MNI INSIGHT: BOE Forecasters Challenged By Supply Chain Snags

Supply chain disruptions have been a recurrent factor in the global economy since the Covid pandemic began, but central bank models still fail to accommodate them, with the Bank of England likely to refer to the potential impact of China’s spreading lockdowns as merely risks around its central forecasts in its May Monetary Policy Report.

While BOE economists have been researching global value chains and disruptions, so far they have not been incorporated into its main model. In the case of the Chinese lockdowns, which could potentially restrict supply of key goods as well as impact global demand, any assessment is also complicated by uncertainty not only regarding the progression of the virus but also as to whether the government in Beijing might adjust its strict zero Covid policy.

In February’s MPR, the Monetary Policy Committee said it “assumed localised restrictions are sufficient for China to implement its zero-Covid policy. If more widespread restrictions are necessary, that would disrupt global supply chains to a greater extent than assumed.” This would further constrain GDP and add to inflation, it noted.

As the MPC’s practice is to accept government policy at face value, it is unlikely to venture any judgement as to how the zero-Covid strategy might evolve.

In May, the BOE is very likely to again increase its forecast of a near-term inflation peak from the 7.25% it expected in February, but there is deep uncertainty about how soon the erosion of real incomes will hit demand.

VALUE CHAIN RESILIENCE

While BOE economists have published detailed work on global value chains and side models can be constructed to explore them, the differences between individual supply shocks make this task challenging. BOE Governor Andrew Bailey has noted that each successive Covid wave has had less impact on the UK economy, but China’s situation is very different.

Even though rolling supply side shocks can have persistent inflationary effects, IMF research highlights the resilience of global value chains during the pandemic due to diversity of supply, supporting the view that disruptions should be temporary.

“It’s quite possible for trade flows to be volatile, while economic activity is stable. For example … goods imports were higher in countries and time periods with higher COVID-19 cases and lower mobility, which could indicate that countries facing pandemic waves got the goods that they needed for consumption and production through imports,” IMF economists said in response to emailed questions from MNI about the research by Davide Malacrino, Adil Mohommad and Andrea Presbitero.

“Diversification enhances economic resilience,” they said.

Their results supporting diversification of supply chains were in line with separate research by BOE MPC member Silivana Tenreyro in collaboration with Francesco Caselli. Bank economists including Lucio D’Aguanno and Rebecca Freeman have also argued that the relationship between global supply chains and volatility is ambiguous in theory and insignificant in the data.