This episode features Megan Green, external member of the Bank of England's Monetary Policy Committee, discussing her transition from economics commentary to actual monetary policymaking. Green brings a unique perspective as an American-British economist who previously worked in the private sector and academia before joining the MPC three years ago.

The conversation covers the current state of UK monetary policy amid persistent inflationary pressures, with UK inflation remaining above the 2% target for most of the past five years. Green explains the MPC's recent decision to hold interest rates despite rising energy prices from Middle East tensions, emphasizing concerns about second-round effects and inflation persistence.

Key topics include the transmission of US monetary policy to UK markets, the challenges of managing supply-side shocks with demand-focused tools, and the evolution of central banking in an era of repeated economic disruptions. The discussion also explores how household and business behavior has changed since the pandemic, making inflation more persistent than traditional models would predict.

From Finance Twitter to Monetary Policy Committee

The Bank of England's MPC structure includes five internal members (Governor, deputy governors, chief economist) and four external members to prevent groupthink and bring diverse perspectives.

External members sit physically separate from internal staff and often dissent from majority decisions, with the Bank uniquely transparent about individual voting records unlike most central banks.

Green's role focuses on international spillovers, particularly from the US, where about half of UK yield curve movements since the pandemic originate from external factors beyond the Bank's control.

UK Economy's Persistent Inflation Challenge

UK inflation has remained above the 2% target for all but one or two months over the past five years, creating embedded inflationary expectations despite recent moderation.

Forward-looking indicators showed signs of stalling before the Iran crisis, with the Decision Makers Panel survey revealing that firms' price and wage expectations had plateaued rather than continuing to decline.

Household inflation expectations were elevated above historical relationships even before recent Middle East tensions, suggesting persistent scarring from previous inflation episodes.

The threshold at which households notice inflation has dropped from 4% pre-pandemic to 3-3.5% currently, making consumers more sensitive to price increases - Green

Supply Shocks and Second-Round Effects

Every UK supply shock has generated second-round effects, but their magnitude depends critically on economic conditions, with 2022's tight labor market producing more severe effects than current slack conditions.

Firms have shifted from schedule-based to state-dependent pricing since COVID, meaning they now adjust prices more frequently when inflation rises, accelerating pass-through of cost increases.

"The trick for us is that we kind of know how to measure direct and indirect effects... The second round effects are pretty difficult to measure. But if we wait until we have real concrete evidence of them, we're too late" - Green

Monetary policy transmission occurs with 18-24 month lags, requiring preemptive action against second-round effects before concrete evidence emerges.

International Spillovers and Bond Market Dynamics

US inflation data ranks as the second most important factor affecting UK financial conditions after UK inflation itself, with US nonfarm payrolls ranking third in market impact.

About one-third of UK yield curve movements came from external sources before the pandemic, rising to approximately half since COVID, primarily from US Treasury and Eurozone bond markets.

UK mortgage market structure with predominantly 2-5 year fixed rates creates faster monetary transmission than the US 30-year fixed system, but also means debt servicing costs continue rising even during rate cutting cycles.

Central Banking in an Era of Persistent Uncertainty

The Bank now analyzes supply-side conditions continuously rather than the previous annual deep-dive approach, reflecting the frequency of supply shocks since COVID.

"Economic statecraft" using tariffs and export controls represents a new source of persistent negative supply shocks, moving beyond the traditional assumption that such shocks are temporary and can be ignored.

Central banks lack appropriate tools for supply-side problems, which often involve choosing winners and losers - decisions that should remain with elected officials rather than independent monetary authorities.

The MPC has shifted to scenario-based analysis rather than point forecasts given extreme uncertainty, focusing on risk management and reaction functions across different potential outcomes.