If we assume that financial crises would otherwise occur once in every 25 years (an annual frequency of 4%) then a rise in banks capital by 10 of riskweighted assets would be justified if it reduced the probability of financial crises so that they occurred with an annual probability of 3.2%, or once every 31 years. Alternatively, taking the most favourable assumptions on cost (full tax offsets, partial Modigliani Miller offsets, a lower use of bank debt and lower sensitivity of investment spending) the blue line indicates a 10% rise in capital relative to assets would be justified if it reduced the probability of financial crises from 4% a year to 3.9%, or from once every 25 years to once every 25.4 years. (The final column in the table shows that calculation for each case). Such a small decline in the likelihood of a financial crisis would not appear to be overly ambitious for such a sharp rise in the capital ratio. For typical banks the capital ratio starts out from a level under 10%, so that a rise in capital of 10% of risk assets is more than a doubling in the amount of bank capital.
But I do not think that is where we are today. So since I joined the MPC just over a year ago I have not voted to increase interest rates – despite the fact that inflation has more often than not been above the target. But even though price rises over the past year have been running at relatively high levels, the underlying domestic inflationary pressures are not strong. Wage rises – despite a move up in household inflation expectations – remain low. Without a pick up in wage inflation I find it hard to think it at all likely that inflation being significantly above target is sustainable. Of course wage pressures may build significantly over the next year or so, though I do not believe this is the most likely outcome. And risks of an extended period of low growth – which would further weaken those pressures – are real. In talking about the possibility of an extended period of low, or no, growth I may sound blasé about inflation risks. But the point about risks is that more than one can exist. There are risks that inflation stays well above the target level; there are also risks that demand in the economy falls even more below supply capacity so that inflation further ahead drifts below the target. In considering how to balance these risks there is a need to look through short run and potentially transitory factors.