1  1  See for example Caballero and Kurlat (2009), “The ‘Surprising’ Origin and Nature of Financial Crises: A macroeconomic policy proposal”, paper presented at the Federal Reserve Bank of Kansas’ Jackson Hole Symposium. BIS Review 119/2009  1  Central banks around the globe cut key rates swiftly and forcefully, in some cases to levels close to zero. In Sweden, the central bank set the interest rate on banks’ deposits in the central bank at negative ¼ per cent. In Norway, it was not appropriate to use instruments as forcefully. But Norges Bank also reduced the key policy rate markedly and rapidly and more rapidly than the inflation and growth outlook alone suggested. Central banks have a long history of dealing with financial crises. The economist and journalist Walter Bagehot formulated as early as in 1873 the principles for central banks’ role in this area: “To avert panic, central banks should lend early and freely (without limit), to solvent firms, against good collateral, and at ‘high rates’.” 2 Bagehot’s principles describe central banks’ liquidity provision in the first phase of the financial crisis – from autumn 2007. Central banks responded swiftly and supplied an extraordinary amount of liquidity through their conventional instruments, i.e. loans against good collateral at a price close to the key policy rate. In most countries, banks also have access to liquidity through automatic drawing rights against the provision of collateral. These facilities are priced at a premium on the key policy rate in line with Bagehot’s advice.
While much has been made of the special relationship between the US and UK, it is not so special that the possibility of a reduction in the pace of additional stimulus in the US warrants a current reduction in the degree of monetary stimulus in the UK. 4  We are not alone in that belief – other major independent forecasters such as the OBR and NIESR share our view that unemployment will be above 7% in 3 years’ time. The MPC’s assessment of the outlook for unemployment and likelihood of hitting the threshold is described in the August Inflation Report, available on the Bank’s website at http://www.bankofengland.co.uk/publications/Pages/inflationreport/2013/ir1303.aspx. 4  BIS central bankers’ speeches  Movements in longer-term market interest rates are certainly relevant, but what matters most to you is what actually happens to Bank Rate, now and in the future. That is because the interest rates on 70% of loans to households and more than 50% of loans to businesses are linked to Bank Rate.5 And it is the Bank of England that controls that rate. We do not intend even to consider raising it before unemployment falls to 7%. When it does reach that point, we will control whether a rise is warranted, taking into account the strength of the recovery and the outlook for inflation. The upward move in market expectations of where Bank Rate will head in future could, at the margin, feed into the effective financial conditions facing the real economy. The MPC will be watching those conditions closely.