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Bank of England Quarterly Bulletin 2007 Q3

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Bank of England Quarterly Bulletin 2007 Q3 Quarterly Bulletin 2007 Q3 | Volume 47 No. 3 Quarterly Bulletin 2007 Q3 | Volume 47 No. 3 Foreword Every three months, the Bank of England publishes economic research and market reports in its Quarterly Bulletin. This quarter’s edition begins with the Markets and operations report which reviews developments in sterling financial markets since the 2007 Q2 Quarterly Bulletin up to the beginning of September — a period of stress in international financial markets. It also reviews the Bank’s official operations during this period. A fuller evaluation of financial market developments will be included in the Bank’s Financial Stability Report, to be published on 25 October 2007. This edition of the Bulletin also contains material on two key issues for monetary policy: coping with economic data that are an imperfect reflection of reality (‘data uncertainty’); and using indicators of money and credit to assess the prospects for inflation. Monetary policy must be forward looking. But even assessing the present is subject to considerable uncertainty: data can provide only an imperfect picture of economic developments. The fact that economic data are typically subject to measurement error is not a criticism of the bodies that provide it. It is inherently difficult to measure an economy — particularly one in which services play a major role — and the steady accrual of information about the past means that early estimates of data will be naturally prone to revision. Such data uncertainty is a fact of life for policymakers, including the Monetary Policy Committee (MPC). Past Quarterly Bulletins and Inflation Reports have reported on some of the techniques currently employed by the Bank to handle uncertain data, in particular the use of business surveys to identify the likely direction and magnitude of future revisions to early estimates. In this edition, Alastair Cunningham and Chris Jeffery describe the results of the Bank’s latest research in this field, which allows for richer forms of measurement error and the use of additional information, such as accounting identities. These techniques are then applied to produce an illustrative ‘backcast’ of business investment growth, a series that is particularly prone to revision. Recent MPC minutes and Inflation Reports have included detailed discussions of developments in money and credit, and their implications for the inflation outlook. Monetary data can potentially provide important corroborative or incremental information about the outlook for inflation. However, past experience, particularly during the monetary-targeting period, strongly suggests that there is no hard-and-fast link between money growth and inflation. So understanding the possible implications of broad money growth for the economic outlook requires a detailed assessment of the causes. Stuart Berry, Richard Harrison, Ryland Thomas and Iain de Weymarn provide an overview of the potential channels through which broad money growth may affect inflation and describe the Bank’s current approach to analysing developments in monetary aggregates. Further work in this area is planned. One important step in analysing monetary demand and supply shocks involves improving the Bank’s information about credit conditions. For some time, the Bank has held periodic meetings with the main lending institutions to discuss trends in credit markets. Earlier this year, the Bank began supplementing these discussions with a formal Credit Conditions Survey, the first results of which will be published on 26 September. Ahead of that first release, Ronnie Driver describes the background to the survey, outlines its main features and discusses, in the light of similar surveys in the United States and the euro area, what we may learn from it. In economies with undeveloped financial systems and in which banks are the main financial intermediaries, it is relatively easy to define a suitable concept of broad money. However, as financial systems become more sophisticated and intermediation between savers and borrowers become more complex, so it gets harder to identify the most useful definition of money. In the United Kingdom, the money-creating sector is defined as those institutions licensed to accept deposits. But it is by no means clear that this results in an appropriate definition of money; for instance, the non-bank private sector includes some institutions which intermediate funds from one bank to another. We are therefore considering refining our definition of broad money (M4), so as to provide a measure that is more likely to reflect its use in economic transactions. The article by Stephen Burgess and Norbert Janssen sets out proposals for reform, and invites outside views on those proposals by the end of December. Charles Bean Chief Economist and Executive Director for Monetary Policy, Bank of England. Research work published by the Bank is intended to contribute to debate, and does not necessarily reflect the views of the Bank or of MPC members. Contents Recent economic and financial developments Markets and operations 346 Box ABCP-funded vehicles 348 Box Recent rise in Libor rates 350 Box Contingency planning in the ‘Red Book’ 359 Research and analysis Extracting a better signal from uncertain data 364 Box Past revisions to the United Kingdom’s National Accounts as an indicator of current uncertainty 366 Interpreting movements in broad money 376 Box Examples of money demand and money supply shocks in the 1980s 382 The Bank of England Credit Conditions Survey 389 Proposals to modify the measurement of broad money in the United Kingdom: a user consultation 402 Box History of UK broad money aggregates 404 Box Current definitions of broad money in four major economies 406 Box Examples of effects of securitisation SPVs on monetary aggregates 410 Summaries of recent Bank of England working papers 415 – Asset pricing implications of a New Keynesian model 415 – A model of market surprises 416 – Cash-in-the-market pricing and optimal resolution of bank failures 417 – The impact of yuan revaluation on the Asian region 418 – Escaping Nash and volatile inflation 419 – Wage flexibility in Britain: some micro and macro evidence 420 Speeches The Governor’s speech to CBI Wales/CBI Cymru, Cardiff 422 Given on 11 June 2007 The Governor’s speech at the Mansion House 425 Given on 20 June 2007 London, money and the UK economy 428 Speech by Sir John Gieve, Deputy Governor for financial stability, given at the University of Surrey, Guildford on 26 June 2007 Uncertainty, policy and financial markets 437 Speech by Sir John Gieve, Deputy Governor for financial stability, given at the Barbican Centre on 24 July 2007 Central banking and political economy: the example of the United Kingdom’s Monetary Policy Committee 445 Speech by Paul Tucker, Executive Director for Markets and Monetary Policy Committee member, given at the Inflation Targeting, Central Bank Independence and Transparency Conference, University of Cambridge on 15 June 2007 Promoting financial system resilience in modern global capital markets: some issues 453 Speech by Nigel Jenkinson, Executive Director, Financial Stability and Mark Manning, Senior Manager, Financial Stability, given at the conference ‘Law and economics of systemic risk in finance’, University of St. Gallen, Switzerland on 29 June 2007 UK monetary policy: good for business? 462 Speech by Andrew Sentance, member of the Monetary Policy Committee, at an event hosted by Dow Jones at Tower 42, London on 10 July 2007 Consumption and interest rates 471 Speech by Professor Tim Besley, member of the Monetary Policy Committee, given at a discussion meeting held by the Centre for Economic Policy Research, Chartered Accountants’ Hall on 19 July 2007 Appendices Bank of England speeches 478 Contents of recent Quarterly Bulletins 479 Bank of England publications 481 The contents page, with links to the articles in PDF, is available at www.bankofengland.co.uk/publications/quarterlybulletin/index.htm Author of articles can be contacted at [email protected] The speeches contained in the Bulletin can be found at www.bankofengland.co.uk/publications/speeches/index.htm Except where otherwise stated, the source of the data used in charts and tables is the Bank of England or the Office for National Statistics (ONS). All data, apart from financial markets data, are seasonally adjusted. Quarterly Bulletin Recent economic and financial developments 345 Recent economic and financial developments 346 Quarterly Bulletin 2007 Q3 Markets and operations This article reviews developments in sterling financial markets since the 2007 Q2 Quarterly Bulletin up to the beginning of September, which was a period of stress in international financial markets. It also reviews the Bank’s official operations during this period. A fuller evaluation of the significance of financial market developments will be included in the Bank’s Financial Stability Report, to be published on 25 October 2007. International influences on sterling markets(1) more generally, including US mortgage-backed securities (MBS) of higher credit standing; MBS in other countries, A broad deterioration of conditions across credit markets was including the United Kingdom; and ABS backed by other associated with increased volatility and impaired liquidity in receivables such as credit card payments (Charts 1 and 2). global financial markets more generally in the review period. The trigger was renewed concerns about the US sub-prime Chart 2 Spreads on UK asset-backed securities(a) mortgage market in June, following an earlier episode of stress Basis points in February and March this year.(2) This resulted in the near 300 failure of two large hedge funds in the United States. Efforts by the creditors of these two funds to realise the value of the Previous Bulletin 250 collateral they held, in order to limit their exposure to the funds, raised concerns about secondary market liquidity and 200 the valuation of all, but especially senior (AAA-rated), tranches 150 of asset-backed securities (ABS) of US sub-prime mortgages, CMBS,(b) BBB-rated and of collateralised debt obligations (CDOs) containing those 100 tranches.
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