13th June 2014 by Simon Ward
The MPC supposedly places significant weight on an estimate of the “medium-term equilibrium unemployment rate” in calibrating its policy stance. The August 2013 Inflation Report, for example, stated that “The gap between actual unemployment and the medium-term equilibrium unemployment rate is a measure of effective slack in the labour market, and is likely to be most relevant for assessing wage pressures over the MPC’s three-year forecast period.”
So what is the Committee’s current judgement about this crucial policy metric? The May Inflation Report, on close inspection, is contradictory. The text at the top of page 30 of the Report refers to a current estimate of 6-6.5%. Chart 3.7 on page 28, however, contains a first-quarter figure for the “unemployment gap” – the difference between the actual and medium-term equilibrium rates – of 0.9%. Since the MPC expected actual unemployment to be 6.7% in the first quarter, this implies an equilibrium rate of only 5.8%.
How has this contradiction arisen? One possibility is that Bank of England staff generated the 5.8% estimate but the MPC majority refused to endorse their assessment, preferring a 6-6.5% range. Chart 3.7 may have been retained in the Report owing to an editorial insight, or because the still-significant unemployment gap shown supports the dovish policy stance of Governor Carney.
The single-month unemployment rate fell to 6.45% in April, within the MPC majority’s 6-6.5% range for the medium-term equilibrium rate. The MPC believes that there is additional labour market slack associated with part-timers working fewer hours than they would like, although the implications of this shortfall for wage pressures is uncertain. With a further unemployment decline assured, the majority position suggest an interest rate rise before end-2014.
Governor Carney, of course, is strongly resistant to such a scenario, and may press for a downward revision to the estimated range for the medium-term equilibrium unemployment rate in the August Inflation Report, probably to 5.5-6%. This change would be presented as a response to new information; it would, in fact, simply make explicit an assumption already incorporated in the Bank’s May projections.