Medium-term inflation expectations, forecasts, and models: nominal stuff In terms of the primary objective of delivering stable inflation, it has helped the UK to have a clear target. In contrast to many inflation-targetting countries 10 , we have a point target: 2% on the consumer price index. That leaves no room for debate in our (one person – one vote) committee about what the target is. And there should be no uncertainty amongst households, firms and participants in financial  4  Wicksell, K., 1898, ‘Interest and prices’, London , Macmillan, 1936. Translation of 1898 edition. 5  The classic reference, in the context of the relationship between money and inflation, is Friedman M., 1961, ‘The lag effect in monetary policy,’ Journal of Political Economy, vol. 69, no. 5. 6  For example, Svensson, L.E.O., 1997,’Inflation forecast targeting: Implementing and monitoring inflation targets’, European Economic Review, vol 41, issue 6. 7  See Batini N. & E. Nelson, ‘Optimal horizons for inflation targeting’, Journal of Economic Dynamics and Control, vol. 25, issue 6-7. 8  A recent example in relation to r* is Weber, A.A., 2006, ‘The role of interest rates in theory and practice – how useful is the concept of the natural real rate of interest for monetary policy?’, G.L.S. Shackle Memorial Lecture 2006, Cambridge. 9  ‘Remit for the Monetary Policy Committee’, letter from Chancellor of the Exchequer, the Right Hon. Gordon Brown, to Mervyn King, Governor of the Bank of England, on 22 March 2006. Available at www.bankofengland.co.uk/monetarypolicy/pdf/chancellorletter060322.pdf.
These ABSs are in the balance sheets of non-banking financial entities (NBFEs) throughout the world, such as hedge funds agencies, or financial vehicles tied to banks, the latter particularly in Europe. Although the main global banks do not seem to be directly and significantly exposed to this component of mortgage loan risk in the US, they do have indirect exposures through credit lines or guarantees to NBFEs and in Europe they also have direct exposure to financial vehicles or conduits that they own. As these ABSs are illiquid, no direct information exists on their market value, which restricts the access to the market for NBFE trade securities that have – or are suspected to have – ABSs backed by sub-prime mortgage loans among their assets. This uncertainty has eroded insurance companies and pension funds’ appetite for buying NBFEs’ trade securities, which has substantially raised costs and reduced access to financing, hindering the renewal of their liabilities. Thus, the central point of this adjustment is located in the ABS-backed trade securities’ market and in NBFEs that have – or are suspected to have – large investments in ABSs backed by sub-prime mortgages. In addition, in face of the difficulties to renewing their traditional funding sources and investors’ redemption claims, occasionally these agencies or funds have been forced to make aggressive changes in their investing and financing strategies by selling off assets, using their commercial banking credit lines, raising capital contributions or resorting to sponsor banks’ guarantees.