For several years the Bank of England and other UK participants in the international fora argued for a major reform of the international monetary system and the IMF in order to address this issue. The gravity of the present crisis demonstrates the urgency of rectifying both of these deficiencies. In the past year the true scale of the risks taken by financial institutions has become painfully apparent. As losses mount it has become obvious that banks did not have sufficient capital to support their inflated balance sheets. Questions about the adequacy of liquidity have turned into questions about solvency. In response, banks have been trying to raise new capital and shrink their balance sheets. The banking system is in the throes of a difficult and prolonged adjustment to much smaller balance sheets relative to their equity capital – or leverage, as it is known. Leverage ratios of large banks remain at remarkably high levels, and the required adjustment will not happen quickly. I know that bankers around the world realise this. The incentives they face to adjust, in whatever way they can, are now overwhelming. With fresh capital from the private sector difficult to obtain, banks have opted to reduce their lending and that is why the flow of credit to all parts of the economy, here and abroad, has been heavily disrupted. And the credit that is still flowing is available only on materially tighter terms and conditions.
In particular, “following periods when inflation has been running persistently below 2 percent, appropriate monetary policy will likely aim to achieve inflation moderately above 2 percent for some time. "6 A second tangible evolution in our approach is that we made explicit that in seeking maximum employment, we are focused on eliminating shortfalls from that goal. We also emphasized the inclusive nature of our maximum employment goal. This means thinking more broadly than the aggregate rate of unemployment and examining the full range of indicators when it comes to assessing shortfalls from maximum employment. Together, these changes position us to deliver on our dual mandate goals in a world of very low r-star and persistently low inflation. What Does This Mean for Policy? My colleagues at the FOMC and I have talked extensively about the nature of these changes and how we drew our conclusions. But, it’s important to apply these decisions to the current situation. The pandemic has presented us with extraordinary and devastating economic circumstances. The good news is that the economy has started to recover and the unemployment rate has come down. About half of the jobs lost during March and April have been regained. Despite these improvements, we are nowhere near where we want to be: the total number of nonfarm jobs is still 10.7 million below February’s level, and the unemployment rate is nearly 8 percent.