The UK’s major markets in Europe are benefiting from strong demand for their exports; and the latest news suggests that domestic demand in most of these countries is finally picking up, though consumers probably still remain a little wary. As the news from abroad has steadily improved, we have also seen a marked strengthening in demand at home. After a fairly weak first half, retail sales bounced back, the housing market took on a new lease of life and investment began to recover. It now looks as if the UK economy has been growing around or above trend since the middle of last year. It was against that background that the Monetary Policy Committee raised interest rates in three further stages to 4.5%. Meanwhile inflation remains low, well below the Chancellor’s target of 2%. This might seem to bear out the old taunt, that central bankers are the sort of people who want to close the bar as soon as the party starts to go with a swing. It would be fairer to say that we want to be sure that the party remains under control. We don’t want to encourage binge behaviour any more than you do, and for much the same reason; it makes life unpleasant for other people, and it leaves a nasty mess behind. That points to taking action at the first sign of trouble, and preferably before. In current circumstances, strengthening demand is beginning to put upward pressure on costs.
As a consequence, at times, we must be willing to intervene to restrain financial booms in order to temper the busts.   Reform should be undertaken in ways that better align the economic incentives of participants in the financial system with the goal of financial stability.   We should strive to achieve a degree of transparency in the financial system that would enable market participants to make informed judgments about their financial market risks and exposures.   The core of the financial system – the major banks, non-bank financial intermediaries, and financial market infrastructures – must be made more resilient to adverse shocks and less susceptible to runs. BIS central bankers’ speeches  1    Recovery and resolution regimes must be effective in limiting the contagion to the broader financial system when major financial intermediaries or financial market infrastructures come under stress.   We must pay close attention to how all the components of the financial system interact. It can’t just be about particular institutions and infrastructures. Market processes and practices are also very important. Turning first to the issue of financial booms and busts, empirical observation makes it clear that financial markets are inherently unstable. Throughout history we have seen numerous sizable booms and damaging busts. The notion that financial markets are dynamically unstable is also supported by controlled experiments conducted by behavioral economists. Now I accept the notion that some minimum degree of instability is unavoidable.