Protecting the cycle from the banks In my view there is a case for taking this further and adopting the more ambitious goal to use regulatory requirements to smooth out the credit cycle. In other words, preventing the imbalances within financial markets destabilising the real economy. This would involve varying the regulatory requirements to stabilise the supply of credit and the terms on which it was granted – for example by requiring banks to hold more capital when they would otherwise be loosening credit conditions, and allowing banks to run down capital when they would otherwise by restricting access to credit. This approach could offset  BIS Review 21/2009  11  to some degree not just a domestic credit cycle but the impact of developments elsewhere in the global economy which affect the terms on which banks are able to raise funds in financial markets or the he value of their assets. To a limited degree this would allow the authorities to make the banking system a shock absorber. Policymakers would be raising capital requirements to preventing shocks that occur outside the banking system from destabilising the real economy. But I would limit the goal to smoothing the credit cycle and would not be inclined to go further and use it as a general stabiliser of the economy. Weapons in the arsenal So what is the choice of instruments? I see great attractions in “dynamic provisioning”, in other words amending the accounting system to recognise likely future losses.
It is crucial in a period of economic hardship – with companies going to the wall and people losing their jobs – that people do not think the Bank is focused on a narrow inflation target for its own sake. If they feel that we are not accepting responsibility for what happens to growth and jobs, they will look for someone else to do so. If we want to preserve the framework we have a job on our hands – now more than ever – to explain our strategy to the general public. The Bank and MPC need to convince them that the policy we are pursuing is the best way of restoring growth and full employment without reawakening inflation. Indeed it is by bringing output back to potential that we will bring inflation back to target. Secondly, I share the view that setting a target for a measure of consumer price inflation which excludes the costs of home ownership has done us no favours. It is widely recognised as a flaw in the harmonised CPI across Europe but it is of particular significance in the UK given the critical role that home ownership plays here in household budgets and wealth. Something needs to be done to remedy that situation, and if progress can’t be achieved at a European level I think we ought to consider going it alone. More fundamentally, if inflation targeting by an independent central bank is an essential foundation of policy, it is pretty clearly not sufficient on its own.