House-holds became more interested in borrowing at the same time as the inflation-targeting regime gained increased credibility and the future became  2/5  less uncertain. As it became possible to lower real interest rates, borrowing became cheaper. Low and stable inflation expectations also meant that in the long run households could count on nominal interest rates being lower than before. It is conceivable, moreover, that the low-inflation regime has enabled households to borrow more on account of low interest expenditure. Can there be a setback for consumer demand later on? Thus, neither the high level of debt nor the high house prices are considered to constitute a threat to the banking system. But could households’ inflated balance sheets tend to subdue consumption and growth later on? Is there a risk of households being forced to cut back sharply on consumption when interest rates sooner or later move up? And how will rising interest rates affect house prices? Will the decline in household wealth (in the form of housing) that could result from higher interest rates lead to decreased consumption? These are questions we try to take into account when assessing the economic outlook on which monetary policy is based. There are no simple answers here either; as always, the decisions have to rest on assessments. Most things suggest, however, that the adjustments we can foresee after a future increase in interest rates belong to the normal transmission mechanism and will therefore occur in orderly forms.
Market-based finance has grown rapidly and not been subject to the same regulatory scrutiny as banks. And as monetary  Page 9  policy makers gradually implement QT, financial markets will adjust, perhaps in unexpected ways[26]. This is a key motivation for our upcoming non-bank exploratory stress scenario, and an ongoing area of focus for us and international counterparts. How we work – and the need for diverse policymakers Finally I’ll say a bit about the different ways the two committees work, and how you might fit in. As I said, the MPC is older with more measurable objectives. That is reflected in the kinds of analysis it uses. It has a well-established forecasting process, which takes in new data to update its projections for the economy. Supporting the forecast are many models, some of them fancy ‘general equilibrium’ setups that account for interaction between different parts of the economy[27]. Of course that’s not to say there are no unsettled questions in monetary policy, but there is a good deal more theory and practice around its conduct. The FPC is not quite in the same position. We certainly receive lots of in-depth analysis from Bank staff, often drawing on data and models. But our objective is harder to measure, and we have fewer models that tie everything together. Partly that’s because the ‘science’ of financial stability is still in its early years. We need to focus on worst-case outcomes, so have less data to work with than monetary policymakers.