In the case of the DWF, we lend securities (gilts) that are eligible in our OMOs, so they can be turned into cash either in the market or via our repo operations. But, in its usual mode of operation, the DWF does not directly affect the Bank’s aggregate supply of reserves. 15 Indirectly, it may even reduce the demand for reserves, as it gives sound banks a source of liquidity insurance separate from holding precautionary balances with the Bank. By contrast, the wider-collateral LTR OMOs do inject reserves. For a given monthly reserves target, that means that, other things being equal, the Bank has to reduce the size of its weekly short-term OMOs, in order to ensure that its net supply of reserves is equal to the target; otherwise overnight rates would sink below the MPC’s policy rate. But when, as during the current crisis, the scale of wider-collateral repos is massively increased, reducing short-term repos to zero is not always enough to achieve our monetary objective. The Bank of England has therefore introduced the sale, via auction, of very short-term Bank of England bills to drain excess (ie above target) reserves from the market. That has enabled us to make a very significant (order of magnitude) discretionary increase in our cash-liquidity insurance without cutting across monetary policy. (In my view that is preferable, on technical and presentational grounds, to draining the market by HMG depositing with the Bank the proceeds of increased Treasury issuance, which could be confused with deficit-financing operations.)
While labour supply in these countries will remain abundant, it is not all that clear whether it will remain cheap. Indeed, we are currently seeing  1  Speech by Charles Bean, “Globalisation and Inflation”, to the LSE Economic Society, 24 October 2006. BIS Review 103/2007  1  an increase in export prices in emerging countries, which translates into higher import prices for developed economies. This inflationary impact seems to have grown over the past few years, while, by contrast, the disinflationary impact of globalisation seems to have slowed down. Going further, some analysts have suggested that, because of capital market integration, real interest rates will equalize around the world, thus reducing the ability of national Central Banks to control inflation. However, this need not be true. Indeed, the classic MundellFleming analysis concludes that monetary policy should be more effective, rather than less, in the case of international capital mobility, although it can operate through different channels of transmission including the exchange rate. But inflation is more than the direct result of macroeconomic shocks. It is a process in which business cycles as well as expectations play an important role. Has this process changed? A change in the output – inflation trade-off? Inflation dynamics have changed over the past fifteen years or so. Inflation persistence has declined, or, in other words, upward changes in the path of prices have become more temporary and easily reversed. Also, inflation itself has become less responsive to shocks. Both are very welcome developments for monetary policy.