BIS Review 11/2005  1  Low inflation is not in itself a solution to problems like this. But it is a pre condition for solving them. Merseyside had bad luck to be confronted with more economic change in the second half of the twentieth century than most people could cope with at the time. Liverpool never lost its sense of humour, though there were times when it came close to losing its way. Sadly, you can’t laugh your way out of economic decline. High inflation and economic instability fostered the wrong climate for taking the long term decisions that were needed to give Merseyside a new future. The levels of economic inactivity and social deprivation that you are still grappling with today are in part legacies of the 1970s and 1980s, when the sharp ups and downs in inflation, interest rates and national output made it much harder to adapt to structural economic change at the regional level. But more recent success in delivering low inflation and economic stability has created a much better climate for you to succeed. Economic regeneration can’t get off the ground without inspired local leadership, and committed local partnerships. But even with them, it is a long haul to make the investments in infrastructure that modern businesses expect. And so called soft investments – in people, skills, and communities – are even more of a challenge. Low inflation and low nominal interest rates matter to you because they provide a sound foundation for just this kind of long term planning.
The other key uncertainty concerns the speed with which inflation will pick up. Consumer price inflation remains below the Government’s 2% target but there are good reasons to expect it to rise over the next few years. Input cost inflation has risen sharply, and import prices are not falling as much as they were. We think there is very little slack in the economy. The labour market is certainly tight. But the  2  BIS Review 11/2005  growth in labour costs has been surprisingly muted, and some cost pressures have been absorbed by lower profit margins. How long can this last? At present we think inflation is likely to rise above target sometime next year, though we judge the risks to be somewhat on the downside. But it’s a difficult call, and our judgement about the balance of risks will be influenced by the way the data shape up in the coming months. The MPC faces a familiar dilemma, torn between the importance of well grounded analysis and the need to act promptly. On the one hand, there is a case for waiting for more evidence on the issues that underlie these risks – as there almost always is; on the other hand, since interest rates take a year or more to affect the economy, we need to be pre emptive, to head off trouble at the pass so to speak, even at the risk of sometimes taking the wrong decision.