Home > Bank of England, Inflation, Monetary Policy > The Supply Shock is Coming… in 2016(!?)

The Supply Shock is Coming… in 2016(!?)

Carney has stuck by his line that the falling oil price is “unambiguously positive” for the UK economy, repeating it in the Inflation Report last week   The oil price collapse started in September 2014.  I’ve charted here the latest three median forecasts produced by the Bank in each Inflation Report, for both CPI inflation and real GDP growth:

BoE Median CPI Forecast

BoE Median CPI Forecast

BoE Median Real GDP Forecast

BoE Median Real GDP Forecast

What do we see?  A huge downgrade to the expected path of inflation concentrated on 2015.  You do not see revisions like that very often.  At the same time we have a very slight downgrade to real GDP growth over the year to 2015 Q1, and a rather small upgrade, mostly in 2016.  So, the “unambiguously positive” effect seems a bit ambiguous to me, less a Draghi-esque “with low inflation, you can buy more stuff“, but something more like: “with low inflation, a year later you can buy more stuff.”

Here’s a crazy theory – let’s call it the Bernanke, Gertler, Watson theory.  The effect of the falling oil price has little to do with oil, or even the relative price of oil, but is mostly a reflection of the central bank’s reaction to the effect of the oil price on headline inflation.  Though interest rates are definitely ambiguous, in September 2014 the Bank was expected be raising rates from early 2015.  Today, the MPC is not expected to be raising rates until late 2016.  The Bank’s CPI/RGDP forecasts are based on the market curve, and the forecast model will have “lower rates for longer” cause faster growth.

Alternatively we could look at the “unambiguously negative” effect of the rising price of oil in 2011 on the Eurozone: similarly, very little to do with oil, and everything to do with the ECB’s reaction to the rising oil price: two rate hikes aimed at slowing AD growth and inflation.  They declared that policy a success!

Really, no big surprises here.  An honest Governor could confess: “The falling oil price is a good thing because it means the MPC is less likely to screw up like it did in 2008 and 2011” – although he might look a little foolish.

  1. jamesxinxlondon
    February 19, 2015 at 20:24

    Very clever of the BoE to forecast a CPI above target in 2018 … as the oil price recovers? And then causes RGDP to start to dip. Is that because they are tightening in response to
    the higher oil price? And so can’t help themselves, asymmetrically speaking?

    [Good work at Mainly Macro today. Can’t help but think trying to find common ground with the SWP is futile. Supply side economics is just a fig leaf for evil capitalism, don’t you know. All (UK) mainstream macroeconomists know this. It’s a qualification for a job at a university or elsewhere in the public sector, though pretty much an anti-qualification for a job in the private sector or soon unlearned in the private sector. I was originally taught supply side economics by a very maverick O-Level Economcs teacher many moons ago.]

  2. February 19, 2015 at 21:14

    I’m not sure what is happening with RGDP growth falling lower going into 2018, there are downgrades to the participation rate and quite a bit of discussion around that, I presume that feeds into the RGDP forecast.

    Yes, that CPI forecast is really high – I was confused about why Carney kept making mildly hawkish noises about path of rates on TV, until I saw that forecast. A CPI forecast that high has typically preceded a tightening of policy: early 2008, late 2009 and mid-2011.

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