The Bank of England's Megan Greene on Monetary Policy in a World of Supply Side Shocks | Odd Lots

The Bank of England’s Monetary Policy Committee (MPC) consists of nine members, split between five internal executive members and four external members. This structure is designed to prevent groupthink by intentionally incorporating diverse backgrounds, including international perspectives and private sector experience. Unlike many other central banks, the MPC operates with full transparency regarding individual voting records, which frequently feature dissents. External members play a critical role in analyzing international spillovers and providing a business-oriented viewpoint, ensuring that policy decisions are not confined to a single institutional perspective.

The UK economy has experienced weak growth and persistent inflation for several years, driven by successive negative supply shocks including the pandemic and geopolitical conflicts. Unlike traditional demand-side economic models, the current environment is characterized by a weak supply side that risks turning even modest demand into inflationary pressure. Inflation expectations have become more sensitive, with households and firms showing increased attentiveness to price changes. This shift toward state-dependent pricing means that firms adjust prices more frequently in response to cost increases, leading to second-round effects that keep inflation above the 2% target.

Monetary policy transmission in the UK is influenced by the structure of the mortgage market, which is dominated by two- and five-year fixed-rate products. While these shorter-term fixes allow for faster transmission of interest rate changes compared to the US 30-year fixed model, they also create significant debt-servicing pressure as households refinance at higher rates. Even as interest rates stabilize or decline, the cumulative effect of these resets continues to constrain consumer spending. This creates a complex environment where policymakers must balance the risk of persistent inflation against the potential for weaker-than-expected consumer demand and economic growth.

The UK economy faces long-term supply-side challenges, including a lack of business investment that predates Brexit. While AI represents a potential positive supply shock that could boost productivity, there is currently no definitive evidence of a meaningful impact on the economy within the next three years. Furthermore, the UK remains highly vulnerable to energy price volatility, as electricity prices are closely linked to gas markets. These structural issues, combined with repeated negative supply shocks, have led to a deterioration in potential growth, forcing central bankers to move beyond traditional models that assume productivity will naturally revert to long-term trends.

Rising gilt yields reflect a combination of geopolitical risks, such as tensions in the Strait of Hormuz, and market positioning around fiscal policy. While bond market participants sometimes act as vigilantes, their influence is balanced against the central bank's focus on financial conditions. Rising interest payments on government debt are monitored primarily through their impact on overall financial conditions rather than as a direct inflationary impulse. The central bank maintains a strict separation between its mandate to achieve 2% inflation and the government's fiscal choices, incorporating only legislated fiscal policy into its economic forecasts.

Central banking has entered a new era characterized by radical uncertainty and successive, unpredictable supply shocks. In this environment, traditional point-forecasts are less effective than scenario analysis and risk management, which focus on minimizing costs across different potential states of the world. Because central banks lack the tools to address supply-side problems directly, they must rely on proactive judgment to lean against second-round effects before they become embedded. This shift requires a more flexible approach to communication and decision-making, acknowledging that the old frameworks for understanding the global economy no longer provide a reliable guide for future policy.