Pod Insights Odd Lots The Bank of England's Megan Greene on Monetary Policy in a World of Supply Shocks About this episode Ever since Covid, central banks around the world have had the same problem. They have tools that are designed to modulate demand, but so many challenges have involved the supply side of the economy. Whether we're talking about supply chain disruptions, the war in Ukraine, and now the war in Iran, these are all issues for which monetary policy is of limited value. Of course, the temptation is to "look through" these events, recognizing the fact that these disruptions don't say much about the actual underlying state of the economy. But when we get one shock after another, it gets harder and harder to keep using words like "transitory." On this episode we speak with Megan Greene, an external member of the Monetary Policy Committee at the Bank of England. We talk about the compounding effects of all these shocks (including the trade war and Brexit), how she's thinking about the first- and second-order effects of each, and why for now, despite the underlying weakness of the UK economy, she remains squarely focused on the risks of higher inflation. Subscribe to the Odd Lots NewsletterJoin the conversation: discord.gg/oddlotsSee omnystudio.com/listener for privacy information.
Transcript 10,769 words · 8 speakers
Speaker names marked ? are inferred from speaking time and the show’s known hosts — they are not voice-verified.
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1:12 Tracy Alloway? Hello and welcome to another episode of the All Thoughts Podcast. I'm Tracy Alockway.
1:16 Joe Weisenthal? And I'm Joe Weisenthal.
1:17 Tracy Alloway? Joe, you know one nice thing about getting old?
1:22 Joe Weisenthal? Go on.
1:23 Tracy Alloway? I've been thinking about this a lot, actually. The nice thing about getting old is that a lot of people that you have known for a very long time and that you've sort of grown up with, let's say, over the years, start to get into really interesting positions and sometimes senior positions or sometimes positions of power.
1:43 Joe Weisenthal? I love this take. Right. Yeah. There are certain people that you don't get to know or you're, you know, when you're in your twenties or whatever, your peers are your peers and that's great, but they probably aren't, for example, external members of the Bank of England Monetary Policy Committee and so forth, or other such roles. But as you get senior, you're like, oh, wow, I know that person. I recognize that name. As you guys like to say, who went to university in London, I went to uni with that person. My impression is that everyone in London, quote, "went to uni" with literally everyone else, because I've heard you and Sid say that specific phrase so many times over the last decade.
2:21 Tracy Alloway? No, not that often, surely. But you're absolutely right. You've sort of given the guest away.
2:26 Joe Weisenthal? Yeah, I know.
2:26 Tracy Alloway? We're going to be speaking with someone that we've known for a long time, and I think a lot of people have known her for a long time, from her very public role on finance Twitter.
2:36 Joe Weisenthal? That's right.
2:36 Tracy Alloway? As they say, and also in various columns in different media organizations.
2:41 Joe Weisenthal? And professional roles in their serious jobs.
2:43 Tracy Alloway? And professional roles. To me, she will always be a member of finance Twitter.
2:47 Joe Weisenthal? That's right.
2:47 Tracy Alloway? But yes, various professional roles. And now she is, in fact, an external member of the Monetary Policy Committee at the Bank of England.
2:53 Joe Weisenthal? And it's a really interesting time, of course, to be talking about monetary policy. I mean, I would say it's an interesting time, it's always an interesting time to be talking about monetary policy, but I would say it's a particularly interesting time, because I could list several reasons for that. So obviously, we are still in the wake of the incredible inflation wave that we had post-COVID, and at least in much of the world, inflation has not returned to target. In fact, in some countries, the rate hike cycle has begun, so there's still the live issue. There is the shifting political situation in many countries in which the very premise of like, well, how much independence should the central bank have to operate is being rediscussed and so on.
3:36 Tracy Alloway? And it is, in fact, local elections in the UK right now.
3:39 Joe Weisenthal? That's right. We're speaking during a week of local elections. And then, of course, COVID, shock, maybe transitory, a one-off thing. Governor Christopher Waller in the US, he had a good speech recently called "One Transitory Shock After Another," of course, in this case alluding to the war in Iran. And so what does the price in oil and so forth mean for inflation? There are so many interesting questions right now for anyone in the seat of a monetary policymaker.
4:04 Tracy Alloway? So much. And also the interaction between monetary policy and the bond market as well, right? So we're recording this, I feel I have to say this for every episode now, on May 6. Yesterday, we saw the 30-year UK gilt yield hit its highest since 1998, and that was after the BOE decision from last week to actually hold interest rates. So there's a tension there. Anyway, we have so much to talk about.
4:27 Joe Weisenthal? So much.
4:28 Tracy Alloway? Truly the perfect guest. We are, of course, going to be speaking with Megan Green. Thank you so much for coming on the show, Megan.
4:33 Speaker 04 Thank you for having me. It's great to see you guys again.
4:36 Tracy Alloway? It's very, very fun, very nostalgic. What's it like to go from, I guess, thinking and writing and tweeting about economics to actually practicing economics? Yeah, setting economic policy.
4:48 Speaker 04 Yeah, so first of all, I love that you guys think of me as finance Twitter.
4:52 Joe Weisenthal? Core, core, old school.
4:53 Speaker 04 Certainly was not paying any of my bills.
4:55 Joe Weisenthal? I bet not.
4:56 Speaker 04 Over the years, now sadly, my Twitter account is relegated mostly to baseball commentary.
5:01 Joe Weisenthal? Understand.
5:02 Speaker 04 Go Red Sox. But you know, it's very different to go from kind of analyzing and forecasting what central bankers will do to being a central banker and, you know, making the sausage myself. So it's a very different position with a whole lot more responsibility.
5:18 Joe Weisenthal? We like talking to Americans who have served on the MPC.
5:21 Speaker 04 Who's made it.
5:21 Joe Weisenthal? Yeah, well, we've, you know, Adam Posen has been on the show.
5:24 Speaker 04 There's hope for us, Joe.
5:25 Joe Weisenthal? A bunch of times. So, you know, it's plausible that you and I could be MPC members. What is your role? What does it mean to be an external member of the MPC at the BOE?
5:33 Speaker 04 Yeah, so that's a great question. And the Bank of England is pretty unique for its setup this way. So the Monetary Policy Committee, which meets every six weeks and votes on interest rates, is comprised of nine people. Five are so-called internals and four are so-called externals. And the internal members are the governor, the deputy governors, and the chief economists. Some of them grew up at the Bank of England, some of them didn't, some of them came in, but they're all part of the executive. And then the four external members of the MPC, of which I'm one, quite intentionally came from outside the bank. And what that means exactly is, you know, differs in every case. So it could be from outside the industry entirely. It could be from outside the country, as you can tell from my accent, and also from my background. I'm a little bit of both, although actually I'm also British, so I'm not sure how they're... Oh, I know that.
6:18 Speaker 04 Yeah, by passport. I'm not sure how they're classifying me. But there's always been an American, actually, on the MPC. It's not a rule.
6:24 Joe Weisenthal? So you and Adam aren't the first?
6:27 Speaker 04 No, so there have been, yeah, there have been others. But the idea is just to have, to quite intentionally bring in different perspectives. The external members sit in a different part of the bank from the internal members so that we don't all collude and get stuck in group think. So the idea is to have different perspectives. I come from the private sector. Many members of the MPC come from academia, so I bring kind of the business environment, corporate side of things, and also from outside the country. So I spend a lot of time looking at international spillovers. You can see in my speeches how the UK's Affected by things happening in the US and the Eurozone, for example. So the idea is to just fight group think. And you can see that often in our votes, right? We're also unique for reporting who voted for what every time.
7:11 Speaker 04 And so you you can see what the vote split is.
7:14 Tracy Alloway? Figuring out which dot is who.
7:16 Joe Weisenthal? So in the US they report, but I guess in in Europe they don't, right? So you don't actually get those vote counts or you don't know who if they dissented or what.
7:25 Speaker 04 That's right. People can out themselves if they want to. But at the Bank of England, we're fully transparent about all of that. And so you can see that often there are dissents. In fact, after the last Fed vote, I had a number of friends say, gosh, the Fed looks a lot like the MPC right now because there were four dissents.
7:38 Joe Weisenthal? Yeah.
7:39 Speaker 04 It's quite normal to have dissents at the Bank of England, which is pretty different from most major central banks. But it's all part of this idea of sort of personal accountability for your votes and having different perspectives on a committee.
7:50 Tracy Alloway? You kind of anticipated my next question, but how much of your role is viewed as sort of explaining perhaps US monetary policy and its potential impact on the UK versus actually analyzing the UK and having to know that particular economy? And, you know, when you first joined the MPC, did they hand you like a UK economic handbook that you had to like get up to speed on?
8:16 Speaker 04 So, no, there was no handbook, but I did have to get up to speed pretty quickly, including up to speed with kind of the data in the UK, which is quite different from the US. But my role really is about looking at the UK economy, trying to understand what's going on, but also understanding how there are spillovers from other places. So by way of example, before the pandemic, when the gilt yield curve moved, about a third of that move was usually from outside the UK entirely. So from mostly from the US and also the Eurozone. Since the pandemic, it's been about half of the moves in our yield curve. So financial conditions are affected pretty significantly by what we have absolutely no control over whatsoever at the Bank of England, but it's important to understand how those spillovers might happen.
8:59 Speaker 04 You also have spillovers via trade, which obviously we've looked into a whole bunch through the past year, given tariffs and the economic statecraft.
9:06 Joe Weisenthal? It occurs to me, well, I actually don't, what is the BOE's mandate? Of course, in the US, it's the famous dual mandate. My understanding is the ECB is a more ostensibly singularly priced mandate. What is the BOE's mandate?
9:18 Speaker 04 Yeah, so our mandate is to achieve price stability of 2% inflation sustainably over the medium term and then subject to that to support the goals of the government. But it really is, whereas the Fed does have a dual mandate, we really have one primary mandate and the rest is secondary to that.
9:37 Tracy Alloway? How would you characterize the health of the UK economy at the moment? And Jo and I get to ask this very basic question because we don't live here. And you know, we see the headlines that everyone else does. We see headlines about energy shocks, trade and tariffs, as you mentioned. But then we walk around the city and things seem pretty crowded and people seem to be eating out and shopping.
9:59 Joe Weisenthal? In central London, where the tourists go, things look plenty active to me.
10:03 Tracy Alloway? That's right. How would you describe it at the moment?
10:05 Speaker 04 Yeah, particularly on a Tuesday through a Thursday, less so on a Monday or Friday. And people aren't necessarily coming into the office. Look, the UK economy has been pretty weak. It's been weak since I started this role three years ago. And the question is why it's so weak. And most economists, you guys included, I imagine, think of the economy through the demand side because that's what we were all taught for generations to just think about demand. And so, demand is pretty weak in the UK, but actually the supply side is pretty weak as well. And as you mentioned earlier, Jo, has been hit by a number of successive supply shocks. And so, we have growth that's, it's there, there's some, but it's pretty weak.
10:47 Speaker 04 And even though you have variations, we have monthly GDP data in the UK, which we don't have in the US. That was a real surprise to me. But there are, you know, variations in the monthly GDP data, but underlying GDP, which is what we tend to look at, and we build it based on a bunch of surveys, that's pretty weak, you know, 0.2% growth per quarter. So, that's not significant. That said, the supply side of the economy is also pretty weak. And so, if you had more demand than that, that could actually... Actually end up becoming inflationary.
11:18 Joe Weisenthal? Yeah, just intuitively, you know, you mentioned the supply side and like much of the sort of developed Western world, there is the, okay, there's the struggles of the industrial sector in large part due to competition with China. There is the fact that if you're in a sector that's not AI, you're probably not getting a ton of investment. The London is, what I, London specifically at least, a decent AI hub. Okay, so we've established that the economy is somewhat weak, but you voted to hold rates. So what is it about the inflationary environment such that this weakness does not call for cuts right now?
11:56 Speaker 04 Yeah, so part of that story is the supply side, which is also incredibly weak. So if you had stronger growth, that could be inflationary. But I think it's worth thinking about where the UK economy was before the war in Iran, before we had this energy shock, because I think my and others' views on where we are right now very much depends on where we started from. So before, a few months ago in February, you know, we had inflation that was still above target. It was coming towards target, but was still above target. We've had inflation above target for the best part of five years now in the UK. So it's been above 2% for all but one or two months in the past five years. And that's off the back of a couple of successive shocks, particularly
12:36 Speaker 04 COVID and also the Russian invasion of Ukraine. And so as we were looking at inflation start to come down towards our 2% target, it had been coming down more slowly than we had hoped since I got here, in fact. And if you looked at some of the forward looking indicators for wages and also for prices, those actually seem to be stalling out. So we run a survey called the Decision Makers Panel, the DMP, where we ask companies about their own price expectations a year ahead and their own wage growth expectations a year ahead. And their own price expectations a year ahead had pretty much stalled out. So they weren't really coming down anymore. Also, more worrisome, in my view, was what they thought about wages a year ahead,
13:19 Speaker 04 where they thought they were going to drop a little bit from last year. So not much, not as much as we had expected.
13:25 Joe Weisenthal? Wage growth was.
13:26 Speaker 04 Wage growth was going to drop a little bit. That's right, not wages, wage growth. And also, we have agents who are based around the country who go and talk to firms. They do a whole survey on pay settlements. And pay settlements were due to come in a bit lower. This year, pay settlement growth was due to come in a bit lower than it was last year. So this disinflationary process had signs of stalling out. Also, if you look at inflation expectations, so household inflation expectations were really elevated before Iran was invaded. In fact, up until February, they were above what you could explain, looking at historical relationships between inflation outturns and inflation expectations. So it was a concern that households were thinking that inflation was going to be higher.
14:10 Speaker 04 That could feed through into wage setting, which could explain why wage growth was coming off more slowly than we'd expected. And therefore, price growth was coming off more slowly than we'd expected. So there were already some signs of some persistence from previous shocks left in the economy. In fact, I've been working on a speech on second round effects since before Iran was invaded. And part of me thought, gosh, is this going to be irrelevant? You know, in six months, when I finally give this speech, of course, it's only more relevant now. But I was already worried about some of this inflation persistence and some of the second round effects from the last couple of negative supply shocks, even before Iran was invaded. And of course, since then, we've now had a negative supply shock, an energy shock.
14:52 Speaker 04 And that stands to push inflation up and growth down, which is a terrible situation for a central banker to be in.
14:59 Tracy Alloway? So just to emphasize this point, is the idea that if we keep getting transitory shock after transitory shock? Or if we keep getting, I think you've used the word mini waves of inflationary bouts over and over and over again. Expectations will be more vulnerable towards higher inflation levels. So people will be even more worried about inflation once we get like the third shock and the fourth shock.
15:22 Speaker 04 That's right. And the size of the shock matters too. So inflation was 11% a couple of years ago. That was on the front page of every newspaper. Households kind of knew about it. They saw it at the grocery stores. So we've done a lot of research showing that households and businesses are possibly just more attentive to inflation. And particularly once inflation comes within a certain band, so there's a threshold. It used to be no one paid attention to inflation. If it was below 4%, that ban has actually shifted down. So in the UK, we think that if inflation is somewhere between 3%, 3.5%, that's the threshold at which people actually notice it a lot more. So if you then have another negative supply shock and inflation go up, people will be much more sensitive to that. We also have done research showing that people are more sensitive
16:07 Speaker 04 to upside surprises in inflation than downside surprises in inflation. And so that's a concern, given we're now facing rising inflation. And then for firms, when they're looking at inflation, it used to be, before we had these supply shocks, that firms kind of set prices on a schedule. And since the pandemic, they've shifted much more to state-dependent pricing. So when inflation gets higher, they set prices more often and pass through their higher costs through to the end user in the form of higher prices. And that's remained. So if you have more state-dependent pricing from firms, then actually you can get a pass-through from inflation expectations from them much more quickly.
17:00 Tracy Alloway? There are some market stories where you want every detail. Joe and I have made quite a few podcasts on that basis. But sometimes you've only got 10 minutes and just want to know what's moving markets, fast. That's the Barclays Brief podcast. Every week, experts from Barclays Markets and Research get you up to speed on what's happening and what to watch next. Concise, focused, and brief. Search Barclays Brief wherever you get your podcasts.
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18:50 Tracy Alloway? So with people clearly caring about higher inflation more than they care about deflation, being more attuned to higher inflation and with companies more willing to reset prices in the face of higher inflation. And to what degree does the BOE try to get ahead of higher inflation versus wait for it to actually emerge?
19:09 Speaker 04 Yeah, so the way that we think about these kinds of shocks propagating through the economy, it's sort of in three different phases. The first phase is kind of direct effects. So when you have an energy shock that automatically makes energy prices higher for everyone. In the UK, we actually have a price cap for households, the off gem price cap. And so households have been shielded from that bit until July and then they'll see energy costs go up. So this could happen in stages. But in any case, monetary policy doesn't kick in for 18 to 24 months, so it kicks in with a lag. So if we were to respond to that right now, by the time it hits the economy, it's just too late and we could risk suppressing activity unnecessarily. So mostly you look through direct energy effects.
19:53 Speaker 04 Then you think about indirect energy effects. So firms that are using energy pass it on. For example, food production is a great example. It's pretty energy intensive, both through fertilizer, but also transport. And so you see food. Prices start to go up, which I think we probably will see. And so those are indirect effects. And the jury's out a little bit amongst the central banking community on whether you should try to lean against indirect effects or not. Generally, you should try to lean against some of them, but not all of them, again, because of lags in monetary policy. The real kicker is second round effects. And that's when actually all these price increases start changing wage and price setting behavior. So that you get individuals and households saying, well, I can't, my money's just not going as far anymore.
20:38 Speaker 04 You're going to have to pay me more. And then firms might say, fine, we'll pay you more, but now our costs are higher. So we're going to pass that through in higher prices and that can turn into a bit of a spiral. We've looked at past supply shocks in the UK and every single one of them has had second round effects, but to very differing degrees, depending on the state of the economy at the time. So in 2008, 2011, 2014, 2022, you had second round effects in all of these situations. But the economy was very different in these different periods. We tend to look at 2022 because it's the most recent one. And I think for a lot of people, kind of the most scarring one, when you had energy costs go up so much.
21:20 Speaker 04 And in 2022, of course, it's worth remembering, we had just reopened after COVID. So you did have pretty strong demand and also the labor market was pretty tight. That's not the case now. Actually, we have much weaker demand in the UK economy and we have a much weaker labor market and it's continuing to weaken. So we have slack in the labor market. So that suggests that we shouldn't get the same degree of second round effects now that we did in 2022. I think that's of little comfort, actually. Those were pretty extreme second round effects. I also look at 2011, when the labor market was actually much weaker than it is now. You had unemployment of 8% in the UK and you had some second round round effects then. So right now, the economy is somewhere in between those two.
22:05 Speaker 04 So we will get some second round effects. It's impossible to calibrate them exactly in advance. The trick for us also is that, you know, we kind of know how to measure direct and indirect effects. Do that pretty easily. The second round effects are pretty difficult to measure. But of course, if we wait until we have real, concrete evidence of them, we're too late in responding. So we're going to have to make a judgment, a proactive judgment in advance about the size of the second round effects that we're going to want to lean against so that we can lean against them in time.
22:37 Joe Weisenthal? You know, Kirsten, I have a theoretical question I've been meaning to ask someone about this. When the inflation started to explode in the immediate wake of the pandemic, really globally, one of the stories that people like to tell was that monetary policy would have weaker teeth or be less effective in the US, in part because so many American households are on 30-year fixed mortgages. Unlike in much of the other Western world or the Anglosphere world, where a lot of people's mortgages reset regularly. Did that actually play out in practice? Did BOE decisions transmit quicker to the real economy? Because fewer households see their mortgage bill reset on a regular basis.
23:21 Speaker 04 Yeah, so we've done a lot of looking into the monetary transmission mechanism to see how the change in the structure of the UK mortgage market has affected things. Because to your point, in the UK, we weren't always all on two- and five-year fixed mortgages. In fact, you used to have longer-term fixes. You've had periods with variable mortgages.
23:39 Joe Weisenthal? Today, it's dominated by two and five.
23:40 Speaker 04 Mostly, it's two and five-year with, I think, an increasing number of variable mortgages. And so what you find is that it does transmit a bit more quickly. But it's also very different in the US. In the UK, you can port your mortgage with you. Whereas in the US, you can't. So there's an entire supply problem in the US that we don't face. We face supply problems in real estate in the UK, but for completely different reasons. So that's a difference that's worth taking into account as well. But it's also meant, even though it's a shorter fix that we have here, it does mean that, you know, over the course of this hiking and cutting cycle, even though rates have been coming down for a while now, consumers haven't really been spending.
24:21 Speaker 04 And I think one of the reasons for that is that even though rates are coming down, as people come off. Off a five-year fixed mortgage, their own debt servicing costs are jumping massively from where they were when they first Oh, sure. took out the mortgage. And so even though rates are coming down, people's debt servicing costs continue to go up. Yeah, makes sense. And so as you're in a rate cutting cycle, you would expect consumers to spend a bit more. We're not finding that so much. So this is one potential explanation for why consumers aren't spending more. It could also be scarring from previous bouts of inflation as well. But that's going to feed into the current conjuncture because one of the concerns, of course, I'm worried about inflation. I think that's paramount, and I think the risks to inflation are on the upside. But of course, you have to offset that with the risk of weaker
25:06 Speaker 04 demand. And if consumers aren't spending in the UK because they're scarred from previous experiences, then they're looking at this energy shock and probably thinking, well, no way I'm going to spend now. I'd better save for a rainy day, which, by the way, could be now. And so there is a chance that consumption and therefore growth could be even weaker than we've been expecting as well. So you have to offset that with concerns about greater inflation.
25:30 Tracy Alloway? Since we're talking about the consumer, I mean, it feels like one of the few potential deflationary forces out there, but still potentially a very big one is AI.
25:38 Speaker 04 Yeah.
25:38 Tracy Alloway? Right? And this idea that, well, if there are fewer jobs because of AI, then obviously people are going to be earning less and spending less, and that's going to exert deflationary pressure on many different economies. What have you seen so far in terms of the impact of AI on the job market? And how are you thinking about this, you know, kind of very new still development?
26:00 Speaker 04 Yeah, so the bank has done some research on how AI is affecting the labor market in particular. And there's some nascent evidence that maybe those industries that are more exposed to AI are seeing fewer job openings than industries that are less exposed, which you can imagine. Use unemployment is particularly high in the UK. So I think it's quite easy to jump to a conclusion that suggests that, you know, it's very difficult to get a job if you're just coming out of uni. And maybe that's an AI effect, but I think there's actually very little evidence to directly make that link. And so there isn't much evidence of that. It's not just the labor market, of course, though, as I mentioned already, I'm worried about the supply side of the UK economy. So most of the supply shocks we've seen over the past couple
26:45 Speaker 04 of years have been negative supply shocks. AI represents the one potential positive supply shock that we might see coming down the pike. And so that could be possible. We look at the supply side of the economy all the time now at the Bank of England. When I first started, we only looked at it once a year because it's not supposed to move around that much, but we've learned actually.
27:03 Tracy Alloway? What does that mean, once a year? Did you have like, supply side week or something where you all got together and thought about it? I find this very interesting.
27:10 Speaker 04 It's not that we didn't ever talk about it in the intro, but we did like a real deep dive on the supply side of the economy to try to measure productivity growth, total factor productivity, I mean, really deep dive. And it really was a once a year event. And now we do it all the time because obviously the supply side moves more than we had expected. We keep getting hit by supply shocks. But you know, when we look at the supply side of the economy, there is no judgment that we've put in on the supply side to do with AI. So possibly it's in our assumptions about productivity growth, just through some assumption about investment. But generally, we haven't made a judgment that over the next three years, AI will meaningfully impact productivity. And I'm not, I'm not sure that that's right. I think the timing of this is the hardest part.
27:54 Joe Weisenthal? Well, actually, when I think about the term supply side or supply side shocks, or I think of, there are sort of two things, right? There's a supply side shock. You can't do anything. Suddenly, the price of electricity goes up everywhere. And we call that a supply side shock. And it's not great when that happens. And then there is also the sort of like, core productive capacity of a country and how productive industries are and what type of investment is there and so forth. Even setting aside the shocks, the trend seems to be negative in the UK in terms of business investment. You hear about the last steel mill or whatever that's closing. Or I read something recently, the UK might be importing salt for the first
28:39 Joe Weisenthal? time or whatever. In your, whether it's formerly annual, but now regular studies of the supply side of the UK economy, do you have a diagnosis or do you have an assessment about what is driving this sort of long term deterioration?
28:54 Speaker 04 I mean, we do insofar as you can say there hasn't been a whole lot of investment in the UK. Starting with the global financial crisis, I think most people pin that on Brexit and Brexit didn't really help. But it predates Brexit. And so that has been a long-term drag on potential growth, productivity growth. We assume that productivity growth in particular will rebound to its long-term trend. And I'm not sure that that's right. I think my own view is that the risk to that is entirely on the downside. But, you know, a lack of investment is part of it. And then on top of that, I mean, I understand how you're splitting these out. But if you keep getting negative supply shocks, then eventually that does feed through into potential growth.
29:35 Joe Weisenthal? Sustained.
29:36 Speaker 04 Yeah, and so I think that's a concern. And the way that central bankers have approached negative supply shocks has always been you just look through them. They're temporary, you know, you, Bank of England can't do anything about the Strait of Hormuz, for example. Can't actually address it. We have-
29:52 Joe Weisenthal? Can't reverse Brexit.
29:53 Speaker 04 No, we have tools that are uniquely designed for demand-side problems. They can't really address supply-side problems. And so we've always learned to just look through them and consider a sort of underlying inflation, underlying growth. And I think that when you keep having negative supply shocks and you consider that households and businesses are more attentive to inflation, that, you know, they're setting prices more often, that some kinds of inflation are more salient for households and businesses and other, particularly food and energy inflation, and we keep having increases in both of those things. Then that eventually gets embedded into people's expectations and then their wage and price setting. And so that creates the kind of inflation persistence that I've been worried about even before this invasion of Iran.
30:38 Speaker 04 But now I continue to be worried about it.
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32:20 Tracy Alloway? I'm going to ask another sort of background American visiting London, haven't been here for many years kind of question, but when people talk about the UK's high-
32:29 Joe Weisenthal? We were here last year.
32:30 Tracy Alloway? Oh, yeah. I haven't lived here for many years. When people talk about the UK's high exposure to energy volatility, why is that? Because the other thing people talk about in relation to the UK is like it does actually have North Sea oil, it does have kind of its own supply. Like, what exactly is that vulnerability in this economy?
32:51 Speaker 04 So it has some supply, not massive amounts. And I think part of the trick is it's also very exposed to gas prices, which, you know, were what went up so dramatically when Russia invaded Ukraine. And then in the UK, electricity prices are keyed off of gas prices. So then electricity is particularly vulnerable as well. So unfortunately, I mean, the US has kind of energy independence at the moment. The UK's nowhere close to that position.
33:20 Joe Weisenthal? I know in the US, there is an entire art to asking a monetary policy setter a question about fiscal policy because you have to do it very delicately. Otherwise, they might faint over in their chair if they're presented with something outside their remit. I don't know what exactly the norms are here about how we're supposed to phrase such questions to elicit some sort of answer. But with all that out of the way, when you think about upward pressure on inflation and why you're so concerned about inflation, and we've talked about energy and all that, how much does the seeming inability of government after government to engage in fiscal consolidation, how much is that a factor
34:05 Joe Weisenthal? when you think about the future trajectory of inflation?
34:09 Speaker 04 Yeah, so I mean, I'll say what any rate setter will tell you. So thank you for that.
34:15 Joe Weisenthal? Yeah, I've done all the third clearance for you.
34:17 Speaker 04 Yeah, but I mean, the way that we think about fiscal policy is we take exactly what's legislated and we put that into our models.
34:25 Joe Weisenthal? Okay, so we stipulate that it doesn't seem like there is any real impulse at fiscal consolidation or capacity right now. So what does that mean?
34:33 Speaker 04 Well, so, I mean, actually, the government has legislated some consolidation given fiscal rules. And so that is exactly what we put into our forecasts. And so that's just one of the conditioning assumptions is what's legislated. We assume will happen.
34:46 Joe Weisenthal? Okay.
34:46 Speaker 04 And then we base our forecasts off the back of that.
34:49 Joe Weisenthal? But so just to push further, some of these fiscal choices, like the inviolability of, say, the triple lock, which again, I'm not asking you whether these are good or bad policies, et cetera. But are these contributors to the persistence of upside inflation risks?
35:09 Speaker 04 So I think it contributes to government borrowing costs. So we're sitting in the UK a day after long-term rates went up. Some of that is to do with the Strait of Hormuz. Some of that is to do with true social posts.
35:22 Joe Weisenthal? Sure.
35:23 Speaker 04 Some of that may be because there are local elections coming up, and I think there's just a whole bunch of positioning around that in a gilt market, which is pretty niche and fairly small relative to the US Treasury market in particular. So I think that's all worth considering as well. And that all feeds through into financial conditions.
35:40 Tracy Alloway? You mentioned gilt yields. Now that you've gone from sort of finance Twitter to, you know, hardcore economic practitioner, monetary policy practitioner.
35:49 Joe Weisenthal? She did have real jobs.
35:50 Tracy Alloway? I know. I know. But not like, not on a central bank. Come on. I'm complimenting the current role, not denigrating the previous ones. That's my intent.
36:01 Speaker 04 I'll always be Economist Meg to you.
36:03 Tracy Alloway? That's right. But like, how do you think about bond vigilantes? Do you have nightmares? Or have you gone from tweeting about bond vigilantes to thinking about them relentlessly as you watch UK gilt yields go up?
36:18 Speaker 04 No. So I neither have nightmares about them, nor do I wish I could tweet about them. I think markets are sometimes efficient and sometimes get things totally wrong. And so we have an entire function at the bank that talks to investors to get a sense of kind of what's behind their positioning, what they think. Often it's what do they think about us? What do they think we should be doing? What do they think we will do? And I think that's all worth understanding because like I said, sometimes they get things right. Certainly not always.
36:50 Joe Weisenthal? Well, let me ask you a mechanical question about the bond market, which is, are the coupon payments, as we see yields rise, and this is a question for all developing economies, and it certainly leaves a little bit of an anxiety in the US as well, as we see those coupon payments rise, are we anywhere near where those interest payments themselves are creating an inflationary impulse in the UK, which economists would call fiscal dominance?
37:17 Speaker 04 Yeah. I mean, most Usually look at this through financial conditions.
37:20 Joe Weisenthal? Okay.
37:21 Speaker 04 And so if you get bond yields rising, then that's that's tightening financial conditions and that feeds through into the economy. And then there's a judgment to be made about what monetary policy should do about it.
37:32 Joe Weisenthal? But that's a fiscal expenditure, that that coupon payment. And so the question is, is it of a size such that that fiscal expenditure, which the screens tell us is rising when we see the rates rising? Is that large enough or is there a delta there such that that actually itself creates an inflationary impulse?
37:50 Speaker 04 So, no, that's not a significant impulse that we're looking at. Mostly, we're just looking at it through financial conditions.
37:57 Joe Weisenthal? Got it.
37:58 Speaker 04 Yeah.
37:58 Tracy Alloway? So we talked earlier about spillover from US monetary policy. And it is thinkable that the US could be raising rates sooner than it might be lowering rates. How would you anticipate the feed through from a tightening of US monetary conditions to the UK at this current moment?
38:17 Speaker 04 Yeah, so as I mentioned, there's significant read through from the US Treasury market into the UK gilt market, rightly or wrongly. So if you look at economic indicators that come out and how they influence our financial conditions in the UK, the indicator, if it surprises that influences conditions here the most is UK inflation, thank goodness. Secondly, is US inflation, I think third might be non-farm payrolls in the US. It's not at all clear why these things should actually be influencing financial conditions in the UK, right? But I think part of that is an implicit assumption that the Fed is the world's biggest economy central bank. And so when the Fed does something, everybody kind of has to.
39:00 Speaker 04 I don't think that's right, actually, but you can't ignore these spillovers. So if financial conditions were to tighten in the US, that would feed through to the UK and financial conditions. I mean, of course, the reason matters, but you know, if it's because of rate hikes in the US, it could mean that our financial conditions tighten as well. And then that feeds through into kind of our view of how restrictive our monetary policy stance is and how we manage inflation towards our 2% target.
39:29 Joe Weisenthal? Can I go back to something you said at the very beginning when I asked you about what is the the remit or the objective of the central bank? And you said, one thing is to support the government. And that is not like formerly, I don't think that's part of the Fed. But I know that that's like why the whole bank, that's why the Bank of England was founded was to be to the government's bank and to facilitate financing of the government. Does that functionally change anything? Does that mean something substantively different in terms of the conduct of monetary policy within the BOE versus, say, another central bank when that's sort of like part of your founding charter?
40:05 Speaker 04 Yeah. So to be clear, our mandate really is 2% inflation sustainably in the medium term, subject to that, to support the goals of the government. And these change. And this is a mandate that the Treasury sets every November. So it's once a year they look at it. And what fits in that has changed over the past couple of years on the margin.
40:26 Joe Weisenthal? There was an incident a few years ago in which the bank and the government, the bank helped out the government a little bit.
40:31 Speaker 04 But that that had nothing to do with the mandate. Yeah, for what it's worth. But so in my time at the Bank of England, we've only hit our inflation target for one or two months, maybe. And so while I've been at the Bank of England, and I think generally it's the case, really 2% inflation is the target, and we're working tirelessly to hit that. So the secondary part of the mandate, which is subject to that, we haven't, we haven't achieved that yet. So that that is the primary focus.
40:59 Tracy Alloway? Can you talk a bit more about just the decision making process on the MPC? Because again, here, here, I'm going to emphasize Meghan's many other jobs. You've been in academia, you've been in business settings, and now you're at a central bank. What are the sort of differences that you observe between how like the decision making making process works at those types of institutions versus a central bank? This is just a long way of me asking you what the discussions are actually like.
41:26 Joe Weisenthal? How vigorous is Prime Minister's Questions? Which is our only exposure to what policymaking looks like in the UK?
41:34 Speaker 04 Yeah. So we meet every six weeks and every other time we produce a forecast. So when we Produce a forecast, it's a more involved process. This last round was particularly interesting because we didn't produce a forecast. We said, you know what? Things are so uncertain, we're just going to produce three scenarios. We're not going to give you weights on them. Who knows what's happening with energy prices? But we produced three different scenarios and they were based on kind of what energy futures curves might look like, how energy prices might evolve, and then also second round effects off the back of that. And so, as you can imagine, in the good old days, not good old days, in the old days, when we only produced a central forecast, that was a less involved process, I would say,
42:16 Speaker 04 than now producing a bunch of scenarios to think about risk and uncertainty. And now I think we're facing kind of nighty and uncertainty, so radical unpredictability and uncertainty. So it's an incredibly involved process to produce these scenarios, to think about different states of the world, to try to identify where we might be in these scenarios. And then, most importantly, to try to figure out how we would respond if we were in any parts of these worlds. And so, to figure out our reaction function, we look at, we look at the market curve, but we also look at a whole bunch of policy rules. They're all different. And in figuring out where we forecast from, we have to figure out where we are.
42:58 Speaker 04 We've used a whole bunch of different models, get loads of updates and research notes from our fantastic staff to help inform us of where we're starting from, because that's always really important. So, you know, in a forecast round, it's about three weeks of intensive discussions and research and notes. And then figuring out how to communicate that to the outside world, I think, is really important, too. So it is a really involved process. And I would say that the model where we have externals and internals and where dissent is totally normal does work in that we certainly don't agree on everything. In fact, often we don't agree on important things and that comes out in our votes. But I think that's how you make sure that you're making the strongest decisions.
43:42 Joe Weisenthal? This might be sort of like an abstract question. You can take it however you want it. A prior guest we've had on the podcast a bunch of times, Hyun Song Shin, recently became the head of Korea Central Bank. And I read his opening speech, which I thought was really interesting. And he said, you know, central bankers like to talk about theory and putting it into practice. And you have theories like independence is good and so forth, these ideas you put in practice. He said, in reality, the practice happens, so then you sort of form a theory around it. And that we're in a moment of historical change for central banks for many reasons. Perhaps political populism, politics is changing, that might change the nature of central banks. AI, the extreme uncertainty of AI and how that's going to affect the economy. That's the source of change.
44:26 Joe Weisenthal? And therefore, central banks period are going to be in a new period of like the old ways. Does it feel like, whether at the BOE or General, that we're going to be entering a new era of central banking per se?
44:40 Speaker 04 Yeah, I think we already have in fairness. So I've spoken to some of my predecessors, Kristin Forbes, I saw recently, for example. And she said, you're so lucky. My entire time on the MPC, I never voted to change interest rates at all. Oh, my God. That's right. It's like inconceivable now. That's right. And so I've seen a hiking cycle, a holding cycle and a cutting cycle. And who knows what comes next off the back of this shock. And so I do think that that has changed. But also, you know, I think getting hit by successive shocks is just here to stay. And I think you can identify some already. So if economic statecraft is how major world powers are going to operate using economic tools for foreign policy goals. Those just represent negative supply shocks for someone.
45:26 Speaker 04 And so, you know, I think we will continue to have negative supply shocks, whether it's tariffs or export controls or investment controls, all of these things. And then climate change, whether it's physical risk or transition risk. If it crystallizes, that represents a negative supply shock as well. So we're no longer at a point where we can kind of say, well, one day we might have some of these things happen. I think we're already there. And so this old adage that you should just look through. Negative supply shocks because you can't address them directly. I don't think it works when you keep having them wave after wave. And I also think there's just a ton of uncertainty now. A lot of economists feel like they had a framework for understanding how the global economy worked.
46:08 Speaker 04 And it doesn't work anymore, but no one's quite identified the new one. And so in an age when you have this much uncertainty, you need to stop thinking about your very specific forecast where you duke it out, whether inflation's point two percentage points higher or lower in year three of your forecast. It's kind of neither here nor there. It's much more about kind of scenario analysis and risk management when you're making decisions about interest rates. So figuring out if we thought we were in this state of the world and it turns out we're in a different one, how bad would could we mess that up? And how do we minimize some of those costs? And that's a different way of thinking, I think, about central banking than what we had in the past.
46:48 Tracy Alloway? I mean, other than scenario analysis, is there anything else that central bankers should do in order to deal with supply shocks? Because this was a theme post COVID in the US. This idea that the Fed only has an interest rate and interest rate is not a particularly adept tool at dealing with the supply side. As you said earlier, central bankers are often, you know, they're very much trained and focused on dealing with the demand side, not necessarily the supply side of the equation. And part of that is because they don't necessarily have the right tools.
47:17 Speaker 04 Yeah, we don't really have the right tools. So we've got what we've got.
47:21 Tracy Alloway? Could you get tools? This is what I'm asking.
47:23 Speaker 04 Yeah, it's a good question. I think probably if if you're making decisions about the supply side of the economy, often that comes down to questions about who choosing winners and losers. And that's not what central independent central banks are here for. That's what elected politicians are there for. So I think some of these solutions have to come from elected officials and not from central banks at all. But understanding that it's the multiplicative effects of multiple supply shocks, rather than just looking at them in concert, is important. And also, you know, we we look at decompositions of inflation over the past. And you can't explain them all using standard channels. There's just kind of a wedge. And sometimes that's a judgment that we've made.
48:05 Speaker 04 And sometimes it's just an unknown, but being a bit more curious about these wedges, why haven't things panned out in a way that we can perfectly explain? Maybe there's something else going on because of these supply shocks. I think there's a lot of work to be done in that area, too.
48:20 Tracy Alloway? You also mentioned communicating how the central bank, how the BOE is thinking to the market and I guess to households as well. We might have a new Fed governor very, very soon in the form of Kevin Warsh, and he is, as far as I can tell, not a fan of forward guidance. I think that's fair to say. Someone pedantic is going to point out that the Fed may already have abandoned forward guidance of the bond market based off of what happened in 2022. But if we got a more formalized abandonment of forward guidance, does that make your job at the BOE a lot more difficult if you're trying to judge the spillover effects from US bonds?
48:59 Speaker 04 So I think we don't understand the spillovers just from what the Fed is saying about them. We're also looking at the US economy and the fundamentals. So forward guidance has its place, I think. You don't need it all the time. I don't think that means we won't understand what's happening in the US economy and therefore how that might spill over into the UK economy. I think they're just different approaches on this stuff.
49:23 Tracy Alloway? So if I look over the whole of this conversation, you're talking a lot about being wary of inflationary risks, and we talked about maybe the public and companies being more primed towards inflationary risks than they were previously. Why, why did you vote to hold rates last week? Why didn't you? Yeah.
49:43 Speaker 04 Yeah. You know, I think, given that it will take too long to get evidence for second round effects to actually address them, I think that's a fair question. You know, if you don't hike now, then when are you going to? To my mind, a big contribution was that we are going to get some news over the next six weeks or so, but you know, over the next couple of months. And a lot of that news will not be definitive evidence of second round effects, but it will be evidence about energy prices, which are a big feed into what's going on with the economy and with inflation. So is there a state of the world in which? Restrictiveness that we already have in our monetary policy stance, because we are restrictive, I think, just not hugely so. But is there a state of the world in which actually if the war ended tomorrow,
50:28 Speaker 04 the Strait of Hormuz opened up completely, whether that restrictiveness could squeeze out the second round effects that have already been kicked off by this crisis? I think it's, I think it's defensible to think that possibly there are. In my view, the risk is entirely on the upside, though. There's kind of a ratchet here. I think the risk to energy prices and also second round effects are probably on the upside rather than the downside. But I do think that it's worth waiting for a little while to see kind of what happens with the progression of this war and therefore see what we can infer about how it will propagate through the economy before we make a move.
51:03 Tracy Alloway? Meghan, it was so great to catch up with you. Congrats on the new role. I know we're a little bit late to it, but it was really great to be able to actually ask you all the questions about what you're doing right now.
51:13 Speaker 04 Yeah, thanks for having me. It's great to see you.
51:15 Joe Weisenthal? Yeah, thank you so much. That was great.
51:29 Tracy Alloway? Joe, that was really fun.
51:31 Joe Weisenthal? It was great.
51:31 Tracy Alloway? I have to say, I'm, I'm a little bit jealous that Meghan probably has like a really nice office at the Bank of England building. I know.
51:39 Joe Weisenthal? The Bank of England, Bank of England. I know. That would be a pretty sweet job.
51:42 Tracy Alloway? I think I'm going to go through like my entire career without ever having my own office in a building.
51:48 Joe Weisenthal? I know, me too. And it's, I'd like, I love my job. And I'm going to leave it at that. It would be nice to one day just like have an office with a door and all that stuff. But.
52:00 Tracy Alloway? But there are a bunch of interesting things to pick out of that conversation. I mean, I thought her point about the emphasis of central banks and economics in general on the demand side historically versus the supply side kind of captures a lot of the struggle that policymakers have had with the post-COVID economy, right? Like, all of economics is very much focused on the idea of like, well, you need a healthy consumer who's spending, right? And going out and buying stuff versus like thinking about those supply side shocks.
52:31 Joe Weisenthal? I think she made a really good point, which is, it does seem at least theoretically possible to truly have.
52:39 Joe Weisenthal? One supply shock after another, and they really are just independent supply shocks, right? At least it's conceivably possible. A pandemic is not the same thing as a war here, as a war there, and so forth. They could be discrete events. The sort of money line for me when she said was the rise of economic statecraft. And if once governments start using economic tools as foreign policy, and once that cycle gets going, then there begin to be reasons to think that these discrete one-off supply shocks are not just going to be things that are one and done, but that are part of a sustained new part of the world that consistent. And you see this. Obviously, I mean, the tariffs are one part
53:22 Joe Weisenthal? of it, but all of the moves that we talked to about reshoring and strategic domestic investments for backup capacity, et cetera. This is like what constitutes a sustained trend. And so I thought it was really just overall very interesting to hear someone like really wrestle with the reality of conducting monetary policy in a period of sustained supply-side degradation shocks, what have you.
53:50 Tracy Alloway? And then the question, of course, is if the central bank is not the right entity to deal with these supply-side shocks, like should it, given its existing tools, which we touched on, like, should it have new tools? I mean, a lot of people would say no, because that's veering into fiscal and you want governments to decide that and democratically elected governments to decide that. But on the other hand, like, if it keeps happening, it also feels somehow unsatisfactory to just say, like, well, we're going to have to deal with this with like, the existing toolkit.
54:24 Joe Weisenthal? Yeah. And also, again, but it really does cut straight to the core of like, what we want in a democratic society. You could say, you know what, part of the reason we have declining productivity is because regulations on setting up a new factory are burdensome. Do we want non-elected officials deciding, oh, you know what, we're going to change environmental regulations, we're going to change the minimum wage? To change the protected habitat speed like most people would be very uncomfortable with the we're going to change household zoning so that there could be more construction in London. Most people would get really uncomfortable about what it would mean for the central bank to have the capacity to address supply side problems.
55:07 Tracy Alloway? But I think the other point is like, maybe there are more creative ways of doing it that we haven't even thought of yet. So for instance, like, could you do monetary policy on a weekly basis versus like a monthly decision? No, seriously, if like, if the entire world is changing on a week to week basis, maybe you need to start like making these decisions and like, yeah, I don't know. My point is like, there may be creative solutions out there that we haven't even thought about.
55:33 Joe Weisenthal? Well, let's let's get on that. Let's get working on that.
55:37 Tracy Alloway? All right. Shall we leave it there?
55:38 Joe Weisenthal? Let's leave it there.
55:39 Tracy Alloway? This has been another episode of the Odd Lots Podcast. I'm Tracy Alloway. You can follow me at Tracy Alloway.
55:44 Joe Weisenthal? And I'm Joe Weisenthal. You can follow me at the Stalwart. Follow our producers, Carmen Rodriguez at Carmen Armand, Dashell Bennett at Dashbot, Kell Brooks at Kell Brooks, and Kevin Lozano at Kevin Lloyd Lozano. And for more Odd Lots content, go to Bloomberg.com/oddlots for the daily newsletter and all of our episodes. And you can chat about all of these topics 24/7 in our Discord, discord.gg/oddlots.
56:07 Tracy Alloway? And if you enjoy Odd Lots, if you like it when we talk to central bankers, then please leave us a positive review on your favorite podcast platform. And remember, if you are a Bloomberg subscriber, you can listen to all of our episodes absolutely ad free. All you need to do is find the Bloomberg channel on Apple Podcasts and follow the instructions there. Thanks for listening.
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