Andrew G Haldane: Stuck
Speech by Mr Andrew G Haldane, Executive Director and Chief Economist of the Bank of
England, to the Open University, London, 30 June 2015.
* * *
Accompanying charts can be found on the Bank England's website.
The views are not necessarily those of the Bank of England or the Monetary Policy Committee. I would like to
thank Will Abel, Charlotte Adams, Gareth Anderson, Daniel Beale, Will Dison, Ronnie Driver, David Elliot, Jeremy
Franklin, Rich Harrison, Robert Hills, Chris Jackson, Phil King, David Latto, Clare Macallan, Holly-Ann Mansford,
Jack McKeown, Rebecca Maule, Francesca Monti, Ben Nelson, Tom Pattie, Lukasz Rachel, Gareth Ramsay, Jon
Relleen, Martin Seneca, Minouche Shafik, Scott Simmons, Thomas Smith, Matt Waldron, Dan Wales for their
comments and contributions.
Oliver Jeffers is an author and illustrator of children's books. In Stuck, he tells the story of a
boy whose kite becomes lodged in a tree. The boy makes vigorous attempts to dislodge the
kite by throwing up objects, including a cat, a gorilla and an ocean-liner. (The story is
fictional.) Yet the kite remains stuck.
Central banks today can sympathise with the boy's dilemma. Official interest rates in the
major economies remain stuck at unprecedentedly low levels. Central banks have made
vigorous attempts to dislodge them, including through special liquidity schemes, asset
purchases and forward guidance. (This story is factual.) Yet interest rates remain stuck.
This stickiness in interest rates has surprised both policymakers and financial markets. After
they hit their floor, financial markets expected official rates in the US to unstick in 6 months,
in the UK in 10 months, in Japan in 13 months and in the euro-area in 14 months.
But they have remained stuck: in Japan for over 20 years and in the US, the UK and the
euro-area for over 6 years. Indeed, the expected time to lift-off remains as many months
away today as when rates first hit their floor: in the US 9 months, in the UK 10 months, in the
euro-area 34 months, in Japan 72 months (Chart 1).1
Looking at the path of interest rates implied by financial markets, this adhesiveness is
expected to continue. In Japan and the euro-area, official interest rates are only expected to
have reached 1.2% and 2.0% respectively ten years hence. And in the UK and US, they are
only expected to have reached 2.5% and 3.4% respectively by 2025 (Chart 2).2
This implies an extraordinarily slow pace of monetary tightening, at least by historical
standards. On average over the next five years, interest rates are only expected to rise by
13 basis points per quarter in the US, 9 basis points in the UK, 7 basis points in the
euroarea and 2 basis points in Japan. This, truly, is a brave new world: in my time at the Bank of
England I can recall UK interest rates rising by 5 percentage points in a day.
Moreover, even these estimates may overstate the future path of interest rates implied by
financial markets. Market interest rates are probability-weighted averages of different
possible interest rate paths - they are a mean. Model estimates of the modal - or most likely
- path for interest rates are lower still (Chart 3).
Estimates of the modal path of interest rates are drawn from estimated models, so are no
more than illustrative. Nonetheless, the modal interest rate three years ahead in the US is
only 1.1%. In the UK it is 0.8%, little changed from current levels. According to these
estimates, the glue holding interest rates to the floor looks stronger still.
There is an old English aphorism, due to Walter Bagehot in the 19th century: "John Bull can
stand many things, but he cannot stand 2%". Prior to 2009, the Bank of England had been
careful to avoid the wrath of Mr Bull: Bank rate had never been below 2% in its then-315 year
history.
For the past six years the MPC has been testing the patience of Mr Bull, with the 2%
threshold consistently breached. If financial markets are to be believed, Mr Bull, Mrs Bull,
and their children are set to have their patience tested further: UK rates are not expected to
reach 2% until 2019.
So whatever is gluing official interest rates to the floor in major economies is proving
remarkably resilient. What factors are responsible? Are they temporary or permanent? And
what are their implications for financial markets, the economy and monetary policy?
There are many factors which explain the extra-ordinary current constellation of yields. Many
of these factors pre-date the crisis. Global real rates have been falling for over three decades
(Chart 4). They averaged 5% in the 1980s and 4% in the 1990s. So far this century, they
have averaged 2%. Currently, they are around zero or slightly negative.
At a Parliamentary Committee hearing a few years ago I asserted, boldly, that global interest
rates were at their lowest-ever levels. A wise colleague challenged me afterwards: "How do
you know they weren't lower in Babylonian times?" Several exhausted research assistants
later I can report that, luckily, I was on safe ground. Interest rates appear to be lower than at
any time in the past 5000 years (Chart 5).
The explanations for this secular fall in global real rates include excess savings in the East,
deficient investment in the West, worsening demographic trends and rising inequality
(Haldane (2015a)). Some have interpreted their downward drift as evidence of secular
stagnation, in an echo of concerns raised after the Great Depression (Summers (2014)).
Whatever the explanation, there has been a further ratchet down in global real rates since
the crisis. I wish to focus on two factors which have contributed to this fall: dread risk and
recession risk. The first generates an elevated perception of risk, the second an asymmetric
balance of risk. Both are relevant to explaining the path of interest rates, the likely fortunes of
the economy and the optimal setting of monetary policy.
Dread risk
In their classic account, Friedman and Schwartz (1963) believed pessimism among
households and businesses played a key role in explaining the severity and persistence of
the Great Depression: "The contraction instilled an exaggerated fear of continued economic
instability, of the danger of stagnation, of the possibility of recurrent unemployment." In other
words, economic depression contributed to psychological depression, and vice-versa, in a
feedback loop.
Subsequent research has lent support to Friedman and Schwartz's hypothesis.
Psychological studies show that catastrophic events generate an exaggerated sense of fear
and insecurity. This causes people to over-estimate systematically the probability of these
dread events re-occurring, relative to their true probability.3 Perceptions of risk, in other
words, are exaggerated. Psychologists call this "dread risk" (Slovic (1987)).
Dread risk has been shown to be associated with events which, although low probability, are
high impact. Specifically, they are associated with large losses among a large number of
people occurring at the same time. Prominent examples of "dread risks" with these
characteristics are plane crashes and terrorist attacks, such as 9/11 in the US.
This exaggerated sense of risk is stronger, the more recent the event. In other words, the
over-estimation of risk is subject to time decay. This is known as disaster myopia (Guttentag
and Herring (1986)). Rates of time decay from dread events are, however, typically slow.
While the psychological scars from dread events fade, they do so only gradually and never
fully disappear.
Although the over-estimation of risk is, in one sense, "irrational", its anthropological roots are
deep. They are found in the hunter-gatherer communities that existed thousands of years
ago, typically involving groups of 50-100 people. Simultaneous loss of 100 people would, in
this setting, have threatened these communities' very existence. And this "dread" appears to
have hard-wired itself into our psyche to this day (Gigerenzer (2014)).
The consequences of dread risk may not, however, be benign. It generates risk-averse
behaviour which, while instinctive, may be counter-productive even from a risk perspective.
The dread risk associated with 9/11 led to an exaggerated fear of flying and a sharp rise in
car use. The loss of life from this increased car use may have been greater than the loss of
life from 9/11 itself (Gigerenzer (2014)). This is the paradox of precaution.
The self-same logic applies when moving from catastrophic losses of life to catastrophic
losses of livelihood. Financial crises are the classic example of such catastrophic events.
They too cause large losses of income by a large number of people at the same time. In
other words, they have all the hallmarks of a dread event, albeit one associated with
economic, rather than physical, insecurity.
The Great Depression was the most prominent example of an economic dread event in the
20th century. Historical accounts point clearly to it having generated an exaggerated sense
of insecurity (Galbraith (1954)). One way this manifest was a surge in demand for safe
assets. In Friedman and Schwartz's words: "Expectations of great instability enhanced the
importance attached to accumulating money and other liquid assets".
In the 1930s, this search for safety resulted in a rise in the demand for, and price of,
government securities, lowering their yield. The yields on US and UK government bonds fell
significantly and persistently during the 1930s (Chart 6). Insecurities revealed themselves in
securities.
The Great Depression also widened the gap between the return on safe and risky assets
such as equities. This wedge - the equity premium - appears to have risen sharply after the
Great Depression. It remained elevated for several decades thereafter. In finance circles, this
is known as the "equity premium puzzle" (Mehra and Prescott (1985)).
Recent academic evidence has argued, persuasively, that this puzzle can be solved by
recognising that the Great Depression, and other catastrophic output losses, are dread
events which exaggerate and prolong risk perceptions. Catastrophe risk then explains the
size and persistence of the equity premium (Cogley and Sargent (2005), Barro (2005)).
As with other dread events, precautionary responses to the Great Depression worsened its
impact. It blunted entrepreneurial activity, with fewer start-ups of new businesses and lower
take-up of external financing (Malmendier and Nagel (2011)). Moreover, this scarring effect
on risk-taking lasted a whole generation, consistent with a slow rate of disaster time decay.
These precautionary responses reduced investment and innovation by companies, adding to
the depth and persistence of the recession and amplifying insecurities in a negative loop.
This is what Keynes called the paradox, not of precaution, but thrift (Keynes (1936)).
After the Great Depression, the next largest financial crisis of the 20th century was probably
the Asian financial crisis of the late 1990s. Like its predecessors, this caused catastrophic
losses of income for a great many people across Asia at around the same time. In other
words, it too bears all the hallmarks of an economic dread event.
As in the past, this caused a precautionary shift into safe assets, lowering the yield on US
bonds by a similar amount and for a similar period as after the Great Depression (Chart 6).
The increased demand for safety was concentrated among Asian countries. But the fear of a
similar dread event spread to other potentially vulnerable emerging markets too.
In response, they built war-chests of foreign exchange reserves: the global stock rose 6-fold
between 1997 and 2012, from $2 trillion to $11 trillion or from 5% to 16% of world GDP
(Chart 7). The consequences of this precautionary response were far from benign. The
global glut of savings is believed by many to have sowed the seeds of the subsequent global
financial crisis (Bernanke (2005), Wolf (2014)).
That global financial crisis is the most damaging economic and financial event since at least
the Great Depression. To put it in context, Chart 8 plots the distribution of annual GDP
growth across four countries since 1870 and in the UK since 1700. It highlights outcomes
around the Great Depression and the Great Recession. Both occupy a place in the left tail of
the historical growth distribution.
The precautionary responses to these crises have been similar, with the fall in US and
UK government bond yields since the Great Recession mimicking that after the Great
Depression (Chart 6)). As in the 1930s, the global financial crisis also appears to have
caused the equity premium to rise (Chart 9). This time, perhaps it is not so puzzling.
Pre-crisis, one of the causes of low global real rates was felt to be the insufficient supply of
safe assets (Caballero and Farhi (2014)). Since the crisis, the deteriorating fiscal position of
many countries has helped solve that problem. Since 2010, the US, UK, the euro-area and
Japan have issued around $11 trillion in government securities.
Yet over the same period, global real interest rates have fallen further. The demand for safe
assets has overwhelmed this additional supply. Through their asset purchase programmes,
central banks in the UK, US, Japan and the euro-area have purchased government assets
totalling around $5 trillion since the start of 2010.
But they have clearly not been alone. Most global banks have increased their holdings of
safe government assets and central bank reserve balances. Among US banks, the ratio of
liquid assets to total assets increased from 11% in 2009 to 15% in 2014, while among
UK banks it rose from 20% to 23%.4 That has been in part for precautionary purposes and in
part in anticipation of new regulatory requirements.
Among companies in the UK, US and Europe, there has been a significant increase in their
liquid asset holdings, of around $0.5 trillion since 2008, mostly for precautionary purposes.
And among institutional investors, there has been a further portfolio switch into bonds since
the crisis. Since 2009, the size of US bond funds has more than doubled, rising from
$1.5 trillion to $3.5 trillion.
As after the Great Depression and the Asian financial crisis, this precautionary behaviour has
not been confined to the government bond market. It has affected spending behaviour
among households and companies too. And, as previously, the consequences for the wider
economy have not been benign.
In 2008, households and companies were running a combined financial deficit (income less
spending) of 2.4% of GDP in the US and 1.5% of GDP in the UK, while in the euro-area they
were running a small surplus of 2.4% of GDP (Chart 10). In other words, the private sector in
aggregate was neither saving nor dissaving to any great degree.
By 2010, the private sector had switched to a large financial surplus of 7.2% of GDP in the
US, 8.2% of GDP in the UK and 5.8% of GDP in the euro-area. The private sector was now
saving and in significant scale. This precautionary behaviour, as after the Great Depression,
has proved persistent. It has only recently started to normalise.
This is a 21st century paradox of thrift and precaution. The psychological scars of the Great
Recession, as after the Great Depression, have proved lasting and durable. They help
explain the sluggishness of the recovery, and the adhesiveness of interest rates, since the
crisis. And, if the past is any guide, these scars may heal only slowly.
Recession risk
Psychological scarring affects how people perceive and respond to risk in the past. As
important for monetary policy, however, is the economic and financial risk people expect to
face in future. Another lower left tail event could further frazzle the nerves and set back
recovery and risk appetite. Just how likely is that?
Looking at the long-run pattern of growth, across countries and time, gives some guide to the
probability of a future tail event, such as a recession. As Chart 8 illustrates, the historical
distribution of growth is fat-tailed and negatively skewed (Haldane (2012)). Large recessions
are significantly more likely than, for example, the normal (or bell) curve might lead us to
expect.
Based on historical data, the probability of a recession (defined here as a negative rate of
annual GDP growth) over the following year lies between 17% (taking cross-country
evidence since 1870) and 30% (if we take the UK since 1700). In other words, a recession
should be expected one in roughly every 3 to 6 years. Of course, the distant past might be a
poor guide to the future. But even if we took the period since 1945, the probability of
recession would only fall to 12%, or one year in around every 10.
These are probabilities over a one year horizon. In practice, what matters for spending and
saving are people's risk perceptions over a longer-term horizon. By making some
assumptions about how these probabilities evolve over time, it is possible to construct
cumulative probabilities of recession.
Chart 11 shows the cumulative probabilities of recession over a ten year horizon using two
long-run cross-country GDP samples.5
Over the course of a decade, the risk of experiencing at least one recession rises steadily,
reaching between 85-90% after ten years. Using post-war data, this cumulative probability is
just less than 80%. So over any plausible sample period, a recession remains considerably
more likely than not over the course of a decade.6
That is not to say longer periods of interrupted growth are impossible. The world has in the
past experienced lengthy periods of continuously positive annual growth: in the UK, for a
remarkable 26 years after the Second World War and for 16 years during the Great
Moderation starting in the late 1990s. As Chart 12 shows, however, these are extreme
outliers in the distribution of expansions. The probability of an expansion lasting for longer
than 10 years is, on past evidence, less than 10%.
If a recession were to strike in the period ahead, a relevant question for monetary policy is
how much room for manoeuvre might be necessary to cushion its effects. History can again
offer some guide. Table 1 looks at loosening cycles in the UK, US, Germany and Japan in
the period since 1970 and in the period since 1994.
There has been considerable variation in the scale and duration of loosening cycles over
time and across countries. Nonetheless, Table 1 suggests that the average cycle has
typically been in the range 3 to 5 percentage points - towards the upper end in the period
since 1970, towards the lower end in the period since 1994. Fairly sizeable degrees of
interest rate headroom have been necessary in the past.
An interesting thought-experiment is to assess the likelihood of future interest rates having
risen sufficiently to give monetary policy the headroom necessary to cushion a recession.
Chart 13 plots a set of cumulative probabilities of official interest rates exceeding a set of
interest rate thresholds - 2% (the "John Bull threshold"), 3% (the average loosening cycle
since the 1990s) and 5% (the average loosening cycle since the 1970s).7
With yield curves currently low across the major advanced economies, the probabilities of
interest rates exceeding these thresholds are modest. Even at a ten-year horizon, the
probability of UK rates exceeding 2% is only around 50%, 3% around 40% and 5% around
20%. If financial markets' guesses about interest rates are realistic, it is odds-against there
being sufficient monetary policy headroom to cushion a typical recession.
If we now compare the probabilities of interest rates being at these thresholds with the
probabilities of recession, a striking conclusion emerges. Recession probabilities exceed
interest rate threshold probabilities by a factor of anywhere between 1.5 and 4 (Chart 13).
For example, a conservative estimate of the probability of recession over a ten-year horizon
is around 80%. The probability of interest rates having 3 percentage points of headroom over
this horizon is around 40%.
Put differently, based on these estimates there is a considerably greater chance of interest
rates needing to be cut to their floor to meet recessionary needs than of them gliding back to
levels that could safely cushion a recession. Even after interest rates have lifted off from their
floor, it is more likely than not they may return there over a ten-year horizon. For the
foreseeable future, the effective lower bound will exert a strong magnetic pull.
Another way of illustrating the same point is through the lens of real interest rates. In the
1990s, they were around 4%. With a 2% inflation target, that meant nominal interest rates
would be expected to average around 6% over the cycle. That would give more than enough
room to cut interest rates to cushion recession in a typical loosening cycle.
Today, global real rates are around zero. With 2% for inflation, that gives a nominal interest
rate of only around 2% over the cycle. That would give insufficient room above the effective
lower bound to accommodate a typical loosening cycle. Provided real rates remain low, the
lower bound constraint is likely to form part of the new normal.
Of course, part of the reason the yield curve is low in the first place is because markets are
weighing recession risk, perhaps using historical probabilities. That drags down the yield
curve by an amount equal to the probability of recession multiplied by the lower interest rate
bound. As recession probabilities dominate over medium-term horizons, so too does the
magnetic attraction of the lower bound on the yield curve.
There are plausible reasons why financial markets might currently be over-pricing recession
risk, causing an excessive downdraught to the yield curve. Psychological scarring is one
such explanation. Nonetheless, historical experience suggests these recessionary fears are
not unreasonable. Those fears provide a plausible explanation for why interest rates are, and
are expected to remain, resolutely stuck to their floor.
Monetary policy implications
Given these risks, what are the implications for monetary policy? Growth in the UK remains
solid. Robust private sector demand has been a key contributor, with household consumption
growing steadily for two years, largely funded by a pickup in real incomes. Despite some
signs of slowing recently, business investment has also remained robust. We have seen a
reasonable, and reasonably balanced, recovery.
The forecasts for GDP and inflation contained in the Bank's May Inflation Report envisaged
these broad patterns continuing. Growth was expected to remain around its historical
average rates over the next few years, while inflation was expected to rise from its current
near-zero rates to reach 2% after two years. Earlier this year, I used the central paths from
the February Inflation Report to generate some interest rate trajectories, assuming monetary
policy was set to minimise current and future deviations of inflation from target and output
from trend (Haldane (2015b)). It is useful to update these interest rate paths for the MPC's
latest GDP and inflation forecasts.
These are shown in Chart 14. The interest rate profiles are relatively similar to those in
February. As then, they suggest the optimal path for interest rates involves an immediate cut
in rates for about a year, which pushes inflation back to target and closes the output gap.
Thereafter, interest rates rise gradually in line with the market curve.
As with any model-based simulation, these interest rate paths are no more than illustrative.
Nonetheless, I find they serve as a useful benchmark: what is it about the economy, not
captured by the model, which would cause me to deviate from this path? Earlier in the year,
these types of simulations played a role in my judging that a neutral stance on the future
direction of interest rates was a prudent course.
One important drawback of these model-based simulations is that they tend to underplay the
effects of risk, focussing instead on central paths for growth and inflation. So how might risks,
including dread and recession risk, affect the path of demand and the optimal interest rate
trajectory in the period ahead?
In principle, dread risk affects demand in two ways. First, it generates an attitude of caution
when making major decisions - moving house or job or making an investment. People will
tend to look before they leap, to think twice before diving in. It creates the mind-set of the
glass being half empty.
Second, insecurity generates an asymmetric response to news flow. Good news will be
banked or used to strengthen balance sheets. Roofs get repaired during the sunshine. But
when bad news strikes, the response is immediate and defensive. There is a hunkering
down, with cuts in spending and risk-taking.
The exact opposite psychological traits are, of course, exhibited during a boom. Then, good
news is spent and bad news borrowed against. Roof repairs are deferred, whatever the
weather. The glass is half full. There is a wealth of experimental evidence documenting these
psychological swings and asymmetries.
Despite the recovery, evidence continues to suggest a "half-empty" mind-set. World growth
has, since 2010, averaged less than 4%. Forecasts have been consistently over-optimistic by
1⁄2 percentage point per year. The evidence so far during 2015 suggests this pattern may
continue. Caution is a plausible explanation for this dragging anchor.
The household sector has undertaken significant balance sheet repair since the crisis,
dragging on spending.8 This can be seen in the proportionately greater belt-tightening
exhibited among highly-indebted consumers (Chart 15)). These debt-induced adjustments in
spending have also been important among US consumers (Mian and Sufi (2014)).
Several other features of household decision-making over recent years might also plausibly
reflect the effects of insecurity: weak transactions in the housing market, which are 20%
lower than their pre-crisis average; subdued job-to-job flows in the labour market, which
remain below their pre-crisis average; and real wages which remain lower than historical
relationships can explain, as workers' bargaining power has been sapped.
Over the past year, this cautious behaviour has been evident in households' response to the
income windfall arising from the fall in oil prices. This has boosted real incomes by perhaps
0.4%. And it appears also to have boosted consumer confidence. What it appears not to
have translated into, or at least not yet, is higher consumption: retail spending growth is little
different than before the oil price fall (Chart 16).
One interpretation is that consumers are simply waiting to see if the fall in oil prices persists.
My preferred interpretation is that it reflects instead the asymmetric response of a cautious
consumer: good news has been banked, not blown. Consumers are pleased their glass is
now less than half empty. But they are no more willing to drink it.
This cautious behaviour is, to a degree, also mirrored among companies. This can be seen
in the weakness of global investment since the crisis, despite the cost of company borrowing
being at its lowest-ever levels (Chart 17). Uncertainty-induced weakness in investment has
provided a continuing drag on recovery, globally if not nationally.
This uncertainty can be seen, too, in how companies are reinvesting their earnings. The
trend over the past 20 years has been for companies to invest more in passive assets such
as cash, than active ones such as physical capital. But this trend has been accentuated
since the crisis. Table 2 looks at the ratio of liquid assets to investment by the corporate
sectors in the UK, US, France and Germany.
These ratios have risen sharply since the crisis, on average by around 70 percentage points.
Companies are not just saving more of their earnings. They are doing so in a more liquid
form than previously. As among consumers, business confidence has risen in lockstep with
profits. But this good news has been banked, not invested. Despite the sunshine, many
companies are still engaged in roof-repair.
Growth in the UK, the US and some other countries remains solid, if unspectacular. But
caution increases the chances of world growth continuing systematically to underperform, as
it has since the crisis. By generating an asymmetric response to good and bad news, it may
also skew growth risks to the downside, again as we have seen.
While emphasizing the downside, it is important not to forget the potential for upside risks.
The upside risk that has generated most attention over recent weeks has been wage growth.
At a headline level, this picked up to 2.7% for regular pay growth on an annual basis in April,
from a low of 0.7% as recently as the summer of last year. This is around 0.2 percentage
points higher than forecast in the Bank's May Inflation Report.
This pick-up in wage growth is welcome. Indeed, this rise is a necessary ingredient for
getting inflation back to target in the period ahead. Equally, were wage inflation to continue to
surprise to the upside as the labour market tightens, this could pose an upside risk to
inflation, with corresponding implications for the MPC's monetary policy stance.
It is important also, however, to place this wage news in context. This most recent upside
surprise comes against a backdrop of wage growth having surprised to the downside for
much of the past two years. Up until last month, wages had surprised to the downside in
11 of the past 18 months. That has left the level of regular pay in the economy 2% lower than
we expected 18 months ago, even with the recent news.
Second, one explanation for the recent weakness of wages has been the compositional
effects of a greater number of lower-skilled, lower-paid workers entering the job market. This
has clearly had some, probably temporary, depressing effect on wage growth. Over the
postcrisis period as a whole, however, compositional effects have not depressed wages. Rather,
they have inflated them. Without composition effects, the level of wages today would be
around 1% lower, not higher.
Third, my visits to the Bank's regional agencies over the past few weeks talking to
businesses leave me confident wages are not about to embark on a rocket-propelled ascent.
Settlements seem to have edged up from first to second gear: they are now often in the
"2-point-something" zone. But with the exception of a few regions and sectors, I do not yet
see evidence of wage inflation going through the gears into third or fourth.
Fourth, since the May Inflation Report sterling's effective exchange rate has appreciated a
further 3%. That will exert a downward drag on demand and inflation over the policy horizon:
using the Bank's model ready-reckoners, by around 0.2 percentage points at the two-year
horizon. In other words, the exchange rate news may be more important quantitatively for the
two-year-ahead inflation outlook than the recent news from wages.
April's wage data was news, encouraging news. And the Phillips curve may well be
reemerging after several years in hibernation. But one swallow does not a summer make. As
Aristotle inexplicably did not add, "especially once you adjust for compositional shifts". Wage
growth is causing some fluttering, but not in this dovecote.
One reason for that is because expectations of inflation (the MPC's primary objective) at the
two-year-ahead point (the MPC's preferred horizon) are skewed, if anything, to the downside.
Chart 18 plots the MPC's forecasts for inflation at different horizons, alongside companies',
households', financial markets' and professional forecasters' projections.
At the two-year point, outside forecasters' inflation projections lie below the MPC's. The MPC
sees a 50% chance of inflation exceeding its target two years hence. Outside professional
forecasters put that probability at just over 40%. Only around a third of companies and a
quarter of households expect inflation to be above the target at that point.9 The balance of
risks, as perceived by those setting and receiving wages, is skewed squarely to the
downside.
That leads naturally to questions of monetary policy strategy. There is clearly a tightrope to
walk here: lean too much in an expansionary direction and the inflationary cat is let out of the
bag (assuming it isn't already stuck in the tree with that kite); lean too much in a
contractionary direction and the recessionary gorilla is unleashed (ditto).
The asymmetric risks posed by the effective lower bound have led some to suggest that the
optimal strategy is to leave rates "lower for longer" (Evans et al (2014)). The argume