My time on the MPC and monetary policy at Covid and after

I was asked by the IIMR to talk about my time on the MPC and how I reacted to the pandemic and subsequent inflation.  The video (18 mins) is here.  

The blurb says: 

Gain an insight into the thinking behind the Monetary Policy Committee decisions during the Covid crisis from the personal reflections of Jonathan Haskel, who was an external member at the time. From the second session of the 2025 IIMR Monetary Conference 'Why were so many economists wrong about inflation in the early 2020s?' that was held at the University of Buckingham on November 12th, 2025.

The IFS "Green" or Shadow Budget

 I'm asked to discuss the IFS Green budget (this means their budget analysis, nothing to do with the environment specifically). Here is their analysis and my comments, labelled "comment". 

1. Backdrop: growth decelerating, unemployment and inflation rising.  But near-term outlook: inflation falls to target and growth comes back a bit, from previous monetary loosening. 

2. Near term outlook depends on: what happens to current high savings, population./migration and productivity.

3. What matters? In the near-term, Bank of England easing, the budget.  in the medium term, TFP is expected to pick up.  

Activity

4. the key is the public sector and migration.  "with private domestic demand just 2% above its pre-COVID level compared with an increase of 16% in the rest of the economy over the same time frame. The public sector and net trade have instead played an outsized role in driving recent growth, alongside an expanding population, itself driven by net migration. Real GDP per capita grew just 0.1% year on year in 2024, followed by 0.7% in the first half of 2025." 

hence the key questions:

a. can the private sector fill the gap?

b. if migration falls, will productivity rise to drive growth?

They say yes: 

5. on disposable income, a target for the government, some progress is expected. 

6. on investment, the position is extraordinary.

a. revisions have raised investment. "Business investment is now estimated to have been 6.8% higher than its pre-COVID peak in Q2 2024, compared with just 0.4% above in the data that underpinned the OBR’s March forecast".

b. but the biz invest/GDP ratio is 11 in 2025Q2.  It's 16% in the US and 17% in Germany. 

c. margins have been squeezed, depressing investment. 

d. even stronger investment will not be enough to close the Allas and Zenghelis (2025 capital gap.  My comment: their estimates run from 50-12% less capital per hour than peers, with a central one of 33%.  I am closer to 12% then 33%. 

7. Trade.  

a. "the effective tariff rate on UK goods exports to the US, which make up 16% of total

UK goods exports, has increased 8 percentage points to 9%. Application of macroeconomic

multipliers would suggest that this reduces UK GDP via a direct trade channel by 0.1–0.2

percentage points by the end of 2026" 

b. "Yet, for a small, open economy such as the UK, and especially one whose activity is more

heavily focused in the service sector as opposed to goods production and manufacturing, it is the

increased uncertainty and the global trade slowdown, rather than the direct impact of tariffs

applied to the UK, that has the larger consequence" 

8. the labour market. 

a. "we judge the labour market to be loose. Vacancies in the economy continue to fall and the ratio of vacancies to unemployment is now comfortably below estimates of the equilibrium rate" 

b. "With inflation easing and a loose labour market, we expect nominal wage growth to slow to 3–3.5% in the coming 12 months and to settle around 2.5–3% from mid 2026 onward. We expect improving productivity to allow for 0.5% annual real wage growth with unit labour costs growing at a rate consistent with 2% inflation.

One risk to this outlook is that workers look to catch-up perceived past real income losses (Haskel, Martin and Brandt, 2023; Bernanke and Blanchard, 2025). We judge this to be a limited risk. Extrapolating a trend for real earnings growth up to the start of the pandemic and then playing it forward would suggest that this process is already complete and historical losses have been regained (Figure 1.9)." 

Comment. this is interesting, but it depends on stable inflation expectations.  There is some evidence this is rising.  So I think there may be more wage pressure.  My reading of the Bank work is that there is is still unexplained upward wage pressure.

9. inflation

A graph of CPI 

a. this is mostly driven by energy prices, administered prices (e.g. VAT on schools, Vehicle excise duty). 

b. stripping them out give inflation looking much closer to 2.5% and likely to fall. 

c. inflation expectations have risen, but to the extent this is due to food etc. they willl when the base effects fall away. 

Policy

1. Monetary policy. 

"the neutral rate, the appropriate path to follow has become even more unclear.

Despite the recent cuts to interest rates, monetary policy remains restrictive in an absolute sense and is weighing on economic output (Bank of England, 2025, box A). We view the nominal neutral interest rate as between 3% and 3.5% and so, without further easing, monetary policy is likely to continue to act as a headwind to growth and will weigh on inflation. What is more, the economy continues to be haunted by the ghost of tightening past. The lags between monetary policy decisions being taken and them affecting the economy mean that, even though the extent of restriction has been reduced, we are still feeling the effects of more restrictive rates from two years ago. This point can be illustrated by using granular mortgage data from UK Finance which show we are in the midst of a wave of remortgaging (Figure 1.18). People dropping off five-year deals will be moving to a rate that could be more than 2 percentage points higher than previously. This suggests that the cash-flow channel of monetary policy will bite for the foreseeable future."

"We continue to think that quarterly cuts to Bank Rate are the appropriate path for the MPC to take until the rate is closer to the neutral rate. If not, the risk is that the Bank ultimately has to cut faster and further, with a then-unavoidable undershoot of inflation in the interim. Current market pricing implies that Bank Rate will hit 3.6% in Q3 2026, roughly 0.2 percentage points below the level the OBR had assumed in March." 

Comment. Much depends on what you think the neutral rate is. If U* has risen then policy needs to be tighter. 

 Fiscal.

1. "forecast assumes that this fiscal consolidation is achieved predominantly through a combination of extending the freeze on income tax thresholds beyond 2027–28 and a more frontloaded increase in the basic and higher income tax rates (1 percentage point on each). While this would contravene a government manifesto pledge, we judge this to be one of the few ways to raise sufficient funds credibly and reliably" 

2. A major risk for this Budget (discussed in more detail in Chapter 2) is that the consolidation is insufficient to satisfy markets that we will not be back in the same position next spring, or autumn. ...another fiscal consolidation in the future ...would act as a further drag on growth. This can become self-fulfilling.....The government needs to break out of this cycle.

Comment. This is absolutely right.

The supply side.

The potential growth data are nicely set out 

The population data are amazing.

"We calculate potential output growth has been under 1% in 2023 and 2024. This has been driven by growth in the population of the UK, which expanded 1.3% in 2023 and 1.1% in 2024. These were the highest annual growth rates since the series began in the 1940s. This population growth was almost exclusively a result of net migration flows, particularly from outside the EU. Net migration from the previous year to mid 2024 was 738,718," 

But the population growth figures are likely to fall "Lower net migration leads the working-age population to grow by an average of 0.7% per year" 

"These downward trends are offset over the medium term by rising trend (and realised) total factor productivity growth, which we assume moves from –0.3% currently to 0.4% year on year by 2030. The latter effect dominates and the UK’s potential growth rate increases from around 1% in 2026 to around 1.5% by 2030 (Figure 1.23)."

Some issues with this

1. how does this compare with OBR? 

"In March, the OBR forecast that output per hour worked, which had fallen

by 1.0% in 2024, would increase by 0.2% in 2025 and 1.1% in 2026, and by 1.3% in 2029–30. Outside

of the pandemic, the UK has not seen such rates of productivity growth on a sustained period in the

past 20 years. Our own forecast embodies an increase in output per hour worked of 0.8% in the

medium term. We condition it on the same population projections used by the OBR in March, and

broadly similar expectations for declining average hours and participation. Our forecast is actually a

little more optimistic than the OBR’s on capital deepening. The biggest difference derives from our

differing views of total factor productivity (TFP). The OBR assumes this will average 0.8% annually

over the forecast and reach 1% by 2029–30. This is roughly 0.6 percentage points higher than the path

in our forecast by 2029–30." 

2. what might affect productivity?

"Faster adoption of AI. We have seen significant global investment in the infrastructure required for

AI, and plans for this to accelerate in the UK (Department for Science, Innovation and Technology,

2025; Pabst and Marioni, 2025). There are signs that UK firms are increasingly adopting AI, with

55% of firms answering the Bank of England’s Decision Maker Panel already using it in some form

and an expectation this could increase 10–20 percentage points in the next three years.

▪ Realigning trade with the EU and greater openness. Evidence suggests that more open economies

are more productive, with better generation and diffusion of innovation (D’Aguanno et al., 2021). The

UK has seen the negative consequences of this since Brexit, with estimates suggesting it has reduced

productivity by 4% (Office for Budget Responsibility, 2020; Dhingra et al., 2016). Current government discussions with the EU could reverse some of this trend if they can lead to a more flexible labour market (e.g. the Youth Mobility Scheme), sharing of R&D resources and reductions in the costs of doing trade. That said, as discussed above, the trend globally is for less openness to trade, not more.

▪ Fiscal and political stability crowding in productivity. There is an established link between political, fiscal and economic uncertainty and productivity and growth (Hong, Ke and Nguyen, 2024; Bloom, 2007). The UK government currently has a large parliamentary majority and no requirement to call an election for four more years, and if it can maintain stability of both policy direction and tenure then there could be a dividend in the form of better productivity performance.

▪ Public sector productivity increases. Partly as a consequence of the above, public sector productivity increases may be able to leverage the developments above (AI, openness, stability) to improve. However, even the current plans may seem optimistic, as discussed in Chapter 6."

Some overall comments.

1. The fiscal problems must be solved.  We cannot have another year of minimal headroom and higher taxes that might or might not raise money. The attendant uncertainty will be terrible for investment and confidence.

2. I am less hopeful about interest rate cuts.  Current rates are 4%.  "Current market pricing implies that Bank Rate will hit 3.6% in Q3 2026," says the report.  "Our relatively benign economic outlook is predicated on the Bank of England continuing the trajectory it has been on since August 2024 and removing further policy restraint over the coming months, taking Bank Rate to 3.5% – which we judge is within the plausible range of estimates of the UK’s neutral rate, the short-term interest rate that neither adds to nor subtracts from inflationary pressure – by the end of Q1 2026."  Thus they are more hopeful than the market about rate cuts.  I am pessimistic.  I think the labour market has deterioriated and the natural unemployment rate has risen: I note that the Bank still has unexplained wage pressure in its wage equations.  Thus I would not expect so many cuts.

Why has U* risen?  The extension of NI contributions to the lower paid would have been bourne by workers  but it cannot be with the surprise rise in the NLW.  An additional rise to U* will come from the so-called Employment Rights Bill.

3. Regarding TFP, estimated at around -0.2 for 2025 but forecast to rise to 0.2%ps in 2030, with the OBR expecting 0.8% and 1% by 2029, we have the following.

a. market sector TFP was 0.8 and 1.9 1991-95 and 1995-00, falling to 0.2 2011-18 and -0.4 2019-23.  

b. but that is misleading. The "resource" sector, ag, mining, gas, elect, water, construction is very volatile, especially mining.  Without this sector, market sector TFPG is 0.5%pa 2011-18 and -0.1%pa 2019-23. 

c. the sector that's powering TFPG is ICT service, (sector J, info and comms services), contributing +0.4%pa 2019-23 (in the US 0.5).  What the US has seen is a rise in the use of those services, notably, software, with non-ICT services  contributing 0.4%pa.  In the UK, that sector is contributing -0.3%pa.  So an optimistic take is that sector starts to contribute, or at least not be negative. If not negative, the non-resource TFPG would be 0.2.  So one justification for an 0.2% rise, at least for the private sector is that.

d. Buts,  First, TFPG and intangible investment in services depends on many things, but in part on labour market regulation. This will tighten with the Employment Rights Bill and so lower intangible investment. 

e. But also we have negative TFPG in the public sector, particularly health.  What do we know about this? The ONS publish "public service productivity", see here for the latest.  This meaures "Public service productivity is measured differently to labour productivity and multi-factor productivity and is not directly comparable. It reflects the volume of services delivered to end users, relative to the volume of total inputs (which include labour, intermediate consumption, and capital). The measure is dominated by healthcare and education services because of their relative size. " 

So it is a sort of TFP measure and shows a lower level than 2019

Source: ONS. Notice that quarterly estimates differ from annual with no quality adjustments and less full breakdown of inputs via COFOG. 

More on how the ONS calculate outputs and inputs is here.  Broadly speaking, capital, labour and intermediate inputs are collected for different types of inputs. 

e. 

Did persisently low interest rates post GFC lower productivity growth?

Many allege that the long run of low interest rates post global financial crisis lowered productivity growth via zombie firms.  These low productivity firms survived more than they should have done and hence productivity growth stalled.  

An alternative view is that low productivity growth, for other reasons, lowered r* and hence interest rates.  

A paper "Aggregate productivity decompositions using structural business surveys: Evidence from the UK by Russell Black, Rebecca Riley and Garry Young", available here sheds a bit of light on this for the UK.

It uses UK company data to decompose productivity growth into that 

a. within surviving companies

b. reallocation of market share between surviving companies

c. the net effect of exit and entry.

One might think that the zombie firms view would say that the net entry/exit effect would be less as fewer low productivity firms exit.  

Their chart shows this isn't the case.

1. Using various different methods the change in the net entry effect, see middle panel is very small, a slight fall.

2. instead, the fall in productivity growth is due more or less equally to falling within firm growth and falling between firm reallocation.  The latter might be a zombie phenominon, but it isn't clearly so.

Update, with some numbers
1. using the Foster. Halitwanger, Krizan decomp, the 5 year interval, 99-07, within effect is 1.95%, net entry 0.22% (total LPG is 1.4).  The same data, 2011-19 are 0.61%, 0.08% (-0.32%).  

2. so the net entry effect has slowed, but it's 8% of the slowdown.  The change in within effects are 80% of the slowdown.

Teaching Note: Bank of England Monetary Policy Report May 2020

Here are some notes on this report.

Teaching note: QE FAQs from Ben Bernanke

Ben Bernanke has a very interesting review paper on QE.  Here are some excerpts.

1.       He focusses on large-scale asset purchases when the Central Bank (CB) has got to the effective lower bound.

2.       The Fed focus was “former emphasized the effects of buying longer-term assets on longer-term interest rates”

3.       To know if QE will work we have to know what determines long term yields.  “Longer-term yields can be conceptually divided into (1) the average expected short rate over the life of the security, and (2) the difference between the total yield and the average expected short rate, known as the term premium.”

4.       He then splits the effects into two

a.       “To a first approximation, portfolio balance effects work by affecting the term premium, while the signaling effect works by influencing expectations of future short rates.”

5.       These effects are:

a.       “portfolio balance effect.  if investors have “preferred habitats” because of specialized expertise, transaction costs, regulations, liquidity preference, or other factors, then changing the net supplies of different securities or classes of securities should 6 affect their relative prices.

b.       signaling effect.  if QE serves as a commitment mechanism, or perhaps as a signal of seriousness, leading investors to believe that policymakers intend to keep short-term policy rates low for an extended period….market participants are typically confident that central banks will not raise shortterm interest rates so long as asset purchases are continuing. Since QE announcements typically include information about the likely duration of purchases, which may be measured in quarters or years, and since QE programs are rarely terminated prematurely (because of the likely costs to policymakers’ credibility), the initiation or extension of a QE program often pushes out the expected date of the first short-term rate increase. Observing this signal that short rates will be kept low, investors bid down longer-term rates as well.”

6.       He then goes onto the evidence.

a.       The early data were on event studies and appeared to show important effects. “Evidently, QE1 had powerful announcement effects, including a full percentage point decline in the yield on 10-year Treasuries and more than a percentage point decline in the yields on mortgage-backed securities. Qualitatively, these results hold up well for different choices of event days or for shorter or longer event windows.”

Table 1. Responses of asset prices and yields to QE1 announcements

2-year Treasuries -57

10-year Treasuries -100

30-year Treasuries -58

Mortgage-backed securities -129

AAA corporate bonds -89

SP500 index 2.32

b.       But is this evidence clear?  He continues

                                                               i.      “First, in contrast to the results shown in Table 1 for QE1, event studies of later rounds of quantitative easing have tended to find much less dramatic effects. …. A possible interpretation is that the initial rounds of QE were particularly effective because they were introduced… in a period of exceptional dysfunction in financial markets.

                                                             ii.      “second point raised by critics is that event studies, by their nature, capture asset market reactions over only a short period. ... A variant of this objection, which takes a slightly longer-term perspective, begins by pointing out that longer-term Treasury yields did not consistently decline during periods in which asset purchases were being carried out. For example, the 10-year yield at the termination of QE1 purchases was actually higher than it was before QE1 was announced…Using time series methods, Wright (2011) argues that the effects of post-crisis policy announcements died off fairly quickly.”

c.       However, he believes these criticisms are overblown.

                                                               i.      “If later QE rounds were largely anticipated, then their effects would have been incorporated into asset prices in advance of formal announcements, accounting for the event-study results (Gagnon, 2018).”

                                                             ii.      “the prices of assets not subject to Fed purchases—including corporate bonds, equities, 13 the dollar, and a variety of foreign assets—moved substantially following announcements of asset purchase programs…QE also appeared to stimulate the global issuance of corporate bonds... The cross-asset impacts seem inconsistent with the view that the event-study findings reflect only asset-specific liquidity effects.” (longer-term yields did not reliably decline…in part, this pattern can be explained by the confounding influences on yields of other factors, including fiscal policy, global etc.)

d.       This relates to stocks and flows “The portfolio balance channel of QE, recall, holds that policymakers can affect longer-term yields by changing the relative supplies…a stock view of QE…The alternative flow view holds that the current pace of purchases is the critical determinant of asset prices and yields…The flow view would be correct if QE affected asset prices and yields primarily through short-run liquidity effects”.

He then talks about other policies

1.       forward guidance. “.

a.       Forward guidance takes many forms (such as the specification of policy targets, economic and policy projections) and occurs in many venues (speeches and testimonies, monetary policy reports).”

b.       “Delphic guidance is intended only to be informative, to help the public and market participants understand policymakers’ economic outlook and policy plans. In contrast, Odyssean guidance…. incorporating a promise or commitment …to conduct policy in a specified, possibly state-contingent way in the future “.

c.       He remarks that guidance has worked, but is hard to disentanglbe from QE.

2.       Other New Monetary Policy Tools. Various forms

a.       central banks also purchased a range of private assets, including corporate debt, commercial paper, covered bonds.  These have greater effect on private yields, (but there are general equilbirm effects )credit risk and political controversy.

b.       “subsidized bank lending through cheap long-term funding”.  “these lending programs were aimed at broader economic stabilization… offering bank-dependent borrowers the same access to credit as borrowers with access to securities markets... Most …evidence on these programs suggests that they lowered bank funding costs, promoted lending, and improved monetary policy passthrough…However, the efficacy of these programs seems likely to depend in a complicated way on the health of the banking system: If banks are well-capitalized, then their need for cheap liquidity from the central bank may be limited. Conversely, if banks are short of capital, their lending may be constrained or their incentives to make good loans distorted, notwithstanding the availability of low-cost funding”.

c.       Negative rates.  He says they might cause switching into cash and affect Bank’s profits, but aginst that help overall economic conditions.

d.       Yield curve control. He believes this works in Japan, but might not in the US. “…if long-term yields were pegged, and market participants came to believe that the future path of policy rates was likely higher than the targeted yield, the Fed might need to buy a large share of the outstanding bonds to try to enforce the peg. Those purchases in turn would flood the banking system with reserves and expose the central bank to large capital losses.  However, pegging Treasury yields at a shorter horizon, say two years, would likely be feasible”.

3.       What are the costs of risks of these various tools?  He believes all, bar the last, on financial instability, are small

a.       “Impairment of market functioning….Asset purchases likely improved market functioning “

b.       “High inflation. … Fed policymakers and staff understood that, with short-term interest rates near zero, the demand for bank reserves would be highly elastic and the velocity of base money could be expected to fall sharply  [i.e. that money and bonds would be near perfect substitutes]…. However, some FOMC participants did express concern about the possibility that [QE] could un-anchor inflationary expectations”

c.       Managing exit

d.       Distribution “the research literature is close to unanimous in its finding that the distributional effects of expansionary monetary policies… may even work in a progressive direction, for example by promoting a “hot” labor market”.

e.       Capital losses “The large, unhedged holdings of longer-term securities associated with asset purchase programs risked substantial capital losses if interest rates had risen unexpectedly, losses which in turn could have ultimately reduced the Federal Reserve’s remittances of profits to the Treasury”. 

Finally he discusses “. Financial instability….including but not limited to the creation of asset bubbles; incentivizing “reach for yield” and excessive risk-taking by investors; the promotion of excessive leverage or maturity transformation; and the destabilization of the business models of insurance companies and pension funds, which rely on receiving adequate long-run returns, and of banks, whose profits depend in part on their ability to earn positive net interest margins. U.S. central bankers also heard frequently from their foreign counterparts, especially in emerging markets, about the “spillover effects” of Fed policies on financial conditions abroad (Rey, 2013).”  He makes a number of points.

                                                               i.      “Increased risk-taking is by no means always a bad thing, of course: Encouraging banks, borrowers, and investors to take reasonable risks, rather than hoarding cash and hunkering down, is a desirable goal for policies aimed at ending a recession or crisis and restoring normal growth. However, risk-taking may become excessive…”

                                                             ii.      “Most participants in that debate agree that that the first line of defense against financial instability risks should be targeted regulatory and macroprudential policies..”

                                                           iii.      “…the portfolio balance effect of QE involves pushing some investors out of longer-term Treasuries into other, possibly riskier assets; but in general equilibrium, by removing duration risk from the system, QE reduces the riskiness of private-sector portfolios in aggregate, increases the supply of safe and liquid assets, and helps compensate for reduced private risk-bearing capacity during periods of high uncertainty”.