Third, banks have many ways they can adjust their business models to meet the new standards as they are phased in. Many of these changes can occur without any risk of disruption to the flow of credit to households and business. For instance, banks can sell nonstrategic assets to investors and can modify their minority investments in non-consolidated interests. Low-quality legacy assets, such as subprime mortgage loans and second mortgages, will mature and run off. Risk-weighted assets will tend to fall as the economy recovers. Moreover, as banks book profits, deferred tax assets will shrink, reducing the magnitude of these future deductions from common equity. Finally, it is important to note the significant potential earnings power of large U.S. banks, which have historically tended to have higher rates of return on their average assets relative to many of their foreign counterparts. Banks that currently are short of the 2019 standard could retain these future earnings to build up their capital ratios. Equity analysts project that the 20 largest U.S. banks will earn more than $ billion in 2010, and consensus estimates expect that figure will increase to around $ billion in 2011. Of course, because these estimates are dependent on an economy that continues to recover, we need to be cautious about relying entirely on as-yet-unrealized earnings as the primary means to meet the higher capital standards. So what about the long-run consequences?
Productivity has also been weak and this has led to rising production costs. The weak productivity appears to be persisting and leads to continued high cost pressures. Resource utilisation measured in terms of the number of hours worked is still slightly higher than normal. However, we expect it to decline. Expectations of inflation have been high, both in the short and long term. At the time of the September meeting they were still above the inflation target. Expectations are an indication of confidence in monetary policy. Both interest rate increases and falling energy and food prices may have contributed to the slight fall. But it is important to remember that inflation expectations are still too high. There is considerable uncertainty regarding commodity prices and global developments and as I see it we cannot sound the all clear yet. To meet the inflation target it is important to conduct a monetary policy that contributes to long-term inflation expectations being close to 2 per cent. My assessment was that a further increase was required to achieve this. When I looked ahead I considered that both inflation and inflation expectations must be closer to the target before expansionary monetary policy can be reconciled with bringing inflation back to 2 per cent within a couple of years. Weaker economic activity is no guarantee that inflation will “automatically” fall. This is connected to, for instance, the risk of contagion effects and the fact that inflation can become entrenched,  6  BIS Review 115/2008  as I mentioned earlier.