Pill: See Smaller Rise In Unemployment, Supportive Of Consumption

Q: Looking at data in recent months, are you particularly worried about demand developments or is it a terms of trade shock?

• A: Last summer we were forecasting a deep and prolonged recession. Relative to that, GDP even flatlining is a significant improvement. Last August we were in the midst of a change of PM in the UK which created a hiatus on the fiscal side. Every other European country had a policy that supported household incomes - the UK did not announce that by August - and as BOE forecasts use announced policy, the UK energy support was not included in the forecast even though it was anticipated by the MPC. The November forecasts were "contaminated" by the fiscal fallout.
• More recently we have seen a significant fall in gas prices. If we still assumed the levels seen in August remained constant that would have been much higher than used in the forecasts. So updating conditioning assumptions these factors can be anticipatable.
• However, this can't explain everything in the data. So there is something else here. The change in gas prices does lead to an improvement in terms of trade. What is substitutable between energy and non-energy. Are our models measuring that correctly? Over last 20-30 years we haven't seen a similar move in gas prices, so are stress testing models now.
• That leads to the point on how the inflation-targeting framework is framed. It has been in terms of deviations from forecast around target - and assumes deviations around target hold linearly - which is sensible when there are small changes. But in a non-linear world there is a generic problem, which is where we are now. There are a set of things we can understand and think about - but they can't explain it all. If we allow for a more realistic model with greater substitutability we get closer to where we are.
• Do expect to see smaller rise in unemployment than previously - expect more labour hoarding due to difficulties in recruiting. Think this is supportive of consumption - which is a positive demand dynamic.