To develop a robust rebalancing strategy, we must understand why there are other, also highly competitive investors, who take the other side of these trades. We also need to understand our own edge, the comparative advantage – or disadvantage – of the size, time horizon, and governance structure of the fund. These issues are all intimately linked to questions on the research frontier of financial economics. So far, the rebalancing strategy has served the fund well. From 1998 to 2011, around 0.5 percentage point – a considerable portion – of the total annual return can be attributed to rebalancing. We believe rebalancing will also be important going forward, but we need to further deepen our understanding of time-varying expected returns and risks. The other main topic of today’s conference – well-functioning markets – is also of particular interest to us. Without well-functioning markets, the massive reallocation of wealth from oil in the ground to a claim on a small share of future global output would not have been feasible. Well-functioning financial markets are also, through the allocation of real resources, important for sustained growth at a global level. The financial crisis displayed great challenges related to how the markets function. We saw mispricing of risk, and the difficulties of managing financial imbalances. Other problems were related to liquidity. Trading of fixed income instruments take place at the desks of the large investment banks. The problems of these banks in September 2008 implied a literally closing of the main fixed income markets.
In the case of this country these adverse international influences really began to affect us just as overall demand was already weakening in response to the earlier monetary, and incidentally fiscal, tightening. The result was a very sharp decline in industrial – especially manufacturing – confidence, and widespread, and often exaggerated, fears of recession, which in turn appeared to undermine consumer confidence. The slowdown – or soft landing – we had been consciously seeking to engineer threatened quite rapidly to become a much sharper decline – or harder landing – than we had either expected or needed. And that, of course, is why we promptly changed our monetary policy stance as we did, cutting interest rates by 2% to 5½% in the space of five months. In doing so, we have demonstrated that the inflation target is – as we have frequently said it is – symmetrical, so that we would be at least as determined and aggressive in cutting rates if we thought we were likely to undershoot the inflation target as we had been earlier in raising rates to avoid an overshoot of the inflation target. So, where do we go from here? I would strongly advise you to regard anyone who claims to know with any great certainty where we go from here with the gravest possible suspicion. Forecasting the economy is very definitely an art rather than a science – though some artists craft their work rather more carefully than others.