After spiking over the next few months, inflation is, we believe, likely to drop below our 2% target due to the downward pressures from a weak level of demand on wages and prices (Chart 6). But it is then likely to climb back towards the target as the economy recovers. Compared with our previous collective forecast last November, there are differences of nuance in the “most likely” and “mean” paths for growth and inflation, but frankly to my mind those nuances are small beer compared to the main risks. My take on those risks is that, on the downside, the headwinds to demand and activity could prove stronger than currently foreseen. And, on the  1  See Tucker P M W (2009e), “The Debate on Financial System Resilience: Macroprudential Instruments”, Barclays Annual Lecture, London, 22 October, 2009. BIS Review 21/2010  1  upside, that we (and our peers) could prove too slow to withdraw monetary stimulus if animal spirits revive across the economy or further spikes in inflation outturns raise medium-term expectations. Meanwhile, the data are bound to be mixed. Four aspects of the conjuncture Against that background, I shall briefly review a handful of the issues that, one way or another, the MPC will face over the coming months. A balance sheet recession? I have a good deal of sympathy for those who argue that the current downturn owes a lot to stretched balance sheets – in the private sector, public sector, and the national economy as a whole.
The Bank of England’s own November Discussion Paper was only one manifestation. Another is the IMF’s recent review of the macroeconomic policy framework. 11 The basic question is whether the authorities could lean against credit-fuelled booms by tightening capital or liquidity requirements for lenders or, as some economists have advocated, by raising the amount of collateral that borrowers have to put up. 12 In principle, this could be aimed at aggregate or sectoral credit conditions, and it could have a goal of making our banks more resilient. It would need to be pursued by executive agencies under clear mandates from legislators, and it would benefit greatly from transparency. A painful lesson for the Bank of England is that our warnings of “underpriced risk” and system-wide fragilities in our Financial Stability Reports were perhaps admired by some but made no difference. And, alongside our domestic and international peers, we are not in this for plaudits! People – the markets, firms, households – take notice of our Inflation Report, MPC minutes and speeches on monetary policy not, essentially, because they might sometimes be interesting or well done, but for the simple reason that the MPC is the body that sets sterling interest rates in the real world. If the authorities were able to deploy credible macroprudential tools, their stability warnings would probably be taken more seriously in future, because they would be able to follow up words with actions. Monetary policymakers would need to be attentive to the use of such instruments, as they would affect credit conditions.