Foreword by Andrew Bailey
The first Bank of England Agenda for Research (BEAR) was published in 2020, and it successfully generated research projects that informed our policies across our entire remit. But the Bank has since faced a number of new challenges, including a period of high inflation and financial market turmoil. This has required us to re-think the use of our balance sheet for monetary policy and financial stability. The Bernanke review highlighted new areas for further work to develop our forecasting processes for monetary policy making. Further analytical work is also needed to support the Prudential Regulation Authority’s new secondary competitiveness and growth objective, and the Bank’s secondary innovation objective for certain Financial Market Infrastructures, both introduced in 2023.
This second BEAR sets out the key areas for further research to inform our thinking over the coming years in light of these new developments and challenges. It therefore includes a new research theme on the central bank balance sheet, where further research should inform our thinking across monetary and financial stability policies. However, it also highlights some of the perennial issues – such as the drivers of inflation – where further work should assist understanding the changing dynamics of the UK economy.
Experts from outside the Bank have been vital in delivering on the previous BEAR. We continue to encourage external researchers to collaborate with our researchers in delivering on our new research agenda. We publish a selection of research datasets to crowdsource answers to our research questions and to support collaboration between our staff and external researchers. Collaborative work with external researchers has helped us in gathering evidence on the impact of our policies, and in ensuring that our policies are subject to independent challenges. As always, we welcome the deployment of a wide range of approaches and techniques from across multiple disciplines to inform our thinking.
The Macroeconomic Environment
The macroeconomic environment has changed profoundly in recent years, reshaping the challenges faced by central banks in stabilising inflation around target. Economic and inflation dynamics, notably in the price/wage/cost nexus, appear to have changed. Alongside this, structural changes may have altered how policy transmits to the economy. This calls for research to understand this substantially changed macro backdrop and what it means for policy.
Inflation dynamics
Recent inflation dynamics call for a deeper exploration of the drivers of inflation and expectations. Further research can fruitfully explore how expectations evolve and influence macroeconomic dynamics. This calls for more study of non-linearities, asymmetries and potential differences in the drivers and dynamics of inflation in times when inflation is higher than historical averages. Of particular importance is understanding how monetary policy should respond when the economy is subject to larger shocks than normal, or a series of shocks.
Further work is also required on the determinants of firms’ price setting behaviours and how they may have changed. Important questions include how firms adjust prices in response to shocks to input costs such as energy, and how technological changes may have altered price stickiness.
More generally, there is a need to develop a richer understanding of how wages adjust to shocks and feed through to prices (and vice versa), and how monetary policy should respond. More work is also needed on how production networks respond to shocks. Further research is also needed on what drives entry and exit of firms, as well as investment of incumbent firms, and how these are affected by financial constraints.
Modelling apparatus
The Bernanke Review’s call for prioritising model maintenance and development, alongside the broader recommendation to update the forecast framework, creates a key set of topics for research. There is a pressing need to enhance forecasting frameworks and models to enable analysis of different scenarios, and to develop further empirical methods to improve forecast accuracy. The latter also includes making best use of timely big data. More broadly, work is required on the best way to combine insights from top-down models with more granular sectoral models, as well as on how to build an optimal forecasting framework by drawing on different types of models for forecasting and scenario building.
Communication of forecast narratives and scenario analysis by monetary policymakers can have important influences on the expectations of market participants as well as firms and households, which in turn shape the inflation dynamics. This calls for further research on how central bank communication affects expectations, and how best to describe and communicate uncertainty around central case scenario and alternative forecast scenarios. Further work is also needed on how to balance communication of collective opinions with diversity of individual views.
Transmission mechanism
More research is also needed to understand better how changes in policy rates and other policy tools transmit to the financial system and the broader economy, as well as whether and how this transmission is state-dependent. This requires further research on how the financial positions of households, firms and financial actors, as well as the structure and the state of the economy, affect the transmission mechanism of these policies. It is also important to understand how various central bank policy tools interact to influence the macroeconomic outcomes and financial stability risks.
This opens up a wide set of questions on the role of financial markets and institutions in transmitting central bank policies, as well as how changes in housing and mortgage tenure, and heterogeneity across households and firms affect the transmission mechanism. The growth of non-bank financial institutions (NBFIs) opens up a rich avenue of work on how they affect the transmission of policies through credit and other financial markets.
Important developments in the labour market include short- and long-term changes to labour supply and labour market flexibility. Exploring the effects of these on labour market dynamics is an important avenue for future study as well as potential non-linearities in the Philips curve.
Long-run change
Prolonged weak productivity growth since the financial crisis calls for more work to understand the drivers of trend growth. Future work can usefully examine long-term drivers of the UK capital stock, labour supply and total factor productivity. Potential drivers of these include technological changes, intangible capital and demography.
Understanding the evolution of, prospects for, and uncertainty around long-run equilibrium interest rates remains important for assessing the monetary policy stance and evaluating risks to financial stability. More research is welcome on understanding and modelling the drivers of long-run equilibrium interest rates – be they monetary, technological, economic and demographic – and the broader implications of long-run trends in interest rates for the economy and the financial system.
Long-term structural changes including growth in working from home, the increased deployment of Artificial Intelligence and climate change have the potential to reshape the economy, and research on all of these topics is very valuable.
Priority topics for 2025
- What are the drivers of inflation and inflation expectations, have they changed over the recent past, and how should monetary policy respond?
- What is the best approach to improve the forecast framework, forecast accuracy, and forecast scenario analysis?
- What are the transmission mechanisms of conventional and unconventional monetary policy, how effective and state contingent are they, how do they interact with other central bank tools, and what are the implications for the strategy for deploying these tools?
- How are long-term features of the economy such as productivity growth and the equilibrium interest rate evolving, and how do structural changes such as the increased deployment of artificial intelligence and climate change influence these?
+ Other work on inflation dynamics and transmission of shocks to the macroeconomy.
The Financial System
Novel forms of credit provision, financial innovation, greater financial market volatility and new kinds of shocks all have the potential to alter the financial system. In addition, changes in interest rate and liquidity environments could have important ramifications. There are also deeper questions about the allocative efficiency of the system and its effects on the real economy. A body of new research exploring these key issues is needed to help financial policymakers navigate this changing landscape.
Market-based finance
Given the growth in market-based finance, there is a need for further research on how this emerging part of the financial system contributes to corporate and household funding and how it has changed the workings of the system as a whole. This poses new questions about how much risk is generated across different types of institutions and how that might be transmitted from non-banks to households, corporates and the real economy more broadly, and the effect on the payments architecture.
Further progress in understanding these issues will require better modelling of liquidity of non-banks (both individually and collectively), understanding their sensitivity to different types of shocks and the interconnectedness between banks and non-banks.
Financial market dynamics
Recent turbulence in markets traditionally seen as liquid and stable have reinvigorated work on market dynamics. More work is required on understanding the roles of different financial actors in generating and mitigating fire sales, and how regulatory constraints influence their behaviour under stress.
Insurers, pension funds, and mutual funds play an important role in several markets by virtue of being large investors in assets. This opens up issues around their role as buyers and sellers during times of turbulence, their impact on market liquidity and the impact of their having to pay large variation margins. There are also important questions on the effect of long-term asset purchases by insurers, and its implications for funding costs for corporates.
New structures for financial products and markets have the potential to reshape financial linkages. Two key developments worthy of further study are the rise of exchange-traded funds (ETFs) and the rise of principal trading firms as an alternative to dealers, and how this development affects shock transmission and risk propagation. More broadly, there are important questions on the design of financial market infrastructure, which can affect market dynamics. Important questions remain about where and how to determine clearing mandates, the optimal time frame over which transactions can be netted for settlement and the appropriate degree of securitisation.
Technological innovation
Financial innovation continues apace, with new products, platforms and technology reconfiguring traditional linkages. Key work remains to be done on the potential systemic and risk propagation consequences of digitalisation, cryptoassets and other technological developments, including the transmission mechanisms between digital asset markets and traditional financial markets and institutions. Work exploring the properties of distributed ledger technology (DLT) and core issues related to the technology is also welcome.
Increased deployment in Machine Learning (ML) and Artificial Intelligence by agents, intermediaries and supervisors have opened up a number of novel research topics, including the impact of algorithmic trading on markets, and the interpretability and robustness of AI/ML models. Technological developments have also created new ways of intermediation, such as peer-to-peer lending, novel fintech clearing and settlement practices. Impact of such development on financial stability and potential policy responses are a valuable area for further exploration.
System-wide efficiency
There is a broader set of questions on the systemic efficiency of the financial system as an allocator of resources. The PRA’s secondary objectives create a need for work to understand the effects of regulation on competition and the UK’s competitiveness as a global financial centre. There is also a need to understand better the channels via which financial regulations affect the contribution of financial services sector to growth, including the quantitative significance of these.
Recent turmoil also highlights the need to better understand the potential importance of new frictions which could prevent the financial system from performing its traditional function of intermediating between savers and borrowers, sharing risks and providing maturity transformation.
A separate set of questions relate to climate and finance. More work is needed on how climate-related financial risks can be quantified and priced, and how improved disclosure of such risks impacts their pricing and firm behaviour. At a system-wide level, there are open questions about the role of finance in facilitating the transition to net zero, and the financial stability implications of such a transition.
Priority topics for 2025
- How can the resilience of core markets be assessed and ensured?
- What effects do leveraged non-bank financial institutions have on the financial system and are they sufficiently resilient?
- How might different design choices for privately issued and central bank digital currencies affect monetary transmission, financial stability, and financial innovation?
- How might technological innovation and programmable platforms, and increased deployment of artificial intelligence and machine learning by financial market participants affect the financial system and the macroeconomy?
+ Other work on FinTech and the impact of financial frictions on the productivity of the non-financial sector.
The Prudential Architecture
The prudential architecture has changed substantially over the past few years, as the PRA gained repatriated powers and an additional secondary objective on competitiveness and growth, requiring fresh evaluation of the regulatory toolkit. At the same time, the growth of non-bank finance and new types of creditor interactions may give rise to new challenges to financial firms’ resilience. These changes open up a rich new research stream on the design of financial regulation.
Evaluating regulations
Over the lifetime of this agenda, reforms such as the third tranche of Basel III, post-Brexit repatriation of rules and Solvency UK will have been in operation for several years, creating potential observations on their consequences. There is clear need to evaluate whether the existing set of regulations achieved the intended aims, but also whether they had any unintended consequences, particularly on the competitiveness of the UK as a financial centre and competition within the financial sector. Further work is also needed to refine cost-benefit analysis of regulatory measures, both to inform ex ante policy design and ex post impact evaluation.
Key areas for further study include examining the impact of regulations on credit supply and risk of individual banks and insurers. Similarly, the potential effects of financial regulation on the cost and availability of financial products available to heterogeneous households and firms merit future exploration. Work is also needed on whether and how regulations on banks and insurers could indirectly affect other entities, markets and the financial system as a whole.
Regulatory framework
The evolution of regulatory structures also poses novel questions about the interaction of policy instruments. These include the desirability or consequences of a complex regulatory capital stack, and the interplay between microprudential, macroprudential and monetary policies. More work is welcome to explore the potential role of new macroprudential tools such as borrower-based tools or tools focussed on corporates, as well as interaction between supervision and regulation.
Key strategic questions include how financial stability policy should seek to balance prevention of turbulence and minimising the cost of turbulence, and what tools are needed. New analytical frameworks with a well-defined objective function for macroprudential policymakers could potentially help answer such questions.
Institutional investors
Episodes such as the 2020 ‘Dash for Cash’ and the 2022 liability-driven-investment (LDI) crisis have shone a new light on institutional investors’ role in driving market dynamics – including in asset classes and investor types traditionally associated with safer, more liquid, or longer term investment strategies. Further work is needed on how institutional investors can transmit shocks across asset markets, the financial system and to the broader economy, and how financial policymakers should respond. Specifically on insurers, more work is needed on the determinants of the optimal level of capital and the implications of the move of defined benefit pensions to the life insurance sector.
The emergence and growth of new actors outside the traditional financial and banking system create fresh issues about what the appropriate regulatory perimeter should be. More broadly: What are the indirect effects of regulation in terms of pushing activities, especially credit provision, outside the banking sector? Are new instruments needed to address risks to financial stability arising from non-bank actors?
Resilience
To respond to emerging risks, financial regulators need to understand how banks and non-bank financial institutions behave during stressed market conditions and how they collectively affect the financial system. More work is needed on the determinants of liquidity demand and supply under stress, and the propagation mechanisms of large asset market price movements to the wider economy.
There is scope for further work to quantify tail risks and how macroprudential policy mitigates them. Another avenue for future study is around better understanding the role of financial frictions in propagating shocks to the wider economy. Relatedly, there is a need to develop models that capture feedback loops between the financial system and the real economy for stress-testing purposes. Further work is also needed on whether new technologies and competition have changed the dynamics of depositor and creditor runs, and how regulators can contain such events and prevent system-wide contagion.
There is also a broader agenda around making policy robust to a range of tail outcomes, which may not be captured by historical data and models based on these. Informing policy under uncertainty requires going beyond the traditional probabilistic models. A framework for formulating policy under uncertainty is needed in certain contexts, for example to ensure financial system resilience to mass deployment of AI models, that are hard to evaluate, by financial firms.
Priority topics for 2025
- How do market-based finance and non-bank financial institutions affect the transmission of shocks across the financial system and to the wider economy, and what are the implications for financial regulation?
- How could prudential policies promote the competitiveness and growth of the UK economy while continuing to ensure the safety and soundness of regulated financial institutions?
- How do prudential policies affect risk taking within and across financial sectors and the resilience of the financial system as a whole?
- What is the optimal level of capital for insurers considering how they may affect systemic risk and long-term economic growth?
+ Other work to build risk assessment toolkit for supervisors and regulators, including through the deployment of artificial intelligence and machine learning techniques.
The Interconnected World
The UK is part of an interconnected world where many forces, shocks and mechanisms are international in nature. The reshaping of global trade, evolution of international finance, and the changing nature of cross-border shock transmission all have the potential to recast linkages. This calls for new work to understand how this changed international context has reshaped the UK’s interactions with the rest of the world.
Reconfigured trade
Recent developments such as geopolitical risks, changes in formal trading arrangements and the rise in protectionism have the capacity to reshape trade flows. More work is needed on the determinants of trade flows, and their consequences for the domestic economy.
The growth in trade of intermediate goods also raise an important set of questions around resilience and risks associated with longer, more complicated supply chains, and how these interacts with larger global shocks and higher uncertainty.
The rising share of services in global trade, their even larger share in UK exports and the UK’s role as a prominent financial services exporter also call for a deeper exploration of global services trade. This includes understanding the determinants of services trade, the interplay between services and goods trade, and the factors affecting trade in financial services.
Global drivers
The international co-movement of many macroeconomic and financial variables poses questions centred on common global cyclical and structural drivers. In particular, the global drivers of equilibrium interest rates such as demographics, productivity, fiscal policies, investor risk appetite and other factors are all worthy of further investigation. Understanding the global ramifications of climate change is also a key question here. More generally, the role of such factors operating at a global level in shaping macroeconomic and financial outcomes requires further exploration.
A deeper understanding of the forces shaping the global business cycles is also needed, including the drivers of output and inflation co-movements. In addition, there is room for more research on global financial cycles, their drivers, channels of transmission and how they interact with the global business cycles.
Cross-border spillovers
A key area for further research is how shocks originating in one country spill over to others. More work is also needed on how increased integration of financial markets, changing rules for international commerce, structural forces and other factors may have changed the channels of transmission. The role of the exchange rate in cross-border transmissions of shocks as well as the monetary transmission mechanism remains an important area of research. As macroprudential policies have become an established part of the policy toolkit, it is important to understand how policy measures enacted in one country affect other economies.
Whereas much traditional analysis of spillovers focussed on the average outcome, more work is needed on the transmission of tail risks, and whether the mechanisms are different to central cases.
International finance
The aftermath of the global financial crisis saw developments in the global rule book for the financial system, but momentum has since slowed. This raises fundamental questions such as how to consolidate and preserve the benefits of global structures and rules, and reforms to the global financial safety net. Further work is needed on the optimal combination of existing tools to tackle shocks, including central bank policy coordination via activation of tools such as swaps.
The role and evolution of global currencies, and their potential effects on the wider system are open questions. And if retail central bank digital currencies (CBDCs) are issued, how does that affect safe assets and reserve currencies? In addition, work understanding the effects of, and innovations in, cross-border payments is important. More generally, the growth of the digital economy also has an important international dimension, including how it affects the volume and speed of capital flows.
Priority topics for 2025
- What are the global factors driving inflation and economic activity, and what challenges do these pose to central banks?
- What are the key drivers and emerging risks shaping the international flows of goods, services and capital?
- What roles do banks, non-banks, market-based finance and new forms of financial intermediation play in originating and propagating shocks internationally?
- What are the macroeconomic and financial stability implications of fragmentation?
+ Other work on international spillovers and macro-financial implications of structural shifts such as climate change, digitalisation, and developments in the structure of global payment systems.
The Central Bank Balance Sheet
The size and composition of the central bank balance sheet pose questions that cut across a range of central bank policy areas. Key developments include the anticipated reduction in central bank asset holdings, changes in reserve demand, and creation of new balance sheet tools. These in turn raise the question of the optimal footprint of the central bank in private markets. These emerging issues call for research to inform the future of central bank balance sheets.
Central bank assets
The historically large size of central bank balance sheets in the aftermath of the Global Financial Crisis and of the Covid pandemic raises important issues about their role as tools for, and in the transmission of, monetary policy. Thus, understanding how reductions in the size of central bank balance sheets play out across financial markets and affect credit provision and risks in the system is a key topic for research.
More research is needed to understand the effects of central bank balance sheet adjustments on macroeconomic outcomes, financial stability, and individual institutions. This includes research on the potential asymmetries between quantitative easing (QE) and quantitative tightening (QT). Further research is also needed on how changes in central bank asset composition – in terms of maturity, asset class and issuer – might affect credit conditions, asset prices, market dynamics and other financial conditions more broadly.
Central bank reserves
There is a need to study how interbank liquidity and activity in money markets influence the monetary transmission mechanism, and more broadly the future central bank operating framework.
More work is needed to understand both the appropriate ‘steady state’ and the nature and speed of the transition towards it. The potential differences in frameworks across central banks afford a rich opportunity to study whether and how these lead to differences in the behaviour of money and credit markets, and the broader macroeconomic and financial stability effects.
Other key issues include the shape and slope of the reserves demand curve, the reasons why reserves demand appears to be substantially higher than in the past, the trade-off between the quantity and velocity of reserves, and the differential effects of intra-day versus overnight liquidity. More broadly there are open questions on the effect of reserves on the liquidity of both bank and non-bank financial institutions, and the financial stability implications of reserves recycling.
Central banking toolkit
There is scope for research on new counterparties that might gain access to central bank balance sheets. This raises broader questions about the design of new tools, and the potential use of the balance sheet for monetary policy versus financial stability purposes. Further work is needed on the merits and consequences of various options, which could include reserve-backed stablecoins, issuing a wholesale central bank digital currency (CBDC) and finally allowing access to retail customers in the form of a retail CBDC. Such research would include the design parameters of access including interest rates and convertibility, the interactions between demands for different central bank instruments, and the implications for the wider payments system.
More work is also needed on the role of central bank balance sheets as a public backstop to prevent systemic liquidity risk from destabilising core financial markets and undermining monetary and financial stability. Important considerations include how such tools should be designed while maintaining incentives of market participants to achieve appropriate levels of self-insurance against liquidity risks, as well as limiting risks to the stance of monetary policy and public funds. More research is also needed on the appropriate mix of lending and asset purchase/sales facilities for dealing with systemic liquidity risk originating in the non-bank financial sector.
In addition, work is needed to understand how balance sheet policies interact with other central bank tools. There are also the wider questions around whether it is better to have a small balance sheet which can be rapidly adjusted in response to crises, or maintain a larger stock of reserves, and how to balance steady state versus crisis prevention needs in designing tools. Other questions concerning traditional policy instruments are also relevant for new balance sheet tools: Should they be co-ordinated across countries, and if so how? And how might policy differ in normal times versus crisis episodes?
Central banking footprint
The size, scope and nature of central bank balance sheets and the potential for new instruments give rises to a deeper set of issues around their wider effects on the functioning of private markets. The potential presence of large risks on central bank balance sheets raises the issue of whether the benefits in terms of risk sharing and liquidity outweigh the costs in terms of private market functioning and price discovery, and more broadly whether larger central bank balance sheets lead to crowding-in or crowding-out of private activity.
As central banks contract their balance sheets, this raises wider consequences for markets, such as what institutions will absorb the bonds, how smaller reserves will affect bank deposits, and how liquidity management, collateral availability, and financial sector competitiveness and market power will be affected.
Priority topics for 2025
- How have the operating frameworks, asset composition, and reserve levels of central banks affected monetary policy transmission, interaction with other policy instruments, and private market crowding-in or crowding-out?
- How do Quantitative Easing (QE) and Quantitative Tightening (QT) transmit to banks’ and non-bank financial institutions’ (NBFI) activity in reserves and money markets, and from there to financial sector balance sheets and the real sector?
- What can we learn about the shape and slope of the demand for central bank reserves, and how has it been affected by changes in the velocity of reserves circulation?
- What will be the effects, including on traditional banking, of new counterparties, such as NBFIs, stablecoin issuers, and central bank digital currency holders, gaining access to central bank balance sheets?
+ Work on the causes for asymmetric transmission of QE and QT, the impacts of transitioning into a new monetary operating framework that balances the trade-off between control of market interest rates, liquidity recycling in money markets, and sufficient levels of ex-ante reserve supply.