Alternatively, that can be thought of as being equivalent to a fall in the real risk-free rate of interest that would equilibriate supply and demand. 11 Taken on its own, this rather leans against the proposition, advanced by a number of commentators, that monetary conditions are loose on the grounds that deducting CPI inflation of between 4 and 5% from a Bank Rate of 5% leaves a “real rate” close to zero. First, as I have been arguing, it is vital to take into account the possibility that the real rate warranted in the current conjuncture has fallen. Second, headline CPI might not be the best deflator for calculating the relevant real rate of interest. CPI may not necessarily be the price – the “own real rate” – relevant for individual households’ and businesses’ spending decisions. 12 For example, firms’ investment might be more dependent on the price of capital goods. Despite the pickup in oil prices, the pace of inflation for capital goods has been much lower than for CPI. So that might suggest a correspondingly higher real rate for businesses than one based on CPI (Chart 4). A similar question could be posed about the real rate facing households, given that the CPI currently excludes the costs of owner occupation. So one can safely conclude that it is not all straightforward at present to calibrate monetary conditions. For researchers, that underlines the importance of renewing work directed at gauging monetary conditions.
If the channel is thought to work through broad money, as transactions balances, 22 then of course it is the supply of bank lending that matters. Essentially, when “liquidity” is plentiful, it may be undervalued. That may build a bridge to the literature on how the supply  18  See Cochrane, J, “Financial Markets and the Real Economy. 19  See Tucker, PMWT “Reflections on Operating an Inflation Target”, Bank of England Quarterly Bulletin, 2006 Q2 pp 212-224. 20  See Tucker, PMWT (2007) “A perspective on recent monetary and financial system developments” Bank of England Quarterly Bulletin 2007 Q2 pp 310-316. 21  Including the current G of the BofE and myself; see King, M (2002) “No money, no inflation – the role of money in the economy” Bank of England Quarterly Bulletin 2002 Q2 pp 162-177. 22  See Thornton, D. L, (2008) “Monetary policy: Why monetary matters and interest rates don’t”, Federal Reserve Bank of St Louis Working paper 2008-011. 10  BIS Review 112/2008  of credit from the banking sector can influence the liquidity of asset markets. 23 This echoes my earlier discussion of the potential utility, as indicators, of the data on money and credit quantities when the degree of credit rationing shifts. We’d do better at making sense of those issues if we had a better understanding of the determinants and macro-significance of risk premia in the first place.