The rapid growth across most large emerging market economies (EMEs) in particular has fuelled global demand for raw materials, which in the short term are in relatively fixed supply, pulling their prices upwards. In August, oil prices were up 60% higher than a year earlier, wholesale gas prices were up 90%, and food prices 40%. These sharp increases in costs have fed into food and petrol prices and passed along the supply chain, driving up the prices of other goods including in particular household gas and electricity bills (Chart 2). But so long as the prices of wholesale energy and foodstuffs on global markets stabilise at their new higher levels, their direct impact on inflation should wash out after a year. In other words, by late 2009 these items would not be making any contribution to the rate of consumer price inflation: whereas, at present, they are contributing almost 3 percentage points. Moreover there are some signs that the commodity cycle may have turned down. Since the peak in July, the price of food has fallen by 10% and the price of crude oil has fallen by over a quarter, and that is consistent with other indicators that point to a slowing in growth in both emerging and advanced economies. That good news on commodity prices has been offset somewhat in the UK by a falling exchange rate. Sterling has been trading at around 1.8 against the US dollar – a year ago it was 2.0.
But with hindsight, seen across the world as a whole, there was a case for somewhat tighter monetary policy to prevent the demand for resources outstripping supply (although I would note that our interest rates have been consistently higher in recent years than those elsewhere in the advanced economies). The rise in oil and food prices has appeared as an external pressure on each country on its own but it is not external to us all collectively. A particular problem here – that has yet to be resolved – is the expansion of the dollar bloc. The emerging economies were importing loose monetary policy, which scarcely seemed appropriate to their domestic conditions. However it is hard to believe that a somewhat tighter monetary policy would have been guaranteed to head off the credit boom and subsequent crunch altogether. Put another way, monetary policy is a blunt instrument. To prevent excesses in financial markets, we might have had to generate an unnecessary slowdown in the real economy. I share the view therefore that we have to look for new regulatory measures to complement interest rates. There are a number of specific lessons on regulation which have already been identified. The FSA, for example, is already strengthening its prudential supervision. And internationally, we need to fill gaps in the current framework – for example on mortgage origination in the US, increasing the capital requirements for some credit products and loan commitments, and ensuring that investors and rating agencies assess new products more diligently.