First, how much comfort should we take from the recovery seen so far and what factors are likely to determine its future vigour? And second, to what extent are the Bank’s planned new responsibilities for macroprudential policy likely to address the “missing instrument” problem exposed so painfully by the financial crisis? I will conclude with some reflections on monetary policy. The recovery so far There has been a strong start to this recovery. After four consecutive quarters of growth, the pace of the recovery to date compares favourably with previous episodes: output is  BIS Review 161/2010  1  estimated to have grown by 2.8% over the past year, quicker than at the same stage of either the 1980s or 1990s recoveries. Some encouragement can also be taken from the composition of growth. Spending by households and businesses has begun to pickup; this despite strains on private sector balance sheets, muted disposable income growth and an impaired banking system. Over the past year, this increase in private sector spending has helped offset a weaker net trade performance, which has been particularly disappointing given the early and substantial depreciation of sterling. However, it is too soon to say we are out of the woods. Economic recovery has to be judged in terms of the level of output, not the rate at which it is growing. It is the level of households’ incomes that determines their well-being. And it is the level of economic activity which governs companies’ profitability and their viability.
I will return to the monetary policy implications of this growth outlook in a while. The missing instrument problem But before doing so, I want to report on the progress that has been made in strengthening the macroeconomic policy framework in the UK in response to some of the fault lines exposed by the financial crisis. Much analysis and soul searching has been conducted in the aftermath of the crisis, and the lessons and implications for different aspects of economic, financial and other areas of public policy are wide ranging. In terms of the lessons to be learnt for monetary policy, many commentators and policymakers – myself included – told a variant of what could be termed the missing instrument problem. 3 This analysis argues that the case for an inflation targeting framework remains sound: the focus on a clear numerical target for monetary policy has served our  3  4  Dale (2009). BIS Review 161/2010  economy well, and low and stable inflation remains a cornerstone of our long-term prosperity. However, it acknowledges that control of short-term interest rates – the main tool of monetary policy – is a relatively blunt instrument best deployed maintaining a broad balance between nominal demand and supply. In particular, movements in short-term interest rates are not well suited to managing risks from credit cycles and other imbalances within the financial sector.