I said just now that I wanted to address two questions, the first of which was why the subject is so important. Well, in this murky and difficult area, there is perhaps one aspect which commands a fair consensus, which is that financial crises, specifically banking crises, produce real economic costs. There are the immediate direct costs to the public sector if crisis-hit banks require lender of last resort support or have to be bailed out, and longer term costs to growth. There is a lively debate on how to measure the latter, which I hope we can take further during this conference, as one of the papers is addressing this very subject, but I would describe the range of estimates in some countries as starting at large and ending at very large indeed. Interestingly, on some measures, the longer term output costs seem to end up higher in developed countries than in emerging market countries, in the main we think because crises in developed countries have typically dragged on for long er. On top of evidence about the impact of financial instability, there is also evidence that the incidence of banking crises has become more frequent over the past 20 years. In fact four out of the G-10 countries have suffered a banking crisis of one sort or another in the last ten years. It is thus clear that financial instability remains a hugely relevant topic to both developed and emerging market economies.
On the other hand, since the inflation forecast is not only an important internal decision-making tool, but also a crucial communication device, market participants have a good knowledge of the central bank’s forecast and can compare their own view on the economy with the central bank’s one. This implies that both the central bank and the market are well informed about each other’s forecast. It is clear that a huge portion of uncertainty is inherent to any practical forecasting. Moreover, from the monetary policy perspective this uncertainty is complicated by the fact that the results of today’s monetary policy action will be effective with a significant lag. On top of that, from the economic theory we know not only that today’s monetary policy decision is important, but also that the expectation about future monetary policy has an important impact. With a certain degree of simplification we can state that in general any future value of inflation depends on three main factors. These are the current state of the economy and its underlying inflationary pressures, current and future monetary policy actions and, of course, future economic shocks. Consequently, the surrounding uncertainty can also be divided into similar parts. Let me first shortly address the last point, something we can call the “shocks” uncertainty. It is necessary to admit that both today’s central bank forecast and today’s central bankers’ decision are deterministic from this point of view.