In case that sounds odd given that Bank Rate has been at 0.5% for over two years, I should underline that, even in normal circumstances, monetary policy works through the expected path of our policy rate. The markets now expect us to keep Bank Rate low for longer. Two-year risk free money market rates are over 100bp lower than in the late spring. That has helped to offset the rise in credit spreads, and so means lower borrowing costs in the real world. I place weight on that, as my MPC colleagues know. Above that, we have decided to add £ to our programme of Quantitative Easing (QE). The degree of monetary stimulus will slowly increase as the agreed QE is executed. That money does not, as is sometimes suggested, get stuck with the banks. The whole point of the Bank’s operating framework for QE has been to avoid that. All central bank money is ultimately held by banks: that is what a banking system is. But by buying bonds from insurance companies, pension funds and others, we put the money into their hands. It is money that, by construction, provides a meagre return – negative in real terms – and so money that they will want to get rid of by purchasing other higher-yielding assets. Policy still works through asset prices, increasing wealth and reducing the cost of capital relative to where they would be otherwise.
We could have chosen instead to offset the price level shocks by running a much tighter monetary policy. Had we done so, spending in the economy, activity and employment would all have been squeezed. Conditions have anyway been difficult for many households due to the squeeze on real incomes, but I think it would have been worse if we had tightened policy. Our ability to sustain exceptional monetary stimulus has, I should reiterate, depended on the credibility of our commitment to low inflation over the medium term being preserved. I worried that chatter in the markets in late 2010/early 2011 marked incipient signs of fragility in that credibility. That was one of the reasons why, at the beginning of this year, I had expected to vote for an increase in Bank Rate at our February meeting. The weak output data for Q4 2010 published shortly before that meeting changed my mind, and the Committee’s course, as they revealed that the economy was softer than I had thought. Escape velocity In the months that followed, I made clear that, with inflation well above our 2% target, I would be looking for an opportunity to begin the process of withdrawing the exceptional monetary stimulus once the economy had achieved “escape velocity”. By that, I meant that the economy would need to be growing, and be set to continue to grow, at a rate that would gradually absorb the slack in the economy. “Escape velocity” has not yet been achieved.