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Bank of England and The Times Interest Rate Challenge
TARGET
Bank of England and The Times
Interest Rate Challenge 2014/15
CONTENTS
Foreword
3
Introduction
5
Section A
Introducing the Challenge
7
What the Challenge involves
9
Judging
12
What you might gain from the Challenge
14
Dates, venues and expenses
16
The Challenge rules
17
Contacting the Target Two Point Zero team
18
Section B
Monetary policy – setting interest rates to control inflation
19
What is inflation?
21
What causes inflation?
23
What is monetary policy for?
25
Why do we want stable prices?
26
How do interest rates affect inflation?
28
Section C
The inflation target and the Monetary Policy Committee
31
Monetary policy in the United Kingdom
33
An independent Bank of England
36
Quantitative easing – injecting money into the economy
38
Monetary policy as the economy recovers
41
Section D
Assessing economic conditions and the inflation outlook
49
Assessing economic conditions
51
Judging the inflation outlook
55
© Bank of England 2014
Section E
Using economic information
59
Building up the economic picture
61
Official statistics
62
Surveys and business intelligence
67
The economic jigsaw – how many pieces of data should you use?
69
Organising economic information
70
Section F
The economy – from money to prices
71
Recap
73
Money and financial markets
75
Demand and output
80
The labour market
89
Costs and prices
93
Guidance for using the datasheets
97
Section G
Making your presentation
99
Developing your presentation
101
Delivering your presentation
103
And now... over to you
106
© Bank of England 2014
Bank of England and The Times
Interest Rate Challenge 2014/15
Foreword
It gives me great pleasure to welcome you to Target
Two Point Zero – the Bank of England and The Times
Interest Rate Challenge. We introduced the Challenge
in 2000 to give students a practical understanding of
the way the economy works and an insight into how
the Bank’s Monetary Policy Committee goes about its
task of achieving the Government’s inflation target.
We have been delighted by the enthusiastic response of students and teachers alike.
I hope that you will enjoy taking part in the Challenge as much as your
predecessors.
The competition offers students a great opportunity to broaden their understanding of monetary policy and how it
relates to the economy as a whole. You will learn about how interest rates affect inflation and what matters when
making interest rate decisions – what information the Monetary Policy Committee uses and how judgements are
formed. And, of course, you will have the chance to have a go yourselves and tell members of the Monetary Policy
Committee what interest rate you would set – and why. There will also be ample opportunity to develop and
demonstrate key skills, which are now an important part of post-16 education. There will be no right or wrong answers –
there never are. The Challenge is to demonstrate your understanding, present a well-argued case for your interest rate
decision – and any other policy recommendation – you may wish to make and then answer the judges’ questions
convincingly. All the necessary information will be provided in this resource manual and on the Bank’s website, but you
can use other information if you wish. Finalists will be guests of the Bank of England in London for the two days of the
national final. The winning team will receive the Bank of England and The Times Interest Rate Challenge trophy and
there are cash prizes for schools.
May I take this opportunity to wish you success in the Interest Rate Challenge. We look forward to the fifteenth national
final in London in March 2015. I hope that you will always feel that taking part in Target Two Point Zero was worthwhile
and rewarding.
Ben Broadbent, Deputy Governor, Monetary Policy
Bank of England and The Times Interest Rate Challenge 2014/15
Foreword
3
Introduction
Monetary policy and the Challenge
Inflation, growth, manufacturing, consumers, exchange
rates, exports, employment, wages…There seems to be
a long list of terms that might be relevant to the
Bank of England and The Times Interest Rate Challenge.
But do not be put off by this, or by the thought of too
much economic theory or too many statistics, or the
jargon and the ‘buzz’ words of the day. The level of
knowledge and understanding needed to take part in the
Challenge is for your team to decide. It will probably be
greater in some areas than others. You may want to
concentrate on a few key factors. This might depend on
what is being covered in the classroom or has already
been taught, or what the participants think is most
important for their assessment of the outlook for inflation
and thus the interest rate decision. You will have to
decide where to draw the line. The main requirement is
that your team builds up a convincing case to justify its
interest rate decision – that is the Challenge.
Monetary policy is not just about looking at inflation and
interest rates. It is also about the growth of the economy,
employment and, ultimately, our collective living
standards. But all these considerations are framed around
the inflation target and the policies required to achieve it.
The Challenge therefore asks teams to set the level of
Bank Rate and asset purchases to meet the Government’s
2% inflation target.
Target Two Point Zero invites schools and colleges to
assume the role of the Bank of England’s Monetary Policy
Committee and make a presentation that sets out their
view on current economic conditions and future
prospects, culminating in a policy recommendation aimed
at meeting the inflation target. In doing so, teams may
wish to consider how their decision fits with any ‘forward
guidance’ communicated by the MPC.
Economic theories and concepts can guide our
understanding of the economy and help to explain what
we observe around us, both in the economic statistics and
first-hand. But they cannot tell us what inflation will be or
what the interest rate should be. Policy decisions depend
on an interpretation of current economic conditions and
Bank of England and The Times Interest Rate Challenge 2014/15
events, and judgements about the likely future path of the
economy. Many considerations will be relevant to the
outlook for inflation – some more so than others, and to a
different degree at different times. Evidence on the
economic picture is often unclear or contradictory. Some
factors will point to less inflationary pressure, others to
more. That is why judgement is central to setting
monetary policy. There is no complex formula to work out
or a mechanical rule to follow. The interest rate decision is
based on the best information that we have to hand. That
is never perfect, nor does it result in a definitive or certain
answer. So when you are reading the resource material,
you will find information and tools to help you make your
policy decision. But the answer will be up to you. We look
forward to your economic assessment, your monetary
policy decision and an imaginative presentation.
Using the resource material
The purpose of this resource manual is to tell you in a
clear and concise manner about the main factors that are
relevant to what the Challenge is all about – setting
interest rates and asset purchases to control inflation. It
does not repeat what you can find in text books or in
other course material, and we are not going to overload
you with everything that is, in some way, connected to
monetary policy. Instead, it helps to explain in a practical
way how the economy and monetary policy work, and
what factors determine and influence inflation and
interest rate decisions. We hope the resource manual will
benefit you not just in the Challenge itself, but also in
expanding your understanding of the economy and
monetary policy more generally.
You will see that the resource manual contains
a large amount of information. But do not be
overwhelmed by this. It is designed to be a
comprehensive reference source for you to use
throughout your preparation.
You do not need to read and understand
everything all at once. You can use the
contents pages to refer to different parts of
the manual when necessary.
Introduction
5
The following brief summary shows you at a glance what
each section of the resource manual contains. A more
detailed summary is provided on the contents page of
each section. Copies of the minutes of the Monetary
Policy Committee’s meetings are available on the Bank’s
website. Datasheets and data updates will also be
available on the website.
Using the website
Section A
Introducing the Challenge gives you practical information
about taking part in the Challenge.
A webcast of the 2014 national final, is available on the
Bank’s YouTube channel:
Section B
Monetary Policy – Setting Interest Rates to Control
Inflation introduces you to the principles of monetary
policy and the control of inflation. It explains why we
want low inflation and how interest rates affect inflation.
Section C
The Inflation Target and the Monetary Policy Committee
explains how the Committee takes decisions on the
interest rate and quantitative easing, and how it provides
forward guidance.
Section D
Assessing Economic Conditions and the Inflation Outlook
explains how you might think about developing your
assessment of current and future inflation and judging the
inflationary pressure in the economy.
Section E
Using Economic Information tells you about the economic
information that is used to assess economic conditions
and inflation prospects. It explains some of the
characteristics of the information and data that we will
give you and tells you how to use them.
Section F
The Economy – From Money to Prices gives you more
detailed information about the inflation process and the
economy. It explains why the Monetary Policy Committee
looks at the different areas of the economy and why they
are important.
The resource material and data, as well as practical
information about the presentation rounds of the
Challenge, are available on the Bank of England’s website:
www.bankofengland.co.uk/education/Pages/
targettwopointzero/default.aspx
www.youtube.com/bankofenglanduk
Although we will provide you with information and data
that are relevant to setting monetary policy, you can use
whatever information you think is relevant from whatever
source. You can access the Bank’s regular monetary policy
publications on the Bank’s website:
www.bankofengland.co.uk/Pages/home.aspx
The minutes of the Monetary Policy Committee’s meetings
will give you an idea of the factors that are influencing the
Committee’s policy decisions. In addition to help from the
Bank, teams are encouraged to use the Office for National
Statistics and whatever other data and information sources
they think will be useful and relevant to their presentation.
The Office for National Statistics provides much of its data
on its website:
www.statistics.gov.uk
We hope you find the resource material helpful and enjoy
the challenge of setting interest rates for the UK economy.
If you have any comments about the Challenge you can
e-mail us at:
[email protected]
Section G
Making Your Presentation gives you guidance on preparing
and delivering your presentation.
Bank of England and The Times Interest Rate Challenge 2014/15
Introduction
6
Section A
Introducing the Challenge
In this section, we tell you what the Challenge involves and how you and
your students might benefit from taking part. We set out the practical
arrangements and the rules.
What the Challenge involves
9
The teams
9
The task
9
Judges’ questions
11
Resource material
11
Judging
12
Judges
12
Judging criteria
12
What you might gain from the Challenge
14
Understanding the economy
14
Resource material
14
Key/core skills
14
Prizes
15
Publicity
15
Dates, venues and expenses
16
Competitive rounds
16
Expenses
16
The Challenge rules
17
Participants
17
Teams
17
Presentations and questions
17
Contacting the Target Two Point Zero team
18
Bank of England and The Times Interest Rate Challenge 2014/15
Section A Introducing the Challenge
7
Section A
What the Challenge involves
Target Two Point Zero invites teams of 16–18 year old students to take on the role of
the Bank of England’s Monetary Policy Committee. Each team will assess the state of
the economy and the outlook for inflation, and then set the interest rate to meet the
Government’s inflation target. It will present its analysis and its decision to a panel of
Bank of England judges.
The teams
Each school or college can enter one team. Each team
should consist of four students. The composition of the
team and the way in which the team members are chosen
is entirely up to teachers and students. Although the
Challenge will probably appeal mainly to students of
economics and business, students studying any subject can
take part. The main criteria for taking part are having an
interest in learning about how the economy works and
having skills which will help the team towards its objective
of presenting a well-argued case for its monetary policy
decision.
Each team should decide on the level of Bank Rate, asset
purchases or sales, and whether to provide forward
guidance.
Each school should nominate a teacher to act as the
team’s adviser and coach, and to accompany the team to
the presentation events. Each team should also nominate a
team captain. He or she will act as the team co-ordinator
and, like the Chairman of the Monetary Policy Committee,
will have a casting vote, should the team decide to put its
interest rate decision to a vote, which then results in a tie.
Help and support
Although only the four team members will represent their
school or college at the presentation events, other class
and school members, teachers or friends are encouraged
to get involved by helping the team to undertake their
research and prepare their case. The more students that
get involved the better. You could consider the following
approaches.
• The team of four could work largely on their own,
seeking the assistance of teachers and others as
necessary.
Bank of England and The Times Interest Rate Challenge 2014/15
Each team should decide on the level of
Bank Rate, asset purchases or sales, and
whether to provide forward guidance.
• The team might want to consider identifying a reserve
who will work closely with the team and can replace a
team member who is unable to attend a presentation
event.
• The class could divide into several teams of four and
hold an intra-class play-off to decide which team should
represent the school or college in the three presentation
rounds.
• The whole class could help with the research and
preparation and then brief the team of four in the same
way that economists in the Bank brief the Monetary
Policy Committee. The class could divide into small
groups, with each group monitoring a different aspect of
the economy and presenting their findings to the team.
• Some or all of the class members could form a
Monetary Policy Committee, could carry out the
research and preparation and then, like the real MPC,
could vote on what the interest rate should be. A team
of four would be selected to present the views of their
Monetary Policy Committee in the presentation rounds.
The task
The Challenge has three identical rounds – regional heats,
area finals and the national final. In each round, the team
will examine economic conditions and decide what level of
interest rate it would set to achieve the Government’s
inflation target. The inflation target is currently 2.0% and
teams should decide what interest rate they would set,
and any other monetary policy recommendation, to
achieve this target.
Section A What the Challenge involves
9
Each team will then prepare and give a short presentation,
arguing the case for its decision, to a panel of judges. The
judges will ask team members some questions about their
decision and presentation.
Using information and data to assess economic
conditions
Teams can use information and data from any source, but
all the essential data will be provided by the Bank.
In Section B of this manual, we discuss some of the
principal causes of inflation. Essentially, teams will need
to assess the balance between demand and supply
(output) across the economy as a whole, and the extent
to which any imbalance might lead to more or less
inflationary pressure. They will look at the various
components of demand – for example, consumer
spending and exports; developments in the labour market
– such as wages and employment; and information on
costs and prices. And they will look at data on different
sectors, such as manufacturing and retailing.
We will tell teams about the data that they may wish to
look at to assess trends and the recent picture – both
official data and business surveys. But teams can also
make use of first-hand information, perhaps from their
local areas. Much of the data that are available only
provide a partial picture of the economy. Teams will have
to piece the various bits of evidence together to form an
overall view. But the data rarely say the same thing about
the current economic picture, or provide clear signals
about the economic outlook. MPC members have to use
their judgement throughout the process. And that is what
the teams will have to do.
The team’s decision has three parts:
• whether to increase or decrease
Bank Rate;
• whether to increase or decrease the
level of asset purchases; and
• whether to provide any new forward
guidance for future monetary policy.
date as possible. This could, of course, mean some last
minute changes if the team receives new data that cause
it to alter its view of the inflation outlook and, hence, its
decision.
The task is not to find the right answer. There is no right
answer. Deciding on the level of the interest rate and
quantitative easing are a matter of judgement and, like
the real policymakers, team members may disagree. There
may, for example, be differences of opinion about
whether to change the interest rate. Even if team
members agree that the rate should change, they may
disagree about whether the rate should go up or down, or
about the extent of the change, say ¼% or ½%, or some
other number. During the preparation stage, the team
may choose to vote on its interest rate decision. If this
results in a tie, the team captain will have the casting
vote. If there is a split decision, both sides of the
argument must be explained in the presentation to the
judges.
The presentation
The policy decision
In each round, the team should take the Monetary Policy
Committee’s most recent decision on the level of
Bank Rate, the level of asset purchases and forward
guidance as its starting point. The team’s decision
therefore has three parts:
Having made its policy decision and prepared its case,
each team will make its presentation to a panel of judges.
Presentations should be no more than 15 minutes long.
The precise format of the presentation is up to the team
but it should:
• examine current economic conditions;
• whether to increase or decrease Bank Rate;
• give an assessment of the outlook for the economy and
inflation; and
• whether to increase or decrease the level of asset
purchases; and
• present the team’s decision on Bank Rate and asset
purchases, together with supporting evidence to the
judges. If team members have different opinions on
what should happen to the interest rate, this will need
to be explained to the judges in the presentation. The
team should also be prepared to defend any additional
policy recommendations.
• whether to provide any new forward guidance for future
monetary policy.
Just like the MPC, the team’s assessment of economic
conditions and the outlook for inflation should be as up to
Bank of England and The Times Interest Rate Challenge 2014/15
Section A What the Challenge involves
10
Judges’ questions
Following the presentation, the judges will ask the team
a series of questions. This is an important part of the
proceedings. The questions allow the judges to test the
team’s understanding and knowledge, to see how they
justify their policy decision, just as the MPC has to do in
public, and to see how they think on their feet. Team
members might be asked to clarify, or expand on, points
made during their presentation or they might be asked
about the workings of the economy and how their policy
decision will achieve the inflation target. The style of
questioning will be constructive and sympathetic.
Team members may confer but will be pressed for an
answer if they take too long. They should work together
as a team when answering the judges’ questions.
Answers should not be dominated by one or two team
members. The section on Delivering your presentation on
pages 103–105 gives more guidance on answering the
judges’ questions.
The section on Judging on pages 12–13 gives details of the
criteria that the judges will use to evaluate each team’s
performance.
Resource material
The resource manual sets out clearly all the economic
information and much of the data needed to take part in
the Challenge. It explains the main principles behind
monetary policy and describes the United Kingdom’s
framework and processes. It contains sections on:
It includes an explanation of why the Monetary Policy
Committee looks at each of these aspects of the economy
when deciding the outlook for inflation. It also includes an
explanation of how teams might use the data, which will
be made available on the Bank of England’s website and
will be updated as new data becomes available. Finally, it
gives teams guidance on how to set about developing and
making their presentation and on answering the judges’
questions. The information in the resource manual and
the data, as well as practical information about the
competitive rounds and answers to frequent queries can
be found on the Bank’s website:
www.bankofengland.co.uk/education/Pages/
targettwopointzero/default.aspx
A webcast of the 2014 national final can be found on the
Bank’s YouTube channel:
www.youtube.com/bankofenglanduk
You should not be put off by the amount
of information and data. You do not need
to read and understand everything all at
once. You can refer to different parts of
the website and the resource manual as
necessary.
In addition to help from the Bank, teams are encouraged
to use the Office for National Statistics and whatever
other data and information sources they think will be
• money and financial markets;
• demand and output;
• the labour market; and
• costs and prices.
Bank of England and The Times Interest Rate Challenge 2014/15
Section A What the Challenge involves
11
Section A
Judging
In each of the three rounds of the competition, presentations will be made to
panels of judges.
Judges
The regional heats will be judged by staff from the Bank’s
Agencies based around the United Kingdom and from its
Head Office in London.
The area finals are likely to be judged by a Bank of England
Agent, a senior member of staff from London and possibly
a member of the Monetary Policy Committee.
There will be four judges for the national final. The panel
will be chaired by Ben Broadbent, Deputy Governor for
Monetary Policy, and will include other members of the
Monetary Policy Committee.
Judging criteria
The winning teams will be those who demonstrate
the clearest understanding and who present the most
convincing decision on Bank Rate and the level of asset
purchases.
Although the content of the presentations is up to the
teams, the judges will expect the teams to examine
current economic conditions, assess the outlook for
inflation and justify their interest rate decision. If team
members disagree about the level of the interest rate,
differences of opinion should be explained.
The judges will assess teams’ performance against the
specific criteria listed below. The judges’ assessment will
be based both on the teams’ presentations and on their
answers to the judges’ questions.
Bank of England and The Times Interest Rate Challenge 2014/15
• Understanding of economics and monetary policy
Teams will be assessed on their understanding of how
the economy and monetary policy work. They will need
to demonstrate that they have grasped the basic
economic concepts; that they understand the key
economic influences on the outlook for inflation and
monetary policy decisions; and that they understand
the monetary policy framework and process. The judges
do not expect teams to reproduce textbook theories.
The judges are interested in how teams explain why
they are looking at particular issues or data and their
relevance to the interest rate decision. Teams also need
to show that they understand how their policy decision
will help to meet the inflation target. The judges’
questions are an important way of finding out how well
teams understand their material.
• Research and information
Teams will be assessed on the quality of their research
and investigative work. The judges will be looking at the
way in which teams have used data and other
information. They will be particularly interested in how
well teams have covered key issues and the relevance of
the data and information they have used. They will be
looking at how accurate and up to date the data and
information are. The judges may question teams about
their data and information.
• Quality/structure of presentation and teamwork
Teams will be assessed on the structure and clarity of
their presentations including their creative approach
and their use of visual aids. The judges will be looking at
the style of delivery. They do not expect teams to
memorise their presentation, but they will expect teams
to refer to notes rather than read verbatim from scripts,
laptop screens or other visual aids. Teams will also be
assessed on how well they work together as a team.
Section A Judging
12
The judges will want to see all team members making
a significant contribution to the presentations and
participating in the answers to questions.
• Conclusions and justifications of monetary policy
decision
Teams will be assessed on the analytical strength and
clarity of thought in their presentations and their
answers to questions. The judges will be looking at the
extent to which the team’s decision is supported by the
data and other information and whether the decision
flows from the arguments put forward. The judges will
expect any differences in opinion between team
members to be explained. They will be looking at the
extent to which monetary policy decisions are based on
teams’ assessment of the outlook for the economy and
inflation – ie. the extent to which the teams are looking
ahead. The judges will also be looking at whether teams’
answers to questions support their conclusions and
decision.
Teams must adhere to the rules of the Challenge.
These are set out in the section on The Challenge rules
on page 17.
Teams will receive written feedback on their performance
shortly after the presentation event.
The judging and feedback criteria are as follows.
Understanding of economics and monetary
policy
Quality/structure of presentation and
teamwork
• Good understanding of basic economic concepts.
• Presentation was engaging and had a good, clear
structure.
• Sound knowledge of the monetary policy framework
and processes.
• Good grasp of the key influences on inflation.
• Confident delivery, without reading verbatim from
scripts or visual aids.
• Answers to questions demonstrated clarity of
thinking and the ability to defend their views.
• Even contribution from team members, without one
or two members dominating answers to questions.
Research and information
• Made good use of time allocated for presentation,
without overrunning.
• Evidence of good research and investigative work,
with data drawn from a range of sources.
• Covered the relevant issues well, without significant
omissions.
Conclusions and justifications of monetary
policy decision
• Decision based on assessment of the outlook for the
economy as a whole.
• Data, charts and other information were used
effectively to support arguments.
• Decision based on forward-looking analysis, taking
account of the risks to the outlook for inflation.
• Data were accurate and up-to-date, and charts were
clear and well labelled.
• Decision flowed from the presentation, supported by
relevant information, with no unsubstantiated
assertions.
• Balance of opinion within the team was explained,
including the reason for any difference of view.
Bank of England and The Times Interest Rate Challenge 2014/15
Section A Judging
13
Section A
What you might gain from the Challenge
The Challenge offers a number of benefits to students, teachers, schools and colleges.
Understanding the economy
The Challenge provides students with the opportunity to
deepen their understanding of the economy and the way
in which interest decisions affect economic growth and
inflation. It will allow students to apply economic
concepts and principles to the analysis of developments in
the real economy and to appreciate the interrelationships
between the different topics that they cover in their
course in a practical and lively way. It will also help them
to develop their critical thinking and other skills. Accepting
the Challenge will bring students into direct contact with
working economists.
Resource material
The resource material should be useful for anyone
teaching or taking an AS, A level, the IB, Higher, Advanced
Higher, Vocational A level or equivalent course in
economics or business. The wealth of macroeconomic
information and carefully selected, up-to-date data make
the resource material highly relevant to many of the units
and modules in post-16 courses. In particular, it will be
relevant to those relating to government policy,
macroeconomics, the national and international economy,
the business environment and the operation of markets.
Information technology
IT will be a useful tool for anyone accepting the
Challenge, which will give students the opportunity to:
• use different IT sources to search for and select
information;
• develop information and lines of enquiry, including
using spreadsheets; and
• present and edit information, including text, numbers
and images.
Communication skills
The Challenge is about gaining understanding and
gathering and communicating information, both to other
members of the team and to the judges. It will give
students the opportunity to:
• read and summarise information;
• contribute to discussions;
• make a presentation; and
• write documents, such as visual aids for the
presentation or perhaps a report on the Challenge for
their school or college or a press release for the local
media.
Problem solving
Key/core skills
The Challenge will give students the opportunity to:
Key/core skills are an important part of post-16 education.
This section gives examples of how the Challenge could
help teachers to deliver key/core skills and how it might be
used by students to provide evidence of these skills.
• explore problems and different ways of solving them,
and select the appropriate solution;
Application of number/numeracy
During the Challenge, students will handle large amounts
of data. The Challenge will give students the opportunity to:
• gather and interpret numerical information from
different sources;
• carry out calculations; and
• plan and implement the chosen solution; and
• ensure the problem has been solved and review the
approach.
Working with others
The Challenge is a team activity which will give students
the opportunity to:
• plan work as part of a group, including agreeing
objectives, responsibilities and working arrangements;
• present findings and explain results.
Bank of England and The Times Interest Rate Challenge 2014/15
Section A What you might gain from the Challenge
14
• establish and maintain co-operative working
relationships; and
Area finals
• review work and agree ways of improving future
collaborative work.
The winning team in each area final will receive a trophy
for their school or college. There will be certificates for all
the area finalists.
Improving own learning and performance
Regional heats
By being clear about what they want to achieve from
undertaking the Challenge, and by planning the work
round their other commitments, students will have the
opportunity to show that they can:
All team members that participate in the competition will
receive a certificate of participation.
Publicity
• agree personal targets such as improving confidence,
team work, critical thinking, presentation or IT skills,
and plan how these will be met;
The Challenge is being run in conjunction with The Times,
which will provide national coverage of the various stages
of the competition. Local and regional media will also be
encouraged to take a close interest in the progress of
teams from their areas. Schools that do well can expect to
receive coverage in the local and national press – you
might have to justify your monetary policy decision to
your local community!
• use the plan, seeking feedback and support from others;
and
• review progress and present evidence of achievements.
Prizes
National final
For the six teams in the national final there will an
expenses-paid trip to the Bank of England in London,
including a programme of events and an opportunity to
meet senior Bank staff.
The winning team will receive the Bank of England and
The Times Interest Rate Challenge trophy.
All national finalists will receive a cash prize for their
school or college.
There will also be non-monetary prizes and certificates for
all the national finalists.
Bank of England and The Times Interest Rate Challenge 2014/15
Section A What you might gain from the Challenge
15
Section A
Dates, venues and expenses
Competitive rounds
Expenses
The Challenge is organised in three rounds: regional heats,
area finals and the national final.
Schools will be expected to make their own travel
arrangements to the regional heats, and area and national
finals. With the exception of short journeys, reasonable
travelling expenses will be reimbursed on prior application
to the Bank.
Regional heats
Those teams successful in the ballot will participate in one
regional heat. The regional heats will take place between
17 November and 28 November 2014 during the school
day at venues across the United Kingdom. The winning
team in each heat will progress to an area final. A
runner-up will also be announced.
Area finals
There will be six area finals. Each regional winner will
participate in one area final, which will take place in
February 2015. The area finals will be held during the
school day. The areas will be announced after the regional
heats, when the geographical spread of the regional
winners is known. The winning team in each area final will
progress to the national final. A runner-up will also be
announced.
Teams which have to travel long distances may require
accommodation for the regional heats and area finals.
The cost will be reimbursed by the Bank. The Bank will
provide accommodation for the national final in London.
Schools and colleges wishing to claim expenses
should contact the Target Two Point Zero team
(see page 18) for contact details to agree the claim
and request a claim form before making their
arrangements.
National final
Six teams will compete in the national final at the
Bank of England in London. The national final will be
a two-day event, which will take place on 12 and
13 March 2015.
Bank of England and The Times Interest Rate Challenge 2014/15
Section A Dates, venues and expenses
16
Section A
The Challenge rules
Participants
The Challenge is open to any school or college in the
United Kingdom. Each school or college can enter one
team. If the demand for places is high, the number of
schools taking part will be restricted, in which case entry
will be by ballot.
The Challenge is limited to students aged 16 to 18 who
are taking an AS level, A level, the IB, Higher, Advanced
Higher, Vocational A level or equivalent course. Employees
and relatives of employees of the Bank of England and
The Times may not participate. There is no restriction on
the subjects being studied but the Challenge will probably
appeal mainly to students of economics and business.
Teams
The team should consist of four students, who must be
registered at the school or college. Each team should
nominate a teacher to act as a coach and adviser and to
accompany the team to the regional heats and the area
and national finals. Although the team members alone will
represent the school or college in the regional heats and
the area and national finals, teams may enlist help and
support with their research, analysis and preparation from
other class and school members, teachers and friends.
There is detailed guidance on this in the section on What
the Challenge involves on pages 9–11.
Team membership must not change during the
competition except in exceptional circumstances and with
the prior agreement of the Bank.
Presentations and questions
When making their presentations and answering
questions, teams should adhere to the following rules.
• Presentations should be no more than 15 minutes long.
The chairperson of the judging panel will indicate when
13 minutes has elapsed, after which the team should
start to conclude its presentation. Teams which overrun
will be marked down by the judges.
Bank of England and The Times Interest Rate Challenge 2014/15
• Each team member must make a significant oral
contribution to the presentation.
• Team members may refer to hand-held notes and to
their visual aids but they should not read verbatim from
their scripts, laptop screens or visual aids. There is no
requirement to memorise the presentation. The rules
permit students to refer to notes but they should look
at the audience as much as possible. Verbatim reading
from scripts, laptop screens or visual aids or
exceptionally heavy reliance on notes does not
automatically disqualify teams from winning but teams
who do this will be marked down by the judges.
• In the regional heats and area finals the format of the
presentation is at the discretion of the teams. National
finalists will be expected to use PowerPoint.
• Teams should bring 3 printed handouts of their
presentation for the judges. The handouts will not be
taken into consideration by the judges in their marking
and teams will not be penalised if, for technical reasons,
they are unable to provide them. The handouts are
simply to help the judges, who find it useful to have
hard copies of the presentation on which to make
notes. The format is up to teams. The important thing
is that the printed slides are clear and easy to read with
space to make notes. Any last minute changes to slides
can be done in manuscript at the event. Teams will not
be marked down for this.
• When answering the judges’ questions conferring is
allowed, but teams will be marked down for lengthy or
excessive conferring which limits the number of
questions that can be asked.
• When answering judges’ questions, the approach used is
at the discretion of teams. The key point is that team
members should work together as a team. Teams will
be marked down if answers are dominated by one or
two team members.
• When making their policy recommendation and when
answering the judges’ questions, team members do not
have to agree with each other, but each point of view
must be explained.
• The judges’ decisions are final. They will be announced
at the end of each round.
Section A The Challenge rules
17
Section A
Contacting the Target Two Point Zero team
If you have any queries about Target Two Point Zero – the
Bank of England and The Times Interest Rate Challenge,
please contact the Target Two Point Zero team at:
Target Two Point Zero
Education & Museum Group HO-M
Public Communications and Information Division
Bank of England
Threadneedle Street
London EC2R 8AH
Tel:
Fax:
e-mail:
The material provided for Target Two Point Zero is
available on the Bank of England’s website.
www.bankofengland.co.uk/education/Pages/
targettwopointzero/default.aspx
020 7601 5366
020 7601 5808
[email protected]
Bank of England and The Times Interest Rate Challenge 2014/15
Section A Contact details
18
Section B
Monetary policy – setting interest
rates to control inflation
Monetary policy is about setting interest rates to control inflation. It sounds
straightforward enough. But to undertake the Interest Rate Challenge,
participants will need to have some understanding of what inflation is and
how it occurs. And they will need to know how monetary policy works. This
section provides some background to set teams on their way.
What is inflation
21
The inflation rate
21
Price indices
21
Changes in the inflation rate
21
What causes inflation?
23
The gap between demand and supply
23
Inflation expectations and monetary policy
24
What is monetary policy for?
25
Price stability
25
Monetary policy, prices and output
25
Why do we want stable prices
26
The value of money
26
The role of prices
26
Economic stability
26
How do interest rates affect inflation?
28
Bank Rate
28
From Bank Rate to inflation
28
The effects on demand
28
How long do these effects take to work?
29
Bank of England and The Times Interest Rate Challenge 2014/15
Section B Monetary policy
19
Section B
What is inflation?
Inflation is a general rise in prices across the economy. This is distinct from a rise in
the price of a particular good or service. Individual prices rise and fall all the time in a
market economy, reflecting consumer choices and preferences, and changing costs.
If the price of one item – say a particular model of car –
increases because demand for it is high, we do not think
of this as inflation. Inflation occurs when most prices are
rising by some degree across the whole economy.
percentage weights are revised annually to reflect changes
in spending patterns. Sometimes new goods and services
are added and sometimes they are taken out. In 2014
interchangeable lens digital cameras were added to reflect
their increasing share of the camera market.
The inflation rate
We often hear about the rate of inflation being 2% or
2.7% or some other number. The inflation rate is a
measure of the average change in prices across the
economy over a specified period, most commonly
12 months – the annual rate of inflation. We typically hear
about the annual inflation rate for a particular month.
If, say, the annual rate of inflation in January this year was
3%, then prices overall would be 3% higher than in
January last year. So a typical basket of goods and services
costing, say, £100 last January would cost £103
this January.
The inflation rate is a measure of the
change in prices over a specified period
Until December 2003, UK monetary policy was based on a
measure of inflation called RPIX. RPIX inflation is almost
the same as RPI inflation but it excludes one component –
namely mortgage interest payments.
But on 10 December 2003 the Chancellor of the
Exchequer announced that in future monetary policy
would be based on the Consumer Prices Index (CPI)
which is explained on page 34.
Price indices
There are a number of different measures of inflation in
use today. The most familiar measure in the United
Kingdom is the Retail Prices Index (RPI). But monetary
policy is now based on the Consumer Prices Index (CPI).
Both measure the prices of products and services that
consumers buy. A price index is made up of the prices of
hundreds of goods and services – from basic items like
bread to new products, like eBooks. Prices are sampled up
and down the country every month; in supermarkets,
petrol stations, travel agents, insurance companies and
many other places. All these prices are combined together
to produce an overall index of prices.
The goods and services included in the index are chosen
and weighted on the basis of the spending patterns of
UK households – for example, if gas bills account for
around 1% of consumers’ total spending, then gas prices
will account for about 1% of the total index. The
Bank of England and The Times Interest Rate Challenge 2014/15
Changes in the inflation rate
Any individual price change could cause the measured
rate of inflation to change, particularly if it is large or if
the item has a significant weight in the price index. But we
are more interested in the general increase in prices rather
than individual price changes. A large rise in the price of
petrol, for example, might affect the overall rate of
inflation. But unless this price carried on rising, the annual
rate of inflation would eventually fall back again – the
example in the box below explains this, if you want to
know more.
Events affecting a range of prices can also result in a
change in the inflation rate. For example, a rise (or fall) in
oil prices might affect the price of other goods if
producers pass on the increase (or decrease). But, again,
unless the oil price continues to rise (or fall), this influence
on the inflation rate will eventually wear off after a time.
Section B What is inflation?
21
Similarly, if the value of the pound falls against other
currencies – ie. the exchange rate depreciates – the price
in the shops of some imported goods might rise. But only
if the exchange rate keeps falling will this influence on
inflation continue.
A change in price
If petrol prices had been £1.25 a litre for some time
and then they increased in, say, February 2014 to
£1.50 a litre while no other prices changed, the
annual rate of consumer price inflation would
increase. If petrol prices remained unchanged after
that, the annual rate of inflation would then fall
back in February 2015. That is because the annual
rate of inflation in February 2015 measures the
change in prices between February 2014 and
February 2015, during which time the price in our
example has stayed the same at £1.50 a litre – the
rise in petrol prices recorded in February 2014
drops out of the calculation. So, although the price
of petrol remains at the higher level, annual
inflation is not higher after a year or more.
Bank of England and The Times Interest Rate Challenge 2014/15
Price changes like those described can have other
indirect effects on inflation. But individual price changes
in themselves do not have a lasting impact on the
inflation rate.
The rate of inflation in a particular month will
depend on movements in all prices. But we need
to distinguish between individual price changes –
which might change the measured rate of inflation
for a period – and the notion of inflation as an
ongoing, general increase in prices.
Section B What is inflation?
22
Section B
What causes inflation?
The measured inflation rate at any point in time will be made up of an array of
individual price changes. But the amount of inflation in the economy is about more
than just the sum of all individual price changes. Something more fundamental
determines the amount of inflation in the economy – whether it is 1%, 10% or 100%.
Demand...
One of the underlying causes of inflation is the level of
monetary demand in the economy – how much money is
being spent. We can demonstrate this by considering what
happens when the prices of some products are rising.
Imagine the price of cinema tickets has risen. If consumers
want to buy the same amount of all goods and services as
before, they will now have to spend more – because the
price of one of the products they consume has risen. This
will only be possible if their incomes are rising, or
alternatively if consumers are prepared to spend a bigger
proportion of their incomes, and save less. But if total
spending does not rise, then higher prices will mean
consumers will either have to buy fewer cinema tickets or
buy less of something else. Any fall in demand for goods
and services will put downward pressure on prices. So
although higher costs or other factors might cause some
prices to rise, there cannot be a sustained rise in prices
unless incomes and spending are also rising.
On the other hand, if the price of some goods falls, people
will need to spend less to buy the same amount of all
goods and services as before. But if people still earn the
same, they will have the same amount of income as
before. So they will be able to buy more of those goods or
of something else. Demand in the economy will rise and
this, in turn, might cause some prices to rise.
The underlying causes of inflation relate
to the amount of demand in the economy
Of course, this process takes time. And the situation will
be complicated if some people’s incomes are affected by
the falls in prices – say because lower import prices cause
firms competing with imports to lose sales and reduce the
Bank of England and The Times Interest Rate Challenge 2014/15
number of people they employ. However, it demonstrates
a key feature of inflation – that it relates to the amount of
demand in the economy.
...and supply
But inflation is not just about demand in isolation.
Inflation reflects the amount of demand in the economy
relative to the available supply of goods and services – in
other words, the amount of money people are spending
relative to what can be produced.
Inflation tends to rise when, at the current price level,
demand for goods and services in the economy is greater
than the economy’s ability to produce goods and services
– its output. One of the original descriptions of inflation
remains valid – that ‘too much money chases too
few goods.’
The gap between demand and supply
How much the economy is able to produce will reflect the
rise of the working population. Increases in output will
also depend on factors that enable more output to be
produced from available resources – in other words,
productivity increases. The amount the economy is able to
produce, ie. supply, might increase due to the introduction
of new technologies, extra investment in new equipment,
improved methods of production and distribution or by
enhancing the skills of the workforce. These things can all
lead to higher productivity.
There will be some price level at which there is a broad
balance between the demand for, and supply of, goods
and services. At this point there tends to be no upward or
downward pressure on inflation. Firms will be working at
their normal capacity – producing everything they can in
the most efficient way with their existing resources.
Section B What causes inflation?
23
Too much demand...
But what happens if there is an increase in demand for
some reason, for example due to a reduction in income
tax, or because consumers suddenly feel more optimistic
and start spending more money rather than saving?
When demand rises above what firms
can produce at their normal level of
operation, there tends to be upward
pressure on costs and prices
Firms can usually increase production to meet higher
demand. But this may only be possible by incurring higher
costs. For example, it might be necessary to introduce
overtime working or hire extra people. If many firms are
trying to recruit extra people in order to produce more,
wages might start to rise. And firms might have to pay
more for additional materials or run their processes and
machinery in a less efficient way.
So to produce more, firms increase their demand for
resources, and this may result in upward pressure on
production costs and prices – for example, the price of
bricks and the wages of bricklayers might rise if there is
high demand for the construction of new buildings such as
houses or offices. At the same time, imports are likely to
rise and the gap between what the country imports and
exports – its trade balance – might widen.
Higher prices in general might lead people to demand
higher wages so they can still buy the same amount of
goods and services. An increase in wage costs might then
feed through to a further rise in prices. The inflation
process can then continue until prices have risen to such a
level that demand is once again equal to supply.
We say more about demand, output and inflation on
page 25 and in Sections D and F.
Inflation expectations and monetary
policy
Even when demand and supply (output) are roughly
balanced, inflation will not necessarily be zero or indeed
particularly low and stable. When firms and employees
negotiate wages and when companies set their prices,
they often consider what inflation might be in the period
ahead, say the next year.
Expected inflation matters for wages and prices because
future price rises reduce the amount of goods and services
that today’s wage settlement can buy. So, if inflation is
expected to be high, employees might push for a higher
wage increase. If wage settlements build in these
expectations, then firms’ costs increase, which in turn
could be passed on to customers in higher prices.
So if people expect inflation, their behaviour can lead
to inflation.
If people expect inflation, their behaviour
can lead to inflation
What determines the expected rate of inflation? The
simple answer is monetary policy and how much people
believe in the ability and commitment of the authorities –
the government and the central bank – to achieve their
inflation objectives. People have to believe that there will
be low inflation before they stop building expectations of
high inflation into their decisions. The authorities have to
demonstrate that they will not allow inflation to rise –
that they will act to ensure demand does not rise too
much ahead of output.
...too much supply
The opposite to this is when there is slack – ie. spare
capacity – in the economy. That is when the amount that
can be produced is greater than demand. In this situation,
there tends to be downward pressure on costs and prices.
Inflation is usually generated by an
excess of demand over supply
To contain inflationary pressures in the economy, demand
needs to grow roughly in line with output. Output grows
over time at a rate which largely depends on factors
which increase productivity. If demand grows faster than
this, unless there is spare capacity in the economy – such
as after a recession – inflation is likely to rise.
Bank of England and The Times Interest Rate Challenge 2014/15
The ultimate cause of inflation can really be said to be
central banks, like the Bank of England. Their behaviour
and actions determine whether inflation is allowed to rise
or is kept low – in other words, whether they allow prices
to rise unchecked by monetary policy, or whether the
central bank seeks to influence the amount of money in
the economy.
To keep inflation low, we want to ensure that the
growth in demand does not get ahead of the growth
in what the economy can produce. We want output
to rise, but at a steady rate across the economy as
a whole and not so fast that the resulting demand
for resources generates upward pressure on costs
and prices.
Section B What causes inflation?
24
Section B
What is monetary policy for?
Price stability
The aim of monetary policy is to achieve stable prices.
Price stability means that changes in the general level of
prices across the economy are relatively small and gradual
– in other words, prices do not rise by much from month
to month and from year to year. In practice, price stability
equates to low and stable inflation.
The broad aim of monetary policy is to
achieve price stability
A quote from Alan Greenspan, a former Chairman of the
US Federal Reserve – the central bank of the United States
– is one of the most apt.
"For all practical purposes, price stability means that
expected changes in the average price level are small
enough and gradual enough that they do not materially
enter business and household decisions."
The goal of price stability has become widely accepted as
the appropriate objective of monetary policy, and is now
one of the primary considerations of central banks around
the world. This consensus reflects an understanding of
how the economy works and a practical experience of the
ineffectiveness of using monetary policy to achieve other
economic objectives.
Monetary policy, prices and output
The effects of monetary policy are ultimately seen in
prices. A change in interest rates feeds through the
economy, influencing demand, costs and then prices. This
process is explained on pages 28–29. Boosting demand, by
lowering interest rates, may cause output to rise at a
faster rate for a time. But monetary policy does not have
a lasting impact on output.
Suppose the Bank of England printed double the amount
of money in the economy and left it on street corners for
people to help themselves. People would go out and
spend more. But the economy cannot simply
Bank of England and The Times Interest Rate Challenge 2014/15
produce twice as much. Firms would try to increase
output to meet the extra demand and imports might rise.
But the extra demand for resources would force costs and
prices higher. In the same way, changing interest rates will
result in changes in demand in the economy. But, overall,
it cannot affect what the economy is able to produce,
other than in the short term as output responds to
fluctuations in demand.
Some of the mistakes in economic policy in the past
resulted from a belief that it was possible to raise output
and employment permanently by accepting a degree of
inflation – there was an assumed trade-off between
inflation and unemployment. But efforts to exploit it, by
trying to boost demand through higher government
spending or lower interest rates, led to increasing rates of
inflation – they revealed that, in the long run, there was
no such trade-off.
There is no general, lasting trade-off
between output and inflation
There is, however, a recognised trade-off between output
and inflation in the short term, ie. a few years. This is very
important to the workings and conduct of monetary
policy. In the short term, if demand and output are
growing too quickly, increasing interest rates can reduce
output growth back to a level which does not result in
inflationary pressure. Conversely, reducing interest rates
can increase output growth. But, in the longer run, there
is no lasting trade-off between output and inflation.
Changes in interest rates affect prices only.
The effects of monetary policy are
ultimately seen in prices
The role of monetary policy is restricted to
influencing the level of demand in the economy in
order to control inflation. Changes in monetary
policy do affect output and employment in the short
term. But these influences do not last.
Section B What is monetary policy for?
25
Section B
Why do we want stable prices?
The value of money
Ensuring that prices are fairly stable amounts to trying to
maintain the value of money, ie. ensuring that what £1
buys today will be roughly the same as what it will buy
tomorrow or next month. If people expect the value of
their money to fall, this undermines the role of money as
a measuring rod for the value of goods and services in the
economy. It no longer acts as a standard and stable
measure of value, because its own value is falling and
uncertain.
At worst, when confidence in a currency deteriorates
completely, money can stop being used as a means of
exchange. When prices were rising rapidly in Germany in
the 1920s, people had so little confidence in their
currency that they demanded to be paid several times a
day, so they could quickly spend their wages before they
fell in value.
In the United Kingdom in the 1970s, the annual rate of
inflation was more than 20% for a time – what £1 would
buy was reduced by over a fifth in one year. In response,
people sought wage increases to compensate them for
this decline in the value of money. This placed further
upward pressure on prices – creating what is known as a
wage-price spiral.
The role of prices
Uncertainty about the value of money – the future prices
of goods and services – can be damaging to the proper
functioning of the economy. Prices are at the core of a
market-based economic system. They help to determine
what goods and services are demanded and what is
supplied. When prices across the economy are fairly
stable, specific changes in the prices of individual goods
and services allow firms and individuals to make decisions
about how much to consume, how much to produce and
invest, and how much to save or borrow. These price
changes are reasonably clear to see; they are not obscured
by a general rise in prices.
Bank of England and The Times Interest Rate Challenge 2014/15
But when the prices of most goods and services are rising,
it is more difficult to know which items are rising in price
relative to others. For example, if the demand for organic
vegetables is high and prices are rising, this should be a
signal to other companies to increase supply to this
market. But if prices in general are rising, it might not be
clear whether the higher price is part of this general
increase or specific to an individual product.
Economic stability
When inflation is high, it also tends to be more variable
and uncertain. Many of the costs of inflation are
associated with its uncertainty.
Price stability is important because high
and volatile inflation creates economic
instability
Savers and lenders might want some insurance against the
uncertainty of the future value of their money, ie. a higher
rate of interest for lending their money. This will mean
higher borrowing costs for individuals and firms. And
uncertainty about prices and the value of money might
discourage firms from making long-term investments.
One of the main consequences of high inflation has been
greater instability in economic conditions as a whole –
periods when demand and output have been growing
strongly but then fallen sharply. These episodes are
commonly referred to as boom and bust cycles.
In the past, when demand rose much faster than output
and inflation increased, sharp increases in interest rates
were necessary to bring demand back into line. This often
resulted in large falls in output – ie. a recession – as the
imbalance in the economy was abruptly corrected. One of
the costs of unsustainably high output growth – an
economic boom – and the resultant upward pressure on
costs and prices, has been large falls in output and
employment. These falls were probably greater than
would have been the case had demand and output grown
in a steadier and more balanced way.
Section B Why do we want stable prices?
26
One such episode in the United Kingdom was during the
late 1980s and early 1990s. Inflation rose to over 10% as
demand increased strongly. Interest rates were increased
to as high as 15%. With consumers and companies
burdened by high levels of debt, higher interest rates led
to a large contraction in demand and resulted in falling
output and employment in the early 1990s. The boom was
followed by the bust. These episodes inevitably affect
individuals’ and firms’ behaviour. Firms find it more
difficult to plan ahead when there is uncertainty about
demand, prices and interest rates.
Until the first quarter of 2008, output had grown for the
longest continuous period since the mid-1950s – when
current statistical records began – and inflation had been
relatively low over the previous decade. But the sharp rise
in energy and food prices pushed CPI inflation well above
target to a peak of 5.2% in September 2008. Output
growth had started to falter at the end of 2007, and by
2009 Q2 output had fallen by 7.2% from its peak in
2008 Q1.
Monetary policy is aimed at achieving price stability.
But the goal of price stability is not an end in itself.
Stable prices are a necessary condition for the
economy to grow in a stable and sustainable way,
and for the effective functioning of prices and money
in the economy.
Bank of England and The Times Interest Rate Challenge 2014/15
Section B Why do we want stable prices?
27
Section B
How do interest rates affect inflation?
Monetary policy aims to influence the overall level of monetary demand in the
economy so that it grows broadly in line with the economy’s ability to produce
goods and services. This stops output rising too quickly or slowly. Interest rates are
increased to moderate demand and inflation and they are reduced to stimulate
demand. If rates are set too low, this may encourage the build-up of inflationary
pressure; if they are set too high, demand will be lower than necessary to control
inflation. How does this work?
Bank Rate
The effects on demand
Monetary policy operates by influencing the price of money,
ie. the cost of borrowing and the income from saving.
When Bank Rate is changed, demand can be affected in
various ways.
The MPC sets the interest rate for the
Bank of England’s financial market
transactions
In the United Kingdom, the Monetary Policy Committee
(MPC) sets the interest rate that is paid on deposits held at
the Bank of England by commercial banks and building
societies. This interest rate is known as Bank Rate.
From Bank Rate to inflation
Changes in Bank Rate affect the whole range of interest
rates set by commercial banks, building societies and other
financial institutions for their own savers and borrowers. It
will influence interest rates charged for overdrafts and
mortgages, as well as savings accounts. A change in Bank
Rate will also tend to affect the price of financial assets
such as bonds and shares, and the exchange rate. These
changes in financial markets affect consumer and business
demand and, in turn, output. Changes in demand and
output then impact on the labour market – employment
levels and wage costs – which in turn influence producer
and consumer prices.
• Spending and saving decisions
A change in the cost of borrowing affects spending
decisions. Interest rates will affect the attractiveness of
spending today relative to spending tomorrow. An
increase in interest rates will make saving more
attractive and borrowing less so. This will tend to
reduce current spending, by both consumers and firms.
That includes spending by consumers in the shops and
spending by firms on new equipment, ie. investment.
Conversely, a reduction in interest rates will tend to
increase spending by consumers and firms.
• Cash flow
A change in interest rates will affect consumers’ and
firms’ cash flow, ie. the amount of cash they have
available. For savers, a rise in interest rates will
increase the money received from interest-bearing bank
and building society deposits. But it will also mean
higher interest payments for people and firms with
loans – debtors – who are being charged variable
interest rates (as opposed to fixed rates which do not
change). These include many households with
mortgages on their homes. These fluctuations in cash
flow are likely to affect spending. Lower interest rates
will have the opposite effects on savers and borrowers.
• Asset prices
A change in interest rates affects the value of certain
assets, such as house and share prices. Higher interest
rates increase the return on savings in banks and
building societies. This might encourage savers to invest
Bank of England and The Times Interest Rate Challenge 2014/15
Section B How do interest rates affect inflation?
28
less of their money in alternatives, such as property and
company shares. Any fall in demand for these assets is
likely to reduce their prices. This reduces the wealth of
individuals holding these assets, which, in turn, might
influence their willingness to spend. Again, lower
interest rates have the opposite effect, ie. they tend to
increase asset prices.
• Exchange rates
A particular influence on prices comes through the
exchange rate. A rise in interest rates relative to those
in other countries will tend to result in an increase in
the amount of funds flowing into the United Kingdom,
as investors are attracted to the higher sterling rates of
interest. This will tend to result in an appreciation of the
exchange rate against other currencies. In practice, the
exchange rate will be influenced both by expectations
about future interest rates and any unexpected changes
in interest rates. That is because if investors expect
interest rates to rise, they may increase the amount
they invest in a currency before interest rates actually
rise. So there is never a simple relationship between
changes in interest rates and exchange rates.
Other things being equal, an increase in the value of the
pound will reduce the price of imports and, because
many imported goods are included in the CPI, this will
have a direct influence on inflation. In addition, a higher
pound will tend to reduce the demand abroad for
UK goods and services. Any fall in export demand will,
in turn, reduce output, as will any shift of domestic
spending to imported goods. A reduction in interest
rates will tend to have the opposite effect.
How long do these effects take
to work?
Changes in the official Bank Rate take time to have their
full impact on the economy and inflation. All the factors
we have described have an impact on demand and, in
turn, prices. Some influences, such as those on the
exchange rate, work very quickly.
A change in the official Bank Rate takes
around two years to have its full impact
on inflation
But it often takes time for changes in the official Bank
Rate to affect the interest payments made by consumers
or firms – such as mortgage payments – or the income
from savings accounts. It is likely to take a further period
of time before changes in mortgage payments or income
Bank of England and The Times Interest Rate Challenge 2014/15
from savings lead to changes in spending in the shops, and
longer still for this spending to work its way up through the
supply chain to producers. Changes in production, in turn,
can lead to changes in employment and wages and
eventually to changes in prices.
We cannot know with any certainty the precise size or
timing of these influences. And the effects might vary
depending on factors such as the stage of the economic
cycle – for example, the impact of higher consumer
demand on inflation just after a recession will be different
than that after several years of growth. This is because after
a recession, when output has been falling, there will be
plenty of spare capacity in the economy – output will be
able to rise quite strongly without generating inflationary
pressure.
Interest rates have to be set based on
what inflation might be over the coming
two years or so
A change in the official Bank Rate may have some instant
effects – for example on consumers’ confidence – which
may influence spending straight away. But, more generally,
a change in the official Bank Rate will take time to
influence consumers’ and firms’ behaviour and decisions.
Overall, a change in interest rates today will tend to have
its full effect on output over a period of about one year,
and on inflation over a period of about two years. This is of
course a very approximate guide.
In this sense, monetary policy has to look ahead. Interest
rates have to be set based on what inflation might be over
the coming two years or so, not what it is today – though
that is a relevant consideration. Policymakers have to judge
what the likely economic developments will be over that
period, in particular what the rate of growth in demand will
be relative to the growth in supply (output). This is why the
Monetary Policy Committee uses forecasts of growth and
inflation to help it decide on the right level for interest rates.
We don’t expect you to produce forecasts but we explain
more about their role on page 37 and on pages 56–57.
This section has provided a thumb-nail sketch of what
is referred to as the ‘transmission mechanism’ — the
economic route-map between changing interest rates
and inflation. We tell you more about the
transmission mechanism on pages 73–74. We also
describe the different parts of the economy in
Section F. The data you will need to look at to assess
demand, output and price pressures in the economy
will be available on the website.
Section B How do interest rates affect inflation?
29
Section C
The inflation target and the Monetary
Policy Committee
This section outlines the United Kingdom’s monetary policy framework. It tells
you about the inflation target, how the Monetary Policy Committee takes
decisions on Bank Rate and quantitative easing, and how it provides forward
guidance.
Monetary policy in the United Kingdom
33
Inflation targets
33
A symmetrical inflation target
33
From RPIX inflation...
33
...to CPI inflation
34
2.0% on average
34
Why is the target positive?
34
An independent Bank of England
36
The Monetary Policy Committee (MPC)
36
MPC meetings
37
Explaining the MPC’s views and decisions – public accountability
37
Quantitative easing – injecting money into the economy
38
What is quantitative easing?
38
Why was QE needed?
38
How does QE work?
38
How much QE is needed?
39
QE2 – a second round of asset purchases
39
Exiting QE as the economy recovers
39
Has QE worked?
40
The team’s policy decision
40
Monetary policy as the economy recovers
41
Fresh guidance
41
An expectation, not a promise
42
Recovery and the stock of purchased assets
42
The Chancellor’s remit for the MPC
43
Bank of England and The Times Interest Rate Challenge 2014/15
Section C The inflation target and the Monetary Policy Committee
31
Section C
Monetary policy in the United Kingdom
In the United Kingdom, the monetary policy framework has evolved to reflect
differing experiences and circumstances. But since the late 1990s an inflation target
has been the defining feature of the framework.
Inflation targets
A symmetrical inflation target
In 1992, the Government decided to adopt for the first
time an explicit target for inflation. Instead of targeting
something like the exchange rate as a means of controlling
inflation, a rate for inflation itself was targeted. Interest
rates were set to ensure demand in the economy was kept
at a level consistent with a certain level of inflation over
time. Similar policies were already operating in New
Zealand and Canada, and have subsequently been adopted
by other countries.
The Chancellor announced on 12 June 1997 that he was
setting an inflation target of 2.5%. The new target of
2.5% was quite a significant change from the previous
target of 2.5% or less. The Treasury felt there were
uncertainties about the old target – was it 2.5% or less
than 2.5%, and if so how much less? So the new target
was symmetrical. It was designed to give equal weight to
circumstances in which inflation is higher or lower than
the target rate. Inflation below the target was to be
judged as being just as bad as inflation above the target.
The first inflation target was set by the Chancellor of the
Exchequer to be an annual inflation rate of 1%–4%, with
an objective to be in the lower half of that range by the
end of the 1992–97 parliament. The inflation target was
subsequently revised to be 2.5% or less.
Interest rates are set to ensure demand in
the economy is kept at a level consistent
with a certain level of inflation
During this time, interest rate decisions were taken by the
Chancellor of the Exchequer. However, the Bank of England
was asked to publish its own economic appraisals in a
quarterly Inflation Report and was given the task of
deciding the timing of interest rate changes. Each month
the then Chancellor – Kenneth Clarke – met the then
Governor of the Bank of England – Eddie George – to
discuss the level of interest rates. Although the Governor
could offer the Bank’s advice about the level of interest
rates necessary to meet the Government’s inflation target,
the decision remained the Chancellor’s. These
arrangements continued until May 1997 when the new
Chancellor – Gordon Brown – announced a new policy
framework.
Bank of England and The Times Interest Rate Challenge 2014/15
The target was symmetrical – inflation
below the target was to be viewed in the
same way as inflation above it
So the remit was not to achieve the lowest possible
inflation rate – policy should not aim for an inflation rate
below the target. Interest rates should be set to ensure
the level of demand in the economy was consistent with
meeting the inflation target.
From RPIX inflation...
Between 1992 and 2003, the inflation target was
expressed in terms of an annual rate for a measure of
retail price inflation that excludes mortgage interest
payments. This is known as RPIX inflation – it is the
annual change in the Retail Prices Index (RPI) but does not
include one of the RPI's components – the interest paid on
mortgages. Mortgage interest payments are an important
Between 1992 and 2003, the inflation
target was expressed in terms of RPIX –
retail price inflation excluding mortgage
interest payments
Section C Monetary policy in the United Kingdom
33
part of household expenditure and so they are included in
the RPI. But they will tend to rise if interest rates go up.
So an increase in interest rates designed to reduce
inflation would have the perverse effect of initially
resulting in a rise in inflation.
…to CPI inflation
On 9 June 2003, the Chancellor announced that he
planned to change the inflation target to one based on
the Harmonised Index of Consumer Prices – the HICP –
instead of RPIX. This would be the first major change to
the monetary framework introduced since 1997.
2.0% on average
Having a target for annual inflation of 2.0% does not
mean that the Monetary Policy Committee is expected
to hold inflation at 2.0% all the time. That would not be
possible or, in fact, desirable. Inflation might change
month to month for all kinds of reasons, many of which
will only have a temporary influence.
Stormy weather...
The inflation rate might change, for example, because of
the weather. If there had been a very wet or very dry
summer, we might expect this to result in bad food
harvests. Any resultant fall in the supply of food might
push some food prices higher for a time, and raise the
overall inflation rate. But we would not expect interest
rates to be changed because of this.
We do not want to force changes in demand and output
across the economy to get inflation back to 2.0% every
time it moves higher or lower. That would mean interest
rates going up and down all the time. This would create
great uncertainty and unnecessary volatility in the
economy. And, by the time the effects had worked
through the economy, inflation might well have changed
again for another reason. Remember, when interest rates
are changed, there is little immediate effect on inflation.
It takes time.
So we accept that the inflation rate will move up
and down because the economy is subject to all sorts
of influences and unexpected events. The aim is to set the
degree of policy stimulus that we think gives the best
chance of inflation being 2.0% in around two years’ time.
But we know it will not always be exactly that rate.
Bank of England and The Times Interest Rate Challenge 2014/15
When inflation does change, we need to understand why
and assess whether the change is likely to persist or if the
reasons for the change are likely to have a broader impact
on the economy and future inflation. But we do not need
to change interest rates every time this happens. In this
sense, monetary policy is aiming to ensure the inflation
rate is 2.0% on average over time.
Why is the target positive?
Why not have an inflation target of 0%?
Although the objective of stable prices actually means
no inflation, we do not aim for this. We prefer to have a
moderate amount of inflation rather than zero inflation.
There are a number of reasons for this, although
economists debate which matter most.
One consideration concerns the fact that interest rates
cannot fall below zero – banks cannot charge negative
interest rates. But what we call real interest rates – the
interest rate minus the inflation rate – can be, and often
are, negative. That is simply when the rate of inflation is
higher than the actual rate of interest. We call the actual
rate of interest – ie. what is paid in money terms – the
nominal interest rate.
When real interest rates are negative, there is a big
incentive for people to spend and borrow rather than save.
One hundred pounds might earn 5% interest if it was put
in a bank account for a year. But if the inflation rate is
10% in that year, the cash will be worth less in a year’s
time than it is now. The real rate of interest is minus 5%.
In this situation, people are likely to prefer to spend more
today rather than tomorrow. Having negative real interest
rates – when the nominal rate of interest is below the rate
of inflation – might be a useful policy option if demand in
the economy is very weak, such as during a recession.
Monetary policy is aiming to ensure that
the inflation rate is 2.0% on average over
time
However, if we have zero inflation, then the policy option
of having negative real interest rates is lost. Like nominal
interest rates, real rates could not be lower than zero.
Retaining this policy option is often cited as one of the
reasons for having an inflation target above zero.
Section C Monetary policy in the United Kingdom
34
Another reason that we do not have a target of zero
inflation relates to our ability to measure inflation
accurately. It is not possible or practical to record every
single price in the country every day of the week. So we
have to estimate inflation by taking a sample of prices.
This sample tries to be representative but it is only ever an
approximation of what people are spending their money
on and what prices they are paying.
It is generally recognised that the true level of inflation is
usually below the rate of inflation recorded by a measure
like the CPI – it overstates inflation to a small degree.
Some price increases will reflect improvements in quality.
For example, computers might include more features or
have faster processors; cars might be more reliable. So,
from year to year, prices might not be measured on an
identical like-for-like basis. It is difficult to incorporate
quality improvements in a price index although some
adjustments can be made. But we need to acknowledge
that some price increases will be due to quality
improvements – in other words, consumers are getting
more for their money.
Having a positive inflation target allows
real interest rates to be negative which
might be a useful policy option when
demand is weak
Bank of England and The Times Interest Rate Challenge 2014/15
The measured rate of inflation tends to
overstate the true inflation rate
Because of this and other reasons, the measured rate of
inflation tends to overstate the true rate of inflation to a
small degree. So if we had a zero inflation target, we
would be targeting falling prices. A general fall in prices –
what we call deflation – could cause demand to fall if
people expect prices to be lower in the future and
consequently decide to delay their spending.
Why not have an inflation target of 5% or 10%?
Many of the costs of inflation are associated with its
unpredictability. But if we could be sure that inflation
could be held at 5% or 10% a year, then the costs of
higher inflation might not be as great. However, it would
be odd to be using money as a standard measure of value
for goods and services if its value was going to decline by
5% or 10% every year. We would continually have to
adjust the value of everything by 5% or 10%. Because
having higher inflation would bring no lasting benefit – in
terms of output and employment – we would have to ask
why not aim for something lower, which was more
consistent with stable prices? In practice, the higher
inflation is, the more uncertain and volatile it tends to be.
Having high and stable inflation might not be an option.
Section C Monetary policy in the United Kingdom
35
Section C
An independent Bank of England
In 1997, the Government gave the Bank of England independence to set interest rates.
This was a major change in the policy framework. It meant interest rates would no
longer be set by politicians. The Bank would act independently of Government,
though the inflation target would be set by the Chancellor. The Bank would be
accountable to parliament and the wider public.
The objective given to the Bank of England was initially
explained in a letter from the Chancellor. This objective
was then formalised in the 1998 Bank of England Act.
The Bank has ‘to maintain price stability, and, subject to
that, to support the economic policy of HM Government
including its objectives for growth and employment’
(Bank of England Act 1998).
The Bank’s remit recognises the role of price stability in
achieving economic stability more generally, and in
enabling sustainable growth in output and employment.
It also recognises that the inflation target will not be
achieved all the time and that, confronted with
unexpected developments in the economy, striving to
meet the target in all circumstances might cause
undesirable volatility of output.
The Chancellor restates the inflation target each year.
From June 1997 to December 2003 the target was 2.5%
for RPIX inflation. The Chancellor, on 10 December 2003
changed the target to 2.0% for CPI inflation. The most
recent policy statement is reproduced on page 43.
Dear Chancellor
If the inflation target is missed by more than 1 percentage
point on either side – in other words, if the annual rate of
CPI inflation is more than 3.0%, or less than 1.0% – the
Governor of the Bank, as Chairman of the MPC, must
write an open letter to the Chancellor explaining the
reasons why inflation has increased or fallen to such an
extent and what the Bank proposes to do to ensure
inflation comes back to the target. This does not mean
that the Bank has a target of 1.0%–3.0%. The target is
2.0%. But if inflation varies by more than 1 percentage
point from the target, the Bank has to explain why.
So far the Governor has written fourteen open letters to
Bank of England and The Times Interest Rate Challenge 2014/15
the Chancellor. CPI inflation on all of these occasions was
more than 1 percentage point above the 2% target. In his
letter of February 2012, the Governor said that the MPC’s
best collective judgement was that CPI inflation would
continue to fall back to around the target by the end of
2012. In coming months, that further moderation was
likely to reflect the declining contributions from petrol
prices and any remaining VAT impact, together with
recently announced cuts to domestic energy prices. But
the pace and extent of the fall in inflation remained highly
uncertain.
The Monetary Policy Committee
The Chancellor instructed the Bank to create a new
committee to set interest rates – the Monetary Policy
Committee (MPC). The Committee consists of nine
independent members – five from the Bank of England
and four external members appointed by the Chancellor.
The appointment of external members to the Committee
is meant to ensure that the MPC benefits from thinking
and expertise in addition to that gained inside the
Bank of England. The membership of the MPC changes
from time to time. The current members are:
Mark Carney, Governor
Ben Broadbent, Deputy Governor
Sir John Cunliffe, Deputy Governor
Nemat Shafik, Deputy Governor
Kristin Forbes
Andy Haldane
Ian McCafferty
David Miles
Martin Weale
Each member of the MPC has expertise in the field of
economics and monetary policy. Members do not
Section C An independent Bank of England
36
represent individual groups or areas. They are independent.
Each member of the Committee has a vote to set interest
rates at the level they believe is consistent with meeting
the inflation target. The MPC’s decision is not a consensus
of opinion. It reflects the votes of each individual member
of the Committee.
A representative from the Treasury also sits with the
Committee at its meetings. The Treasury representative
can discuss policy issues but is not allowed to vote.
The purpose is to ensure that the MPC is fully briefed
on fiscal policy developments and other aspects of the
Government’s economic policies, and that the Chancellor
is kept fully informed about monetary policy.
MPC meetings
The MPC meets every month to set monetary policy.
Throughout the month, the MPC receives extensive
briefing on the economy from Bank of England staff. This
includes a half-day meeting – known as the pre-MPC
meeting – which usually takes place on the Friday before
the MPC’s interest rate setting meeting. The nine members
of the Committee are made aware of all the latest data on
the economy and hear explanations of recent trends and
analysis of important issues. The Committee is also told
about business conditions around the country from the
Bank’s regionally-based Agents.The Agents’ role is to talk
directly to business to gain intelligence and insight into
current and future economic developments and prospects.
differences of view. They also record the votes of the
individual members of the Committee. The Committee
has to explain its actions regularly to parliamentary
committees, particularly the House of Commons’ Treasury
Committee. MPC members also speak to audiences
throughout the country, explaining the MPC’s policy
decisions and thinking. This is a two-way dialogue.
Regional visits also give members of the MPC a chance to
gather first-hand intelligence about the economic situation
from businesses and other organisations.
In addition to the monthly MPC minutes, the Bank
publishes its Inflation Report every quarter. This report
gives an analysis of the UK economy and the factors
influencing policy decisions. The Inflation Report also
includes the MPC’s latest forecasts for inflation and output
growth. Because monetary policy operates with a time lag
of about two years, it is necessary for the MPC to form
judgements about the outlook for output and inflation.
The MPC uses a model of the economy to help produce its
projections. The model provides a framework to organise
thinking on how the economy works and how different
economic developments might affect future inflation.
But this is not a mechanical exercise – forecasts are not
produced by feeding data into the model and pressing a
computer button to get the answer. Given all the
uncertainties and unknowns of the future, the MPC’s
forecast has to involve a great deal of judgement about
the economy. There are no crystal balls to tell the
Committee what the future will be.
Two days – one decision
The monthly MPC meeting itself is a two-day affair. On
the first day, the meeting starts with an update on the
most recent economic data. A series of issues is then
identified for discussion. On the following day, the
Governor summarises the previous day’s discussions and
the MPC members individually explain their views on what
policy should be. The Governor then puts to the meeting
the policy which he believes will command a majority and
the Committee takes a vote. Any member in a minority is
asked to say what level of interest rates he or she would
have preferred, and this is recorded in the minutes of the
meeting. The Committee’s decision on Bank Rate and the
level of asset purchases is announced at 12 noon on the
second day.
We tell you more about the MPC’s projections for growth
and inflation on pages 55–56. We do not want teams to
produce forecasts and you do not need to understand how
the MPC produces its projections. But we will tell you
something about the factors that might affect inflation in
one or two years’ time – so teams can form their own
opinions and make their own judgements.
The Bank of England is charged with the task of
meeting the Government’s inflation target, which is
2.0% based on the CPI measure of inflation. The
target is symmetrical – inflation below or above the
target is viewed as equally undesirable. Inflation will
not always be 2.0%. The aim is that it is 2.0% on
average over time.
Explaining the MPC’s views and
decisions – public accountability
The MPC goes to great lengths to explain its thinking and
decisions. The minutes of the MPC meetings are published
two weeks after the interest rate decision. The minutes
give a full account of the policy discussion, including
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Section C An independent Bank of England
37
Section C
Quantitative easing – injecting money into the economy
The Monetary Policy Committee announced in March 2009 that it would start to
inject money directly into the economy to boost spending – a policy often known as
quantitative easing. The Committee continues to set Bank Rate each month, and the
objective of monetary policy is unchanged – to meet the government’s 2% inflation
target.
What is quantitative easing?
In March 2009, the Bank’s Monetary Policy Committee
(MPC) began purchasing financial assets funded by the
creation of central bank reserves. These reserves are new
money that the Bank creates electronically. Often known
as quantitative easing (QE), the Bank’s asset purchases are
designed to inject money directly into the economy to
raise asset prices, boost spending and so keep inflation on
track to meet the 2% target.
The Bank has injected money into the
economy to boost spending to meet the
inflation target
Once Bank Rate had reached 0.5%, the MPC considered
this to be the practical limit to how far it could cut
nominal interest rates. But the outlook for demand and
inflation in March 2009 suggested the need for further
monetary stimulus. So the MPC decided to inject
additional money directly into the economy through a
programme of financial asset purchases funded through
the creation of central bank reserves.
In 2009 money was not growing quickly
enough to keep inflation close to the
2% target
How does QE work?
The Bank buys financial assets from banks who may be
selling on their own behalf or, more likely, on behalf of
their clients, such as insurance companies, pension funds
and non-financial firms. The proceeds of the sale are
credited to the seller’s bank account. Most of the assets
purchased since the start of the programme in
March 2009 have been British government bonds (gilts).
Why was QE needed?
Spending in the economy slowed very sharply in the
latter part of 2008 and during 2009 as the global
recession gathered pace. This threatened a downward
spiral through a combination of contracting real output
and price deflation. The MPC responded decisively, cutting
Bank Rate from 5% to 0.5% – its lowest ever level – in
just five months in order to support activity and thus
reduce the risk of inflation falling below the 2% target in
the medium term.
Bank of England and The Times Interest Rate Challenge 2014/15
The MPC’s purchases of financial assets can boost nominal
spending in the economy in a number of inter-related
ways. The immediate effect of buying large quantities of
gilts is to raise their prices and lower their yields relative
to other assets. In response, investors are likely to adjust
their portfolios, for example by buying other financial
assets like shares or company bonds – the return on which
is likely to be more attractive. This increased demand for
those assets pushes up their prices, and lowers their yield.
In this way, the effect of the MPC’s purchases of gilts
spreads out across all other asset markets.
At the same time, those selling assets to the Bank have
more money in their bank accounts and commercial banks
hold more deposits at the Bank of England.
Section C Quantitative easing
38
As a result of QE, asset holders in general – including
ordinary households and businesses – will have portfolios
with higher value and more liquidity. If they feel wealthier
and have more money immediately available, then they
are likely to increase their spending which boosts the
economy directly, or else to take on more risk by
increasing their lending to consumers and businesses. In
turn, consumers and businesses may be encouraged to
take on more debt because lower yields on financial assets
– lower interest rates in other words – bring down the
cost of borrowing.
But there are factors that may work to dampen the
effects of QE. An obvious example lies in the banking
sector. The boost to the value of banks’ asset holdings and
their holdings of liquid assets as a result of QE, by itself,
might be expected to make them more willing to lend.
But in the wake of the financial crisis, banks are concerned
about their financial health and as a result are wary of
expanding their lending. For this reason, the MPC did not
expect QE to result in a material expansion of bank
lending. The Bank has acquired most of the assets from
financial businesses other than banks.
Charlie Bean – the Bank’s Deputy Governor for
monetary policy at the time the policy was initiated –
said that ‘the objective of QE is to work around an
impaired banking system by stimulating activity in the
capital markets’. As a result, companies, particularly larger
companies, wishing to raise money have not had to
depend as much on the banks as they might have done in
the absence of QE, raising funds instead from bond and
share issuance.
How much QE is needed?
There was a lot of uncertainty over the appropriate scale
of asset purchases. When the MPC first discussed the
scale of asset purchases in March 2009, the Committee
noted that spending in the economy had grown each year
by around 5% since 1997 and, over that period, inflation
had been close to target. At that time, it appeared likely
that spending would contract without additional policy
stimulus. That suggested asset purchases needed to be
large enough to boost spending growth back to around
5% a year, bearing in mind reductions in Bank Rate and
other factors influencing the economic outlook.
So at its meeting in March 2009, the MPC voted to
reduce Bank Rate to 0.5% and to spend £75 billion on
asset purchases. Subsequently, at its meeting in May that
year, the outlook for the economy looked somewhat
bleaker than in March. Consequently, the MPC voted to
Bank of England and The Times Interest Rate Challenge 2014/15
keep Bank Rate at 0.5% and to undertake a further £50
billion of asset purchases – bringing total purchases to
£125 billion.
At its meeting in August 2009, there were still few signs
of the fall in economic activity coming to an end. So the
Committee again voted to keep Bank Rate at 0.5% and to
make another £50 billion of asset purchases, so that total
purchases increased to £175 billion. In November the MPC
voted to increase total purchases to £200 billion, and to
keep Bank Rate unchanged. Those purchases were
completed early in 2010.
The MPC kept the level of Bank Rate and asset purchases
unchanged for almost two years after its meeting in
November 2009. The Committee believed that the
stock of past purchases, together with the low level of
Bank Rate, continued to provide a substantial stimulus to
the economy.
This extended pause in monetary loosening did not
necessarily mean that the MPC’s asset purchase
programme had come to an end, but it gave the MPC the
opportunity to take stock of the effects of QE so far.
QE2 – a second round of asset
purchases
At its meeting in October 2011, the Committee decided
that the outlook for output growth had weakened so
that the margin of slack in the economy would probably
be greater and more persistent than previously thought.
This made it more likely than not that inflation would
undershoot the 2% target without further monetary
stimulus. Overall, the case for an expansion of the
Committee’s programme of asset purchases was
compelling and it voted unanimously to purchase a
further £75 billion of gilts, bringing the stock of purchases
since March 2009 to £275 billion.
Subsequently, at its meeting in February 2012 the
Committee voted to make an additional £50 billion in
asset purchases, and in July it judged again that further
stimulus was required to meet the inflation target and
voted to buy another £50 billion in gilts to bring the total
stock of asset purchases to £375 billion.
Exiting QE as the economy recovers
As the recovery in the economy becomes stronger and
more enduring, the appropriate settings of monetary
policy needed to deliver the inflation target will change.
This means at some point the MPC will begin to tighten
Section C Quantitative easing
39
policy by increasing Bank Rate and, later, by selling assets.
In its May 2014 Inflation Report, the MPC said that it is
likely to defer asset sales at least until Bank Rate has been
increased to a level from which it could be cut materially,
were more stimulus required.
Has QE worked?
Monetary policy affects inflation with a long and variable
time lag. So asset purchases – like changes in Bank Rate –
take their time to work through the economy to have
their full effect on inflation. But what impact has the
Bank’s asset purchases had to date?
QE is untried previously in the UK, so there’s little past
experience to go by. The economic circumstances that
necessitated the use of QE were also unprecedented.
The evidence suggests that the first round of QE in 2009
raised the level of real GDP by 11/@% to 2% and increased
inflation by 3/$ to 11/@ percentage points. The Bank’s
forecasting model suggests that a 1 percentage point cut
in Bank Rate increases CPI inflation by about 1/@ a
percentage point, so that the effect of the first round of
QE in 2009 was equivalent to a 11/@ to 3 percentage point
cut in official interest rates.
Taking the MPC’s current plan for asset purchases as its
starting point, the team can decide to maintain or
increase the stock of asset purchases, or to make asset
sales. It is difficult to offer precise guidelines about how
much money needs to be injected into – or withdrawn
from – the economy to keep inflation on track to meet
the target.
For instance, if you think that growth in the economy
could be very low and inflation is set to fall below 2%,
you might decide that justifies more asset purchases. If
you think economic recovery is likely to be strong and
enduring with upward pressure on inflation, that might
suggest asset sales.
But there is no right answer. Deciding on the level of asset
purchases or of Bank Rate is a matter of judgement and,
like the real policymakers, team members may disagree.
So the team may choose to vote on Bank Rate and on
quantitative easing. If this results in a tie, the team
captain will have the casting vote. If there is a split
decision, both sides of the argument must be explained in
the presentation to the judges.
Key resources for the team’s decision
Teams may vote on Bank Rate and the
level of asset purchases
The team’s policy decision
In each round, the team should take the MPC’s interest
rate on the day of its presentation as its starting point,
and decide whether to change Bank Rate and, if so,
whether to increase it or decrease it, and by how much. In
addition to setting Bank Rate, teams may – like the MPC –
wish to consider the option of injecting or withdrawing
money from the economy to meet the inflation target.
Bank of England and The Times Interest Rate Challenge 2014/15
• Watch the Bank’s short animated film,
‘Quantitative easing – How it works’.
www.bankofengland.co.uk/education/Pages/
inflation/qe/video.aspx.
• Read ‘The impact of asset purchases in the MPC’s
projections’ on page 41 of the May 2014 Inflation
Report
www.bankofengland.co.uk/publications/Documents
/inflationreport/2014/ir14may5.pdf.
Section C Quantitative easing
40
Section C
Monetary policy as the economy recovers
The financial crisis and the deep recession that followed prompted exceptionally
loose monetary policy. Now that the economy has begun to recover, the MPC has
provided ‘forward guidance’ on how it will adjust monetary policy to keep inflation
close to the 2% target.
Forward guidance is a statement by the MPC on the
future path of monetary policy. It’s designed to help
people understand how the MPC sets interest rates, so
that households and businesses can spend and invest with
more confidence.
Forward guidance is a statement by
the MPC on the future path of monetary
policy
The MPC first provided forward guidance on monetary
policy in August 2013. At that time, there were early signs
of recovery, but the degree of spare capacity or ‘slack’ in
the economy remained large.
The Committee framed its guidance in terms of the
unemployment rate. It said it would leave interest rates
and the stock of asset purchases unchanged, at least until
the unemployment rate had fallen to 7% – provided this
didn’t pose risks to the outlook for inflation or financial
stability.
The MPC’s forward guidance has
prompted companies to bring forward
spending and increase hiring
Although not a comprehensive measure of slack, the
Committee selected the unemployment rate because it’s
less volatile and prone to revision than other measures,
and is widely understood.
Bank of England and The Times Interest Rate Challenge 2014/15
When it provided its policy guidance, the MPC said that
once unemployment had fallen to 7%, it would assess the
state of the economy more broadly, drawing on a wide
array of indicators.
Evidence collected from business surveys shows that the
MPC’s forward guidance has prompted companies to bring
forward spending and increase hiring.
Fresh guidance
By February 2014, unemployment had fallen close to 7%
and the MPC decided to offer further guidance on future
monetary policy.
The Committee believed there remained spare capacity in
the economy equal to about 1%–1½% of GDP. On that
basis the MPC judged there was scope to absorb more
spare capacity before raising Bank Rate. And the
Committee would maintain the stock of asset purchases
at £375 billion, at least until Bank Rate had begun to rise
from 0.5%.
The Committee said that once it begins to raise Bank
Rate, it expects it will do so only gradually. And when the
economy has finally returned to normal capacity and
inflation is close to target, the appropriate level of
Bank Rate is likely to be materially below the 5% level
set on average by the Committee prior to the crisis.
The Committee said that once it begins
to raise Bank Rate, it expects it will do so
only gradually
Section C Monetary policy as the economy recovers
41
An expectation, not a promise
In its August 2014 Inflation Report the MPC said that the
central message in its previous guidance remained: given
the headwinds holding the economy back, Bank Rate
would rise only gradually and was expected to remain
below historical levels for some time to come.
The Committee’s guidance on the likely
pace and extent of increases in Bank Rate
‘was an expectation, not a promise’.
However, the actual path for monetary policy would
depend on economic conditions. In other words, the
Committee’s guidance on the likely pace and extent of
increases in Bank Rate ‘was an expectation, not a
promise’.
Recovery and the stock of purchased
assets
A factor influencing increases in Bank Rate will be the
speed and timing at which the MPC sells its stock of
purchased assets. Sales of assets represent a tightening of
monetary policy because they withdraw money from the
economy. Therefore asset sales are likely to be associated
with a lower path of Bank Rate than would otherwise be
the case.
Bank of England and The Times Interest Rate Challenge 2014/15
The MPC has said it is likely to defer sales of assets at
least until Bank Rate has reached a level from which it
could be cut materially, were more stimulus required.
Bank Rate will be the ‘active marginal instrument’ for
monetary policy. This means that once asset sales have
begun, the Committee will loosen policy by cuts in Bank
Rate, rather than through new purchases of assets.
Recent Bank publications on monetary policy
guidance
• ‘Influences on policy in the medium term’,
pages 42–43 in the August 2014 Inflation Report.
See
www.bankofengland.co.uk/publications/
Documents/inflationreport/2014/ir14aug5.pdf.
• ‘Monetary policy as the economy recovers’,
pages 8–9 in the February 2014 Inflation Report.
See
www.bankofengland.co.uk/publications/
Documents/inflationreport/2014/ir14febo.pdf.
• ‘The impact of asset purchases in the MPC’s
projections’, page 41 in the May 2014 Inflation
Report. See
www.bankofengland.co.uk/publications/
Documents/inflationreport/2014/ir14may5.pdf.
Section C Monetary policy as the economy recovers
42
Section D
Assessing economic conditions and
the inflation outlook
This section discusses how teams might think about their assessment of
economic conditions and the inflation outlook – building on the material
covered in Section B. It provides more background for the task of setting
interest rates, and will help teams to work through the different parts of
Section F.
Assessing economic conditions
51
Demand and supply...again
51
Assessing demand
51
Assessing inflationary pressure
52
Judging the inflation outlook
55
Economic growth
55
Inflation
55
The MPC’s growth and inflation forecasts – judgement and uncertainty 56
Bank of England and The Times Interest Rate Challenge 2014/15
Section D Assessing economic conditions and the inflation outlook
49
Section D
Assessing economic conditions
By now, you should be clear about your task – to assess economic conditions and
judge whether future inflation is likely to be above, below or in line with the
Government’s inflation target, and then decide what interest rate might best achieve
the target. There is no unique way to go about building up your team’s assessment of
the economic situation and outlook. You should decide what you want to cover and
how. But you need to keep a close eye on the economic principles that underpin
monetary policy and the inflation process.
Demand and supply…again
Assessing demand
In Section B, we explained that the amount of demand in
the economy relative to overall supply is an important
consideration for policymakers. The level of spending, in
money terms, relative to the economy’s ability to produce
will determine the extent of inflationary pressure in the
economy. Assessing the level of demand, whether it is
growing more or less quickly than the economy’s ability
to supply goods and services, and whether this is likely
to continue into the future, are key issues for monetary
policy. Interest rates are set to try to ensure that the level
of demand, in money terms, is consistent with the
inflation target.
Teams will need to build an overall picture of the current
and future level of demand in the economy.
Teams need to assess whether the level
of demand is exceeding the supply of
goods and services
We explained how rising demand might result in output
growing at a rate that leads to upward pressure on costs
and prices. Teams need to assess whether there are signs
that the level of demand is beginning to exceed the
economy’s potential to supply goods and services.
The task can be divided into two related parts:
• monitoring and assessing demand conditions across the
economy; and
• monitoring and assessing the extent of inflationary
pressure in the economy.
Bank of England and The Times Interest Rate Challenge 2014/15
Components of demand
Looking at the different components of demand will help
teams to interpret and understand changes in overall
demand. The main components are:
• Consumers’ expenditure – spending on goods and
services by households in the United Kingdom;
• Capital expenditure – investment in buildings and new
equipment;
• Expenditure on stocks of goods – spending by firms on
increasing their inventories of goods and materials;
• Government expenditure – spending by central and
local government on health, education and other public
services;
• Expenditure on exports – spending by foreigners on
UK goods and services; and
• Expenditure on imports – spending by UK residents on
foreign goods and services.
Each of the main components of aggregate demand is
likely to be growing at a different rate at any point in time,
not least because they are influenced by different factors.
For example, consumers’ expenditure might be rising
strongly because of the growth in wages and other
earnings or because people are confident about the future.
Section D Assessing economic conditions
51
But exports might be falling because demand in overseas
economies is declining or the exchange rate is rising. And
investment might be weak because company profitability
is low.
The extent of inflationary pressure in the
economy will depend on the overall level
of demand
There are also links between different components of
demand – for example, strong growth in consumer
spending is likely to increase import demand, or perhaps
make it more attractive to increase investment in
consumer goods industries.
A large amount of the economic data that teams will
come across relate to one or another of these components
of demand. Consumer spending is by far the largest
component of total demand in the economy. So it is
important to track this particularly closely. Section F
explains more about the different components of demand.
Whether firms are producing output for one component of
demand or another is unlikely to affect the way they use
resources. The pressure on costs and prices will be similar
if output is rising too fast. The extent of inflationary
pressure in the economy will depend on the overall level
of demand.
Money
The amount of money in the economy is the key
determinant of the level of prices. It also provides
important indications about demand conditions. Monetary
statistics, such as narrow and broad money, as well as
consumer credit and mortgage lending data, can provide
information about whether spending is likely to rise.
In addition to total output, information is available
covering the output of different sectors of the economy,
such as manufacturing and services. This can help to build
evidence on economic conditions and how they might
be changing.
Similarly, data on activity in the labour market – such as
the change in the number of people in employment and
unemployment – will also tend to reflect how quickly the
economy is growing. All these aspects of the economy are
covered further in Section F.
Assessing inflationary pressure
Teams can monitor the growth of money, demand and
output using all the economic data and information at
their disposal. But remember it is when the level of
spending in money terms starts to exceed what can be
produced normally or comfortably with existing resources
that prices tend to start rising more quickly. Ultimately,
excess demand will be reflected in higher prices, not
higher output.
The problem is that it cannot be known with any certainty
by how much the economy can grow before it starts to
generate inflationary pressure. There is no simple rule to
follow. The pressure on capacity depends ultimately on
the level of demand rather than its growth: an economy
with plenty of spare capacity can grow more quickly than
an economy where resources are fully utilised. But it is
not possible to estimate with much precision how close
the current level of output might be to the point at which
producers start to reach capacity limits. It is not
something that can be observed directly. The box on
page 54 discusses the long-term trend in the growth of
output and the concept of the output gap.
Spotting signs of inflation
Output
Teams can also look at information that reflects the
growth of output in the economy. We explained in
Section B that the rate at which the economy can grow
over the long term depends on factors that increase the
supply potential of the economy, ie. the capacity of the
economy to produce goods and services. But, in the short
term, output (and employment) can rise and fall in
response to changes in demand. Higher demand might be
met by an increase in imports or from firms’ stocks. But, in
the short run, changes in output are likely to reflect
changes in demand.
Bank of England and The Times Interest Rate Challenge 2014/15
In order to monitor how close the economy might be to
operating at or beyond its normal capacity, evidence has
to be gathered that might indicate production bottlenecks
and pressure on resources within the production process,
particularly in the labour market. This includes data on
wages and other costs and prices.
Cost and prices data can help to tell us how close the
economy might be to operating at full capacity by
providing signs that inflationary pressure is building. But it
is always necessary to understand what factors are driving
higher or lower prices before we draw conclusions.
Section D Assessing economic conditions
52
Rising raw material prices might, for example, reflect
strong world demand and be a sign of wider or pending
worldwide inflationary pressure. But, alternatively, higher
prices could be due to factors affecting supply in particular
sectors – for example, poor crop harvests can raise food
prices, or output restrictions by oil producers can increase
oil prices. In these instances, rising material prices might
temporarily lead to more inflation as higher costs work
through the supply chain and into retail prices. But they
are less likely to be a signal of general inflationary pressure
than if prices were rising because of excess demand.
Evidence of inflationary pressure in the
supply chain and labour market can
indicate that the economy is operating
close to full capacity
Similarly, if manufacturers’ product prices start rising
more quickly, you need to assess whether or not this
reflects strong demand and pressures on capacity,
allowing firms to pass on cost increases. Higher prices
might reflect temporary or one-off influences such as a
change in taxes or duties. These factors might influence
the inflation rate for a period. But, unless this results in
higher inflation expectations more generally – which then
feed into wage negotiations and other prices – these
effects should not have a lasting influence on inflation.
This was explained in Section B.
Bank of England and The Times Interest Rate Challenge 2014/15
The labour market
The labour market is an important area for monitoring
inflationary pressure. Employment levels might reach a
point where there is likely to be upward pressure on wages
and other earnings. Wage costs are a major part of total
costs and so can have a significant influence on retail prices.
Rising wage costs not matched by higher productivity,
may reflect pressures in the labour market, perhaps due
to a shortage of skills and recruitment difficulties.
Costs, profits and prices
It is also necessary to judge whether any increase in prices
within the supply chain is likely to be passed on to
consumers. Cost increases might mean lower profit
margins for firms rather than higher prices for consumers,
at least in the short run. For example, faced with higher
costs, retailers might either take a cut in their profits,
make offsetting cost savings elsewhere, or pass the cost
increases on to consumers by charging higher prices.
The extent to which firms are able to pass on cost
increases is likely to be influenced by demand conditions –
when demand conditions are buoyant, retailers are more
likely to be able to pass on cost increases to the consumer,
and perhaps also boost their profit margins. Competitive
conditions will also be important. If some retailers try to
increase their prices and profits, other retailers might enter
the market and eventually force prices down. These are
the kinds of issue that teams will have to consider.
Section D Assessing economic conditions
53
Sustainable growth and the output gap
The economic cycle
Over time, though not over the past few years, the
UK economy has grown at an average rate of about
2.5% a year. This is a useful guide to how much of an
increase in output can be sustained over time, ie.
without generating inflationary pressure.
The answer will partly depend on the stage of the
economic cycle. After a recession, output might grow
quickly without any signs of inflation rising. That is
because there is spare capacity in the economy – the
actual level of output has been growing below its
potential level. This is generally associated with a
reduction in inflationary pressure. As spare capacity
in the economy is used up, there is an increasing
likelihood that continued growth will result in rising
inflation. Long periods of rising demand can take the
level of output above its potential or sustainable level
and are generally associated with rising inflationary
pressure.
The UK economy has grown on
average by around 2.5% a year – a
guide to its sustainable growth rate
You will see this referred to as the trend or sustainable
rate of growth. This reflects the rate of growth in the
labour force and in productivity. Such things as
investment in new equipment and technology,
improved methods of production and distribution,
and the development of skills have enabled
productivity to rise.
Productivity increases and the growth of the labour
force determine the growth in what is referred to as
the economy’s potential output. As we explained in
Section B, potential output is the ‘normal capacity’
level of output at which there is no upward or
downward inflationary pressure in the economy. We
said that actual output might grow by more than its
sustainable rate in some periods and by less in other
periods as the growth in demand fluctuates. Strong
growth, such as that experienced in the late 1980s, has
often been followed by falls in output – negative growth.
When growth is above or below its sustainable rate,
you need to ask whether inflation is likely to move
above or below the inflation target in the period ahead.
Bank of England and The Times Interest Rate Challenge 2014/15
Economists refer to the difference between the actual
level of output and the potential level of output as the
‘output gap’. It can be positive – here defined as actual
output above potential output – or negative. The
output gap cannot be measured with any precision.
No two economic cycles are alike and the rate of
growth that the economy might be able to achieve
through productivity increases can vary over time.
Growth above or below its sustainable
rate is a guide to potential inflationary
pressure
So it is not possible to have hard and fast rules about
the output gap and its implications for future
inflationary pressure. But this is still a helpful concept
for assessing the balance of demand and supply in the
economy as a whole.
Section D Assessing economic conditions
54
Section D
Judging the inflation outlook
Much of the information the MPC studies tells it something about the economic
outlook as well as current economic conditions. The MPC looks at a range of
indicators of the growth in money, demand and output, and the extent of inflationary
pressure in the economy in order to judge, as best it can, future inflation.
Section B explained that monetary policy has to be
forward-looking because interest rate decisions taken
today only have their full impact on inflation around two
years ahead. The MPC is, therefore, interested in the
prospects for both economic growth and inflation. Like
the MPC, teams will need to form judgements about
future trends in the economy and how these are most
likely to impact on inflation.
Teams will have to judge future trends
and how these might impact on inflation
Economic growth
If the growth in demand and output is currently strong or
weak, teams will have to judge whether the recent trend
is likely to continue or not. They will need to ask whether
the current strength or weakness reflects temporary
factors or more fundamental and lasting influences. In the
case of consumer spending, for example, teams might
look at information in the labour market – such as
employment levels and wage increases – in order to judge
the extent to which incomes are likely to rise and support
future growth in spending. Are there factors which are
likely to change recent trends in employment and the
growth in incomes? This reveals something about the
amount of spending power consumers will have at their
disposal in the period ahead.
Survey evidence might also help teams to assess likely
trends in future spending. Some surveys reveal how
confident consumers are about economic prospects. And
teams can look at how much money people are borrowing
from banks and other financial institutions as an indicator
of future spending.
Bank of England and The Times Interest Rate Challenge 2014/15
In a similar way, developments in overseas economies,
together with exchange rate developments, will largely
determine the outlook for export demand. And future
investment demand will be determined by factors such as
company profitability and the outlook for the sales of
firms’ goods and services, as well as the cost of raising
finance. Teams will have to look at trends in variables that
tend to influence future demand in the economy.
Has the MPC already acted?
Of course, the MPC may have already responded to
strong or weak demand growth and the expected effect
on future inflation, by changing Bank Rate or through
other policies, such as ‘forward guidance’. These changes
will take time to affect demand and output. Teams will
need to assess whether it is necessary to adjust monetary
policy further or whether enough has already been done.
Demand may have been rising quickly up to the period for
which the latest data are available. But growth may
already be moderating to the extent that another change
may lead to even slower growth, with the result that
inflation might fall below its target in the future.
Teams need to assess the impact of any
recent changes in monetary policy
Inflation
Assessing the trend in inflation will depend both on
current and future trends in economic growth and how
these relate to the amount of spare capacity in the
economy. Current demand conditions will tell us
something about the likely future path of inflation. And
much of the information that we monitor to tell us about
current inflationary pressure in the economy is relevant to
Section D Judging the inflation outlook
55
assessing the outlook for inflation. The aim is to spot early
warning signals of higher or lower inflation within the
production process and labour market, and evidence of
spending exceeding the supply capacity of the economy.
These considerations provide clues about future inflation
in relation to developments in the domestic economy. But
the inflation outlook can also be influenced by changes in
the exchange rate, particularly in the short run.
The exchange rate
The exchange rate is a key factor affecting inflation
prospects, although it is very difficult to predict. There
is, however, no mechanical link between a change in
exchange rates and inflation.
A change in the value of sterling can have a direct
influence on inflation through changes in import prices.
An appreciation of sterling will tend to lead to a fall in
inflation. But this is primarily a one-off impact on prices
and so a temporary influence on the inflation rate. The
exchange rate is also likely to affect prices indirectly,
through its impact on the demand for exports and imports
and, in turn, output. Importantly, the size of these effects
will depend on why the exchange rate has appreciated or
depreciated, not least because that will determine
whether any change is likely to be sustained. The exchange
rate is discussed further in Section F.
There is no mechanical link between a
change in exchange rates and inflation
Current inflation
Although monetary policy is the dominant determinant
of the inflation rate in the long run, there are many other
influences on the measured inflation rate over shorter
time periods. This was discussed in Section B.
Teams will have to monitor the current rate of consumer
price inflation and judge to what extent movements
reflect temporary influences or more fundamental factors,
ie. whether the current rate of inflation is a guide to the
future rate of inflation. The current rate may be above or
below the inflation target but that may tell us little about
its future direction. In July 2003, the MPC reduced the
official Bank Rate when RPIX inflation was above the then
2.5% target; the MPC increased the Bank Rate in June
2004 when CPI inflation was below the current 2.0% target.
Bank of England and The Times Interest Rate Challenge 2014/15
Even the likely path of inflation in the immediate future
may not be a good guide to its path further ahead. The
immediate outlook might be for inflation to rise or fall,
perhaps due to one-off factors such as a change in VAT
and duties or a rise or fall in the exchange rate. But
demand conditions might indicate that the underlying
picture differs from this short-term prospect.
The immediate outlook for inflation may
not be a good guide to its trend over the
medium term
You will want to judge whether inflationary pressures are
building or diluting over the two-year period, and whether
inflation is likely to be rising or falling once any short-term
influences on the measured inflation rate have dissipated.
It is not possible to do this with much precision. We
cannot say inflation will be 2.0% in one year’s time and
2.5% in two years’ time. This kind of statement assigns
too much certainty to what is always a judgement about
possible future outcomes.
The MPC’s growth and inflation
forecasts – judgement and uncertainty
The MPC thinks about the economic outlook and future
inflation with the help of an economic forecast. The MPC’s
forecast brings together into a quantitative framework all
the key information on the economy and an understanding
of how the economy tends to work.
The future will always be different in
some way from the past
Although teams will not have the MPC’s forecasting
framework, the task, in many respects, will not be so
different. The MPC’s forecasts involve judgements about
a wide range of considerations. The Committee does not
just plug in a series of numbers and wait for the forecast
models to produce a mechanical answer. Economic
models are part of the monetary policy tool kit, but they
do not provide all the answers.
Given the size and complexity of the economy and the
ever-changing nature of the economic situation, economic
models cannot possibly incorporate all the factors that
matter to monetary policy. Most economic models are
Section D Judging the inflation outlook
56
The MPC’s ‘fan’ charts
One important characteristic of the MPC’s forecasts is
worth explaining. You will see that the forecasts are
not presented in terms of a single number for
economic growth and inflation in one or two years’
time. The only certainty about this kind of
‘single-point’ forecast is that it will be wrong. The
probability of inflation being a particular number in
two years’ time is almost zero.
Judgements about the future involve
a great deal of uncertainty – there are
only ever probable outcomes
So it is better to present a forecast as a range of
likelihoods or possible outcomes – what we call a
probability distribution. The MPC tries to judge the
most likely outcome for inflation and economic
based on an understanding and an estimation of what has
happened in the past. Although this is often a good
starting-point for thinking about the future, the future is
never an exact repeat of the past. Forming judgements
and assessing their implications for monetary policy are
part of the job of the MPC. So do not be put off by some
of the more technical aspects of the MPC’s work.
Teams will have to use their judgement about future
trends to help make their policy decisions.
growth over a two-year period. But it acknowledges
that inflation might be higher or lower. This
uncertainty is reflected by the presentation of the
forecasts as ‘fan charts’. These are shown in the
Inflation Report*. The central bands within the fans
represent what the MPC thinks is the most likely
outcome for growth and inflation over the forecast
period. The outer bands represent other possible
outcomes.
The MPC’s forecasts explicitly acknowledge that
judgements about economic growth and inflation in
the future involve a great deal of uncertainty. So
teams should not feel they need to be too precise or
exact. Like the MPC, they need to make judgements
about what is most likely to happen. And, like the
MPC, teams should acknowledge that those
judgements will involve uncertainty.
In addition, you can look in the newspapers and other
places to see what other organisations and economists are
forecasting for the economy.
This section has discussed, in general terms, the task
of forming judgements about demand conditions and
inflationary pressure in the economy. It has provided
a foundation for thinking about the task of setting
interest rates to control inflation.
*Teams can look at the MPC’s latest forecasts for
economic growth and inflation in the Inflation Report,
which is on the Bank’s website at
www.bankofengland.co.uk/publications/Pages
/inflationreport/default.aspx
Bank of England and The Times Interest Rate Challenge 2014/15
Section D Judging the inflation outlook
57
Section E
Using economic information
This section provides general guidance on the main types of economic
information that are available. It describes some of the common features of
economic statistics. The aim is to prepare the ground for teams to be able to
use the data series discussed in Section F.
Building up the economic picture
61
Official statistics
62
Definitions and coverage
62
Aggregated versus disaggregated data
63
Accuracy and timeliness
63
Values and volumes; current prices and chained volume measures;
nominal and real values
64
Index numbers
65
Seasonal adjustment
65
Data volatility
65
Which growth rate?
66
Surveys and business intelligence
67
The nature of survey information
67
Using survey information – survey balances
67
Business intelligence
68
The economic jigsaw – how many pieces of data should you use? 69
Organising economic information
Bank of England and The Times Interest Rate Challenge 2014/15
70
Section E Using economic information
59
Section E
Building up the economic picture
Economic statistics are published almost every day. A steady stream of new figures
arrives on the desks of economists at the Bank of England each month. And on most
days of the week the newspapers carry reports covering the latest information, often
including comments about what the figures might mean for the MPC’s next decision
on Bank Rate and quantitative easing.
New information does not necessarily change the MPC’s
assessment of the economy. It adds to the current body of
evidence. The latest figures might support an existing view
or establish a clearer trend. But, equally, they might
contradict other information and perhaps suggest that a
trend is changing. The data rarely present a uniform or
unambiguous picture.
Each new piece of information adds to
the existing body of evidence
Whether new data clarify or complicate matters, no one
piece of information can ever provide a complete picture
of economic conditions. And the MPC never makes its
decisions on the basis of a single piece of data. It uses
different types of information and many data series to
form its views. A wide range of official statistics and
other information is reviewed and analysed in the
Bank of England’s quarterly Inflation Report and in the
minutes of the monthly MPC meetings.
The MPC uses a range of different types
of information and many different pieces
of data to form its views
Teams will also be able to read the Monetary Policy
Committee’s own economic assessment in the minutes
of the monthly MPC meetings. These are published two
weeks after each meeting. You can also read regular
commentaries on the latest figures and economic
situation in The Times and other publications. The
following pages of this section should give teams a
better feel for the kinds of data that are available.
We do not expect teams to cover everything. The
Bank of England is providing teams with a selection of the
key data relevant to interest rate decisions. These are
described in Section F. The first set of datasheets will be
available from 5 September 2014. The Bank will produce
data updates immediately prior to the regional heats, area
and national finals. The datasheets will be updated
monthly. The datasheets and data updates will be posted
on the Bank’s website. You can, of course, look at any
information you feel is relevant to your assessment of
economic conditions. You might want to use information
from newspapers and other reports. It is entirely up to you.
Bank of England and The Times Interest Rate Challenge 2014/15
Section E Building up the economic picture
61
Section E
Official statistics
Official statistics are the backbone of the MPC’s assessment of the economy – an
essential guide and tool. They provide a framework for analysing economic developments
and the inflation outlook.
The main official data series on the UK economy are
provided by the Office for National Statistics and the
Bank of England. The data measure such things as:
• the amount of money in circulation and level of
borrowing from banks and building societies;
• output from different sectors of the economy
eg. manufacturing, retailing, business services,
construction;
• expenditure by different groups
eg. consumers, firms;
• activity in the labour market
eg. employment, earnings;
• the costs and prices of goods and services;
• government finances; and
• overseas trade.
Official statistics are the backbone of the
MPC’s economic assessment
Statistics are never perfect, but without them we would
be largely ignorant of how the economy is performing,
and unable to judge where it might be heading. The
official statistics have a variety of characteristics of which
teams should be aware in order to use them effectively.
These are discussed in this section. Examples, often
referring to retail sales, ie. spending in the shops, are used
to illustrate points. You might want to refer back to this
information once you have started looking at the data.
Definitions and coverage
All official statistics have definitions explaining what they
cover and the basis on which they are constructed.
Whatever data series you are using, it is important to have
a good general idea about its coverage. The numbers may
not always be what you think they are, and definitions can
Bank of England and The Times Interest Rate Challenge 2014/15
change from time to time. You should familiarise yourself
with the short descriptions provided in the datasheets.
You also need to be aware of specific details, such as
whether data are seasonally adjusted, or are in current or
constant prices. These and other features are discussed
later in this section.
Always have a good idea of the definition
and coverage of the data you are using
Teams also need to understand that the statistical
coverage of the economy is not uniform. Some sectors
and activities are better measured than others. In
particular, there is a relative lack of data covering some
parts of the service sector. This is because some activities
are genuinely difficult to measure. You need to bear this
in mind so your economic assessment is not too heavily
based on data that relate to just part of the economy.
GDP – a key economic statistic
There is one official statistical series with which
teams need to be thoroughly familiar – Gross
Domestic Product (GDP). GDP measures the size
of the economy – the amount of economic
activity. It does this in a number of different ways,
one of which is to measure total output over a
specified period. We tell you more about GDP and
its components in Section F.
You also need to be aware that the coverage of some data
series is more comprehensive than others. For example,
retail sales data do not cover all types of spending by
consumers. They measure primarily spending on goods
that are bought in shops. They do not include spending on
cars or services such as restaurants, electricity supply and
Section E Official statistics
62
transport. Services account for over half of total
consumer spending, so it would be misleading to draw
firm conclusions about total consumer spending from
retail sales data alone. Nonetheless, we would expect the
trends in retail sales data to be closely related to trends
in total consumer spending. They will tend to be
determined by the same factors. But we have to
acknowledge that, at any particular point in time, an
indicator like retail sales may give a wrong impression of
the wider situation. We often pay attention to such data
because they are available more frequently and sooner
than the more comprehensive pieces of data. Retail sales
data, for example, are available every month and are
released about two to three weeks after the end of the
month. Data on total consumer spending are only
available quarterly – every three months – and are first
released some seven weeks after the end of the relevant
quarter. So although total consumer spending gives a
more complete guide to the economic picture, earlier
additional clues provided by other data are helpful.
Some data provide more timely
information but they need to be used
with care
Some data are likely to provide more reliable indications
about the wider economy than others. The number of
people eating out in your local restaurant or pub might be
an indicator of the trend in consumer spending across the
economy as a whole. But we have little means of knowing
how reliable an indicator it is. Generally speaking, the
smaller and less representative the sample, the less
reliable a guide it is likely to be.
Aggregated versus disaggregated data
You will tend to read most about the aggregate or
‘headline’ figures on the economy, ie. data that cover
either the whole economy or a broad sector or aspect of
economic activity. GDP figures cover the economy as a
whole; the Consumer Prices Index covers the prices of a
very wide range of goods and services. When the MPC is
setting interest rates, it concentrates in the main on
aggregate data series of this type. That is because it needs
to consider the overall economic picture rather than every
individual component within it.
But to understand the data, it is often useful to look at
some of the components that make up the ‘headline’
series – the disaggregated data. This may provide clues
about the current economic situation and enable us to
make a better judgement about whether or not trends are
Bank of England and The Times Interest Rate Challenge 2014/15
likely to continue. We might want to know, for instance, if
the latest figures reflect special or temporary factors which
might be revealed by looking at the disaggregated data.
For example, total output can sometimes be affected by
large falls or rises in energy output, ie. electricity, gas and
oil. These changes are often weather-related and so have
only a temporary influence on output. Similarly, if the
money supply is growing fast, you will need to assess what
factors might be behind the growth and whether they are
likely to be continuing or temporary influences.
Teams will need to concentrate on
aggregate data but individual
components can provide useful clues
How much digging?
Teams will have to judge how much digging beneath the
aggregate data they need to do. That might depend on
the numbers themselves. If new data are surprisingly
strong or weak, you might want to look at the underlying
components. Remember that you will be trying to build
up an overall assessment of inflationary pressures in the
economy. You will need to concentrate your efforts on
data that shed light on the prospects for inflation. Too
much detail might make it hard to see the wood for
the trees!
Accuracy and timeliness
The economy is large and complex. Trying to measure its
size and structure, and by how much it is changing, is a
difficult task. Official statistics are usually based on large
samples of firms and individuals, and they are systematically
checked and reviewed to ensure that they meet high
standards. But any statistic can only be an approximate
guide to reality.
There is often a trade-off between the
timeliness of data and its accuracy
In fact, official statistics provide us with an indication of
what has happened rather than what is happening. There
is always a time lag between the data being available and
the period they cover. GDP data are first released around
three to four weeks after the end of the quarter. A more
detailed second estimate is released one month later.
This means that policymakers are always looking at data
relating to the past rather than the present. That adds to
the challenge of using the data to judge what is happening
in the economy now, and how it will develop in the
months and years ahead.
Section E Official statistics
63
Data that are published soon after the period to which
they relate play a key role in the decisions taken by the
MPC. Interest rate decisions need to be based on the most
up-to-date picture of the economy possible. But there
is often a trade-off between the timeliness of data and
its accuracy.
Revisions – do not overlook them!
Data that are released shortly after the end of the
period to which they relate are often based on less
complete information than is eventually available.
These data are initial estimates. As more information
becomes available, the original estimates may be revised.
Revisions may be trivial, but they can sometimes be
substantial. And data can continue to be revised a long
time after they are first released. Over time, the data
series underlying the aggregate figures are reviewed and
re-estimated. Quarterly estimates of, say, investment
expenditure are often based on smaller samples or less
detailed information than is available on an annual basis.
Estimates of GDP are not finalised for some years.
One major exception is the Consumer Prices Index –
it has had only one set of revisions since it began in 1996.
Because of the time it takes for a change in interest rates
to have an impact on inflation, policymakers cannot wait
for later estimates or finalised data. They have to base
their decisions on the best information that is available
at the time. It is because individual pieces of data are only
ever best estimates of what has happened, and are often
revised, that monetary policy decisions need to be based
on a wide range of information rather than just a handful
of statistics.
Official statistics are always measuring
what has happened rather than what is
happening
The Bank will provide new data to teams during the course
of the Challenge. This will often include revisions to earlier
data. The revised data might cause you to change your
view about what has been happening in the economy.
Revisions to existing data can be just as important as
new data.
Bank of England and The Times Interest Rate Challenge 2014/15
Values and volumes; current prices and
chained volume measures; nominal and
real values
Raw data need to be adjusted in various ways to make
them useful. An important piece of data is the measure
of total output in the economy. But the value of output is
made up of two components – volume and price. A rise in
the value of GDP may be due to a rise in prices rather than
any increase in the amount of goods or services produced.
But we often want to know about volumes, not least to
assess the balance between demand in the economy and
the available supply of goods and services. So statisticians
remove the price change element, ie. values are adjusted
for any change in prices. They deflate values using price
data, which are collected separately, to derive volumes.
So, if the value of sales for a particular product has risen
by 5% over a period, and prices have risen by, say, 4%,
we can deduce that the volume of sales must have
increased by 1%.
Statisticians take value figures measured in today’s prices
– termed current prices – and deflate them by the change
in prices since a particular year, called the reference year.
This gives a value in chained volume measures. The price is
held constant over time in order to identify the change in
volume. You will often see data described as ‘in chained
volume measures (reference year 2010)’. This means that
the level of prices in one year – in this case 2010 – is held
the same for all years. You do not need to know the
details but, if you are interested, this is explained in more
detail in the May 2003 Inflation Report.
Values measured in constant prices allow
us to track changes in volumes
Expressing variables – for example, manufacturing output
– in chained volume measures means that the numbers
will show changes in quantity, ie. volumes. You will
sometimes see this referred to as being in ‘real’ terms –
for example, ‘in real terms manufacturing output grew
by 2%’. This means that it is free of the influence of any
change in prices. When we are observing data in current
prices, they are sometimes referred to as being in
‘nominal’ terms. GDP is usually presented in real terms,
though nominal values, ie. in current prices, are also
available. Data on wage earnings are expressed in nominal
terms. You should watch this distinction carefully when
using data.
Section E Official statistics
64
Index numbers
Seasonal adjustment
Some data are presented in terms of actual amounts of
money – for example, £100 million – either in chained
volume measures or current prices, or as a figure such as
the change in the number of people unemployed. But
other data are presented in the form of index numbers.
For example, you might see manufacturing output
recorded as, say, 110 in a particular month rather than
an amount.
Most official data are seasonally adjusted. This means
they take account of normal seasonal variations in such
things as the amount of spending or production. This is
a necessary step. When trying to assess economic
conditions, it is not sensible to look at changes in the
data that reflect, more than anything else, the time of
year. Removing the seasonality from data is an attempt
to remove variations in the figures that reveal little about
the underlying economic situation. A good example is
the large increase in retail sales in the period leading up
to Christmas. Measuring and removing the seasonal
element can be difficult, especially when seasonal patterns
themselves might be changing over time.
An index number is an arithmetical conversion of the raw
data. Statisticians usually take the value of something in
a particular period and assign it a value of 100. This
becomes the reference year value. For example, if retail
sales volumes were, say, £316 billion in 2010 and that
year is the reference year, then it is assigned the index
number 100. If sales volumes rise to £326 billion in 2011,
ie. 3% higher than in 2010, the index number for 2011
would be 103.
The reference year value should always be shown on the
data series, for example, 2010=100 or 2009=100. The use
of index numbers allows easier comparisons of different
things over time.
The Consumer Prices Index
The Consumer Prices Index is not seasonally
adjusted. For this reason, we usually look at the
annual rate of change in the CPI – the change in
prices over the year. As long as the seasonal
pattern of price changes is fairly consistent from
year to year, then annual inflation rates should
reflect the non-seasonal element of the change in
prices over the year. For example, the annual rate
of inflation in January will reflect the change in
prices between January this year and last year.
The fact that prices always tend to fall in January
because of the winter ‘sales’ will not distort the
year-on-year comparison. Of course, price
discounting might be greater this year than last so
the rate of inflation might fall. In this instance, we
would need to judge the reasons for this – it might,
for example, be due to lower demand – and
whether it was likely to be a temporary influence
on the inflation rate or not.
Bank of England and The Times Interest Rate Challenge 2014/15
We do not want to focus on changes in
the data that just reflect the time of year
Data volatility
Seasonal adjustment removes some of the variation in the
figures. But even when this is done the data rarely follow a
smooth path from month to month or quarter to quarter.
Figures often jump up and down, making an assessment
of the overall trend difficult. Some series are more volatile
than others. Data may be displaying an overall trend, but
there can be a lot of variation around the trend.
Month-to-month movements in retail sales volumes, for
example, tend to be very volatile. If spending in the shops
is very high one month, it can often fall sharply the
following month. This variation can be due to factors such
as the weather or the timing of particular events such as
public holidays. Such factors can affect the timing and
amount of spending in a particular period. But, over time,
factors like the weather do not determine the overall
amount consumers spend. So rather than focus on
month-to-month movements in data, it is sometimes
better to look at changes over longer periods to get a feel
for what is going on.
Section E Official statistics
65
Different annual growth rates
• the annual growth rate in, say, retail sales in
March 2014 will reflect the change in sales
between March 2014 and March 2013;
• for monthly data, the annual three-month
growth rate in March 2014 will reflect the change
in the average level of sales in January to
March 2014 compared with January to
March 2013; and
• for quarterly data, the annual growth rate in the
first quarter of 2014 will reflect the change in
sales between 2014 Q1 and 2013 Q1.
Which growth rate?
You will see that most of the discussion of economic data
in the Inflation Report and minutes of the MPC’s meetings
is framed around growth rates of different variables –
money, consumer spending, output, employment, wages,
exports etc. In tracking economic developments and the
extent of inflationary pressure in the economy, the
movements in variables over time – their growth – is often
important, in addition to their level.
Statistics rarely follow a smooth path –
it can help to identify the trend by
smoothing out short-term volatility
Quarterly growth, annual growth, annual
three-monthly growth...?
The data that we provide to teams are expressed in a
variety of different ways. For monthly data, we often look
at the average growth rate over the latest three months
compared with the previous three months.
This averaging irons out some of the volatility between
individual months in many data series. But three-month
growth rates can themselves move up and down. A large
rise in, say, retail sales in one particular month will initially
increase the three-month growth rate. But it will then fall
back as the large monthly rise moves from being in the
latest three months to the previous three months. You
can work this out with some numbers. The trend in growth
will be somewhere in between these swings.
Bank of England and The Times Interest Rate Challenge 2014/15
Some data are volatile even when measured on a
quarterly basis, for example investment. In this and many
other cases, it is common to look at the annual rate of
growth and to track this quarter by quarter. Annual
growth rates can be expressed in a number of different
ways – as a monthly rate, a three-month rate, a quarterly
rate or even a half-yearly rate. Again, have a look at the
data to become familiar with this.
and annualised growth!
You may also see references to ‘annualised’ growth rates.
These are the growth rates over a particular period – say
three or six months – expressed as an equivalent growth
rate for a full year. In other words, it is the growth rate
that would be achieved if growth over a particular period
continued over twelve months. For example, if GDP
increased by 1% in the first quarter of the year, the
quarterly annualised rate would be 4.06%. If it increased
by 3% over the first half of the year, the six-month
annualised rate would be 6.09%. In the second case, the
annualised rate is not simply double the six-month growth
rate – we will let you work out why...but it is to do with
compounding!
The risk in trying to observe the trend in the data by
averaging monthly or quarterly changes, is that changes
in the trend might be missed by underplaying the latest
figure. Again, by looking at a variety of growth rates and
understanding what is going on beneath the aggregate
data, you can keep alert to indications that trends might
be changing.
There are other features of official statistics, but
what has been covered here should give you enough
grounding to start using official data. Some of it
might seem confusing initially. The best way to
understand the data is to use them. You will learn
by asking questions as you go along. We give you
specific definitions for each of the data series in the
datasheets.
Section E Official statistics
66
Section E
Surveys and business intelligence
In addition to official statistics, the MPC considers a range of surveys provided by
business organisations such as the Confederation of British Industry (CBI) and the
British Chambers of Commerce (BCC). These surveys can provide additional
indications of business trends and conditions.
Surveys can be useful in supplementing the information
from official data sources. They often provide an
independent check on the current situation and trends. In
addition, some survey responses provide forward-looking
information. In many cases, survey information is very
timely, providing indications of economic conditions
before other data are available.
The nature of survey information
Strictly speaking, most official statistical series are
surveys. They are based on samples of firms or individuals,
rather than a full population census. But official data are
normally based on quantitative information – for example,
sales in company A were £100 million in a particular
period. ‘State of trade’ type surveys ask firms for their
views rather than numbers and so are qualitative in nature
– for example, sales in company B were ‘above’ or ‘below’
normal in a particular period, or were ‘higher’ or ‘lower’
than in a previous period.
A typical survey will ask companies or individuals a range
of questions relating to current economic and business
conditions – for example, questions on a firm’s output,
orders, employment and prices – or about confidence in
the future in a more general sense. Responses are often in
the form of whether something like output or prices is
higher or lower than at the time of the previous survey.
For example, a firm might be asked ‘compared with the
situation three months ago, are the prices you charge
higher, lower or about the same?’ We are interested in
how these responses alter over time, ie. how the total
number of firms responding ‘higher’, ‘lower’ or ‘same’ is
changing. For example, if a larger number of firms report
that output is now higher than at the time of the previous
survey, this might be a sign that the growth in output is
increasing.
Bank of England and The Times Interest Rate Challenge 2014/15
Some survey responses cover the same ground as the
official data – for example, they provide information on
output, exports and employment. Others provide
additional information that complements official data –
for example, on orders, skill shortages and confidence.
Survey responses that correspond directly with official
data are useful because they are often available sooner
than the official data and they can be a helpful
cross-check. Survey responses that give additional
information may be useful if they provide a guide to
something that is either not well measured statistically
or is not directly observable – for example, capacity
utilisation or skill shortages.
Surveys can provide an independent
check on current trends, and information
about possible future trends
Survey responses may also provide forward-looking
information. For example, answers to questions about
order books may tell us something about future output,
and responses about investment intentions may tell us
about future investment spending. Similarly, firms’
expectations of prices, employment and output in the near
future can be a useful indication of short-term prospects.
Using survey information – survey
balances
The way survey information is used depends on its
timeliness, track record and coverage. Some surveys cover
particular sectors of the economy. The MPC tends to look
closely at surveys with a broad coverage – for example,
those covering the manufacturing or service sector as a
whole. It also looks at surveys covering activity and
behaviour in the labour market.
Section E Surveys and business intelligence
67
Most surveys do not provide hard data and so the
information has to be interpreted in some way. A typical
approach is to look at survey responses over time and try
to assess the significance of recent changes. It is usual to
look at the ‘balance’ of responses – the difference
between the number of firms reporting a rise in, say,
output or prices and those reporting a fall. Most of the
survey data that we provide will be in this format.
We typically look at the difference
between the ‘up’ and ‘down’ responses
to survey questions over time
Large movements in survey balances might warrant closer
examination, by comparing the latest observation with,
for example, the average over time, or perhaps the same
point in previous economic cycles. But it helps to know
whether a survey has tended to be a good guide to trends
in official data in the past. There is an example of using
survey information in the box below.
Simply observing the latest data and the changes and
patterns in survey responses can be very useful. At the
same time, we have to remember that many surveys are
based on smaller and less representative samples than the
official statistics. They may not always be an accurate
guide to what is happening in the economy or a particular
sector. Surveys are not a substitute for official statistics.
But used in a complementary way, they can help us to
interpret economic conditions and resolve some of the
puzzles and uncertainties about the economic outlook.
The CBI Industrial Trends Survey
The CBI Industrial Trends Survey asks manufacturing
firms how optimistic they are. The balance of responses
from firms saying they are ‘more’ or ‘less’ optimistic
about the future than previously has tended to have a
fairly good relationship in the past with the annual
growth of GDP.
This relationship seemed to have broken down during
the past decade. In 1997 and 2001 the CBI balance
declined sharply, but GDP growth slowed only a little.
However, the CBI survey only covers the manufacturing
sector, and both these declines in the balance reflected
shocks concentrated in this sector. In 1997 sterling’s
depreciation, combined with the crises in East Asia and
other regions, were likely to impact more strongly on
the confidence of manufacturers, and particularly of
exporters. Similarly in 2001, the bursting of the
‘dot-com’ bubble was most likely to affect
Bank of England and The Times Interest Rate Challenge 2014/15
Business intelligence
It is important for the MPC to understand what lies
behind the economic data. In addition to formal economic
research, information can be gleaned by talking directly
to firms, individuals and experts in particular fields.
Each month the MPC receives information from hundreds
of businesses through the reports provided by the Bank’s
twelve regional Agencies, which are located throughout
the United Kingdom. The Agencies speak to companies in
all sectors of the economy and cover topics such as
demand, employment, investment, and costs and prices.
They are able to form an overall view of business
conditions in their areas.
Each month the MPC discusses economic conditions with
a number of the Bank of England’s Agents at the pre-MPC
meeting. The Agents also provide information on topics of
particular interest to the MPC. This information often
adds flavour to the statistics. It might help to distinguish
between different interpretations, perhaps when official
data are giving unclear or conflicting signals. The aim is to
provide the MPC with a better understanding of the
circumstances underlying recent trends.
Teams can look at a summary of the information provided
by the Agencies in the Agents’ Summary of Business
Conditions, which is available on the Bank of England’s
website.
manufacturers of ICT equipment. Therefore, in both
cases, there were good reasons to believe that the fall in
optimism might not be representative of the wider
economy.
During 2007, and continuing into 2008, the CBI
optimism balance fell sharply and was a better indicator
of GDP growth. The increasing concerns over the global
financial system, related to the extent of losses on
sub-prime mortgages in the USA, affected confidence
across the economy. In the event, GDP growth slowed
sharply at the end of 2007 and the economy fell into
recession by mid-2008.
These examples highlight the importance of interpreting
movements in the confidence balance carefully, and of
bearing in mind which specific sectors they refer to, and
whether developments in those sectors are likely to be
representative of the whole economy.
Section E Surveys and business intelligence
68
Section E
The economic jigsaw – how many pieces of data
should you use?
Building up your assessment of economic conditions will be a little like assembling a
jigsaw – except that the pieces of evidence will not always fit neatly together and it
is likely that some of them may be missing.
Given the vast amount of data available on the economy,
the obvious question is how much should you use? That is
a matter of judgement. But given what is available on
both the economy as a whole and different sectors, it is
easy to become over-burdened with information. It is
always tempting to seek one more number to try to add
comfort to your thinking and conclusions. Part of the
Challenge is to decide as a team what you want to look at
and where to draw the line to avoid information overload.
data might be relevant to issues that are important at a
particular time. At all times you will need to ask yourself
how a piece of information influences your view of current
and future economic conditions. And you need to ask and
decide how it influences your judgement about inflation.
Data on money, consumer spending, exports, jobs, wages,
investment or output all need to be considered with that
in mind. Information has to be pieced together to give a
picture of the economy as a whole.
Faced with potentially hundreds of different data series on
the economy, you will need to prioritise your effort and
choose a focus. Some data are essential to follow; other
Bank of England and The Times Interest Rate Challenge 2014/15
Section E The economic jigsaw
69
Section E
Organising economic information
In view of the large amount of data available, it is sensible to organise the information
in some way. The Bank of England’s Inflation Report and the minutes of the MPC
meetings are organised around different aspects of the economy.
The Inflation Report is organised under headings that
reflect different elements of the inflation process – from
the money supply, exchange rates and interest rates, to
the amount being spent in the economy and the rate of
output growth, to the effects on activity in the labour
market and costs and prices. These are the various stages
of the links between interest rates and inflation – the
transmission mechanism – outlined in Section B.
This basic structure is followed in Section F.
The headings are:
• money and financial markets;
• demand and output;
• the labour market; and
• costs and prices.
Bank of England and The Times Interest Rate Challenge 2014/15
Teams will want to look through Section F and familiarise
themselves with each of these areas of the economy. Of
course, the way that teams structure and organise their
presentations need not follow these headings. The judges
will be looking for imaginative formats. For the purposes
of working through the economic information, this is a
logical way of thinking about inflation and interest rates.
But you should still base your decision on Bank Rate and
quantitative easing on an assessment of the outlook for
the economy as a whole, not of particular aspects of it –
such as the labour market.
This section has given some general guidance to
prepare you for using the economic information
included in Section F and the data that we are
providing. It is important to understand the nature
of the information that you will be dealing with.
Section E Organising economic information
70
Section F
The economy – from money to prices
This section covers different aspects of the economy and the inflation process,
building on the material in Sections B and D. It explains why we look at
particular areas of the economy and why they are important. We will provide
many of the statistics discussed under the various headings.
The section is divided into five main parts. We start by looking at money and
financial markets and then go on to consider demand and output, the labour
market and costs and prices.
The different aspects of the economy are not independent of each other –
everything in the economy is inter-related. But there is a great deal of material
here so each member of the team might want to concentrate on a particular
part. You should not feel that you have to be familiar with everything. The
section is intended to be a comprehensive reference source for teams to use as
they come across different issues and data. It will also help you to understand
the minutes of the MPC meetings and the Bank of England’s Inflation Report
where there are further data and charts.
Recap
The transmission mechanism of monetary policy
73
74
Money and financial markets
75
The amount of money and credit
75
Financial market interest rates
77
The exchange rate
78
Other asset prices
79
Demand and output
80
GDP – three measures in one
80
Total output of goods and services – GDP(O)
80
Total expenditure on goods and services – GDP(E)
82
Domestic demand and the balance of trade
82
Consumer spending
82
Investment
85
Inventories (stocks)
85
Public spending
86
External demand
86
Total income from goods and services – GDP(I)
88
Bank of England and The Times Interest Rate Challenge 2014/15
Section F The economy
71
The labour market
89
Employment and unemployment
89
Labour costs
91
Costs and prices
93
Consumer prices
93
Producer output prices
94
Producer input and commodity prices
95
Import and export prices
96
Guidance for using the datasheets
97
Note: The datasheets are only up-to-date at the time of publication. The first
set of datasheets will be available from 5 September 2014. Additionally, the
Bank will produce data updates immediately prior to the regional heats, area
and national finals. These will cover key data released since the most recent
datasheet.
The datasheets and the updates will be available on the Bank of England’s
website:
www.bankofengland.co.uk/education/Pages/
targettwopointzero/default.aspx
Bank of England and The Times Interest Rate Challenge 2014/15
Section F The economy
72
Section F
Recap
In Section B we set out in general terms how a change in Bank Rate affects inflation
over a period of time. We discussed how it leads to changes in spending and how this
influences output and, in turn, the rate of inflation. Section D expanded on this
discussion. This section will add to this material by looking at different aspects of the
economy and how we monitor developments to judge the future path of inflation.
The diagram on the next page illustrates the basic features
of the transmission mechanism – the route by which an
interest rate decision influences the rate of inflation. It
portrays how the rate of inflation is the product of the
degree of inflationary pressure within the UK economy,
Key points
• Bank Rate affects other interest rates – such as
mortgage rates and bank deposit rates. At the same
time, policy actions and announcements affect
expectations and confidence about the future course
of the economy. They also affect asset prices and
the exchange rate.
• These changes in turn affect the spending, saving
and investment behaviour of individuals and firms in
the economy. Higher interest rates will tend to
encourage saving rather than spending, and a higher
value of sterling in foreign exchange markets –
which makes foreign goods less expensive relative to
goods produced at home.
Bank of England and The Times Interest Rate Challenge 2014/15
and the influence on domestic prices from import prices.
The diagram will refresh your understanding of what has
been discussed earlier and provide a quick reference point
as you are looking at the material in this section and the
data that accompany it.
• The level of demand in money terms relative to the
supply capacity of the economy – in the labour
market and in product markets – determines
inflationary pressure in the economy. If the demand
for labour exceeds the supply available, there will
tend to be upward pressure on wage increases,
which some firms might pass through into higher
prices charged to consumers.
• Exchange rate movements have a direct, though
often delayed, effect on the prices of imported
goods and services, and an indirect effect on the
prices of domestic goods and services that compete
with imports and use imported materials and other
inputs.
Section F Recap
73
Bank of England and The Times Interest Rate Challenge 2014/15
Section F Recap
74
Exchange rate
Expectations/
confidence
External demand
Domestic demand
Total demand
Import
prices
Domestic
inflationary
pressure
Inflation
Having a good feel for the transmission mechanism will help the teams to identify how information and signals from different aspects of the economy might
influence future inflation.
Official
Bank
Rate
Asset prices
Market rates
The transmission mechanism of monetary policy
Section F
Money and financial markets
The amount of money and credit
An old song has it that ‘money makes the world go round’.
It certainly turns the wheels of the economy and it is
central to thinking about inflation. As Section B explained,
inflation represents the rate of decline in the value of
money. Without money, there would be no inflation.
As we explained in Section C, the UK authorities no longer
attempt to target the growth in the money supply as a
means of controlling inflation. But the money supply does
play an important role in the transmission mechanism and
as an indicator of economic conditions. And, ultimately,
the control of inflation implies the control of monetary
growth. The box on the next page discusses this.
Narrow money – notes and coin
Notes and coin in circulation in the economy are referred
to as ‘narrow money’. Growth in the amount of notes and
coin in the economy provides one indication of how much
household spending might be rising. That is because notes
and coin are still an important means of payment, despite
the growth in the use of debit and credit cards. If people
withdraw notes from cash machines, they are likely to use
them for spending in the near future.
An increase in notes and coin in circulation in a particular
month might signal a rise in the value of retail sales. Data
for notes and coin are released ahead of retail sales data.
Note that we have said the value of retail sales, not the
volume. Money will reflect the value of expenditure,
ie. the price and the volume. It is a nominal variable, in
the way we explained in Section E.
Broad money – money in bank and building society
accounts
Notes and coin only represent a small part of what we call
‘money’. Money in a wider sense largely consists of what is
held in bank and building society accounts. ‘Broad money’
is the term used to describe the amount of money held in
these accounts plus notes and coin in circulation.
Bank of England and The Times Interest Rate Challenge 2014/15
The measure of money that captures this definition is
called M4. As well as aggregate M4, data are also available
for the money held by different sectors of the economy –
households, companies and financial institutions other
than banks.
Alongside the amount of money deposited, there are also
data for the amount of lending undertaken by banks and
building societies. Again, these are available for the
economy as a whole – known as M4 lending – and for
individual sectors. In particular, there are data covering
lending to households. These are divided into secured
lending, ie. lending backed by assets such as housing, and
unsecured lending, such as credit card debt. Loans secured
on housing represent around 84% of personal debt.
We can look at the growth of bank deposits and lending
both for the whole economy and for different sectors, to
see if they provide any indications about future demand.
Households
Household spending power is likely to be related to the
size of individuals’ bank and building society accounts.
Higher growth in household deposits might reflect an
increase in savings. But it could also signal a future rise
in consumer spending growth.
On the borrowing side, households can borrow from
banks and building societies to supplement their income
in order to help finance spending or to buy a house. Data
on household borrowing can provide information about
current and future consumer spending.
Private non-financial corporations (PNFCs)
Companies’ deposits and borrowing data can provide
similar insights into their investment behaviour. For
example, companies may build up bank deposits or
increase borrowing to finance investment in new
equipment and buildings.
Section F Money and financial markets
75
Money and inflation
The amount of money in the economy and the level of
prices are positively related in the long run. Without
money, inflation could not exist. And, across many
countries, persistently high rates of money growth
have usually been associated with high inflation.
money growth of 4.5% per year would be broadly
consistent with annual growth in economic activity of
2.5% – around the historical average in the
United Kingdom – plus inflation of 2.0% per year, in
line with the inflation target.
Excess demand is likely to be accompanied by strong
growth in the amount of money deposited in banks
and building societies, and the amount of lending
undertaken by banks and building societies. Consider,
for example, what happens if Bank Rate is reduced.
Banks are likely to reduce the interest rates they
charge on their loans to individuals and businesses.
In addition to boosting spending directly, this is also
likely to lead to increased demand for loans which,
if met, will increase the amount of money in bank
deposits. So a change in Bank Rate is likely to result
in a change in both bank deposits and bank lending.
In practice, however, the relationship between money
and inflation has not been stable. Money growth has
been influenced by many other factors, including
financial innovations – such as the introduction of
credit cards – changes in banking regulations, and
developments in international capital markets. The
effects of these changes have not always been easy
to predict accurately. So rules of thumb like the one
above have not usually been useful guides for policy.
Although money and inflation are clearly linked
over the longer term, the usefulness of money as
an indicator of inflationary pressures in the short to
medium term depends on there being a predictable
relationship between money and the value of
spending. For example, suppose money grew at the
same rate as the value of spending over time. Then
Nonetheless, data on bank deposits, bank lending and
cash are helpful in providing indications about both
current and future spending in the economy. They
can corroborate other data or sometimes give leading
indications of spending behaviour since the figures are
released earlier than GDP data. In particular, data on
deposits and lending to households and companies
can provide useful clues about consumer spending
and company investment.
Other financial corporations (OFCs)
Credit conditions
Financial institutions other than banks and building
societies – such as life assurance and pension funds –
also have bank deposits. The deposits of OFCs may rise
or fall in response to their financial market activities –
for example, financial institutions might switch to holding
money rather than other assets in order to carry out
financial transactions such as purchasing company shares.
Such changes might influence asset prices, but often they
may have little to do with future spending and investment
in the wider economy. Whatever the reason, because the
behaviour of financial institutions can cause large
movements in the aggregate measure of M4, it is
necessary to monitor the data for OFCs before drawing
conclusions about the significance of the growth in broad
money more generally.
In addition to providing indications about future spending
and investment, monetary data can also be used to assess
conditions in the banking sector. There may be
circumstances in which the banking sector reduces or
increases the amount of lending it undertakes. For
example, losses on bad loans either in the United Kingdom
or overseas might restrict the ability of the banks to lend.
This is what happened in 2008 when the turmoil in
financial markets that originated in the US mortgage
market disrupted the supply of bank credit to households
and firms in the United Kingdom. This is sometimes
referred to as a ‘credit crunch’, which can reduce spending
and investment and lead to lower inflation. The opposite is
a ‘credit boom’, which might result in an increase in
spending and investment, and lead to higher inflation.
The Bank of England’s quarterly Credit Conditions Survey
gives up-to-date information on lending developments
in the United Kingdom.
Bank of England and The Times Interest Rate Challenge 2014/15
Section F Money and financial markets
76
Key data: money and credit
–
–
–
–
Notes and coin
M4
M4 lending
Consumer credit
Financial market interest rates
Interest rates – the cost of borrowing – are important
determinants of both the demand for, and the availability
of money and credit. By examining interest rates on
savings, such as deposit account rates, and the cost of
borrowing, such as mortgage rates, you can better
understand how Bank Rate decisions made by the MPC
might be affecting spending and saving behaviour in the
economy.
Market interest rates may not change immediately or by
the same amount as changes in Bank Rate. At any point
in time, other factors might be influencing interest rates.
For example, increased competition amongst financial
institutions might result in lower mortgage or credit card
interest rates. The speed and extent of the pass-through
from Bank Rate to market rates will affect the impact of
MPC policy decisions.
The amount by which some market interest rates change
following a change in Bank Rate will also depend on the
extent to which a policy change is anticipated by financial
markets, and how the change affects market expectations
of future policy. If a change in Bank Rate is expected,
market interest rates might change beforehand. It is
possible to observe interest rate expectations by looking
at different financial market prices. Newspaper articles
about MPC interest rate decisions usually refer to what
financial markets expect to happen, and the MPC
discusses market expectations at its meetings.
Short-term interest rates
When Bank Rate changes, this is quickly transmitted to
other short-term interest rates in the money markets –
such as the rates charged by banks when they lend to
other banks. Short-term market interest rates are
important as they tell us about the cost to financial
institutions of obtaining funds that can then be used
to provide loans to customers such as mortgages and
overdrafts.
An alternative source of funds for banks is savings deposits
placed with them by customers. The rate on these deposits
will typically move with Bank Rate set by the MPC. So
movements in Bank Rate set by the MPC are important for
both savers and borrowers.
Long-term interest rates
Households and firms in the economy often want to
borrow money for long periods of time. One way to
borrow in this way is to take out a sequence of short-term
loans at short-term interest rates. Alternatively, borrowers
might want to fix the cost of borrowing in advance. Fixed
borrowing rates for long-term loans are called long-term
interest rates. These interest rates matter most to
individuals taking out fixed-rate mortgages or firms
looking to raise long-term finance for investment. One
way of observing changes in long-term market interest
rates is to look at the returns – or ‘yields’– offered on
government and corporate bonds which extend over long
time periods – for example five, ten or fifteen years.
Key data: interest rates
– Bank of England official Bank Rate
– money market rates (short rates)
– bond yields (long rates)
Bank Rate
The MPC sets the interest rate that is paid on deposits
held at the Bank of England by commercial banks and
building societies. This interest rate is known as Bank Rate.
Bank of England and The Times Interest Rate Challenge 2014/15
Section F Money and financial markets
77
Changes in long rates
Long-term interest rates tell us about financial market
expectations of future inflation and interest rates.
As such, they provide an indication of the credibility
of monetary policy, ie. the extent to which financial
markets believe that the MPC will achieve its target.
In practice, short and long-term interest rates are
likely to be closely related, with long-term rates being
an average of expected short-term rates over the
period of the loan. So if the MPC is expected to raise
short-term interest rates in the future, the current rate
for long-term borrowing might be higher than the
current short-term rate to reflect the expected higher
future cost of funds. And if short-term rates are
expected to fall in the future, long-term interest rates
might be lower than short-term rates.
The exchange rate
Exchange rates are particularly important financial prices.
They measure the price of one country’s money in terms
of another. Consequently, they depend on factors both at
home and abroad, including domestic and foreign interest
rates. Changes in interest rates in the United Kingdom
may affect the exchange rate between sterling and, say,
the euro. But so may changes in interest rates set by the
European Central Bank. It is important to bear in mind,
however, that interest rates are not the only influence on
exchange rates. They will also reflect the demand for, and
supply of, goods and services, and any other factors
affecting international transactions in goods, services or
assets.
Although monetary policy does not aim to achieve a
particular level for the exchange rate, it has to take into
account how changes in the exchange rate impact on
inflation prospects. In Section D, we explained that a
change in the value of sterling can have a direct influence
on inflation through changes in import prices, and an
indirect effect through its impact on demand for exports
and imports. But the nature and size of these effects will
depend on the reasons for a change in the exchange rate.
This means that, while short-term rates largely depend
on the MPC’s interest rate decisions, long-term
interest rates also depend on market expectations of
economic developments and monetary policy in the
future. So long-term interest rates can and do vary
without any change in current Bank Rate, as financial
markets continuously revise their expectations about
future Bank Rate and other variables, including
inflation. A rise in Bank Rate could generate an
expectation of lower future interest rates, in which
case long-term rates might fall.
Although a change in Bank Rate almost always moves
other short-term interest rates in the same direction –
even if some are slow to adjust – the impact on
long-term rates can go either way.
UK goods, it might be a reflection of rising demand. It is,
of course, often difficult to know what has caused the
exchange rate to change. But it is important not to view
changes in exchange rates and interest rates in terms of a
simple mechanical relationship. Some of the possible
effects on import prices and the composition of demand
are discussed in the box on the next page.
Bilateral and effective exchange rates
You can look at the pound’s exchange rate on what is
termed a ‘bilateral’ basis – the exchange rate between
two currencies, such as the pound relative to the US dollar
– and what is termed an ‘effective’ basis.
An effective exchange rate is an average of different
bilateral exchange rates, weighted according to the
importance of each one to a country’s trade. The sterling
effective exchange rate index (ERI) reflects the pattern
of UK trade with its 48 main trading partners. The
sterling-euro exchange rate has a weight of 46.2% in
the ERI.
For example, an appreciation of sterling might reflect an
increase in demand for UK goods and services. So rather
than a higher exchange rate reducing demand for
Bank of England and The Times Interest Rate Challenge 2014/15
Section F Money and financial markets
78
You can also look at other exchange rates to shed light
on movements in sterling. For example, you can see if a
change in the rate between the pound and the euro has
been similar to the exchange rate movements between
the dollar and the euro. This might help to explain what
has caused exchange rate changes. Other exchange rates
also help us to assess future economic conditions in the
United Kingdom’s main trading partners.
Key data: asset prices
–
–
–
–
–
–
£/$ exchange rate
£/€ exchange rate
$/€ exchange rate
sterling ERI
FTSE all-share index
FTSE 100 index
Other asset prices
Asset prices – such as share prices and house prices – can
also provide information about future developments in
economic activity and inflation. Rising house prices might
reflect how confident consumers are feeling about the
future. Falling house prices might indicate the opposite.
The housing market is discussed under ‘Demand and
output’. Share prices will reflect investors’ expectations of
companies’ future profits. In this way, they can provide a
useful barometer of expectations and confidence in future
economic developments. You can monitor UK share prices
by looking at the Financial Times Stock Exchange
(FTSE) indices.
The exchange rate and import prices
Import prices are an important component of many
firms’ costs and of final consumer prices. An
appreciation of sterling – a rise in its value relative to
other currencies – will tend to lower the prices of
imported goods and services, and a depreciation will
tend to increase them. The effects may take many
months to work their way through the supply chain
and into retail prices. Import prices are discussed
under ‘Costs and prices’.
The exchange rate and demand
Depending on the reasons for a change in the
exchange rate and whether it is sustained, a lower
exchange rate will tend to make foreign goods more
expensive relative to goods produced at home. This
can affect the composition of total demand in the
economy, which could have implications for output
Bank of England and The Times Interest Rate Challenge 2014/15
growth and inflation. A fall in the relative prices of
UK output might encourage a switch of spending
towards home-produced goods and services away
from those produced overseas. For any level of
overall demand, domestic production will be higher
and imports lower. This may therefore increase
inflationary pressure relative to what it would
otherwise have been.
The exchange rate has its biggest impact on the
manufacturing sector, which accounts for around 45%
of UK exports. But other sectors, such as agriculture
and service industries like tourism and consultancy,
are also affected – for example, foreign holidays can
become more expensive and UK holidays relatively
cheaper if the pound falls in value. Exports and imports
are considered under ‘Demand and output’.
Section F Money and financial markets
79
Section F
Demand and output
We have already said a great deal about demand and output in earlier sections.
Section D explained why it is important to look at aggregate demand and output in
the economy. This part of Section F looks in more detail at the main components of
demand and output, and some relevant data series. It does this by working though
the different measures of total economic activity – Gross Domestic Product (GDP).
GDP – three measures in one
The rate of growth of the economy is a key piece of
information that the MPC considers when it is setting
interest rates. GDP data provide the most comprehensive
measure of economic growth. They capture different
aspects of economic activity – such as how much is
produced in the economy and how much is spent. Most
of the time you will see references to GDP as a single
measure of economic activity, but there are in fact three
approaches: one for total output – GDP(O); one for total
expenditure – GDP(E); and one for total income – GDP(I).
Each provides a different way of arriving at the same
figure – GDP.
The three measures of GDP are equal in principle. GDP(O)
is the total output of goods and services; GDP(E) is the
total expenditure on that output; and GDP(I) is the total
income generated by producing that output. But, in
practice, the measures always differ to some degree. This
happens because it is not possible to measure everything
perfectly, and different information is used to construct
each measure. And, for initial estimates, data sources are
often incomplete.
The published measure of GDP combines information
from the output, expenditure and income measures. For
the initial estimates of GDP, the output measure tends to
have the largest influence. Output data are thought to
provide the most accurate initial indication of economic
activity. So, for early estimates of GDP, adjustments are
often made to the expenditure and income measures. If
the latest data show GDP rising by 0.5% in the most
recent quarter, that will tend to reflect the measured
growth of output.
Bank of England and The Times Interest Rate Challenge 2014/15
But, in terms of assessing demand conditions in the
economy, most attention is devoted to the expenditure
measure and its components. The main components of
expenditure provide the framework for assessing demand
conditions and most economic forecasts, including the
MPC’s, are organised around them. The income measure
receives less attention, though some parts of it provide
important information.
GDP is most commonly expressed in chained volume
measures, ie. in real terms. It is normal to measure output
in chained volume measures. Expenditure, which is
measured in current prices, can be deflated to provide
expenditure in chained volume measures. Income is
usually presented in current prices, ie. nominal terms,
though for the purposes of producing an average measure
of GDP, it is also deflated to provide a measure in chained
volume measures. Once you are using the data, all this
should become clearer.
Total output of goods and services –
GDP(O)
The output measure of GDP – GDP(O) – measures
everything that is produced in the economy. This is
not simply the value of every firm’s production added
together. This would result in counting some output
more than once because many goods and services are
incorporated as inputs into other goods and services – for
example, part of the output of firms producing tyres will
be included in the value of the output of car producers.
GDP(O) aims to measure what is called ‘value added’.
Section F Demand and output
80
GDP releases
Each quarter the MPC receives three sets of data
releases for GDP. Each successive one gives more
accurate and detailed information about economic
activity and its make-up.
• The first release is called the ‘GDP preliminary
estimate’, available around three weeks after the end
of the latest quarter. This provides an estimate of
GDP growth and output growth in the production
industries and the service sector. Because this
estimate is produced quickly, it is usually subject to
revision as more information becomes available.
• The second release is called ‘Second estimate of
GDP’. It is available about a month later, some seven
weeks after the end of the relevant quarter. It
includes a revised estimate of GDP growth for the
quarter and a breakdown of total output
by sector. It also provides estimates of total
expenditure in chained volume measures and
current prices, along with the main components of
spending, as well as total income in current prices,
along with its main components.
• The third release is called ‘Quarterly National
Accounts’. It provides details of any further revisions
to the previously released estimates and a lot more
detail about the different components of GDP. For
example, it includes a breakdown of consumers’
expenditure into a number of categories, a
breakdown of investment and inventories, and
information about personal and corporate income.
This is the difference between the value of what firms
purchase, ie. their inputs, and their output. Value added
measures each firm’s contribution to total output. But
measuring this from quarter to quarter is a difficult task
and so it often has to be approximated using sales and
other information.
Industrial production
Sectoral output
Surveys
The change in total output in each quarter is estimated by
combining the volume of output in each of the different
sectors of the economy. Manufacturing output accounts
for around 10% of the economy. Services output accounts
for around 78%. Other sectors include agriculture, energy
and construction.
A variety of surveys provide information about trends in
output. These include surveys from the Confederation of
British Industry (CBI), the British Chambers of Commerce
(BCC) and the Chartered Institute of Purchasing and
Supply (CIPS). Collectively, these and other surveys cover
all sectors of the economy, although there tend to be
more surveys for the manufacturing sector.
Each quarter, there are usually differences in the growth
rates of different sectors. Even average growth rates tend
to vary from sector to sector. For example, manufacturing
output has grown by less than other sectors over recent
decades.
It is often important to look at output in different sectors
to assess whether a change in total output reflects lasting
or temporary influences. Energy output, for example, is
often volatile from quarter to quarter because of the
weather. So it may be useful to consider the underlying
situation by excluding temporary effects. You might also
be interested in the balance of overall growth in the
economy. Different economic conditions affect sectors
differently. For example, manufacturing is more export
intensive, therefore factors such as the exchange rate or
foreign demand will affect manufacturers more than they
will construction or services output.
Bank of England and The Times Interest Rate Challenge 2014/15
Data covering the production industries are published
more frequently than GDP data. The Index of Production
is published monthly, consisting of output data for the
manufacturing, energy and water sectors. Industrial
production represents just under a fifth of total output.
Key data: output
–
–
–
–
–
–
GDP
Index of Production
CBI Industrial Trends Survey
CIPS Report on Manufacturing
CIPS Report on Service
BCC Quarterly Economic Survey
Section F Demand and output
81
In addition to information about recent output, many
surveys ask companies about their orders and what they
expect output to be in the near future. This can give us
some idea about future trends in output and whether
the current situation is likely to continue or change.
A selection of survey data is included in the datasheets.
Total expenditure on goods and
services – GDP(E)
You’ll see the following identity or similar versions
in many textbooks:
GDP = C + I + G + (X-M)
where C is consumer spending (or consumption)
I is investment (including stockbuilding)
G is government consumption
The expenditure measure of GDP – GDP(E) – measures
total spending on UK produced goods and services.
Spending in the economy is made up of consumers’
expenditure, investment expenditure and spending on
stocks of goods by companies, government spending on
goods and services, and spending on imports and exports.
GDP(E) excludes spending on imported goods and services
as they are produced outside the United Kingdom, but
includes spending on exports by overseas firms and
consumers.
X is exports
M is imports
demand plus exports minus imports. The difference
between exports and imports is called the balance of
trade. GDP(E) is equal to domestic demand plus or minus
the balance of trade.
Final domestic demand
The proportion of GDP accounted for by each category
varies from year to year. Spending on some categories is
particularly variable – for example, investment spending
tends to fall as a proportion of total spending in economic
downturns. Generally, spending by consumers accounts
for around 65% of GDP. Government spending – both
central and local government accounts for just over 20%,
and investment accounts for 14%. The value of imports is
equivalent to about a third of GDP and the value of
exports about 30% of GDP. The amount spent on stocks
of goods can vary greatly from year to year, but tends to
be small on average.
Domestic demand and the balance
of trade
Combining consumer and government spending,
investment expenditure and spending on stocks gives
domestic demand. You will often see references to the
growth of domestic demand. This tells us about spending
in the domestic economy.
Some spending by consumers and firms will be on
imports, ie. not UK produced goods and services. Exports
might also include some spending on imported goods –
such as materials and components. Imports are therefore
subtracted from total spending. So total expenditure on
UK goods and services – GDP(E) – is equal to domestic
Bank of England and The Times Interest Rate Challenge 2014/15
You will also see references to final domestic demand.
This is domestic demand minus what is spent on
inventories (or stocks). Expenditure on inventories is
not final demand – rather it is intermediate demand by
companies, such as manufacturers and retailers. Changes
in the level of stocks can reflect changes in other
components of demand and also firms’ expectations of
future demand. They can also be large and volatile from
quarter to quarter, making changes difficult to interpret.
Each of the components of total spending is now
considered in turn, along with some of the factors that
influence them.
Consumer spending
In 2012, consumers spent over £1 trillion, in current prices.
The fortunes of the economy are therefore very much tied
up with consumer demand. Small percentage changes can
amount to billions of pounds.
Consumer spending largely depends upon household
income and wealth. It can also be affected by confidence –
how optimistic or pessimistic consumers are feeling – and
by interest rates, as we discussed in Section B. It is
possible to build up an impression of potential future
trends in consumer spending by looking at these factors.
Section F Demand and output
82
Income and spending
What people earn is the main determinant of what they
spend and so changes in income are an important part
of any assessment of demand conditions. Total spending
in the economy will be affected by wage increases and
other earnings, and the levels of employment and
unemployment. These data are considered under
‘The labour market’.
Consumers are unlikely to make spending decisions based
solely on their current income. They probably take into
account their likely income over time – their expectations
of future income as well as current income. So changes to
current income might only impact on spending insofar as
the changes are viewed as permanent or long-lasting.
Wealth in financial assets, like shares and bonds, largely
consists of what is held in pension funds and life assurance
policies. Higher share prices might reflect expectations of
higher future income from company profits. This might
boost current spending, though the implications for
inflation will depend on why share prices have risen.
For example, investors might expect higher company
profits in the future because firms are investing more
and increasing the economy’s productive capacity.
House prices are slightly different. A rise in house prices
increases the value of home owners’ existing houses. But
it also increases the cost of future house moves, for which
households might need to save. So rising house prices do
not necessarily result in higher consumer spending.
Spending and tax
Of course, consumers will spend out of their incomes after
taxes and other deductions have been paid. This is referred
to as disposable income. In this sense, changes in the
amount of tax paid are also relevant to consumer
spending. If the Chancellor increases income tax, this is
likely to reduce consumer spending, though the extra tax
revenues might be used to finance higher public spending,
so the overall impact on demand need not change.
Spending and saving
Consumers do not spend everything they earn – some
part of their disposable income will be saved. What part
of income is spent and what part is saved are important
economic decisions.
It is possible to look at past trends to get some feel for the
average proportions of income that are spent and saved,
and to see how these have changed. It is often useful to
look at the balance between household income and
spending. This is provided by a statistic called the saving
ratio. If consumers seem to be saving relatively little as a
proportion of their income compared with the past, you
might conclude that spending in the future will moderate
as consumers rebuild their savings. Alternatively, if saving
appears high, this might mean that spending will rise in
the future.
Wealth
Developments in household wealth – the value of the
assets that people own – also have a bearing on the
prospects for consumer spending. Most household
wealth consists of financial assets and housing.
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The saving ratio
Saving is what is left from personal disposable
income after spending. The difference between
income and spending is measured by the saving
ratio. It is the proportion of income that is saved
in a particular period. It is published alongside
estimates of personal income and expenditure as
part of the third release of GDP. If household
income is £150 billion in a quarter and spending is
£142.5 billion, then the saving ratio would be 5%,
ie. £7.5 billion as a proportion of £150 billion.
Because the saving ratio is the difference between
two very large totals, it is sometimes revised quite
substantially. Nonetheless, it can provide
indications about consumers’ current and future
spending behaviour.
But rising house prices might be accompanied by higher
spending insofar as they are influenced by the same
factors, such as confidence and expectations about future
income. If people are optimistic about the future, they
may increase their demand for houses as well as goods
and services. And higher house prices might also allow
households to increase the amounts they borrow, secured
on the increased value of their homes. The box on the
next page discusses some of the data the MPC considers
to assess housing market developments.
Section F Demand and output
83
Housing market turnover
The MPC regularly reviews a range of measures of
housing market activity and house price inflation from
official sources and surveys. This includes information
from different stages of the house-buying process –
such as estate agent enquiries, mortgage lending and
Land Registry details. Data on estate agent enquiries
from the Royal Institution of Chartered Surveyors
(RICS) and the numbers of people reserving new
houses from the House Builders’ Federation (HBF)
can provide information about future housing market
activity, and may be useful in giving an early indication
of changes in trends. Data on mortgage loan approvals
by banks and building societies provide information
about future lending for house purchase. They also
give an indication of housing transactions, measured
ultimately by Land Registry ‘land transaction returns’
data when house moves are completed.
House prices
The MPC also reviews a number of measures of house
price inflation such as those from the Halifax and
Nationwide. House price data are also available on a
regional basis. This can provide useful information on
regional conditions in the housing market, and help to
assess the picture in the United Kingdom as a whole.
Categories of consumer spending
Total consumer spending is split 45:55 between spending
on goods and services. Goods spending is divided into
what are called non-durable goods like foods and petrol,
and durable goods, like cars and computers. We tend to
concentrate on total spending but, as with other data, it is
sometimes beneficial to look at the underlying
components.
Retail sales
In addition to quarterly estimates of consumer spending
growth, monthly data are available for retail sales. Retail
sales data consist of spending on goods in shops and
through mail-order companies. The data measure
spending in different types of stores. These include stores
that sell mainly food, clothing, footwear or household
goods (which includes electrical retailers), and those that
sell a range of goods (such as department stores).
Retail sales volumes data are closely related to the
goods component of consumer spending in the quarterly
GDP data, and so they can provide an indication of
changes in spending month by month, in between the
quarterly estimates.
In addition to the official data, the CBI Distributive
Trades Survey provides information from retailers and
wholesalers about their sales, sales expectations, prices
and stocks. This is published ahead of the official retail
sales data.
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Variations in spending
Spending on different goods and services will
be changing all the time, depending on prices,
consumer tastes and other factors. But spending
on some items will vary to a greater degree than
others over the course of an economic cycle. For
example, spending on durable goods and some
services, such as eating out, tends to vary more
as economic conditions change than spending on
non-durable goods. Spending on essential items
like food varies less – we eat roughly the same
whatever the economic conditions! So changes
in overall consumer spending are likely to be
driven more by spending on durable goods and
other discretionary items than by spending on
essential items.
Consumer confidence
How optimistic or pessimistic consumers are feeling about
their own situation and that of the wider economy can be
an influence on their spending behaviour. Changes in
confidence are likely to reflect sentiment about factors
that affect spending, such as income and wealth. They
may also provide indications about what consumers think
about their future income, something that we cannot
observe directly. The MPC regularly considers data from
the GfK and YouGov surveys of consumer confidence.
Section F Demand and output
84
Investment
The amount of spending on new equipment and buildings
matters for both an assessment of demand conditions and
the economy’s supply capacity. Investment that increases
firms’ capacity will raise the economy’s potential output –
for example, a new piece of equipment might produce
more output in less time. This is one of the main ways in
which the economy grows over time. So if total demand is
growing strongly due to increasing investment rather
than, say, consumer spending, there might be less concern
about inflationary pressure because the capacity of the
economy would also be rising. However, the extra
demand could still put upward pressure on prices in the
short to medium term. As ever, it is necessary to judge all
these considerations together and take an overall view
based on the information available.
Total investment in the economy does not just consist
of spending undertaken by companies, ie business
investment. It also includes investment by government
and by individuals. Investment by individuals largely
consists of what is invested in housing. This accounts for a
quarter of total investment. Business investment accounts
for 56% of the total. Investment data are available each
quarter, initially as part of the second release of GDP.
More detailed data for business investment are also
published.
Changes in the amount of investment tend to be quite
volatile from quarter to quarter. This is often because
capital expenditure tends to occur in large ‘lumps’. For
What drives investment?
Firms invest so that they have the capital equipment
they need to allow them to produce goods and
services in a profitable way. How much they invest will
be affected by a variety of factors, such as their use of
existing capacity – their capacity utilisation – and
expected future demand and profits. Firms are more
likely to install new equipment and add to their
capacity when they are optimistic that they can
increase sales profitably. Investment takes time so
firms need to be confident about future demand.
Rising investment tends to be associated with
favourable economic conditions, when the prospects
for demand are good and a high proportion of
companies are operating at, or close to, full capacity.
Bank of England and The Times Interest Rate Challenge 2014/15
example, an airline might purchase a number of aircraft in
one quarter but then nothing else over the rest of the
year. Investment data are also prone to large revisions as
new information becomes available, often from annual
statistical inquiries.
It is also useful to look at other data to assess current and
future trends in investment, including information about
company profitability and borrowing. Surveys also provide
information about firms’ investment intentions and
capacity utilisation, as well as business confidence.
Inventories (stocks)
Inventories are stocks of goods held by companies, either
as materials and components for future production or as
finished goods for future sales. They can be seen as a form
of investment – spending today for revenue tomorrow.
Output can be thought of as sales plus or minus the
change in stocks. Changes in the level of stocks have
important implications for the pattern of both current
and future economic growth.
Firms will have some desired level of stock that they
want to hold relative to their output or sales. Better
management and control of both stocks and production
has meant that stocks as a proportion of output – what
is called the stock-output ratio – have been falling over
recent decades. But changes in stock levels from quarter
to quarter can be volatile and large. Such changes often
reflect temporary imbalances between demand and output.
Changes in technology are also likely to influence the
amount that firms invest. New technology might
enable more efficient, lower-cost production. And the
availability of finance within a company and the cost
of borrowing or raising external finance will also affect
investment. High levels of company debt and high
interest rates will tend to constrain investment.
Changes in investment tend to be more strongly
cyclical than GDP as a whole. Firms tend to cut back
their investment plans when economic activity is
weak – investment can fall sharply in recessions – and
increase spending when the economy is more buoyant.
Section F Demand and output
85
What can cause the level of stocks to change?
A rise or fall in stocks might reflect unexpected
changes in demand. If demand is higher than expected,
companies might run down stocks ahead of increasing
their output. If demand is lower than expected, firms
might see their stock levels rise. Alternatively, firms
might deliberately build up stock levels by increasing
output in anticipation of higher future demand, or
reduce stocks if they expect demand to fall. In a
recession, reductions in the level of stocks can
exacerbate falls in output.
If companies have reduced what they are holding in
stock to excessively low levels, it is likely they will
want to increase stock levels in the future. This will
add to the future growth in output. Alternatively, if
stocks have risen to high levels, firms are likely to
want to reduce them at some point.
Data on changes in the level of stocks for the economy as
a whole and the main sectors are included in the second
release of GDP. Rather than expressing these changes as
a growth rate, they are recorded in terms of millions of
pounds, from which the contribution of the change in
stocks to the change in overall GDP is calculated. This
contribution can be positive or negative. It is often difficult
to explain changes in the level of stocks in any particular
quarter and to judge the likely implications for future
demand and output.
Public spending
Government and other public sector spending on goods
and services is an important component of total demand.
Like any other part of demand, how much the government
is spending and plans to spend on goods and services will
affect the overall balance between demand and supply in
the economy.
MPC projections of public spending are based on the
government's published spending plans, and the MPC
monitors how actual spending compares with these plans
over time.
The overall total for public spending on goods and services
is the most important consideration, rather than the
particular ways in which the money is spent, although this
can also be of significance. Estimates are provided with
the second GDP release. In addition, monthly figures are
also available on the public finances.
Bank of England and The Times Interest Rate Challenge 2014/15
A large proportion of all the stocks in the economy is
held by manufacturers and distributors. Distributors –
retailers and wholesalers – hold stock ahead of sales to
customers, either as goods on the shelves in shops or
in warehouses. Manufacturers hold stocks of materials
and finished goods, and will also have unfinished
goods at different stages of the production process –
what is called work-in-progress. They might want to
hold stocks of raw materials in case of shortages or
disruptions to future supply, or in case they need to
increase production at short notice. They might hold
stocks of finished goods to meet short-term or
temporary fluctuations in demand rather than keep
changing output.
The cost of holding stocks will also be a consideration.
For example, if interest rates are high companies
might prefer to lower stock levels to reduce their
borrowing or increase their bank deposits.
Public finances
Each month, figures are published showing how much the
government has received in revenue – for example, from
income tax and VAT – and how much has been spent by
the different areas of government – such as health and
education. These data provide a check on the extent to
which government spending plans are being achieved.
The difference between expenditure and revenue will
determine the amount of borrowing the government has
to undertake. This is called the Public Sector Net Cash
Requirement (PSNCR). This will be negative, ie. in surplus,
when revenue is greater than expenditure.
Monthly movements in public spending and revenue can
be volatile, reflecting the timing of spending by government
departments and the receipt of revenue. Low spending in
one month might be reversed the following month. Over
time, however, the monthly public finance data do provide
an indication of trends in government spending and whether
it is growing more or less than envisaged by the MPC.
External demand
The balance of trade
The balance of trade in goods and services – the difference
between exports and imports – is an important indicator
of economic activity. Total spending in the economy will
include what is spent on imports; and total output will
include what is produced for export. So the balance of
trade measures the difference between domestic
production and domestic spending.
Section F Demand and output
86
When the balance of trade is negative, ie. imports are
greater than exports, the United Kingdom is purchasing
more from other countries than it is selling to them. A
more negative or less positive trade balance could
indicate that domestic demand is too high relative to
supply, which draws in more imports. But it could indicate
that growth prospects in the United Kingdom are
considered to be good and so investment spending is high,
drawing in imports of machinery and other capital goods.
If the balance of trade is becoming less negative or more
positive, that could indicate that demand overseas is
strong, enabling UK exports to rise. Changes in the
balance of trade therefore reflect both domestic and
external demand conditions.
Exports and imports
Although the balance of trade is a useful summary
measure, it is often more informative to look at trends
in exports and imports separately. They may provide clues
about different aspects of the economy. For example,
strong growth in export volumes might reflect growth in
the world economy, whereas strong growth in import
volumes might signal strong domestic demand growth.
Growth in exports and imports might also reveal
something about the competitiveness of UK producers,
both in domestic and overseas markets.
Data on the volume of exports and imports are available
on a monthly and quarterly basis. The monthly data
releases focus on exports and imports of goods. These
data are broken down into trade with EU and non-EU
countries. Trade with EU countries accounts for a large
part of the United Kingdom’s total trade, for example,
goods exports to the EU are 50% of UK goods exports.
The second GDP release provides details of total trade in
goods and services.
Key data: expenditure
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GDP
retail sales volumes
CBI Distributive Trades Survey
housing market turnover
house prices
GfK consumer confidence
PSNCR
import volumes
export volumes
The world economy
The exchange rate and competitiveness
The prospects for growth in the world economy
are an important consideration for monetary policy,
particularly growth in the United Kingdom’s main
export markets. Demand for UK exports is an
important component of overall demand.
The level of UK exports and imports will also be
affected by the exchange rate. It will influence the
competitiveness of UK exports and foreign imports –
a depreciation of the pound tends to make UK goods
cheaper abroad and imports more expensive; an
appreciation has the opposite effect.
The MPC looks particularly closely at the economies
of the euro area, United States, China and Japan. These
are the world’s largest economies. The MPC has to be
alert to any developments in the world economy that
influence demand for UK goods and services and the
prospects for the wider world economy.
The MPC considers a range of data on the main
overseas economies to provide indications about
current and future growth in demand for UK exports.
A key indicator in many countries is the growth in
GDP. But, additionally, labour market indicators are
also useful, and prices in overseas markets will be the
main determinant of UK export prices.
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Changes in the exchange rate are likely to take time
to influence prices and, in turn, exports and imports.
And the reasons for a change in the exchange rate
and whether it is likely to be a temporary or sustained
change will also influence the impact on prices and
demand. Of course, many other factors will affect the
competitiveness of UK exporters and firms that
compete in the domestic market with imports,
including wage costs and product quality. But the
exchange rate is certainly important, as exporters will
tell you. The exchange rate is discussed under ‘Money
and financial markets’.
Section F Demand and output
87
Total income from goods and services –
GDP(I)
The income measure of GDP – GDP(I) – measures the
incomes paid in the process of producing goods and
services. This includes incomes paid to employees and
profits retained by firms. It does not include incomes such
as unemployment benefits or interest payments because
these are transfers between different parts of the
economy, ie. they are not additional income.
Key data: income
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GDP
household post-tax income
wages and salaries
personal disposable income
saving ratio
Wages and salaries
The main source of income is that paid to employees.
This is referred to as ‘employee compensation’, estimates
of which are available with the second release of GDP.
The data are based on the monthly earnings data that are
discussed under ‘The labour market’. The largest part of
employee compensation is in the form of wages and
salaries. These data are published with the third release of
GDP along with estimates of post-tax disposable income
and the saving ratio. The relationship between income,
spending and saving was discussed earlier under
‘consumer spending’.
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Section F Demand and output
88
Section F
The labour market
Conditions in the labour market are another important influence on interest rate
decisions. They provide information about the balance between demand and supply,
and the extent of inflationary pressures in the economy.
Like other markets, conditions in the labour market
depend on the demand for labour relative to the available
supply – in other words, how many people firms want to
employ and how many people are available to work. Firms
will tend to demand more workers when wages are lower,
and more individuals will be inclined to seek employment
when wages are higher. This interaction will determine,
in a broad sense, the number of people in employment
across the economy as a whole.
Many factors will influence the demand for, and supply
of, labour. So it is necessary to keep abreast of all
developments in the labour market. An example is the
Government’s New Deal programme, which aims to
reduce unemployment. Month by month, the MPC
considers the levels and changes in employment and
unemployment, and the rate of increase in wages
and other earnings. Teams will need to monitor these
data closely.
Employment and unemployment
The numbers of people in work and out of work provide
important indications of the level and growth of economic
activity, and of the level of pressure on the supply of
labour and, in turn, wage increases and prices.
Unemployment
The unemployment rate is a key measure of the balance
between labour demand and labour supply. It can be
thought of as the number of people available and looking
for work, expressed as a proportion of the working
population.
The LFS measure is based on a survey of households and
reflects the number of people who are looking for, and
available to start, work. They need not be claiming social
security benefits, so the LFS measure and the claimant
count measure tend to be different.
Claimant count and LFS data are available on a regional
basis as well as nationally. This gives the MPC a guide
to economic activity and labour market conditions in
each region, and helps them to judge the extent to which
changes in unemployment are broadly based or
concentrated on particular parts of the country.
Unemployment and inflation
As we stressed in Section B, there is no permanent
trade-off between inflation and output, and the same
is true for inflation and unemployment. But, again, there
are important trade-offs in the short term. Unemployment
will vary with output growth in response to changes in
demand. When the unemployment rate is low, firms are
likely to find it more difficult to recruit new staff and retain
existing staff, who will find it relatively easy to find other
jobs. Consequently, firms may need to offer higher wages
to attract and retain labour. Low rates of unemployment
can be associated with higher inflation and vice versa.
But there is no particular rate of unemployment below
which inflation will always tend to rise. It is necessary to
monitor all the information available to determine when
labour is relatively scarce or relatively abundant, and
make judgements about the likely impact on wages and
other earnings.
Inactivity
Unemployment is measured in two main ways – the
‘claimant count’ measure and the Labour Force Survey
(LFS) measure. The claimant count is the number of
people eligible for, and claiming, social security payments
as a registered unemployed person.
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The number of people potentially available to become
employed is likely to be greater than the numbers
measured as unemployed. Unemployment does not
include some groups of people such as those registered
sick or other people who are not currently seeking work –
Section F The labour market
89
The ‘NAIRU’
Economists use a concept called the ‘non-accelerating
inflation rate of unemployment’ – the NAIRU – as a
guide to thinking about the relationship between
inflation and unemployment. This is similar to the
output gap concept discussed in Section D. But, rather
than output reaching a certain level beyond which
inflation starts to rise, the idea is that unemployment
falls to a level below which inflation starts to rise.
The level of the NAIRU cannot be determined with any
precision for the purposes of setting monetary policy.
Like the output gap, it is a useful conceptual tool. It is
easier to construct plausible estimates after the event
– ie. once we have observed inflation – rather than in
anticipation of it. And the rate of unemployment at
which inflation is likely to start rising can vary over
time. For example, if unemployment benefits are
reduced or the skills of the unemployed are improved,
the NAIRU might fall as more people are drawn into
employment. Changes in labour market legislation
over recent decades, and greater flexibility in
employment conditions, such as more part-time
working, might have reduced the NAIRU. But the level
is a matter of inconclusive debate. Consequently,
monitoring wage pressures is especially important.
for example, retired people or parents who look after
young children. These groups are not in employment or
measured as unemployed. But they might enter the labour
market at some point, perhaps as their own circumstances
change or if changes in the labour market make working
more attractive or achievable. Some groups are, of course,
more likely to enter the labour market than others.
Hours worked
We describe this pool of people as economically ‘inactive’.
Inactivity is measured as the size of the adult population
minus the number employed and unemployed. The number
of inactive people is another measure of the pool of people
who are potentially employable. The participation of
women in the labour market has grown considerably over
recent decades. This is one of the reasons why we have
seen the growth in employment exceed the fall in
unemployment. Another factor is population growth,
which will be affected by migration flows in and out of
the United Kingdom.
It is also possible to look at data on the number of hours
worked, provided by the Labour Force Survey. This might
be more closely related to changes in demand and output
than the numbers employed. As demand rises, firms might
initially increase overtime working rather than recruit
extra people. And if demand falls, firms might be reluctant
to reduce the size of their workforce until they are certain
about the level of demand. Given the costs of recruitment
and redundancy, firms might want to retain staff during
periods of lower output growth and instead reduce the
number of hours worked. Equally, they might delay
recruitment until the need for it is clearly established.
So a rise in employment will not necessarily be matched
by a fall in unemployment if people are drawn into the
labour market from ‘inactivity’. It is therefore necessary
to look at unemployment and employment separately.
Employment
There are also two principal measures of employment in
the economy – a measure called ‘Workforce Jobs’ and the
Labour Force Survey (LFS) measure. Workforce Jobs data
are obtained from firms. They record the number of jobs
so the measure may overstate the number of people
employed because some people have more than one job.
The data are available both for the whole economy and
for individual sectors. Data on the manufacturing sector
Bank of England and The Times Interest Rate Challenge 2014/15
are published more frequently than other sectors. The LFS
data are based on responses from households and
measure the number of people employed rather than the
number of jobs. Figures are available for both full-time
and part-time employment.
Employment intentions, vacancies, skill shortages
and recruitment difficulties
In addition to the official statistics, we can also look at
survey information on labour market activity, such as
that from the British Chambers of Commerce (BCC),
Confederation of British Industry (CBI) and Manpower.
Business surveys provide information about firms’
employment intentions – whether they intend to increase
or reduce the number of employees in the future. This
might tell us something about labour market activity in
the future and about firms’ expectations of future demand
– if they expect demand to rise or remain at a higher level,
firms are more likely to want to recruit extra people.
Section F The labour market
90
Employment and output
We would expect changes in employment to be
related to changes in firms’ output. As firms produce
more, they might need to recruit extra people. But the
growth in employment is unlikely to match the growth
in output, in terms of its timing or extent. Extra output
might be produced with relatively more equipment and
machinery rather than people, so we might see a larger
rise in investment relative to employment. Over time,
labour productivity tends to rise – less labour is needed
to produce a given amount of output.
Whether employment rises with higher output will
also depend on the amount of spare capacity available.
If firms are operating with spare capacity, they will be
able to produce higher levels of output without
We can also learn about the extent to which firms are
experiencing difficulties filling job vacancies. This might
tell us something about the balance between the demand
for labour and its supply, and therefore whether there is
likely to be upward or downward pressure on wage
increases. Firms often have difficulty recruiting people
with the right skills for available jobs. Some surveys ask
firms whether or not they are experiencing skill shortages.
These data can be considered, along with data on job
vacancies, to help build a picture of the demand for labour
and the extent of pressures in the labour market.
Key data: employment and
unemployment
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claimant count
LFS unemployment
inactivity
Workforce Jobs
LFS employment
LFS hours worked
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necessarily recruiting additional people. More output
can be produced with the same number of people.
Again the productivity of labour increases.
But even when higher output requires more labour,
employment might not initially rise. Increases in
output might be gradual. Firms might wait for output
to increase by a certain amount before they decide
that it is worthwhile employing additional people.
Furthermore, firms might be uncertain about whether
demand will remain strong and whether the higher
level of output will be sustainable. Of course, some
firms are able to plan increased production, in which
case employment might rise ahead of output. But,
generally speaking, employment growth is likely to lag
behind growth in output.
Labour costs
Labour costs – which include wages and non-wage costs
such as pensions and national insurance contributions –
are a major component of firms’ total costs and are an
important influence on prices. The actual proportion will
vary depending on the activities of each business. For
example, in parts of the service sector, the proportion
is likely to be higher than in the manufacturing sector.
If demand for goods and services is rising strongly, firms
are likely to need to recruit more employees to increase
production. If their extra demand for labour exceeds the
supply available, firms may need to increase wages.
Wages are also the main source of income for most
people and therefore a key determinant of the amount
that they can spend. So the rate of increase in wages
provides a good indication of consumer spending in
the economy.
Wages, unit costs and productivity
Higher wages will be an additional cost to firms. But, even
with higher wages, if each employee produces more, ie. if
productivity is rising, then the cost of producing each unit
of output may still fall. And higher wage costs might also
be offset by lower costs elsewhere in their business. In
short, output might rise more than costs, thereby
lowering the unit costs of production.
Section F The labour market
91
But if wage increases add to firms’ unit costs and demand
conditions are favourable, some firms are likely to seek to
pass these increases on to customers as higher prices.
In this way, higher wages lead to higher inflation.
It is not possible to know what rate of increase in wages
will lead to higher or lower inflation. Productivity growth
will vary over the course of the economic cycle – output
might be rising strongly, lowering unit costs even if wages
are rising. Its trend rate of growth may also vary over
time, for example, in response to factors such as the
increased use of computers and the spread of information
technology. But it is difficult to separate the trend from
cyclical influences on productivity growth. You can
observe the current rate of productivity by looking at the
ratio of output to employment, but only informed guesses
can be made about the future.
Earnings and wage settlements
The main measure of the growth in wages is the Average
Weekly Earnings (AWE). Earnings include basic wages and
other earnings such as overtime and bonus payments.
We can look at data for total earnings and the contribution
made by bonuses and, separately, wage settlements.
Average earnings data are published each month, both
in terms of an annual growth rate and a three-month
moving average of the annual growth rate. The latter is
referred to as ‘headline’ earnings growth. The growth in
average earnings for the whole economy is also broken
down by sector – such as manufacturing and services –
and by industry. This allows us to compare sectoral
earnings data with other sectoral data, such as output and
employment, to judge the nature of demand and
inflationary pressure across the economy as a whole.
Data on wage settlements are available for both the
private and public sectors of the economy. By far the
most important months for wage settlements are January
and April because this is when most annual adjustments
to wage rates are implemented. However, compiling data
for these months is often delayed as wage negotiations
can take time to conclude.
Changes in the annual growth of earnings in individual
months can sometimes reflect a small number of
significant wage settlements, such as those for large firms
or public sector bodies; and bonus payments which can
vary considerably from year to year, both in terms of
amount and timing. Individual wage settlements and
Bank of England and The Times Interest Rate Challenge 2014/15
bonus payments will, of course, reflect specific company
circumstances as well as wider labour market conditions.
So you need to be careful before drawing conclusions
from the data. The ‘headline’ AWE figures smooth the
effect of month to month volatility in earnings growth.
Key data: wages and earnings
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–
–
–
–
Average Weekly Earnings
headline AWE
wage settlements
productivity
unit wage costs
Wage drift
Over the course of the economic cycle, the rate of
increase in basic wages relative to total earnings is likely
to vary. As demand and output rise, elements of total
earnings such as overtime and bonus payments tend to
increase more quickly than basic pay. In other words,
overtime and bonus payments increase as a proportion of
total earnings. The gap between total earnings growth and
wage settlements is referred to as wage drift. The extent
of wage drift is likely to be affected by the demand for
labour. Firms might find that some elements of wage drift,
such as overtime payments, are easier to change than
basic pay as economic conditions change.
It is also useful to consider the nature of bonus payments.
Bonuses paid to staff for good performance or the
profitability of a firm over the previous year might tell us
more about the past strength of demand in the economy.
Bonuses paid to retain staff might tell us more about
firms’ expectations of continued or rising demand in the
future. Of course, it might be difficult to separate these
explanations. And, whatever the reason for bonuses, they
add to the potential spending power of employees,
though some of the money might of course be saved
rather than spent.
Overall, earnings are an important part of the MPC’s
assessment of economic conditions – signalling both the
strength of future demand and inflation. Teams should
monitor the growth of earnings and their composition as
a key input into their overall judgement about the
economy and the inflation outlook.
Section F The labour market
92
Section F
Costs and prices
The MPC looks at the prices of goods and services at different stages of the production
process to help it assess the inflation outlook. Information on commodity, producer
and retail prices can tell us both about general inflationary pressure in the economy
and specific developments that might influence retail price inflation in the future.
The prices ‘pipeline’
Consumer prices represent the final price paid by
the consumer. They can be thought of as the end of
a ‘pipeline’ of costs and prices. The final price will be
made up of many different components of cost as well
as the retailer’s profit or margin. For retailers, the price
of an item will have to cover the cost of buying the
goods from the producer, paying staff their wages and
paying for other services required such as delivery,
rents and electricity. A similar breakdown applies to
producers. This will include the cost of materials and
components that they purchase from other firms.
Prices at one stage of the pipeline become costs for
the next stage – for example, oil prices are a cost for
petrol producers; petrol prices are a cost for haulage
companies; haulage prices are a cost for retailers. The
idea is a simplification and it is not meant to imply
that consumer prices are just the sum of all the various
costs in the pipeline. Prices are determined by the
Consumer prices
We have already said a great deal about consumer prices.
We explained in Section C that the Government’s inflation
target is currently specified in terms of the annual rate of
change in the Consumer Prices Index. We said that
monetary policy is not aiming to keep inflation exactly in
line with the inflation target every single month. Month to
month, the actual rate of inflation will tend to move up
and down. In Section D, we discussed how the current rate
of inflation might be a poor guide to prospects for the rate
of inflation over the next two years or so.
Bank of England and The Times Interest Rate Challenge 2014/15
interaction of supply and demand. If the cost of raw
materials rises, for example, producers or retailers
might accept lower profit margins rather than raise
their prices. They are more likely to do this if demand
is weak or because of competition. The degree of
competition in markets can affect how much cost
increases are passed on to consumers.
The effects of prices in the pipeline do not work in
just one direction. For example, an increase in oil
prices might show up first as an increase in producers’
material prices and then feed through to consumer
prices. But an increase in demand, perhaps due to a
rise in government spending, might first result in
higher consumer prices before higher demand puts
pressure on resources further down the pipeline,
resulting in a rise in oil and other material prices. The
MPC monitors price developments at all stages of the
‘pipeline’ to spot signals and clues about demand and
future inflation.
Components of the CPI
Although we are interested in the overall rate of inflation,
there may be instances when price changes in individual,
or groups of, components of the inflation index contain
useful information. In order to understand movements in
current consumer price inflation and to assess the likely
path of inflation in the future, the MPC regularly monitors
developments in the inflation rates of different
components. For example, some food prices can be
volatile, often reflecting factors like the weather. These
effects are usually temporary in nature, so they can
obscure the underlying trend in inflation from month
to month.
Section F Costs and prices
93
We might even want to look at the price changes of
individual components of the CPI if the inflation rate rises
or falls in a particular month due to specific price
movements. The Office for National Statistics often draws
attention to particular items that have had a significant
influence on inflation in a particular month. You then
need to decide whether the reasons are specific to the
item or items, or indicative of some wider influence that
may affect other prices over time. More generally, the
MPC pays particular attention to trends in inflation rates
for the ‘goods’ and the ‘services’ components of the CPI.
rate of growth of productivity in goods markets relative to
services markets. Goods are traded internationally to a
greater extent than services and capital equipment tends to
replace labour to a greater degree in the production of
goods compared with services.
So, if inflation is around 2.0%, we might expect to see
goods prices inflation below this rate and services prices
inflation above it. Of course, at any specific point in time,
goods prices inflation might be higher than services
prices inflation.
Domestically generated and imported inflation
Some prices go up – some prices go down
Individual prices are going up and down all the
time. If we were to look at the prices of every item
within the CPI then we probably would not glean
very much information about the overall situation.
Rather, we would learn more about the specific
characteristics relevant to the markets for each
product, and changes in consumer tastes.
Computer prices have tended to fall over time
as new technology has made new models better
and cheaper. Computer prices might fall whether
overall inflation is 2.0% or 5.0%. Conversely,
some prices such as those for education services,
like university and school fees, have tended to rise
more quickly than the overall rate of inflation.
These observations do not add much to our
assessment of the inflation outlook. But if there
was a change in these established patterns – which
might change the inflation rate for a period –
we would need to consider them more closely and
assess their significance.
Goods and services prices inflation
Looking at the inflation rates for goods and services prices
can often tell us about the nature of the forces underlying
the current rate of inflation, and provide clues about the
inflation outlook.
Consumer goods prices account for around 55% of the
Consumer Prices Index and services prices account for
around 45%. The goods component includes much of
what is sold in shops, and other items, such as cars and
petrol. The services component includes things like bus
fares, insurance premiums, cinema ticket prices, electricity
and hairdressers’ prices.
On average, goods prices inflation has tended to be lower
than services prices inflation. This mainly reflects a higher
Bank of England and The Times Interest Rate Challenge 2014/15
Prices will reflect both domestic economic conditions and
also international influences, such as the exchange rate and
demand conditions in overseas economies, which can affect
the price of goods imported into the United Kingdom. One
way of thinking about overall inflation is as a combination
of domestic inflation and imported inflation. The
UK economy is very open to international trade and so
domestically generated inflation corresponds to the rate of
inflation that would prevail in the absence of changes in
prices that are influenced by external factors. Goods prices
will be influenced by changes in the exchange rate to a
greater extent than services prices.
A fall in the exchange rate – a depreciation – will tend to
increase the level of prices, at least relative to what they
would otherwise be. This might mean that any downward
pressure on prices from weak demand could be offset to
some extent, or upward pressure from strong demand
could be exacerbated. An appreciation of sterling is likely
to have the opposite impact – reducing the level of prices.
So if changes in the exchange rate are influencing
inflation, we would need to assess what inflation might
be once these effects had worn off. This goes for any
temporary influence on inflation, although if changes in
inflation affect inflation expectations and, in turn, wage
demands, these influences can prove more persistent.
It is the job of monetary policy to ensure that this does
not happen.
Producer output prices
The prices charged by producers for finished products are
an important influence on consumer prices. They will be
influenced by the costs of production, including wages, and
also the prices of imports that feed into the production
process. They will reflect the balance between demand and
supply in the same way as consumer prices. There
is a close relationship between changes in producer price
Section F Costs and prices
94
inflation and consumer price inflation, and particularly
consumer goods prices, though this will vary depending
on factors such as the level of demand.
We can monitor producer prices by looking at the
Producer Prices Index. Producer output prices reflect the
prices charged by manufacturers to other sectors such as
retailing, business services and construction. They will also
include any taxes and duties levied on manufacturers’
prices, for example those on fuels like petrol. Changes
in duties set by the Chancellor in the annual Budget can
have an influence on the rate of inflation for producer
prices, as well as consumer prices. So we sometimes also
look at producer prices excluding tax effects to get a
better view of the underlying situation.
Producer input and commodity prices
Price indices are also available for the materials used by
manufacturers — what are called producer input prices.
Inputs are materials such as timber, fuels, metals, and
food materials. Of course, one firm’s input is another
firm’s output, so the producer input price index also
includes items like steel and plastics. The producer input
price index weights materials and components according
to their use as inputs by manufacturing firms. Many basic
materials are also included in indices of commodity prices.
Commodity price indices consist of what we call primary
products, such as oil and timber.
Producer input and commodity prices can rise and fall by
large amounts. Trends in material and commodity prices
are usually more volatile than the prices charged by
manufacturers and retailers. This has been particularly
noticeable in the recent past when consumer price
inflation has been relatively low and stable. Raw materials
are only a part of manufacturers’ total costs, so large
changes in these prices do not tend to lead to changes
in manufacturers’ output prices of the same magnitude.
They are likely to have some impact, particularly if price
changes are large and manufacturers think they will be
permanent. Large one-off changes in prices of
commodities like oil can have temporary effects on
consumer price inflation. But only if these effects resulted
in higher inflation expectations might any rise in inflation
be more persistent.
Changes in commodity and material prices
Commodity and material prices are sensitive to
changes in demand and expectations about future
demand. In the short term, supply tends to be fairly
fixed, particularly for commodities which are grown –
for example, rubber and wheat. If demand growth is
expected to rise, this might put upward pressure on
prices unless there are large stocks of commodities
available to increase supply in the short term.
Similarly, if demand grows more slowly, there will be
excess supply and lower prices. Changes in commodity
and material prices can also reflect movements in
exchange rates. Many commodities that are traded
Bank of England and The Times Interest Rate Challenge 2014/15
internationally are priced in US dollars so the price in
pounds will reflect the £/$ exchange rate.
Large price changes for individual materials and
commodities can often reflect specific events, such
as crop failures or processing problems in particular
markets or countries that are important suppliers –
for example, Brazil produces a large part of the world’s
total coffee crop. The oil price is affected by the
amount that major oil producers agree to produce
under arrangements set by OPEC (the Organisation
of the Petroleum Exporting Countries).
Section F Costs and prices
95
Import and export prices
Key data: costs and prices
The MPC also looks at import and export price indices
to track the effects of exchange rate changes and demand
pressures in both the United Kingdom and abroad, and
how these might affect consumer prices in the future.
Exchange rate changes will lead to changes in sterling
import and export prices. If prices in foreign currency
terms do not change, then an appreciation of the
exchange rate will lower sterling prices.
–
–
–
–
–
–
–
consumer prices
producer output prices
producer input prices
commodity prices
oil prices
export prices
import prices
The timing and extent of any fall in import and export
prices might depend on the strength of demand. If
demand is strong, importers might choose to increase
their profit margins and perhaps sacrifice some sales
rather than reduce their prices in sterling terms. Similarly,
exporters might hold their prices and sacrifice sales. If, on
the other hand, demand is weak, importers might reduce
sterling prices instantly in order to boost their sales. The
MPC monitors export and import prices alongside data on
export and import volumes.
Bank of England and The Times Interest Rate Challenge 2014/15
Section F Costs and prices
96
Section F
Guidance for using the datasheets
The first set of datasheets will be available from 5 September 2014 on the
Bank of England website: www.bankofengland.co.uk/education/Pages/
targettwopointzero/default.aspx
Monthly datasheets
Data updates
The datasheets will provide you with some of the statistics
that have been mentioned in the discussion of different
aspects of the economy. They cover:
In addition to the monthly datasheets, the Bank will
produce Target Two Point Zero data updates immediately
prior to the regional heats, area and national finals. These
will cover key data released since the most recent
datasheet.
•
•
•
•
•
money and financial markets;
demand and output;
the labour market;
costs and prices;
the international economy.
Some of the data are more important than others. You
should not feel that you have to use all the data. You will
need to decide which data you think are important for
your assessment of economic conditions and your interest
rates and quantitative easing decision.
The datasheets contain tables of the latest available data
so that teams can monitor the recent economic picture.
In addition, long-runs of data are available for a selected
number of key statistics. These will enable teams to
compare recent changes in data with previous experience.
The datasheets will be updated monthly as new data
become available, so the first set should only be used as
a starting-point. Teams will need to follow new data and
revisions to existing data as they become available.
The tables in the datasheets are in PDF format. The
long-runs of data are in Microsoft Excel format. You will be
able to download and use the long-runs of data if you
wish. Always make sure that you are using the latest
available data and do not forget revisions.
Many of the features of these data were discussed in
Section E but we did not provide individual descriptions of
the data series. Short descriptions accompany each of the
tables provided in the datasheets. Teams should make sure
that they understand what the data are before they start
drawing conclusions from them.
Bank of England and The Times Interest Rate Challenge 2014/15
All the data, including the long-run series and the updates,
will be available on the Bank of England’s website:
www.bankofengland.co.uk/education/Pages/
targettwopointzero/default.aspx
When you make your policy decision, data for the most
recent quarter or month will not necessarily have been
published for every data series. That is one of the realities
of setting interest rates. You have to make the best of
what is available. Teams are welcome and encouraged to
use whatever other data and information they think will
be useful and relevant to their presentation and interest
rate decision. Pick up The Times and other publications to
get some pointers about the current situation. There are
plenty of people offering opinions on the economy and
interest rates. Visit the websites of the organisations that
publish statistics. The Office for National Statistics has
much of its data on-line. You can obtain the latest
releases and briefings from their website:
www.statistics.gov.uk
Links to the key data releases can be found in the Data
section of the Target website. For ONS data, select the
data release you want to look at click on statistical
bulletin and then download pdf.
You may also want to look at some of the data and charts
included in the relevant parts of the minutes of the
MPC meetings and the Bank of England’s Inflation Report.
Section F Guidance for using the datasheets
97
Section G
Making your presentation
This section provides some guidance on how to go about developing your
presentation and some tips on how to present well.
Developing your presentation
101
The objectives
101
Planning your approach
101
Managing your workload
101
Thinking about your presentation
102
Reaching your decision
102
Thinking about the judges’ questions
102
Delivering your presentation
103
Style of delivery
103
Overcoming nerves
103
Visual aids
103
Length
104
Answering the judges’ questions
104
Equipment
104
Technology
105
And now... over to you
106
Bank of England and The Times Interest Rate Challenge 2014/15
Section G Making your presentation
99
Section G
Developing your presentation
The objectives
Before you begin, make sure you are clear about the
objectives of the Challenge, so you have a good idea of
what you are aiming to achieve and what, in general
terms, the judges will be expecting from your team’s
presentation. How you go about the task is up to you
but remember that the broad objectives are:
want to rely entirely on the information provided by the
Bank of England, or do you want to use other data and
information that are available?
It might help to draw up a checklist of questions that you
want to answer such as:
– is the economy slowing down or speeding up?
• to assess the balance between demand and output, and
the extent of inflationary pressure in the economy;
– what areas of demand are strong or weak?
• to assess the future outlook for the economy in general,
and the outlook for inflation in particular – in other
words, you need to look ahead;
– what are the money supply data showing?
• to judge whether interest rates should be changed or
left at the current rate set by the MPC in order to meet
the inflation target;
– what is the outlook for demand?
– what is happening in the world economy?
– in which direction does employment appear to
be moving?
– how close is the economy to operating at full capacity?
• to make an interest rate recommendation and offer
supporting arguments and evidence; and
– are wage pressures and other costs rising or falling?
• to deliver an interesting and effective presentation.
– is the current rate of inflation likely to rise or fall?
Teams may consider if appropriate to make additional
policy recommendations beyond that for interest rates.
Again, the decision making process and presentation of
these is entirely at the team’s discretion.
Managing your workload
Planning your approach
You will want to spend a fair amount of time considering
the resource material, familiarising yourselves with the
data on the economy, and thinking about the issues
that are most likely to be relevant to your decision on
Bank Rate and quantitative easing. You can then decide
how you want to go about your work. You might want to
start with an interest rate discussion and vote to establish
what each member of the team thinks about the
economic situation and inflation outlook, and then
decide the main issues that the team wants to cover.
Alternatively, you might want to start by understanding
the background to the latest MPC decision and discuss
areas where team members agree and disagree.
You will also need to decide how you want to undertake
your assessment and analysis of the economy. Do you
Bank of England and The Times Interest Rate Challenge 2014/15
– how has the exchange rate changed?
However you decide to get the ball rolling, you will need
to keep the workload manageable. Do not start by visiting
a library and taking out a collection of textbooks. The aim
of the Challenge is not to cover a course in economics in a
few months. You will have to become comfortable with
some basic ideas – such as why inflation rises and falls –
and be familiar with some of the language that is used.
But the resource manual and newspaper articles should be
sufficient for this.
It might be a good idea to establish how much time you
can devote to the Challenge, and how much help you can
expect from others in your class or group. Design your
efforts around this and be realistic. You could also think
about prioritising what you want to do. You could
establish a list of the data and issues you think it will be
essential to cover, and perhaps have a second list of things
to do if time allows.
A polished and well-argued presentation that focuses on a
limited number of themes will work better than one that
Section G Developing your presentation
101
attempts to cover everything but lacks coherence. The
Challenge is not about which team can assemble the most
information. Remember, your presentation should be no
longer than fifteen minutes. Cramming everything in will
not allow you to focus on the issues you think are central
to your decision. And the judges might not spot your main
lines of argument if they are weighed down by too much
information, delivered at high speed.
You will also need to decide how you want to divide the
material amongst team members – do not forget the
Challenge rules say that each person must make a
significant oral contribution to the presentation. Establish
who is responsible for different elements of the work –
such as collecting new data, reading newspapers, and
overseeing the overall progress of the team in relation to
an agreed timetable. You might want to divide the material
on the basis of the different aspects of the economy
covered in Section F. But, if you adopt this approach, you
should still base your policy decision on an assessment of
the outlook for the economy as a whole, not of particular
aspects of it – such as the labour market.
Thinking about your presentation
As there are only two months between the start of the
Challenge and the regional heats in November, teams
will need to think about their presentations quite early
on. They will need to decide what kind of presentation to
give and how it might be structured. For example, do you
want to start with your policy decision or conclude with
it? How do you want to cover current economic
conditions and your thoughts about the economic
outlook? Do you want to focus on a small number of
key points, perhaps those which are central to your
interest rate decision? Or do you want to cover different
aspects of your economic assessment in a more
comprehensive way?
Some teams might want to work through the material
in the same way as the minutes of the MPC meetings or
Inflation Report; other teams might want to present in
an entirely different way. These are all questions for your
team to consider – that is part of the Challenge.
You should assume that the judges are familiar with
textbook theories and the workings of monetary policy –
they will all have had first-hand experience of the
Monetary Policy Committee and its decisions. So there
is no need to give them background information or to
discuss economic theories. But you might want to make
it clear why you are looking at a particular issue or piece
of data. This will help to demonstrate your understanding
Bank of England and The Times Interest Rate Challenge 2014/15
– for example, ‘data on the growth in wages tell us
something about how much consumers might have
to spend’.
You will want to demonstrate in your presentation that
you have reached your policy decision in a thoughtful way.
You do not want to give the impression that you thought
about it the day before, or have only considered a few
pieces of information – your decision will be based on
uncertain judgements, but that is not to say that you
should arrive at it casually. After all, you are deciding how
much interest everyone in the country should pay on their
borrowings and receive from their savings!
Reaching your decision
To reach your decision, you might find it useful to list all
the factors that you think suggest lower interest rates,
higher interest rates and no change in interest rates. This
might help you to organise your thinking and allow you to
form an overall judgement. Alternatively, you could list
factors as being either inflationary or deflationary. Once
you have identified all the relevant factors, you can decide
where the balance of evidence lies, and make your decision.
Do not forget that teams are not required to reach a
unanimous decision about interest rates. But if there is
a difference of opinion within the team, you will have
to explain this. You could let each member of the team
explain their own vote. But each team member should
still base their decision on the whole picture not just the
aspects of the economy they have covered.
And remember that your team’s interest rate decision
must relate to the level of Bank Rate set by the MPC at
the time of your presentation. So you will need to be
flexible and keep in touch with developments as you
approach the regional heats. If you build all your thinking
and work around the need to raise or reduce interest rates,
and the MPC does just that at its meeting in early
November, you might have to re-think your approach and
presentation. Do not put all your eggs in one basket!
Thinking about the judges’ questions
You should think about the questions that your
presentation and decision might prompt. You might find
it helpful to get someone to ask you some questions.
What questions flow from your key points? What areas
might the judges be uncertain about? How might the
judges challenge your conclusions and interest rate
decision? Rehearse your answers with your teachers
and friends.
Section G Developing your presentation
102
Section G
Delivering your presentation
One aspect of good communication is being able to present information in a clear
and interesting way. The Challenge gives you the chance to develop and demonstrate
these skills. Here we offer you some guidance on how to go about it.
Style of delivery
Clarity of argument and familiarity with your material will
take you a long way, but your audience will be more receptive
if you can present it in a relaxed and confident style.
• Do not read
Spontaneous speech is much more lively and interesting
to listen to than a text being read. Referring to short
notes on cards is acceptable but make sure that you use
your notes only as prompts and that you look at the
audience as much as possible. Teams who read verbatim
from scripts, laptop screens or visual aids or rely
exceptionally heavily on notes will not automatically be
disqualified from winning but they will be marked down
by the judges. This does not mean that you have to
memorise your presentation. The rules permit teams to
refer to notes and visual aids. Try to look at the
audience as much as possible and try to believe in what
you are saying – if you are convinced, then you are more
likely to convince your audience.
• Speak loudly and clearly
Speak loudly enough so that the person furthest away
from you can hear, and speak more slowly than usual.
Try to avoid sounding hesitant with expressions such as
‘um’ and ‘er’.
• Establish a relationship with your audience
Try to establish eye contact with as many members of
the audience as you can. Wherever possible face the
audience and not your visual aids. It might be helpful
to include some humour but the overall impression you
must give is of a serious and thoughtful analysis.
• Pause
When you are making a point, pauses can give you
authority and they give the audience time to get to grips
with your arguments.
Bank of England and The Times Interest Rate Challenge 2014/15
• Gesture
You may be feeling too nervous to gesture spontaneously,
but gesturing can help to reinforce your points and to
liven up your talk. But make sure that it does not
distract the audience from what you are saying.
• Practise
Practising will improve the flow of your presentation and
give you confidence and poise. It will also provide an
opportunity to make improvements and spot any errors
or inconsistencies in what you are saying. Good speakers
practise everything, including not only what they will
say, but also their style and using their visual aids.
Overcoming nerves
Nerves are to be expected. Knowing your subject
thoroughly and practising aloud with your visual aids
will help.
Even regular speakers are nervous, but there are some
tricks of the trade to overcome the symptoms. A glass of
water can help with a dry mouth. Trembling hands can be
calmed by resting them on the table or by making
gestures. Try not to put them in your pockets. And do not
use a pointer as this draws attention to the shaking.
Butterflies or a thumping heart can be soothed by taking
deep, steady breaths to relax. Overall, try to enjoy the
event.
Visual aids
Listening to a talk is very different from reading the same
words. When a member of the audience’s attention
wanders momentarily, there is no written word to remind
them what was being said, and they cannot re-read the
argument – the speaker will already have moved on to the
next subject. Visual aids provide a useful reminder and an
opportunity to recap.
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Whiteboards, overhead projector slides, flip charts and
computer-generated graphics can all keep the audience’s
attention. And you do not have to create all your visual
aids from scratch – simple yet powerful visual aids such as
charts on many aspects of the economy can easily be
found in major newspapers, business journals and the
publications of financial institutions. They can also
be found, of course, in the Bank of England’s own
publications, particularly the Inflation Report, which
is available on our website.
When giving your presentation, you should describe to the
audience precisely what is on each visual. For example, if
you decide to show a graph of inflation you might say:
‘This slide shows the annual rate of inflation over the past
two years’. If it is not obvious, you might need to explain
things in more detail – for example, what the axes on a
graph show. Once the audience understand what they are
seeing, they will be more receptive to your explanation of
it, for example ‘As you can see from this slide, investment
appears to be increasing more slowly than before’.
Aim to finish in under 15 minutes. The real thing usually
takes longer than practice runs.
Answering the judges’ questions
After the presentation, the judges will ask each team
a series of questions.
You may confer before answering the judges’ questions
but you will be pressed for an answer if you take too long.
There are several ways to answer the questions. You
should agree on which method you are going to use and
practise it as part of your preparation. The approach used
is at the discretion of teams. The key point is that the
judges will want to see all team members making a
significant contribution to the answers. Answers should
not be dominated by one or two team members. You
could consider using one or more of the following
approaches.
• Team members could specialise in certain topics and
field any questions on their specialism.
It is important not to cram too much into your slides,
otherwise it becomes confusing. Too few points are always
better than too many. And you could vary the number to
add interest. Occasionally putting only one point on a
slide will change the pace of the presentation and help to
keep the audience alert.
• Team members could agree that, after conferring, a
team spokesperson or the team captain will answer.
• Text is the most widely used form of visual aid. It is
usual to set out key ideas as bullet points. But keep the
bullet points simple. Whatever you do, be sure to leave
lots of space so your points are easy to read.
Teams will also have to consider how they handle
questions if there has been a split decision on Bank Rate
and quantitative easing . Answers may differ depending on
what view the individual team members took of the
outlook for the economy and inflation.
• Graphs are useful for showing how variables change
over time, or for showing how one variable relates to
another. Beware of including more than three variables
on one graph as they may confuse. Too many charts
might diminish your main points, so be selective.
• Teams could select whoever is best placed to answer.
Perhaps the team captain might make the choice,
particularly if more than one team member wishes
to make a contribution.
• Tables might be useful to draw attention to the
latest data.
You may want to think in advance of questions that the
judges might ask, and to prepare answers. You might also
consider how you will respond if you do not know the
answers. You might find it helpful to get teachers and
friends to ask you a few difficult questions, to give you
practice in answering in a formal setting.
Length
Equipment
The Challenge rules specify that your presentation should
be no more than 15 minutes long. You may decide that
you can present a well-argued case which covers all the
relevant points in less than 15 minutes. It is the quality of
your arguments and your ability to put your case across in
a clear and convincing way that matters, rather than the
length of your presentation.
In the regional heats and area finals, your presentation can
be in any format. The Bank will provide the presentation
equipment listed below at all the venues for the regional
heats and area finals:
Bank of England and The Times Interest Rate Challenge 2014/15
• PowerPoint equipment – laptop or PC, projection
equipment and screen.
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Teams are required to use PowerPoint in the national final
in London.
PowerPoint presentations should be in Microsoft
PowerPoint 2010 format. They should be stored on a
USB memory stick but should not be compressed ie. no
zip files. Speakers for the laptop or PC will not be
provided.
If your presentation is dependent on equipment that is
not mentioned above, you will need to ask us to provide
it (see page 18 for contact details) or bring your own. If
you intend to bring your own, please notify us as soon as
possible so that we can make any special arrangements for
you to deliver and set up your equipment.
Technology
PowerPoint has the advantage of enabling teams to
present to a professional standard, in colour and with a
variety of graphics and special effects. But using technology
has its drawbacks. The more sophisticated the presentation,
the greater the risk that something will go wrong, either
with the presentation itself or with the equipment. The
risks can be minimised by:
Bank of England and The Times Interest Rate Challenge 2014/15
• Rehearsing your presentation with technology
Practising your presentation before the event in front
of friends will not only help you to familiarise yourselves
with your visual aids but will also enable you to identify
any problems. For example, you should ensure that the
visual aids are sufficiently large and clear for the
audience to read. If you have incorporated graphics
you should ensure that they appear where and when
you expect them to.
• Rehearse your presentation without technology
Since you cannot plan for every eventuality, it is
advisable to have a back-up presentation that is not
dependent on technology and to have practised with
them in advance. This will enable you to perform to a
high standard if something unforeseen happens on the
day – for example software incompatibility or
equipment or power failure.
But do not be discouraged if you are not masters of the
technological wizardry – judges will always think more
highly of a carefully reasoned argument than of a
colourful display.
Section G Delivering your presentation
105
Section G
And now... over to you
The Target Two Point Zero resource manual provides teams with the foundations for
their policy decision on Bank Rate and quantitative easing. It explains the main
ingredients of monetary policy and has provided teams with a framework for thinking
about the economy and inflation outlook. It will have given you many things to think
about – too much for one person, so it will be important for team members to work
together.
The resource manual does not cover everything that is
potentially relevant to interest rate decisions, and it is not
a blueprint for setting interest rates. But if your team
became the Monetary Policy Committee tomorrow, it
would hopefully give you enough of an idea of how to go
about the job. You can, of course, approach the task from
whatever angle you wish and investigate anything that
you believe is important and relevant. You might not
agree with the way the MPC goes about its job and the
issues it identifies as being the most important. So how
you undertake the task – the Challenge is up to each
team. We look forward to plenty of imagination and
variety in the presentations.
But even if your team does not progress to the next
stage, we believe every student taking part will find the
experience rewarding, both in terms of their immediate
studies and further ahead. Participating will provide you
with a greater understanding of the economy and, we
hope, some appreciation of what it is like to make a major
decision that affects nearly everyone in the country in
some way or another. You might even discover skills you
did not think you had.
Good luck to everyone.
We hope that all those people taking part will find the
Challenge as stimulating and rewarding as the members
of the MPC find it when they are setting interest rates.
Like them, you will discover that there are areas where it
will be difficult to make a judgement and, in some cases,
you will have to settle for not knowing enough or not
being able to reach a concrete conclusion. That is all part
of real-life decision-making. But you must take a decision
– there is no escaping that. If your team’s presentation is
imaginative and well argued, you may well win a regional
heat and revisit your policy decision – like the MPC – in an
area final in February 2015.
Bank of England and The Times Interest Rate Challenge 2014/15
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