bis-Andrew Bailey供应事宜 bis-Andrew Bailey供应事宜

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BankofEngland

Supplymatters

−speechbyAndrewBailey

GivenatLondonSchoolofEconomics

27March2023

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Speech

ItisagreatpleasuretobeattheLondonSchoolofEconomics.

Introduction

Thepastfewyearshavebeenatimeofmacroeconomicupheaval.AseriesofsignificanteconomiceventshavedeeplyaffectedtheUKeconomy.ThisincludesthechangeinourtradingrelationshipwiththeEuropeanUnion,theCovidpandemicwithshutdownsofsomesectorsoftheeconomyandsupplychainbottlenecksinothers,andtheriseinenergypricescausedbyRussia’sbrutalwaronUkraineanditspeople.TheseshockshaveaffectedtheUKeconomyindifferentways.Buttheyhaveallerodedthetermsonwhichwetradewiththeoutsideworld.Thishasmadeuspoorerasacountry;manifestingitselfinariseinthepriceswehavetopayforthethingswebuyasconsumers.

UKConsumerpriceinflationiscurrentlyat10.4%.Thisismuchtoohigh,andweneedto,andwill,bringitbackdowntothe2%target.ThatiswhylastThursdaytheMonetaryPolicyCommitteeincreasedBankRateattheeleventhmeetinginarow,to4.25%.WehaveincreasedBankRatebymorethan4percentagepointssinceDecember2021.Theseincreasesarebeingfeltbyhouseholdsandbusinessesacrossthecountry.

Iamafraidthatmonetarypolicycannotmaketheshockstoournationalrealincomegoaway.Butwhatmonetarypolicycan–andmust–doistomakesurethattheinflationthathascometousfromabroaddoesnotbecomelastinginflationgeneratedathome.

OurmostimportanttooltobringinflationdownisBankRate.ThisistheinterestpaidonreservesheldbycommercialbanksattheBankofEngland.Becausecommercialbanksareatthecentreofasystemofintricatelylinkedfinancialmarkets,BankRateaffectsinterestratesandyieldsmorewidely.Andbecausethoseinterestratesandyieldsdeterminethereturnsonsavingsandthecostofcredit–includingtheratespeoplepayontheirmortgages,andtheratesbusinessespayonloanstofinancetheirinvestments–monetarypolicyexertsapowerfulinfluenceonspendingbyhouseholdsandbusinesses.

Monetarypolicy,inotherwords,worksthroughthemanagementofaggregatedemandintheeconomy.Simplyput,wheninflationistoohigh,weincreaseBankRatetodampendemand;wheninflationistoolow,wereduceBankRatetoboostdemand.

Inreality,thingsareofcoursemorecomplicated.

Forastart,monetarypolicyoperateswithalag.IttakestimeforchangesinBankRatetoworkthroughthefinancialsystemtoloanandmortgagesrates,andforthosechangestoaffectconsumptionandinvestmentdecisionsbyhouseholdsandbusinesses.Itthentakes

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timeforchangesinthosespendingchoicestoaffectpricesintheshops.ThismeansthattheMonetaryPolicyCommitteeneedstolookaheadandfocusontheoutlookforinflation,asmuchasonitscurrentlevel,whendecidingtheappropriatelevelofBankRatetoday.

Whenwelookattheoutlookforinflationtoday,wehavetorecognisethatthefulleffectofthehigherlevelofBankRateisstilltoworkitswaythroughfinancialmarketsandtherealeconomy.

Thereisanothercomplication.Whatactuallyhappensintheeconomy–toeconomicactivityandinflation–willbedeterminedbyaggregatedemandandsupply.Economiclifeplaysoutattheintersectionbetweenthem,inaneconomicequilibrium.Whileitissometimesusefultofocusononeofthetwo,takingtheotherasgiven,wealwayshavetobearinmindthatmarketeconomiesworkthroughtheforcesofbothdemandandsupply.

Formonetarypolicy,thenaturalstartingpointisthedemandside.Monetarypolicyexertsapowerfulinfluenceonthecomponentsofaggregatedemand–onconsumptionandinvestment–butitcandolittletoaffectthesupplyside–theproductiontechnologiesandknow-howusedtomakegoodsandservicesavailableforuseintheeconomy.

Butultimately,itisthebalancebetweendemandandsupplythatdeterminesinflationarypressuresintheeconomy.Andsometimesshiftsinsupplycanbeasabruptandasimportantfortheinflationoutlookasshiftsindemand.

WehaveseenthisveryclearlyinthepastthreeyearssinceCovidhit.Throughoutthistime,theMonetaryPolicyCommitteehashadtoplaycloseattentiontothesupplysideoftheeconomy–andmakeanumberofcriticaljudgementsaboutit–forinstance,ascareforthepublic’shealthnecessitatedapauseinarangeofeconomicactivities.

ThatisthereasonIwouldliketofocusonsupplyinmyremarksherethisevening.

Supply,R*andmonetarypolicy

Iwillstartbymakingadistinctionbetweentheshortrunandthelongrun.

Monetarypolicy’sinabilitytoinfluencesupplyhasattimesbeentakentosuggestthatmonetarypolicyhasnoeffectsonrealeconomicactivityatall.Inclassicaleconomictheory,forexample,monetarypolicyonlyaffectsnominalvariablessuchaswagesandprices,notrealvariablessuchasthelevelofproductionandemployment.Inthistradition,realbusinesscycletheorieshavebeendevelopedinwhichsupplysidedisturbancesarethemaindriversofrealactivity.

Butoverwhelmingempiricalevidence,andmanyyearsofpracticalexperience,showthatmonetarypolicyaffectseconomicactivityandinflationthroughaggregatedemand.IntheNewKeynesianmodelsthathavedominatedmonetarymacroeconomicsoverthepast

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threedecades,monetarypolicyhasrealeffectsbecausemarketpricesaresticky.Sowhennominalinterestrateschange,therealinterestratesthatdeterminerealconsumptionandinvestmentdecisionschangewiththem.Andmarketsmayoperatewith‘excesssupply’or‘excessdemand’foraslongasittakeswagesandpricestoadjusttoshiftsineitherdemandorsupply.

Rather,itisoverlongerstretchesoftimethatmonetarypolicyisindeed‘neutral’,andthatwecanthinkofthelevelofeconomicactivityasbeingdrivenentirelybysupply.Byfacilitatinglowandstableinflation,monetarypolicyhelpscreateconditionsconducivetoeconomicgrowth.Butotherforceswillultimatelydeterminethegrowthpathoftheeconomy.Economicgrowth–andwithittheprospectsforourrealnationalincome–willbedeterminedbytechnologicalprogress,investmentandinnovation,andbyskillsandtrendsinthepopulation.

Equally,boththestructureoftheeconomyandthedistributionofrealnationalincomearebeyondtherealmofmonetarypolicy.Yes,monetarypolicyaffectsassetpricesandunemploymentoverthenearterm.Andyes,excessdemandorsupplymaygiverisetosectoralimbalances.Butoverthelongerterm,thesefeaturesofournationaleconomywillbedrivenbyrealfactorsandbystructuralpoliciesratherthanmonetarypolicy.

Overtime,eventhelevelofinterestratesisdeterminedbysuchstructuralfactors.Whilemonetarypolicysteersmarketinterestrateshereandnow,wedonotsetBankRateinavacuum.Thelevelofinterestratesisanchoredinanunderlyingequilibriumrateofinterestdeterminedbyeconomicfundamentalsonboththesupplyanddemandsideoftheeconomy.Thisequilibriumrateofinterestisthehypotheticalinterestratethatwouldsustaindemandinlinewithsupply,andinflationattarget.Wecallitr*.

Theequilibriuminterestrateisatheoreticalconceptwecanusetoorganiseourthoughts.AusefulframeworkforunderstandingitwassetoutbytheMonetaryPolicyCommitteebackinAugust2018.Atthecoreofitisadistinctionbetweentheactualleveloftheequilibriumrate,r*,whichmovesaroundwithcyclicalfactorsactingontheeconomy,anditslonger-runtrendcomponent,R*,whichmovesmoreslowlywithunderlyingstructuralfactorsintheeconomy.Theequilibriumrate,r*,inotherwords,fluctuatesarounditslong-runtrend,R*,asaresultofshorter-runinfluencesontheeconomy.

Neitherr*itselfnotitstrendcomponentR*canbedirectlyobserved,andwecannotusethemasadirectguides.Buttotheextentthattheycanbeestimated,theymayhelpusexplaintheevolutionofinterestratesoverthepastandinformourassessmentofwhereinterestwillgointhefuture.

Letmeexplainthisinabitmoredetail.

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Oneofthemoststrikingglobaltrendsoverthepasthalfcenturyhasbeenanoveralldeclineinthelevelofrisk-freeinterestrates–risk-freeinthesensethattheyarereturnsonlendingthatcarriesanegligibleriskthatpaymentobligationswillnotbemetbytheborrower.Chart1showshow,whenwelookatthisoveralongerperiodoftime,ten-yearUKnominalrateshavefallencomparedtowheretheywereinthe1980s.BoththeverylowlevelsofinterestrateswehaveseenintheyearsleadinguptotheCovidpandemic,andtheirrecentrisefromthoselevels,mustbeseenagainstthebackdropofthatdownwardtrend.

Chart1:TheUKten-yearnominalratehasfallenoverrecentdecades

Ten-yearzerocouponyield(spotinterestrate)fromUKgilts(a)

Percent

15

10

5

0

-5

19851990199520002005201020152020

15

10

-5

0

5

(a)Sources:BloombergFinanceL.P,TradewebandBankcalculations.

Agoodpartofthisdeclinecanbeexplainedbylowerinflationitself.Itreflectsthesuccessofinflationtargetingindeliveringlowandstableinflationoverlongperiodsoftime.Underinflationtargeting,monetarypolicymakersactdecisivelytoreturninflationtotargetwhenevershockscausepricestoriseorfallbytoomuch.Soevenifinflationisnowhigh,peoplecantrustinflationtocomebackdowntotarget.Asaresult,savershavecometodemandalowerpremiumtocompensateforexpectedinflation.

Butitisnotjustnominalinterestratesthathavefallen.Ifweadjustnominalinterestratesforinflationandlookatrealinterestrates,wecanseethattheyhavefallentoo.Chart2showstheUKten-yearrealinterestrate,measureddirectlyfromindex-linkedbondprices.Itisclearthattherealinterestrateisquiteresponsivetocyclicalevents,andthatithasrisensharplyoverthepastyear.Butbeneaththevolatility,thereappearstohavebeenafairlysteadydownwardtrendfromthe1990satleastupuntiltheonsetoftheCovidpandemic.

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Chart2:TheUKten-yearrealratehasfallenoverrecentdecades

Ten-yearzerocouponyield(spotinterestrate)fromUKindex-linkedgilts(a)

Percent

19851990199520002005201020152020

6

4

2

0

-2

-4

6

4

2

0

-2

-4

(a)Sources:BloombergFinanceL.P,TradewebandBankcalculations.

Muchhasbeensaidaboutthistrendinrisk-freeinterestrates.Chart3,replicatedfromaspeechIgavelastyear,showsestimatesoftheglobaltrendcomponentoftheequilibriumrealinterestratebyBankstaff(inblue)alongwithotherestimatesfromacademicpapers.WecallthistrendcomponentGlobalR*.

Chart3:EmpiricalmeasuresofGlobalR*havefalleninrecentdecades

Estimatesfrompanelof31countriesfrom1900-2015(a)

(a)Source:‘Theeconomiclandscape:structuralchange,globalR*andthemissing-investmentpuzzle–speechbyAndrewBailey’(withreferencestoacademicpapers);and‘Structuralchange,globalR*andthemissing-investmentpuzzle’,BankofEnglandStaffWorkingPaperNo.997(2022)byAndrewBailey,AmbrogioCesa-Bianchi,MarcoGarofalo,RichardHarrison,NickMcLaren,SophiePitonandRanaSajedi.

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Therearewideerrorbandsaroundthecentralestimate,butthedirectionoftravelhasbeenclear.GlobalR*hasfallenmarkedlyoverrecentdecades.

Aswelookdeeperintothecausesofthis,twosupplyfactorsstandout:aslowdowninproductivitygrowthandpopulationageingacrossadvancedeconomies.

Whilethisisaglobalstory,letmefocusontheUnitedKingdom.

Chart4:UKproductivitygrowthhasslowedsincethefinancialcrisis

Annualgrowthinoutputperhourforthewholeeconomyandmanufacturingsector(a)

(a)Sources:ONSandBankcalculations.

Chart4,reproducedfromourlatestMonetaryPolicyReport,showsthattherehasbeenamarkedandsustainedfallinproductivitygrowthintheUnitedKingdomfollowingtheglobalfinancialcrisisinparticular.Lookingcloseratindividualsectorsrevealsthatproductivitywassignificantlyboostedbyveryhighgrowthinmanufacturingsectorproductivityinthedecadebeforethefinancialcrisis,muchfasterthaninthepreceding25years.Thisistheperiodsometimesreferredtoasthe‘GreatModeration’,aperiodcharacterisedbyunusuallylowvolatilityinbotheconomicactivityandinflation.Butfollowingthefinancialcrisis,manufacturingproductivitygrowthfellbacksharply.Thisfallinmanufacturingproductivityisthemaincauseoftheslowdown.

Thereasonsbehinditaremuchdebated–andproductivitymaybehardertomeasureinthemoderneconomywherebusinessesinvestasmuchinintangiblecapital,likesoftwareandbranding,asinphysicalcapital,likebuildingsandmachinery.Measurementproblemscouldbeabigpartofthis.Butmuchalsopointstostructuralchange.Perhapsnewideashavebecomehardertocomeby,orperhapstechnologicalinnovationandspecialisationhavefadedasglobalisationslowed.

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Whateverthereason,whenproductivitygrowthisweak,companiesgainlessfrominstallingnewcapital.Soweakerproductivitygrowthhasmeantthatfirmshavesoughttoborrowlesstofinanceinvestmentsatagiveninterestrate.Thisreductioninthedemandforcapitalhasloweredtheequilibriumrate.

Thesecondimportantfactorispopulationageing.

Chart5:Populationageingisexpectedtocontinue

Agedistributionintheadult(16+)UKpopulation(a)

(a)DashedlineandhashedbarsarecalculatedusingtheONS2020-basedinterimnationalpopulationprojections:yearendingJune2022estimatedinternationalmigrationvariant.Sources:ONSandBankcalculations.

Chart5showstheagedistributionfortheUnitedKingdom.Theshareoftheadultpopulationaged20-59hasfallenbelow65%inthepastdecade,anditissettodeclinefurtherinthecomingyears.ThispopulationageinghasbeendrivenbyadeclineinbirthratesrelativetothehighlevelsseenintheyearsthatfollowedtheSecondWorldWar–aswellasbythehappiernewsthatpeoplenowliveforlonger.

Aspeopleaccumulatesavingsovertheirworkinglifetofundtheirretirement,wealthintheeconomyincreasesastheagedistributionshiftstowardsoldercohorts(indicatedinthischartbybarsindifferentcolours).

Soageinghouseholdshavesoughttolendmoreatatimewhenlessproductivefirmshavesoughttoborrowless.Theonlywaytoestablishanequilibriumbetweenthesupplyanddemandinthemarketforinvestablefunds–thatis,toincentivisefirmstoinvestthis

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additionalwealthintoproductivecapital–hasbeenforthepriceofthosefunds,therealinterestrate,tofall.

Thetrendequilibriumrate,R*,islikealong-termanchorformonetarypolicy.AsR*hasfallen,monetarypolicyhasmovedwithit.Thisisanimportantpoint.Thelowlevelofinterestratesoverthepastfewdecadesreflectsdeepunderlyingfactorsonthesupplysideoftheeconomy.Astheseunderlyingfactors–trendsintechnologyanddemographics–onlymoveslowly,itisnotunreasonabletoexpectthatR*willremainlow.Thismeansthat,evenaswenowrespondtorisinginflationbyraisingBankRate,interestrateswillnotnecessarilyhavetoreturnfullyto,andremainaround,thehigherlevelstheyoncehad.

Butletmeaddacaveat:

“It’simportanttonotethatforecastingthefuturepathofR*ischallengingandsubjecttoasignificantdegreeofuncertainty.Economicdevelopmentsandpolicydecisionscanhaveunpredictableandcomplexeffectsontheeconomy,anditisdifficulttopredicttheiroutcomeswithcompleteaccuracy.”

Thiswasnotsaidorwrittenbyaneconomistofthehumansort.ThisisacaveataddedbyChatGPT.The‘artificialintelligence’underlyingitremindsusthattechnologysometimesprogressesinleaps,whichcanleadtoasuddenemergenceofproductiveinvestmentopportunitiesacrosstheglobaleconomy.NewroundsoftechnologicalrevolutionareamongstthefactorsthatcouldshiftupGlobalR*.Monetarypolicywouldhavetomovewithit.

Soevenifmonetarypolicyisneutralinthelongrun,long-runsupplydoesaffectmonetarypolicybyanchoringthelevelforinterestrates.

Overtheshortterm,moreover,theactualequilibriuminterestrate,r*,willfluctuatearoundthetrendlevel,R*,drivenbyshorter-terminfluencesfrombothdemandandsupply.Thisiswhatmattersformonetarypolicyhereandnow.Why?Becauser*istherateatwhichdemandisinlinewithsupplysothatthereisnooutputgap–neitherexcessdemandnorexcesssupplyintheeconomy.Respondingtoshiftsinr*iswhathelpskeepinflationclosetotarget.

ThisdoesnotmeanthatmonetarypolicyshouldalwaysalignBankRateexactlytor*.Sometimes,monetarypolicyfacestrade-offsbetweeninflationandthebalanceofsupplyanddemand.

Butitdoesmeanthatsupplymattersformonetarypolicyalsointheshortrun.Bydeterminingthelevelofdemandtheeconomycansustainwithoutgeneratingexcess

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inflationarypressures,itaffectstheappropriatelevelofinterestrates,effectivelybysettingthespeedlimitfortheeconomy.

Andwhenshocksdriveinflationawayfromtargetinthewaywehaveseen,monetarypolicyrespondsbysteeringdemandtoalevel–relativetosupply–thatensuresthatinflationreturnstotargetsustainably.Monetarypolicycannotaffectthislevelofsupply.Butthelevelofsupplywillaffecttheappropriatesettingofmonetarypolicy.

Itmatters,therefore,thatbigshockstotheeconomyhaveweighedheavilyonsupplyinrecenttimes.

Chart6:Thelevelofsupplyremainsweakerthanitspre-pandemiclevel

GDPandestimatedpotentialsupply(a)

(a)Diamondsareprojectionsfor2023Q1,2024Q1,2025Q1and2026Q1.DiamondsforGDPshowMPCprojections.GDPin2022Q4isaBankstaffprojectionincorporatingofficialdatatoNovember2022.DataincludethebackcastforGDP.EstimatedpotentialsupplyisderivedusingtheMPC’sprojectionforthelevelofGDPandthelevelofexcessdemand/supply.BothGDPandestimatedpotentialsupplyareindexedtoGDPin2019Q4.Source:ONSandBankCalculations.

Chart6,takenfromtheFebruaryMonetaryPolicyReport,showsthattheMonetaryPolicyCommittee’sestimatedlevelofpotentialsupplyhasnotyetregaineditspre-pandemiclevel.ItillustratesthattheCommitteebaseditsmostrecentforecastoftheeconomyonthekeyjudgementthatthelevelwouldonlyrecoververygradually.

Onourlatestestimates,thegrowthrateofthepotentialoftheUKeconomy–thesupplyside–isprobablynowaround1%perannum.Thiscomparestoatypicalgrowthrateinthedecadeleadinguptothefinancialcrisisofnearly2¾%.

Tounderstandthesemovementsinsupply,wecandiveintoitsconstituentparts.Supplydependsontheamountofbothlabourandcapitalintheeconomy.Mostsimply,itcanbethoughtofastheamountoflabouravailableintheeconomyandtheproductivityofthatlabourinproducinggoodsandservices.

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Thereisalottobesaidaboutboth.Butletmefocusononeofthemostnoticeableaspectsoflaboursupply.

AsCovidhit,laboursupplygrowthcametoanabrupthalt.Thesizeoftheworkforce–thatis,theshareofthepopulationtakingactivepartinthelabourmarket–declinedby132,000people,or0.4%,fromthethreemonthstoDecember2019tothethreemonthstoJanuarythisyear.Thatstandsinstarkcontrasttoasteadygrowthrateofaround¾%peryearduringtheprecedingdecades.Thesemaysoundlikesmallnumbers,butevensmallchangesinthesesmallpercentagesofthewholeworkforceofnearly33millionadduptoalotofpeople.

Chart7:Labourmarketinactivityhasrisen

Changeininactivitysince2019Q4byage(a)

(a)ChangesfromthethreemonthstoDecember2019,basedonthoseaged16+.Sources:ONSandBankCalculation.

Theprimarycauseofthisreductioninlaboursupplyisanincreaseintheproportionofthepopulationthatdoesnottakepartintheworkforceeitherbyworkingorlookingactivelyforajob.AsyoucanseeinChart7(whiteline),sucheconomicinactivityrosenoticeablyduringthepandemic.Unlikemovesinemploymentandunemployment,thisrisehasnotunwoundastheeconomyhasrecovered.

Therearetwoimportantfactorsthataccountforthisincreaseineconomicinactivity.

Thefirstistheageingofthepopulation,which,aswehaveseen,hasincreasedtheshareofpeoplewhoareolderthanwhatatleastusedtobetheretirementage.Asshownhere

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inblue,thataccountsforaroundathirdoftheincreaseineconomicactivity.Itwillprovideacontinuingdraginthecomingyears.

Thesecondfactorisachangeintheshareofworking-agepeopleactivelyparticipatinginthelabourmarket.Particularlystrikingistheriseininactivityofpeopleaged50-64.Whenleavingthelabourforce,manypeopleinthisagegroupsaytheyhaveretiredearly,makingachoiceaboutthelifetheywouldliketolive.Atthesametime,peoplewhohavebecomeinactiveseemtohavemovedfurtherawayfromthelabourmarket,mostcommonly,theysay,becausetheirhealthhasdeteriorated.

Chart8:Long-termsicknesshasdrivenmuchofthepersistentriseininactivity

Changeininactivitysince2019Q4byreason(a)

(a)ChangesfromthethreemonthstoDecember2019,basedonthoseaged16–64.Otherreasonsinclude:discouragedworkers;thoseawaitingtheresultsofajobapplication;havenotyetstartedlookingforwork;donotneedorwantemployment;havegivenanuncategorisedreason;orhavenotgivenareason.Sources:ONSandBankCalculation.

AsyoucanseeinblueinChart8,long-termsicknesshasdrivenmuchofthepersistentriseininactivityamongst16to64yearoldssincethestartofthepandemic.Thatisastrikingfact.

Astheirnumberhasincreased,theinactivepopulationappearsmoredetachedfromthelabourmarket.Moreoftheinactivepeoplenowsaythattheywouldnotlikeajobthanbeforethepandemic,andfewernowexpecttoreturntowork.

Howshouldmonetarypolicyrespondtosuchareductioninlabourforceparticipation?

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Thefirstthingtonoteisthatthisdoesnotseemtobeacaseinwhichparticipationhasfalleninresponsetoweakereconomicconditionsandaweakerlabourmarket.Thisisnotafallinparticipationdrivenbyashocktodemand.So,weshouldnotexpecttheretobeamarginofsparecapacityoutsidetheworkforcethatexertsdownwardpressureoninflationinawaythatwouldcallforalowerlevelofinterestratestostimulatedemand.

Instead,theriseineconomicinactivityisachangetothesupplyoflabour,independentofdemand,inparticularbyolderworkers.Ifthoseworkershaveaccumulatedenoughsavingstosustainadesiredlevelofconsumptionmuchliketheonetheyhadbeforetheirearlyretirement,atleastforawhile,aggregatedemandwillnothavefallenbyasmuchasaggregatesupply.Weshouldexpectthistoputupwardpressureoninflationinawaythatwouldcallforahigherlevelofinterestratestodampendemand.

Sowhilepopulationageingisverylikelytopulllong-runR*down,asIdiscussedearlier,theeffectsonshorter-runr*fromachangeinlabourforceparticipationarehardertoassess.Intheshorterrun,byreducingtheproductivecapacityoftheeconomy,theriseininactivitydrivenbyearlyretirementseemslikelytohavecontributedtoariseincyclicalr*.ThisispartofthereasonwhywehavehadtoraiseBankRatebyasmuchaswehave.

MonetarypolicyinthetimeofCovid

LetmetakeastepbackandrevisitourresponsetoCovidinlightofthisdiscussion.Thisepisodeisaparticularlyclearexampleofhowdifficultitcanbeinpracticetojudgetherelativeimpactofsupplyanddemand.

Thepandemicwashighlyunusualanddifficultformanyreasons.Intermsoftheeconomy,itwasunusualforthesuddenandextremefallineconomicactivity,butalsoforthealmostsynchronousandequivalentfallinbothaggregatedemandandsupply.Inmostrecessions,demandfallsmuchmoreabruptlythansupply.Anoutputgapopensup,creatingsparecapacityintheeconomyandusuallyariseinunemployment.ThatisnotwhathappenedduringCovid.

Thereasonthisunusuallysynchronouspatternofmovementsinaggregatedemandandsupplytookplaceisnothardtofind.Governmentpolicyonpublichealth,inthefaceofthemostextremepandemicforatleastacentury,ledtodeliberatelockdowns.Muchofeconomicactivitysimplyceased.

TheimportantquestionwefacedasmonetarypolicymakerswaswhatwouldhappenwhentherestrictionswereliftedasCovidabated.Wouldasynchronousandequivalentfallindemandandsupplysimplybefollowedbyasynchronousandequivalentrise?

Atthetime,Irememberbeingaskedquiteoftenifthepandemicwouldleavescarsontheeconomy:wouldtherebeanylastingdamage