An investor such as the Government Pension Fund – Global will earn more in the long term because of wide fluctuations in equity values. Many investors have suffered losses on equities. As a result of this experience, required returns will be higher in the future. Under the Fund’s investment strategy, more equities are purchased when equity prices fall and fewer when prices rise. Thus, the Fund purchased a large volume of equities in the period 2001-2003 and is buying a considerable volume now. Of the equities now held, 40 per cent were acquired in 2008 when prices were falling. The Fund’s average ownership share in international equity markets was ¾ per cent at the turn of the year, with allocations to equities accounting for close to 50 per cent at that time. The Fund has a longer investment horizon than the vast majority of other market participants. The important question is therefore how sound today’s investments prove to be in the long term. The government now owns a fair share of the global business sector. This represents real value that will provide a return reflecting both global economic growth and the risk related to fluctuations in equity prices. The financial crisis is having a broad impact and most forms of investment are falling in value. State ownership in the Norwegian business sector and its share of subsea petroleum reserves on the continental shelf have declined in real value. For large investors, there have been few places to hide from the panic that has gripped financial markets.
Certainly I seriously underestimated the scale of the downside risks from a potential financial crisis, and that implied overrating the ability of monetary policy to offset this shock. I will return later to the question of how a more long-term perspective might sometimes alter the desirable approach to policy. Before that, I want to discuss some issues around the MPC’s inflation projections and how we assess uncertainty. The balance of demand and supply The MPC’s projections for inflation, absent external shocks, are determined to a significant extent by our judgements about inflation expectations and about the likely developments in the pressure of demand on supply (this phrase is a better description than the more usual “output gap” – however I will now use the latter as a convenient shorthand). During my stint  4  Large (2005). 5  Gieve (2009). 2  BIS Review 27/2010  on the MPC, the way in which we have chosen to assess the output gap, as reflected in the assumptions underlying our main macro-model, has changed on a number of occasions. Of course, one model has never been the sole guide to our projections – a number of other models are also drawn on as appropriate. And the final shape of the fan charts published in the Inflation Report is the product of the MPC’s judgement including on the insights from these models.