Paul Tucker: A few remarks on current monetary policy in a rebalancing economy Speech by Mr Paul Tucker, Deputy Governor for Financial Stability at the Bank of England, at The Joint 1900/City Club Lunch, London, 22 November 2011. *  *  *  The outlook for economic activity has deteriorated over the past few months. The MPC has responded with a further round of quantitative easing to underpin demand, and so reduce the chance of inflation undershooting our target in the medium term. Monetary credibility: accommodating the price level shocks Our ability to provide and sustain that stimulus depends absolutely on the credibility of our commitment to the 2% inflation target. If our credibility were to slip and medium-term inflation expectations were to rise, we would have to run with a tighter monetary stance than otherwise in order to put the genie back into the bottle. The Committee’s most important judgment over the past year or so has, accordingly, been that the elevated rate of inflation, now about 5%, is temporary. We have had conviction in that judgment because of the observable upward impulses to the price level from sterling’s depreciation, the VAT increase, and the rise in commodity prices. There is occasionally a rather odd debate about whether the MPC could have avoided the consequent increase in inflation. Big picture, the answer is that we could have done, but we chose not to. We have, in effect, accommodated something like half of the cumulative impulse to the price level.
Rebalancing: impediments We recognise that the stimulus we have provided risks slowing further progress with the necessary medium term rebalancing of the economy. Rebalancing will not, in any case, be easy. The composition of demand in the UK was imbalanced for so long that the productive capacity of economy is unbalanced. Crudely, the balance of aggregate demand needs, over the medium term, to shift away from household and public consumption towards net trade and investment. Up to a point, some of that has already happened. But domestic monetary expansion will work partly through deferring some of the restructuring of household balance sheets, underpinning consumption. And, looking ahead, the greater question is whether rebalancing can be sustained as and when the economy returns to “full employment”, ie when the economy’s spare capacity is utilised again. Rebalancing is already impeded by tight credit conditions. Although our banking sector has done much to strengthen capital and liquidity over the past few years, it would still have ground to cover in rebuilding balance sheets even if the external environment were more propitious. With instability from the euro area crisis threatening the UK, our banks cannot avoid being exposed to outsized risks. That is reflected in elevated funding costs, which they pass on to their customers to a greater or less extent. The gradual improvements in credit conditions seen until the summer, and documented in the Bank’s quarterly Credit Conditions Survey, have been arrested for now.