The economic costs of
restricting trade: the
experience of the UK -
speech by Ben Broadbent

Given at the Federal Reserve Bank of Kansas City 46th Economic
Symposium, Jackson Hole, Wyoming

Published on 26 August 2023

Ben Broadbent discusses the economic costs of restricting trade. The
pandemic and the war in Ukraine provide a stark illustration of the impact of a
sudden contraction in the supply of imported goods for an open economy like
the UK. He argues that in 2021 and 2022 these shocks reduced real national
income significantly and contributed to the rise in domestic inflation. He
explains that although import costs have been declining in recent months, it
is likely that monetary policy will have to remain in restrictive territory for
some time.

Speech

Introduction and summary

Good morning. I haven't been to this conference for a number of years and it's a great
pleasure to be back.

Quite a bit has happened in the interim. We have been through a terrible pandemic. Just as
the world was overcoming the worst of Covid-19, Russia invaded Ukraine. We are now
witnessing the most serious armed conflict on the European continent since the Second
World War.

These events have taken a terrible human toll. They've also had significant impacts on the
world economy.

Despite their differing origins, the economic consequences of these shocks have quite a bit in
common. The pandemic disrupted the supply of traded goods, much of it from Asia. This
contributed to a material rise in their relative price and a reduction in the real incomes of
goods importers.

Similarly, Russia's invasion of Ukraine was accompanied by a sharp reduction in the supplies
of energy and food from that region and a further hit to the wellbeing of those reliant on them.

The resulting real-income squeeze has led to rapid inflation in domestic wages and prices in
these importing countries, through the normal mechanism of "real income resistance". In both
cases it's also led to calls for policymakers actively to reduce dependence on these imports -
whether goods from parts of East Asia or gas from Russia - in order to "de-risk" trade.

However, one should be careful not to over-generalise. The fact that they've both involved
significant interruptions to the supply of traded goods doesn't mean these two episodes have
the same implications for trade policy. Nor should we imagine that, just because they're
global, the economic consequences of these shocks - for either real income or inflation -
have been identical in every country.

The argument that trade has been over-concentrated - and that governments have a role to
play in addressing the problem - is surely reasonable when it comes to Europe's (pre-war)
reliance on Russian gas. Arguably, the security of energy supply is something for which
governments should and do take some responsibility. (There are significant increasing returns
in the physical infrastructure and therefore an economic case for the involvement of public
policy. It's also an area in which political risk is ubiquitous: this isn't the first time a
monopolistic producer has restricted the supply of energy for political ends[1].) And although
this reliance was considerable - and clearly not costless to replace - there's nothing
intrinsically special (or "non-substitutable") about Russian gas in particular: one molecule of
methane is much like another.

It's not clear the same is true of supplies of goods affected by the pandemic. The extensive
global value chains (GVCs) built up during the 1990s and 2000s have almost certainly
increased economic inter-dependence[2]. There's little doubt either that, at least in the face of
this very particular and very severe shock, the dispersed and specialised nature of production
worsened the hit to the supply of goods during the pandemic. But the shortages and price
rises weren't just because of supply problems. Covid-19 also led to a material rise in the
global demand for goods, as consumers in many countries shifted spending away from
services. Even a closed economy would have had trouble adapting to a switch in demand on
this scale.

Nor was the pandemic a typical shock. Some warn they could become more common in
future. But over the past, at least, there's little evidence that greater openness has led to
greater volatility in economic growth - or, therefore, that there's some "risk-return" trade-off to
be struck when it comes to international trade. If anything, the correlation seems to have gone
the other way. And whatever the particular shocks to which they might be exposed in the
future it's not obvious that private-sector firms involved in these GVCs should somehow be
unaware of, or fail to internalise, the risks involved (or, therefore, that there's a prima facie
case for government intervention). Finally, many of the goods prices affected by the pandemic
have since subsided, or at least decelerated. This suggests that, even without a significant
degree of "re-shoring", these supply chains may be more adaptable, and more robust, than
sometimes imagined.

I don't want to pretend that the difficulties caused by the pandemic are the only (or even the
primary) argument made in favour of curtailing international trade. There are also geopolitical
factors at play. But when policymakers suggest the "fragility" of supply chains is another

reason to push in the same direction I'm not sure I agree. In fact, perhaps the lesson of the
past three years is not that there was too much international trade before the pandemic but
that there was too little of it immediately afterwards (or, at least, that it was closed down too
readily in response). After all, it also heavily disrupted economic activity within countries, not
just between them, yet no-one ever makes the case for lasting intra-national restrictions on
the flows of goods, services or people.

Turning to the consequences of these shocks for real incomes and inflation, one thing I want
to stress today is how different these have been, even among developed economies in the
west. I think it's well understood that the economic costs of Russia's actions have been
greater for Europe. Unlike oil, gas is not easily tradable between continents and the cost of
energy rose to a much greater extent than elsewhere. But the scale of the difference is
nevertheless under-appreciated at times. At its peak last August, the wholesale price of gas
was over ten times higher than in North America and the equivalent of nearly $600 for a barrel
of oil (Chart 1).

US Dollars per barrel of oil equivalent
600

European natural gas
500

-- US natural gas
400

European oil

300
SSO ISS I]

200

100

Sources: Bloomberg Finance L.P. and Bank calculations.US gas is Henry Hub natural gas. European gas is Dutch TTF
natural gas. US oil is West Texas Intermediate (WTI) crude. European oil is Brent crude.

Thanks to the particular way in which retail energy bills are calculated in the UK, the direct
impact on the CPI and on real household income has been both larger and more drawn out
even than in the rest of Europe (Chart 2)[3].

Index: 2019 = 100
210

Sources: ONS, Eurostat, US Bureau of Economic Analysis and Bank calculations.Chart shows price of household energy
utilities in UK's CPI, Euro area's HICP and US's PCE.

If the hit to household income has been greater in the UK even than in other countries in
Europe the same is true for the country's aggregate real income. As a relatively large
consumer of imported energy and goods, and against the backdrop of the UK's withdrawal
from the European single market and customs union, which raised its costs of trade, the UK's
aggregate real national income was hit particularly hard both by the war and the pandemic.
Chart 3 plots average rates of growth of import prices, relative to the GDP deflator, over
longer periods in the past and then the early part of the current decade. Having for many
years benefitted from the scale and nature of globalisation - the UK's comparative advantage
has long been more in tradable services than in goods - the turnaround in the two-year period
to 2022Q3 was particularly dramatic. The cost of imports rose by around 20%, relative to
domestic prices. Because they account for around 30% of domestic expenditure this knocked
close to 6% off real national income.

Change in import prices relative to GDP deflator, annual average, per cent
10

Annualised

1960-74 1975-89 1990-2004 2005-19 2yearsto 6 months to
22q3 23q1

Sources: ONS, FRED and Bank calculations.US bars weighted by ratio of US import share of output to UK import share of
output in volume terms, for comparability with UK bars. Euro area not included in chart due to limited back run of data and
limited external trade data.

By contrast, the US - even the non-energy US economy - saw little deterioration in its terms
of trade following the pandemic and is in any case a less open economy. So these external
events caused barely a ripple in its national income (relative to GDP).

This difference in the scale of the real-income squeeze has been reflected in a sharply lower
path for consumer spending in the UK (Chart 4). It's also likely to have contributed to
significantly worse "second-round effects" on domestic wage and price growth/4].

Consumption per capita, 2019 = 100

95
90
85
80
75

70
2015 2016 2017 2018 2019 2020 2021 2022 2023

Sources: Refinitiv Eikon Datastream and Bank calculations.Population of Euro area and UK available on annual basis and
interpolated linearly to quarterly frequency.

The big jumps in import prices don't just affect their counterparts in the CPI. They will also
have raised the cost of imported intermediates, including those used to meet domestic
spending. If there's any degree of "real income resistance" in the economy, hits to real income
from a worsening terms of trade can add further to domestic inflation. Employees seek to
defend real pay by bidding for higher nominal wages; firms protect the real (consumption)
value of profits by raising their own prices. Collectively this cannot succeed: the hit to real
national income is what it is. But, in the meantime, the process fuels higher domestic and
overall inflation. I won't claim this proves the point but there is some evidence that, in
countries where import price inflation has been higher, wage growth has also been stronger
(Chart 5).

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Percent change in (price of imports / GDP deflator) over 2021 Q3-2023 Q1

Sources: Eurostat, OECD, ONS and Bank calculations.Percent change in (import deflator / GDP deflator) is adjusted by
country's import share of output. UK wages are AWE total pay, Euro area countries' wages are total wages and salaries. For
Greece, wage data for 2023 Q1 not available so wage growth calculated over 2021Q3- 2022Q4.

The good news is that these import prices have now been subsiding (or at least decelerating)
for a while. Wholesale European gas prices peaked almost a year ago and have fallen back a
long way since. In many countries manufacturing output prices have also been declining in
recent months.[5]

We can expect this to feed through to retail goods inflation over the next few months. In time,
and even for given levels of unemployment and wider spare capacity in the economy, it's also
likely to relieve pressure on real incomes and, for that reason, on domestic rates of inflation. A
crucial question for monetary policy is whether this unwinding of "second-round effects" will be
as rapid or as marked as their emergence over the past two years. The judgement of the
MPC is that this is unlikely - we think the process will take longer - and, therefore, that policy
will probably have to remain in restrictive territory for quite some time yet.

Anyhow, having picked off some of the main points in this introduction I'll now fill in some of
the details. I'll begin with some remarks about trade. The second main section is about the
effects of the real-income squeeze on domestic inflation and the prospects for a reversal of
these "second-round effects" now that the real price of imported goods and energy prices has
started to decline. I close with some remarks about the behaviour of monetary policy in the
presence of these sorts of shocks.

The global supply of traded goods and UK income

It's now common knowledge that the huge expansion in world trade, during the latter part of
the last century and the first years of this one, then petered out around the time of the global
financial crisis (GFC). Globalisation gave way to "slowbalisation". The share of trade
accounted for by GVCs, whose growth had been the main engine of the long expansion,
levelled out around the same time (Chart 6). Unsurprisingly, the same pattern can be
observed for many individual countries. In the UK, during the fifteen years from the early
1990s until the GFC, the share of imports in domestic spending almost doubled.

World trade, per cent of world G

1980 1990 2000 2010

Sources: ONS, World Bank Development Indicators, Borin and Mancini (2019) -_as reported in World Development

Report (2020) and Antras (2020) and Bank calculations.World trade is defined as the sum of world exports and
imports of goods and services as a share of world GDP in value terms, divided by two as a country's import is another
country's export.

Some have blamed the subsequent flattening out in trade shares on more restrictive policy[6].
That may be true to some extent. But the more accurate description is that the rate of
liberalisation slowed down, not that policy turned significantly more restrictive. Thanks to a
succession of regional agreements, progress on multilateral rules and, in 2001, China's
accession to the WTO, average tariff rates declined significantly in the years ahead of the
GFC. In Europe, the EU's expansion, and the creation of the single market, removed many
non-tariff barriers (Dhingra et al, 2022) I Perhaps it was always going to be difficult to
maintain that rate of progress.


And, as Antras (2020) argues, many other factors contributed to the expansion of trade
and they too were always likely to run out of steam, or at least to decelerate, at some point.
By dramatically reducing the costs of information exchange and improving the efficiency of
supply chains, the ICT revolution also made it easier to disperse manufacturing across
different countries. Political developments brought significant numbers of people - from
Eastern Europe and above all China - into the global economy. The growth of air freight and
improvements in shipping reduced the physical costs of trade.

As we know, the gains from this earlier period weren't evenly distributed, either across
countries or within them. Much has been written about the effects of China's rise on
competing sectors in the developed world, and in particular on the wages of the less skilled
(Autor et al, 2013) I As Samuelson (2004) pointed out, greater openness needn't be
beneficial even at a national level if it lowers relative prices in a sector in which the country
happens to enjoy an initial comparative advantage (thereby reducing its terms of trade).

The effects and benefits of openness don't hinge solely on the terms of trade. But at least as
far as these aggregates are concerned[7], this was not the experience of the developed
economies: the terms of trade of most large OECD countries were broadly constant or rising
during that period. And for small open economies - particularly ones like the UK, whose
comparative advantage had long been more in tradable services than goods - the relative-
price benefits look to have been sizeable. Chart 3, in the introduction, plotted the average
rates of change of import prices relative to the output deflator. Chart 7 gives an alternative
presentation - it's the level of UK import prices relative to domestic wages - but conveys the
same message. National and household income benefited significantly from declines in real
import prices during the "hyper-globalisation" years.

Index, 2019 = 100
210

190

Import prices / wages '
Se LN oe

I~

1988 1992 1997 2002 2007 2012 2017 2022

Sources: ONS, World Bank Development Indicators and Bank calculations.Wages are AWE private sector regular pay.

Some of this reflects rapid gains in productivity in tradable goods production, at home as well
as abroad. But a good part will also have been caused by declines in the costs of trade and
the opening up to China in particular{g].

Conversely, as both UK and world trade growth slowed, over the subsequent decade, the gap
between income and output growth also narrowed. And if this was disappointing - compared,
at least, with what had come before - the huge dislocations of the pandemic and the war in
Ukraine, against the backdrop of the UK's departure from the EU's single market and customs
union, proved much worse. As we saw in the introduction, the jump in import prices between
mid-2020 and mid-2022 reduced the consumption value of UK output by over 5%.

As much as UK incomes had gained from the increased supply of tradable goods over the
preceding decades - and particularly during the "hyper-globalisation" period before the GFC -
so they suffered (and dramatically so) when those supplies were curtailed.

Is there a trade-off between openness and the stability of output
growth?

For some, these experiences have raised questions about the wisdom of unfettered
openness, and in particular the rapid growth of GVCs in the 1990s and 2000s. Accepting that
trade has brought gains on average, across the population and over time, does it not also
result in greater volatility in output and income? The risk - well identified long before the
growth of GVCs (by Newbery and Stiglitz (1984) for example) - is that, by encouraging
specialisation, international trade also makes production more vulnerable to local and sector-

specific shocks. If one part of a car is built in country A, another in country B and the two
assembled in country C, there would seem to be three potential points of failure instead of
one. The widespread effects of the Tohoku earthquake, on manufacturing sectors well beyond
Japan's borders, are well known (Carvalho et al, 2020 I. More recently, the war has
disrupted production of cars in Western Europe because manufacturers had relied for a
particular electrical component on factories in Ukraine. More materially, the argument is made

that the shortages and price rises following the pandemic, for a wide range of goods,
represented a failure of "fragile" supply chains. The suggestion is that these problems
wouldn't have arisen had production been less dispersed.

I think this is overdone and I want to make some points in mitigation. Two are particular to the
pandemic, the third more general.

The first thing to point out is that the shortages and price rises in the wake of the pandemic
cannot be blamed on global supply disruptions alone. Big increases in the demand for goods,
as consumers worldwide switched their spending away from services, were also important
(Chart 8). This shift was probably amplified by the nature and scale of the US fiscal easing in
2021, as one-off transfers are more likely to be spent on durables than non-durables like
services. (Remarkably, US consumer spending on durables was over 30% higher in the
second quarter of 2021 - in volume terms - than it had been immediately before the
pandemic.)

Level of consumption in OECD countries, 2019Q4 = 100
110

Goods

80_ YH. 80
Mar 18 Mar 19 Mar 20 Mar 21 Mar 22 Mar 23

Sources: OECD Quarterly National Accounts, IMF World Economic Outlook and Bank calculations.

Nor is it right to imagine that production itself would have been unaffected had it only been
less dispersed across different regions. Lockdowns severely restricted transport within
countries, not just between them. The decentralised nature of GVCs certainly mattered, as did
the problems with shipping. The big rise in container shipping costs is enough to tell you that.
But one suspects that, even without these constraints, or this dispersed pattern of production,
the global economy would have found it difficult to adjust to a shift in demand on this scale.

Second, judging by the behaviour of wholesale prices, quite a bit of this supply has now come
back. Shipping costs peaked in early 2022 and have since declined markedly (Chart 9). And
global producer price inflation has recently turned negative after over a year in double digits
(Chart 10). Some of this reflects a moderate rebalancing of consumer demand: as the
pandemic retreated so too, to some degree, did the skew towards goods. But the volume of
global manufacturing output is still higher than in 2019, indicating that a revival of supply is at
least part of the explanation for the decline in price pressures. Nor has "reshoring" been a
significant part of this recovery. If anything, the evidence suggests that GVCs have played a
critical role in the revival of supply (Goldberg and Reed, 2023 _.


Shanghai Containerized Freight Index , May 2020 = 100
- China Containerized Freight Index

Freightos Baltic Container Index 1000

Baltic Exchange Dry Index

Harpex Charter Rate Index 800

600

400

200

May 20 Nov20 = May 21 Nov 21 May 22 Nov22 May 23

Sources: Refinitiv Eikon Datastream, Baltic Exchange, Freightos Baltic Index, Harper Petersen, Shanghai Shipping
Exchange and Bank calculations.

pal non-UK PPI

Source: Refinitiv Eikon Datastream, JPM Global PMI index and Bank calculations.'Global non-UK PPI' is the average of PPIs
from the Euro area (manufacturing PPI), US, China, Switzerland, India, Poland, Japan, Hong Kong, Sweden, Canada, South
Africa, Denmark, South Korea and Singapore, weighted by their shares of UK imports. These economies account for over
90% of UK imports.

Third, as a more general matter, the evidence that greater openness means more economic
volatility is at best patchy. If anything, there's more that suggests the opposite. Certainly, a
very simple and crude comparison of the two in the UK time series indicates that, during
periods of greater openness, UK output growth has generally been less, not more, volatile. In
Chart 11, the blue line is the share of imports in demand, the red line the standard deviation of
GDP growth (measured over rolling ten-year windows and plotted on an upside-down scale).

€ openness, pe

1898 1939 1980

Sources: ONS, Thomas and Dimsdale's Millennium of UK data (2017) and Bank calculations.UK trade openness is
defined as the share of (exports + imports) in GDP in value terms. Output volatility is the standard deviation of real UK GDP
growth over the previous 10 years.

The negative correlation between the two isn't that tight (the period after the Second World
War, when trade was still heavily restricted but output growth relatively stable, is one clear
exception). Nor can we really claim this tells us anything about causation. There could well be
third factors that have independently affected both trade and economic volatility.

But, for what it's worth, you get the same (albeit smaller) negative correlation with the
variability of output growth if you look not at openness itself but the fitted values from a simple
regression of openness on trade costs (a sort of "instrumentation", to use the econometric
term).

More significantly, a couple of recent studies point out that, although there are clearly
mechanisms through which greater openness raises an economy's exposure to foreign supply
shocks, it can also help defray the effects of domestic shocks.

A 2021 report by economists at the Bank of England (D'Aguanno et al. 2021) makes this
point by focusing on the role of GVCs. When there is trade in intermediate inputs, a decline in
productivity at home raises the relative price of a country's own output and encourages the

production of substitutes abroad. This dampens the domestic impact of the shock: it's

effectively shared with its trading partners. The authors demonstrate that, when this effect is
sufficiently strong[9], and in the face of variable productivity in both countries, greater
openness can actually reduce the variance of their output.

In a similar vein, Caselli et al. (2020) I develop a model in which greater openness can have
two opposing effects on the stability of output. By encouraging greater specialisation it
exposes economies to sector-specific shocks (a la Newbery and Stiglitz). But, rather like well-
functioning international capital markets, greater openness also allows countries to dampen
the effects of domestic shocks on their own output.

In both these models the net effect of openness on output volatility is ambiguous. And
previous empirical studies had also failed to come down clearly on one side or the other:
some found a positive relationship, some a negative one[10]. Caselli et al. claim that their
model-based estimates allow for a better identification of the pure effect of lower trade costs -
and that, for most of the twenty-five countries in their sample, greater openness has actually
lowered the variability of output growth. This is essentially because country-level
disturbances, which trade can dampen, have tended to be more important than sector-specific
shocks (whose effects are enhanced by trade-induced specialisation).

The inflationary consequences of real shocks

In the introduction we saw that countries whose import prices rose more after the pandemic
have since tended to experience faster rates of domestic inflation. The UK certainly qualifies
as one of them.

Other things have clearly contributed to UK inflation. Thanks in part to a sharp drop in labour-
market participation the rate of unemployment declined steadily after the economy re-opened
in early 2021, falling to 372% last summer. Despite relatively weak cumulative growth of output
over the preceding two and a half years this was a touch below where it had been just before
the pandemic (indeed the lowest for forty years), lower than estimates of the UK's long-run
natural rate of unemployment and close to levels in the United States (Chart 12[11]). Alongside
this decline, measures of labour market tightness - vacancies, surveys of firms and the rate of
job-to-job moves - all rose sharply. Only in the past few months has tightness in the labour
market begun to subside.

Unemploymentrate, per cent

6

Sources: ONS, Refinitiv Eikon Datastream and Bank calculations. The unemployment rate did not increase materially in the
Euro area and the UK during the pandemic thanks to government-provided employment support.

Furthermore, even allowing for the scale of the rises in import prices, their "second-round"
effects on domestic inflation have been significant and, to all appearances, stronger than past
relationships (at least over the inflation targeting period) would have led one to expect.
Controlling for the impact of changes in unemployment, productivity and a measure of inflation
expectations, Chart 13 plots a rolling estimate of the sensitivity of wage growth to the change
in the wedge between consumer and producer prices. This is a measure of real-income
resistance. Back in the 1970s and 80s, according to these estimates, a 1% hit to real incomes
would on average have raised domestic inflation by around half a percentage point, with the
effect persisting over several quarters. Observationally, the effect resembles a rise in the so-
called NAIRU - the rate of unemployment consistent, at any point in time, with stable inflation.

Elasticity of nominal wage growth to real income hit
1.0

4¢

LNJ estimate over
1956-85 sample

-0.5-§ -MHAAN)]HJ TT
1974 1979 1984 1989 1994 1999 2004 2009 2014

Source: Layard, Nickell and Jackman (1991) ONS and Bank calculations.Rolling coefficient on wedge between
consumer and output prices using 18-year regressions. Dotted line shows coefficient estimated by Layard, Nickell and
Jackman (LNJ) on 1956-85 sample.

Over the years, and in particular after inflation targeting was introduced in the early 1990s,
this sensitivity appeared to decline. The sizeable benefits of falling import prices during the
pre-GFC "hyper-globalisation" were less disinflationary than those earlier estimates would
have implied. The sharp decline in trend productivity growth, around the time of the GFC,
seemed to be accommodated by nominal growth rates without any need for higher
unemployment (in Chart 14, the wage Phillips curve shifted down in line with the drop in trend
productivity). Similarly, the big depreciations in sterling after the GFC and the EU referendum,
both of which squeezed real household income relative to GDP, had almost no perceptible
effect on wages or domestic price inflation.

Annual nominal wage growth less inflation expectations, per cent

1993-2012

ce) 10 11
Unemploymentrate, per cent

Sources: ONS, Bank of England and Bank calculations.Wage growth is AEI until 2010 and AWE since. Inflation expectations
are implied by the indexed gilt market. The unemployment rate did not increase materially during the pandemic thanks to
government support.

But if this muted response was the new rule, compared with earlier decades, the experience
of the past eighteen months has proved the newer exception to it. Over the past year UK
wages have risen by almost 8%, as much as twice the rate consistent with the 2% inflation
target. There've been similar rates of inflation in services prices and the GDP deflator. Given
the estimated slope of the labour market Phillips curve, and if one assumes a stable "NAIRU",
one can explain at best one percentage point of this (roughly) 3'2 percentage point overshoot
in nominal wage growth.

Some of these "second-round" effects can be represented as the usual response to higher-
short-term inflation expectations - which, in their turn, track actual, spot inflation quite closely.
To this extent it's not that surprising that wage growth has been stronger than the path of
unemployment alone can explain.

But even controlling for the rise in near-term inflation expectations, recent growth in average
wages (and in domestic output prices) has been higher than conventional models would have
predicted.

It's not clear why this has happened. One plausible possibility is that the labour market has
actually been tighter than even the low rate of unemployment would suggest: the assumption
of a stable NAIRU is wrong. Certainly many other indicators of labour-market tightness

suggest as much. The presence of the furlough scheme makes it hard to follow what
happened to the Beveridge curve - the inverse relationship between unemployment and
vacancies - during late 2020 and early 2021. But even then there were other indications that,
for a number of possible reasons - the shifts in demand caused by the pandemic, early
retirement and restrictions on movements of people (including across borders) - the degree of
"mismatch" in the labour market had risen[12]. And during the second half of 2021, when the
economy was re-opening and the number of furloughed jobs beginning to decline, these
earlier indications of labour-market frictions were corroborated by a marked rightwards shift in
the Beveridge curve (i.e. large numbers of vacancies, even relative to the low rate of
unemployment - see Chart 15. Note that, in recent months, the V/U ratio has declined
significantly - on this evidence, at least, these acute frictions may now have begun to recede.)

Vacancy rate, %

NNT
Ho *fs-, 2007 -

© eo.

Unemp. rate, %

Sources: ONS and Bank calculations. Vacancy rate calculated as number of vacancies divided by employment level (both 3-
month averages). The unemployment rate did not increase materially during the pandemic thanks to government support.

It's also possible that there are non-linearities in these relationships. Perhaps the wage
Phillips curve is convex - falls in unemployment from low levels have more powerful effects
on inflation than those from higher levels. Or maybe these two underlying drivers - the
worsening terms of trade and the tight labour market - have interacted in some way, each
amplifying the effect of the other (i.e. there's a multiplicative term in the Phillips curve - see
Pill, 2023).

Unfortunately, I don't think we have the evidence to say with much precision how important
these factors have been. But to the extent they've contributed to wage growth, this would
obviously lessen any estimate of the genuine degree of real-income resistance over this
period.

Monetary policy and uncertainty about the NAIRU

What we can say is that, in the face of these uncertainties, setting monetary policy becomes a
good deal more complicated.

When I first came to this conference, in 2014, I sought to ex