To come up with its forecast, the MPC has to reach a view based on all the information available to us: data, theories, a variety of models, business and market intelligence, our own experiences and judgement and so on. But there are huge uncertainties within the information set and so there must be equally great uncertainties about the resulting judgements. That is why the one, indeed the only, thing we know for certain about any forecast of the economy is that it will be precisely wrong. That is also why the MPC puts little weight on its central projection, and chooses to communicate its judgments to the public by focusing on the range of possible outcomes and the balance of risks, as summarised in the fan chart.7 What this means is that setting monetary policy is about decision making under uncertainty. It isn’t clean. In fact it’s very messy. But nobody has a working crystal ball. The important question for us is not whether we got the central projection right but whether we set the right policy, given what we knew at the time. Crucially, we are accountable to the public, including via the Treasury Select Committee, for our policy decision. I do not think I have heard many argue that we should have done something materially different with policy during the depths of the recession in 2009 (i.e. to the extent necessary) in order to generate a different outcome for inflation now.
The closer these cushions are to levels that reflect potential future exposure across a more adverse set of market conditions, the more resilient markets and institutions will be under conditions of stress, and the less likely the prospect that the behavior by institutions will amplify financial shocks. Stress testing and scenario analysis is an important part of the process of calibrating this relationship between risk and capital and margin. The test of a sufficiently strong process is not simply the realism of the process used to measure potential losses, but the impact that it has on the decisions made by the institution on the size and type of exposures relative to earnings, capital and collateral or margin and the terms on which it extends credit. Let me conclude by noting again that we are in a period of perceived strength in economic fundamentals in the United States and many countries around the world. This strength has helped to induce significant reductions in a range of market-based perceptions of risk. Much of this confidence may prove warranted and durable, but the extent to which it endures will depend in part on the degree to which those running the major financial institutions in the United States use the opportunity presented by this period of relatively high profitability to strengthen their capacity to withstand a less favorable overall macroeconomic and financial environment.