This is an area where the private sector has made enormous advances in recent years, much of it strongly encouraged by the banking supervisors. Risk management has become more sophisticated with more differentiation between risks: the separation of credit and market risk; the recognition of operational risk as a distinct category; and the importance of reputational risk. Notwithstanding that the nature and size of our operations are different and smaller than many private sector institutions, the Bank is exposed to many of these same risks. In managing these risks, we have wanted to ensure that our practices are consistent with best practice in the private sector, to the extent that this is applicable to a central bank. We have invested heavily in technology to allow management of the risks on a consolidated basis and where appropriate in real time. We have also instituted a number of organisational changes, setting up an Assets and Liabilities Committee which I chair and which reviews at senior level the management of our balance sheet; and a Risk Monitoring Department (based in part on the Middle Office model of the private sector), independent from our banking line management. Above this, like public companies, we have a number of Board sub-committees, and in particular an Audit Committee, taking reports from the Internal and External Audit, looking carefully at our internal systems and controls and our policies and processes for management of the main financial, operational and reputational risks.
But since the target is set at 2.5% on a symmetrical basis, the concept of “prudence” cannot be applied in the same way. The result is that we worry as much about being below the target as we do about being above it. And I believe this makes good economic sense: the problems of severe deflation are at least as great as severe inflation. The particular indexed measure of inflation the Chancellor has chosen is RPIX, that is the headline RPI number after excluding - this is the X bit - mortgage interest payments. Some believe that we should move to the Harmonised Index of Consumer Prices (HICP), widely used in Europe and, accordingly, making comparison with Euroland inflation easier. HICP inflation in this country has been running consistently below RPIX by about 1%. This reflects differences in the construction of the index, in particular the treatment of depreciation of property costs. Some have argued - most recently the Engineering Employers’ Federation - that if we moved to HICP, then interest rates could immediately be lowered. But this does not follow. If we moved to a different calculation of inflation, it would seem natural to revise the target at the same time. A 2.5% target for HICP would mean that we are targeting a higher level of inflation than we are at present.