and 2011 growth rates are IMF forecasts.
Source: IMF World Economic Outlook, January 2011 update.
2006
2007
2008
2009
2010
2011
Manufacturing rebounding strongly
Annual growth rate of manufacturing output, percent
10
5
0
-5
-10
-15
1990
1992
1994
1996
Source: Office for National Statistics.
1998
2000
2002
2004
2006
2008
2010
Foreign direct investment, 2000-2010
Cumulative sum of annual FDI flows between 2000-2010
$ tn
3
Inflow
2.5
Outflow
2
1.5
1
0.5
0
United
States
Source: OECD.
United
Kingdom
France
Germany
Canada
Japan
Italy
International spare capacity measures
Percentage deviation from potential GDP
3
2
1
0
-1
-2
-3
Global output gap (IMF)
-4
-5
OECD countries output gap (OECD)
-6
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
2012
Note: Global output gap for the years 2010 -12 based on IMF forecasts; OECD output gap for 2011-12 based on OECD forecasts.
Source: IMF, OECD.
Monetary policy, the global economy
and inflation
Impact of monetary
policy
Cost of
imports
Global
economy
Demand
Pricing
climate
Exchange rate
Domestic
demand
Expectations
and credibility
UK inflation
Effective exchange rates – UK, US
and Euro-Area
January 2007 = 100; monthly averages
120
Euro
UK
US
110
100
90
80
70
60
2005
2006
Source: Bank for International Settlements.
2007
2008
2009
2010
Domestic demand growth, 2005-10
Percentage change on previous year
6
4
2
0
-2
UK
-4
US
Euro-area
-6
-8
2005
Source: OECD.
2006
2007
2008
2009
2010
Capacity utilisation in manufacturing
Percentage balance of firms at or above capacity
80
Average since 1980
70
60
50
40
30
20
10
0
1980
1985
1990
1995
2000
Note: The percentage balance of manufacturing firms reporting they are working at full capacity.
Source: CBI Quarterly Industrial Trends survey.
2005
2010
CBI price expectations since 1990
Percentage balance of manufacturers expecting higher prices less
those expecting lower prices
60
40
20
0
-20
-40
1990
1993
Source: CBI Industrial Trends Survey.
1996
1999
2002
2005
2008
-60
2011
The case for gradual interest rate rises
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Current monetary policy settings reflect exceptional
conditions in late 2008 and early 2009
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Growth has turned round at home and abroad
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Inflation, rather than deflation has been the problem
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Further global price shocks on the way
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Inflation expectations rising and wage growth
picking up
Credibility of inflation target and confidence in MPC
risk being undermined
Risks of delay - future shocks to confidence/recovery