Jon Cunliffe: The UK economy post crisis – a series of unfortunate events? Speech by Sir Jon Cunliffe, Deputy Governor for Financial Stability of the Bank of England, at the Centre for International Business Studies, London South Bank University, London, 24 February 2016. *  *  *  There is a well-known myth – much loved in management schools – that if you put a frog in boiling water it will jump out; but if you put it in cold water and bring the water very slowly to the boil, its nervous system will not register the temperature change and it will be boiled. I am assured by zoologist friends that it is indeed a myth. Frogs sense gradually changing temperatures like the rest of us. But it is an instructive parable. Sometimes when you focus on incremental changes you can forget the big picture until the water has become very hot – or very cold. The Monetary Policy Committee (MPC) meets every month. We assess a very wide range of changing data – for the world and the economy is constantly changing. The past usually becomes clearer but the future is always uncertain. So as a policymaker occasionally it is worth standing a long way back and asking “What did I expect to happen last year and the year before? And what can I learn from what actually happened?”. And, crucially, “Have I been lulled by the ever turning kaleidoscope of data and missed a change in the big picture?”.
The risk here is that when the current external disinflationary pressures subside, domestic cost growth pressures will have built up and will push inflation above target before monetary policy can restrain it. I would not discount this risk. The labour market has clearly become much tighter. And if pay is being held down by cyclical or scarring effects, these could change quickly. And there has been a substantial depreciation in sterling in the past three months which will push up on inflation, possibly more quickly than the usual prolonged lag between changes in the exchange rate and inflation. But with interest rates near the effective lower bound, with powerful disinflationary forces from abroad likely to persist for the next year, with low growth in unit labour costs and with an economy growing at around 2%, I think this is the lesser risk. Second, there is the concern that continued low interest rates lead to the build-up of financial stability risks through an acceleration of credit growth, increase in bank leverage and household indebtedness. The financial system has only recently come back to life with economy-wide credit now growing in the UK at around the rate of GDP. While there are some elements of credit that are growing more strongly, such as buy to let mortgages and unsecured debt, I think we are now emerging from the post-crisis phase and in a more standard stage of the credit cycle and we now have macroprudential tools to manage risks as they build up.