Fortunately, all political parties recognise the need to put in place a credible plan for the consolidation of the public finances over the medium term, even if their preferred routes to doing so differ. Finally, question marks remain about the durability of the recovery in the rest of the world and particularly in the UK’s main export markets. Some of the advanced economies face headwinds similar to those facing the United Kingdom. The fate of the euro area, the destination of more than half our exports, is particularly important. The recovery there all but stalled in the fourth quarter and business surveys point to only moderate growth in the first part of this year. Moreover, Greece and some other euro-area countries face significant fiscal challenges. The necessary fiscal consolidations are likely to depress overall euro-area demand unless offset by demand expansion elsewhere. But as I noted, there are also reasons to be cheerful. Two factors in particular should provide a boost to the demand for UK goods and services. First, there is a substantial policy stimulus still working through the economy. Bank Rate remains at a historical low of 0.5%, while the Bank has bought some £ billion of assets, mainly gilts, financed by the issuance of central bank reserves (think of these as Bank of England IOUs that are held by the commercial banks) – so-called “quantitative easing”.
The fact is that policy has to be made in ignorance of how the future will turn out, and one has to weigh certain near-term costs against uncertain longer-term gains. Moreover, it seems unlikely that higher interest rates in this country alone would have prevented us experiencing a severe recession. Events in the United States would have proceeded in much the same way, regardless of what the MPC chose to do. And, as we have seen, the downturn has been global in nature, not confined to those economies with overblown financial or housing markets. Would it have helped if our target variable had, say, included a measure of asset prices, particularly house prices? There is certainly a good case for including a measure of owneroccupied housing costs in any consumer price measure, as for many households it represents their largest single expenditure. And, depending on the measure used, that could have resulted in higher inflation figures during the years leading up to the crisis. That does not, however, translate directly into a higher level of Bank Rate. Monetary policy affects inflation with a long and somewhat variable lag and there is little the MPC can do to offset unanticipated movements in near-term inflation. Instead, we have to look at inflation prospects two or three years ahead. But it is in the nature of asset prices, including house  6  BIS Review 31/2010  prices, that one can say rather little about their likely direction of movement that far ahead.