Exogenous changes  0.5  in firms’ pricing power are one example – so-called cost-push shocks. Shocks to the exchange rate, the  0 Source: Bank calculations. economy’s supply capacity, or commodity prices also  10  See Blanchard, O., and J. Galí (2007). "Real Wage Rigidities and the New Keynesian Model". Journal of Money, Credit, and Banking, 39(1), pp. 35-65. 11 See Broadbent, B (2013), “Conditional guidance as a response to supply uncertainty”, speech at the London Business School. 6  All speeches are available online at www.bankofengland.co.uk/publications/Pages/speeches  6  Chart 2: … whereas after the financial crisis, the economy experienced a challenging monetary policy trade-off  have this flavour. 12  Because monetary policy’s  influence on inflation is predominantly an indirect one, via demand, in such circumstances inflation can only  Financial crisis and after  6  Inflation (%)  be controlled by delivering an opposing movement in aggregate spending. If something pushes up on  5  inflation directly, monetary policy can only bring inflation back down by causing a reduction in  4  spending via higher interest rates. The speed with 3  which this adjustment is delivered is determined by the monetary policy maker guided by their remit.
Bluntly, the challenge is how to sustain the provision of financial services during a crisis without the state bailing out uninsured creditors. BIS Review 33/2010  1  Handling LCFI complex derivative/trading portfolios Some types of business activity, particularly complex trading, do not lend themselves at all well to the standard resolution tools I summarised just now. Not least, unwinding a derivatives book is especially complicated; it typically requires dynamic hedging to preserve value, and that would be very hard indeed in a liquidation. Counterparties flee. Funding flees. The Lehman and AIG experiences demonstrate this. So, in a different context, does the time it took Berkshire Hathaway to wind down the complex derivatives portfolio of its Gen Re subsidiary; years, not months. What can be done? One route, suggested by those examples, would be for the authorities to finance the wind down of complex trading positions, in what would be in effect an analogue to US-style debtor-in-possession financing. The authorities would be preferred creditors. That kind of approach could be used either briefly, in order to bridge to an insolvency procedure, which would amount to putting a framework around the kind of operation the NYFed mounted for a week or so to contain disruption from the failure of Lehman’s US broker-dealer. Or, alternatively, it could in principle be used over a prolonged period, to finance the run off of a whole book.