The immediate task was to repair the banking system so that it would not be crippled by future economic shocks - forcing it to cut back sharply on credit supply. We now have standards in place that ensure banks can keep lending through economic shocks more severe than the financial crisis. Next was to guard against the financial system enabling other parts of the economy to become too highly indebted. It’s well established that high levels of mortgage debt magnify economic downturns as high-debt 2  households cut back sharply to keep paying the mortgage. That’s why we’ve set limits on high loan to income mortgage lending. Because we are tasked with achieving a general outcome, not with implementing a specific rule book or even a set of principles, we have a duty to adapt regulation as risks change and the financial system evolves. We must fight the next war as well as the last one. The Brevan Howard Centre’s own mission statement is clear on this: “Future research may show that the current focus on capital and liquidity regulation is inadequate. Among the topics that require further research are panics, asset price bubbles, contagion, deficiencies in the financial architecture, and foreign exchange mismatches.”  1  Financial crises often lead to a long-run reduction in GDP, with a persistent decline in output relative to pre-crisis trends. Staff estimates based on the impact of historical financial crises in a sample of advanced economies, reported in Brooke et. al.
And it is interesting to note that within the past year both the Federal Reserve  BIS central bankers’ speeches  5  and the Bank of Japan have adopted a target for annual inflation of 2%. The anchoring of inflation expectations has been the most successful aspect of the inflation targeting regime and it has allowed the Bank to avoid an unnecessarily damaging tightening of policy in response to short-run movements in inflation. It would be irresponsible to lose that. Second, the inflation target is not an impediment to achieving recovery today. It has not prevented the MPC from taking measures to combat the downward momentum in the economy following the shock of 2008. It is precisely because inflation expectations have so far remained firmly anchored that the MPC has been able to respond flexibly to weak demand. So the challenge we face is not the inadequacy of the framework, but the fact that there is no easy route to recovery after a major banking crisis. Recovery is inevitably slow and protracted. The healing process will take time, and patience is not a quality associated with our political debate. Patience and a sense of realism are sometimes mistaken for fatalism. Our economy is recovering, more slowly than we might wish, but we are moving in the right direction. The Bank has not been, and will not be, inactive. Low interest rates will not be withdrawn prematurely, but we should not rely solely on general stimulus to aggregate demand.