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Turning Points And Monetary Policy Strategy

6th February 2023

Catherine L. Mann of the Bank of England talks about how we use data to spot turning points in the economy. She explains how that feeds into her policy decision.

From a speech Given at the Lámfalussy Lectures Conference in Budapest, Hungary.

Over the last week or so, many advanced economy central banks increased their policy rates. The Federal Reserve increased by 25 basis points, the European Central Bank and the Bank of England by 50, although the Bank of Canada signalled a pause and the Bank of Japan maintained its updated yield curve control target. It seems that at least some central bankers are seeing a turning point in data to which they are responding with an inflection in their respective policy paths. Recent market chatter has focused on when central banks will stop hiking and if they will reverse, with fears torn between the risks of overtightening and stopping too soon. What has everyone been looking for and what have they seen?

It is worthwhile even to consider what we mean by a turning point. In general, it reflects data that reveal transition points between phases of a business cycle. This can help guide monetary policy makers with the calibration of future policy. It is difficult, though, to identify a cyclical turning point in real time, even more so to foresee one ahead of time so that policies (and portfolios) can be adapted to the future path of the macroeconomy. Harbingers of macroeconomic turning points may occur at different points in time in different parts of the macroeconomy, and in different regions across the world, even when hit by a common global shock. Moreover, what represents a turning point in the data which would lead to a re-assessment of policy is related to the mandate of the central bank. Calibrating policy to affect inflation is key for all, but some have to be equally mindful of how policy affects other metrics of macroeconomic performance, for example employment.

One approach to identifying turning points puts substantial weight on forecasts from large macroeconomic models, because these take account of the complex inter-relationships among economic variables and policy. One must be humble about the stability of the relationships, for example of inflation dynamics and the monetary policy transmission mechanism, that underlie predicted turning points and macro outcomes. Adding to these uncertainties are policy spillovers. For example, as a UK monetary policy maker, I am mindful of other central banks decisions, as reflected in their assessment of their turning points, and their impact on the UK economic situation.

All this adds up to acknowledging that macro data and forecasts need to be complemented by a range of more granular data and higher frequency assessments of what data presage the turning points in the inflation process that represents, according to our remit, a sustainable return to the 2% target. Putting too much trust in simple, linear, historically estimated macro-relationships risks making a policy mistake when uncertainty is high (Mann, 2022a). My reading of the more granular data and likely asymmetries in the inflation process has led me to vote for a more robust monetary policy path that stays the course because inflation dynamics have not yet been quelled.

Today, I'd like to put more structure on how I think about these turning points, mostly by using the UK as an example, but also with some views across regions and through the lens of different channels of the monetary policy transmission mechanism.

Read the full speech and see several graphics HERE