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Monetary policy in a high-

inflation environment

Bank Indonesia Institute Seminar on Central Bank

Policy Mix

Stuart Berry (Head of Global Analysis)

Plan for the presentation

• Current inflationary environment

- Supply shocks
- Inflation persistence
• Challenges facing monetary policy
- Usefulness of models in the current environment
- Nonlinearities and asymmetries
- Monetary policy transmission
• Interaction with broader macro-financial policy
- Financial stability
- Fiscal policy

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Chart 1: Supply chain constraints have continued to ease
Indicators of supply constraints (a)

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Chart 2: Wholesale gas spot price and forecast conditioning
assumptions for wholesale gas prices (a)

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Chart 3: Older people have driven the rise in labour market inactivity
Change in inactivity since 2019 Q4 by age (a)
Chart 4: Labour markets remain tight in absolute terms

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Chart 5: Both higher input costs and pay growth appear to be playing a role in
the rise in services inflation
Contributions to model-implied services inflation relative to 1997–2019 mean (a)

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Chart 6:Decomposing headline inflation rates

UK (CPI) EA (HICP) US (PCE)

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Chart 7: Policy rates in the UK, US and EA with latest yield curves

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Chart 8: CPI inflation projection based on market interest rate
expectations, other policy measures as announced

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Chart 9: GDP growth projection based on market interest rate
expectations, other policy measures as announced

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Chart 10: Unemployment rate projection based on market interest
rate expectations, other policy measures as announced

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Chart 11: Household inflation expectations have fallen back, but remain
above pre-pandemic averages
Household inflation expectations (a)

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Chart 12: Staff analysis suggests that the expected fall in inflation will drive
down nominal pay growth this year
Contributions to annual private sector regular pay growth (a)

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Chart 13: CPI inflation projection based on market interest rate
expectations, other policy measures as announced

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Chart 14: Components that have exhibited persistent inflationary dynamics in
the past have driven the increase in core CPI inflation
Contribution to change in core CPI inflation (a)

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Challenges for monetary policy

• Usefulness of models in the current environment

• Unusual set of shocks
• Models typically estimated over periods where such shocks have not occurred
• Need to rely more on interpreting the incoming data

• Nonlinearities and asymmetries

• Relationships between slack and inflation may be non-linear or state-dependent
- Some evidence of this in the data
• But dynamics could also be different on the way up and the way back down (asymmetry)
- Harder to judge

• Monetary policy transmission

• Lags in transmission mean much of the impact still to come
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Chart 15: The share of fixed-rate mortgages has increased over time
Distribution of mortgages by type of product (a)

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Chart 16: The cash-flow effects of higher interest rates are expected to
increase
Changes in mortgage interest payments as a share of consumption (a)

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Interaction with other macro-financial policy

• Financial stability
• Recent financial stresses raised questions about implications for monetary policy
• Need to take macroeconomic impact into account
• But no trade-off between price and financial stability
• Use other tools to ensure financial stability

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Chart 17: UK wholesale funding spreads rose sharply after the failure of
SVB, but have since fallen back
UK banks’ indicative funding spreads (a)

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Interaction with other macro-financial policy

• Financial stability
• Recent financial stresses raised questions about implications for monetary policy
• Need to take macroeconomic impact into account
• But no trade-off between price and financial stability
• Use other tools to ensure financial stability

• Fiscal policy
• Take fiscal policy as given
• But need to factor in macroeconomic impact
• Fiscal policy can affect inflation outlook in various ways
- Demand impact (eg. income support during Covid)
- Influence path of supply (eg. measures in latest budget package)
- Direct impact on inflation (eg. Energy Price Guarantee)
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Chart 18: Public sector net borrowing

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