samchain/econo-pairs-v1 huggingface dataset:
Sea change Speech given by Mark Carney, Governor of the Bank of England  Local Government Association Annual Conference and Exhibition 2019, Bournemouth 2 July 2019  I am grateful to Clare Macallan and James Benford for their assistance in preparing these remarks, and to Charles Gundy, Emil Iordanov, David Glanville, George Rodger, Alison Schomberg, Anina Thiel, Mo Wazzi and Gabija Zemaityte for background research. 1  All speeches are available online at www.bankofengland.co.uk/news/speeches  It is a pleasure to join this Local Government Association (LGA) conference. The LGA supports councils across the country as they deliver local solutions to national problems, helping them to build the skills they need and ensuring the voice of local government is heard at the national level. My only regret is not being able to enjoy the beaches for which Bournemouth is rightly famous. The closest I will get is using a nautical analogy – a sea change. A sea change is a profound transformation. The term was originally coined by Shakespeare in The Tempest, of which there are five productions across Dorset this summer.1 These productions will mix tragedy and comedy in a play whose themes range from magic and creation to betrayal and revenge. My focus is more limited and prosaic – but also more immediately relevant to your work. In recent months, there has been a sea change in financial markets driven by growing concerns over the global economic outlook.

11  13  All speeches are available online at www.bankofengland.co.uk/news/speeches  13  Global developments, Brexit and UK monetary policy Now consider the implications of global developments for the outlook for UK inflation and growth Unlike many other jurisdictions, inflation in the UK is currently at the MPC’s 2% target, the labour market remains tight with wages and unit labour costs growing at target-consistent rates, and inflation expectations of UK households and businesses remain well-anchored. The UK outlook also continues to be shaped by Brexit. Until the turn of the year, the UK economy had been growing around its trend rate. As the MPC had anticipated, this year increased Brexit uncertainty is causing volatility in the UK data. Output increased by 0.5% in the first quarter of this year, boosted by an important contribution from companies bringing forward production to build stocks ahead of the potential 29th March cliff edge. Growth in the second quarter will be considerably weaker, in part due to the absence of that stock building effect and Brexit-related, temporary shutdowns by several major car manufacturers. 12 Recent data also raise the possibility that the negative spillovers to the UK from a weaker world economy are increasing and the drag from Brexit uncertainties on underlying growth here could be intensifying. The latest surveys point to no growth in UK output. Looking across the first half of the year, in my view, underlying growth in the UK is currently running below its potential, and is heavily reliant on the resilience of household spending.
The element that marks a growing concern with regard to restrictiveness relates to the capital of banks. Clearly, the considerations in respect of the need to replenish capital are starting to exert a strong influence on the decisions of banks to grant new credit. This dynamic is worrying. It indicates that the banking system is interpreting the new regulations restrictively for credit. This approach is undesirable and out of line with the objectives so far followed by the economic policy authorities of supporting the financial system, not as an end in itself but as an essential function of savings intermediation. The outcry surrounding the effects that future capital standards and risk management – the so-called “Basel 3” – will have on credit developments in the short term seems unjustified. The new rules are specifically intended to ensure a more orderly and sustainable flow of credit, not a reduction. Moreover, as I said earlier, a gradual process of adaptation to the new requirements is foreseen. The new capital requirements may be attained in two different ways, although they have opposite effects on banking activities: reduction in banking activities, particularly in credit to firms, on the one hand, and capital increase on the other. The alarm that seems to be widespread in the banking sector concerning the new rules seems to mask the intention of adapting to them via a reduced exposure to the real economy, rather than via a capital increase.

Moreover, the originate-to-distribute model was adopted not only by large institutions but also by others, such as Northern Rock, which were not equipped to deal with funding sources considerably more volatile than traditional sources, such as deposits. Recourse to wholesale markets contributed to exacerbating credit pro-cyclicality, with more abundant credit in periods favourable to markets but also greater vulnerability in the case of  GDP ratio, the variations in the long-term interest rate and the house price/equity price gaps can signal asset price busts that are likely to occur in the next two years. 4  Syndicated loans extended to finance LBOs in the euro area reached an annual sum of almost € billion around mid-2007, and in the 2005-07 period loans to finance LBOs constituted around 13% of the total syndicated loan market compared with around 6% both before and after the boom years, based on data from Dealogic. 5  The Tier 1 ratio fluctuated around 8% and the total capital ratio around 11%. See the ECB’s Financial Stability Review, December 2007. 6  See also the box entitled “Developments in MFI loans to non-financial corporations by industry” in the December 2009 issue of the Monthly Bulletin. tighter markets conditions. This problem is not new. The crisis affecting savings and loan undertakings in the United States also originated in the differing maturities of bank assets and liabilities, which gave rise to risky activities in the junk bond and derivatives markets.
Chart 1  Chart 2  Inflation close to target despite protracted Lower bond yields not always associated decline in short term interest rate with higher equity prices  2  Note: * adjusted for changes in leverage Source: Bank of England and ONS  Source: Bank of England and Datastream  The decline in the natural rate of interest At around the time that inflation targeting began, the economist John Taylor proposed a simple representation of rate-setting by the US Fed – the so-called “Taylor rule”. This suggested that variations in real short rates were well explained, empirically, by movements in the “output gap” and inflation. Allowing for these real short rates looked relatively stable. The word “rule” wasn’t meant prescriptively. In this context it simply meant “reaction function” – a description of the way US policy rates had in practice, and over a particular period of time, responded to the economy. But as the concept took hold, many began to interpret the relationship not just as a description of what central banks had been doing but as an indicator of what they should do. In particular, the Taylor rule cemented a view that only cyclical factors could justify deviating from a particular level of the policy rate.

In this respect it’s interesting to look at a passage from Keynes’s Treatise on Money, written in the teeth of the Great Depression in December 1930: We cannot hope for a complete or lasting recovery until there has been a very great fall in the long-term rate of interest throughout the world … Yet [that] is likely to be a long and a tedious process, unless it is accelerated by deliberate policy. Of specific remedies two [are] appropriate. The Bank of England and the Federal Reserve Board might reduce the rate of  4  4  A policy surprise is defined here as the difference between the announced Bank rate and a proxy for market expectations embodied in meeting-to-meeting interest rate swaps on the day of the MPC decision. BIS central bankers’ speeches  interest to a very low figure, say ½ per cent. At the same time these institutions should pursue open-market operations à outrance. That is to say, they should buy long-dated securities either against an expansion of Central Bank money or against the sale of shortdated securities until the short-term market is saturated. So QE certainly isn’t a novel idea (in fact the US Fed conducted large scale asset purchases in 1932, something that Milton Friedman5 later suggested was critical in stabilising the economy later that year). And, as Keynes suggests, the purpose was to “accelerate” a decline in long-term interest rates that would otherwise have been a “tedious” process.
But what is driving the growth of London in particular? One approach to this question is to ask executives in major financial companies, both in the UK and abroad, why they choose to locate business here. A number of these surveys have been conducted recently and they show several common factors. 11 London benefits from English as an international language of commerce, and from its time zone, which means the working day overlaps with Asia in the morning and America in the afternoon. London also has well established financial infrastructure and telecommunication networks. Many of those surveyed point to the regulatory and legal environment. This is partly a matter of the regulatory style – the “risk based and proportionate” approach that the Financial Services Authority has adopted based on general principles where possible. It is partly the simplicity of dealing with a single regulator. 10  Caballero, R. “On the macroeconomics of asset shortages” NBER WP 12753, December 2006. 11  For example, Cook, G. A. S., Pandit, N. R., Beaverstock, J. V., Taylor, P. J. and Pain, K. (forthcoming in 2007). “The role of location in knowledge creation and diffusion: Evidence of centripetal and centrifugal forces in the City of London financial services agglomeration”. Environment and Planning A. 4  BIS Review 29/2007  English law, which is also the basis for financial services law in the United States, prevails here, with the added advantage that practitioners are less likely actually to invoke the legal system.

And the eurozone’s financial depth has increased at twice the pace of the US over the past 10 years. 13 If this gap continues to narrow, I expect this to favour the growth of London as the main centre for Europe’s capital markets. The development of capital markets in Asia is further behind still and I would expect to see continued rapid growth in these markets in the next decade. The rationalisation brought by the single financial market in Europe should push in the same direction. The number of central counterparty (CCPs) clearing houses by ownership has halved in Europe since 1999. And there were over 650 mergers and acquisitions in the EU banking sector between 2001 and 2005, a quarter of which were cross-border within Europe. But the process has some way to go and as the European financial sector becomes more consolidated, and financial institutions become larger and more complex, they tend to become more intensive users of capital markets. The major UK banks’ trading book assets, for example, now account for over 30% of their balance sheet assets compared with little over 15% back in 2000. What of the countervailing – centrifugal pressures? The creation of Canary Wharf, the expansion of office space in the Square Mile and the West End has helped to allow the rapid expansion of recent years. But of course London is an expensive city with high land and labour costs.
The interest rate level does not affect the Riksbank’s balance sheet According to traditional textbook models, the central bank steers the short-term interest rate by buying and selling securities in order to expand or contract the money supply, known as “open market operations”. The basic premise is that commercial banks that receive deposits from households must keep a certain amount of liquid funds to be able to serve customers wishing to withdraw money from their accounts. These liquid funds constitute the monetary base of the economy and can consist of either banknotes in the banks’ cash vaults or reserves held by the banks in non-remunerated accounts at the central bank. When the market rate is positive, the banks lose money as they are obliged to maintain liquidity reserves, and the higher the interest rate is, the less willing the banks are to maintain reserves. According to this textbook model, there is therefore a directly negative correlation between the size of the monetary base and the level of the interest rate. The central bank can conduct monetary policy either by setting an interest rate and letting the monetary base adapt to it, or by determining the size of the monetary base and thereby let the interest rate adjust itself. Up until the outbreak of the financial crisis, the textbook model was quite an applicable description of monetary policy in the United States.

13 If it is considered important to influence market expectations in a certain way, I believe that it is normally easier to achieve this using well-considered communication, for example in the form of more or less forceful statements from the Executive Board about future interest rate policy, rather than in the form of bond purchases. … but increased likelihood of unconventional monetary policy in times of economic slowdown When the acute phases of the financial crisis began in the autumn of 2008, the Riksbank owned no domestic bonds. As a result, the Riksbank found it difficult to quickly intervene on the market with appropriate support measures. A lesson learnt from this episode was that the Riksbank needed to have preparedness in order to be able to act on the bond market in special situations. Such preparedness presupposes that the Riksbank maintains at least a small portfolio of government bonds in order to have the necessary systems, agreements and knowledge in place. The Riksbank therefore built up a government bond portfolio in 2012– 2013. 14 This justification for maintaining a bond portfolio is still relevant. A future reduction of the Riksbank’s bond holdings will therefore most likely not result in a complete phasing out of the portfolio. But the bond portfolio built up in 2012–2013 was small in relation to the one built up for monetary policy purposes. Bond purchases in 2012–2013 totalled SEK 10 billion, compared with purchases for monetary policy purposes since 2015 totalling more than SEK 300 billion.
I believe China should be able to sustain 8 percent annual growth over the next 20 years. China is drawing in investments, capital, technology, foreign management expertise and talent. It is investing heavily in education and human capital. Much of its growth is also internally generated and increasingly consumer-led. 12. China is forcing the pace of change throughout Asia. This is for the better. The Chinese dragon will usher in a new prosperous Asian Century. For example, as China grows, so will its appetite for imports. Credit Suisse First Boston expects China to become the second largest consumer market by 2014. That is less than 10 years away. The Chinese middle class is expected to reach 45 percent of the population by 2020, around 580 million or more than 4 times the current Japanese population. 13. However, China's growth will not be an upward-sloping straight line. The country faces very real challenges. In 2003 when I visited China, Premier Wen Jiabao explained to me the magnitude of problems facing China's development through the concept of 'division and multiplication'. China's wealth of resources became very small when divided by 1.3 billion people, while a small problem became huge when multiplied by 1.3 billion. Premier Wen also highlighted the divide between the coastal and inland regions and stressed that China's priority was on economic and social development. 14. China will also have to cope with the impact of development on the environment. Take for example the use of chopsticks.

China uses 45 billion pairs of disposable chopsticks per year, which requires 25 million full-grown trees to make (International Herald Tribune, 27th October 2005). This means massive deforestation and an adverse impact on the environment. Another problem is the widening income gap. Bear in mind that there are 26 million Chinese still living in abject poverty, earning less than $ annually. China will also face the trickier problem of managing the demand for political change and greater political participation as it becomes a middle income country. For the first time, China recently published a White Paper on 'Building of Political Democracy in China'. 15. China's leaders know that they will retain the mandate of heaven only if they deliver the economic goods and a better standard of living. Having tasted the fruits of market-oriented policies, the Chinese people will want more. To grow, China needs a stable external environment. This is why China's leaders have been careful to assure the world that it will pursue a 'path of peaceful development' ( ). They are well aware that China's rapid growth is creating enormous pressures on the international system and that they need to craft a development and foreign policy strategy that will ensure the peace and stability needed for its growth. The trundling Indian elephant 16. Let me now turn to India, which is also shaking off old mindsets and taking pragmatic steps toward reform and liberalisation. 17. I first visited India as Prime Minister in 1994.
Banks are also giving greater thought to the impact of an extreme event on the value of collateral and the proportion of that value that can be borrowed, as well as the sale value of any assets that they might consider liquidating. The assumptions here might prove to be optimistic particularly in circumstances such as those seen in 1998, when extreme events led to one-way markets and a vicious circle in which asset price falls did not lead to increased demand but rather to further increases in supply. It is for reasons such as these that the contingency planning that firms put in place needs to be sufficient. Banks have also placed increased emphasis on identifying potential sources of liquidity shocks. Products which entail the posting of margin, such as derivatives, can result in significant calls on liquidity. 4. Policy responses  So what gaps does this leave, and what policy responses are therefore needed on top of firms’ own actions? There is scope for further work by the private sector on improving liquidity risk management. But there are also a number of issues for public authorities to address. The preparations that firms make are influenced by regulation. When balancing the costs and benefits of measures to mitigate risk, banks naturally have regard to the interests of their own shareholders.

The European Central Bank’s proposed ‘Single List’ will also include certain bank loans; indeed these are already eligible in some member countries. Similarly, the Fed has broadened the range of collateral accepted at the Discount Window. A working group commissioned by the Basel-based CPSS (Committee on Payment and Settlement Systems) in 2004 has examined whether existing arrangements would prove adequate in an emergency. It would appear that some of the infrastructure required to facilitate more extensive crossborder use of collateral is already in place: links between securities settlement systems, for example. Nevertheless, central banks may need to put in place more cooperative and coordinated policies, such as the establishment of a framework for information-sharing. When risks do crystallise it is imperative that central banks, along with regulators and ministries of finance, are well prepared so that they are able to respond in an effective manner. The CPSS working group looked at preparations that are needed in order to be able to make effective use of existing infrastructure in a crisis. But it is equally important that central banks and regulators be in a position to make the decisions necessary for resolution of a crisis, both individually and, when needed, collectively. This entails gathering data and intelligence on firms and markets, sharing it appropriately amongst all relevant public authorities, understanding the systemic conjuncture, and setting up national and international frameworks for coordination of decision making. I could give an entire speech about questions in these areas, and current and potential initiatives to address them1.
The majority of financial sectors are in foreign hands, well capitalized and well managed. Institutions from the EU are governing the largest financial institutions in the new member states. Introduction of the Single Passport policy will mean a change only de iure, not de facto. Foreign institutions that wanted to provide their services in the new member states are already present there. I do not expect any rush of new players to the new countries of the European Union. It is more probable that with increasing living standards of the population, the space for new financial products’ penetration will increase as well. I expect to see increased competition in this area, as already established institutions compete for new clients. It is unlikely that many new financial institutions will enter the market, because the market is already saturated, and players who had a strategic interest in Central Europe have already established themselves. Authorities from the new countries are already participating in committees and working groups established by the European Commission and European Central Bank, so that rules, as well as the policy thinking are being coordinated and harmonized. Challenges from the EU accession will therefore not represent any major risk.

For nearly 20% of companies the premium was more than 150bp. Today, in almost no case is it more than 150bp. (slide 5)  But according to the models used by banks to assess creditworthiness, based on company balance sheet characteristics, default probabilities have barely changed. 3  In global debt markets, investors seem to be willing to take the same risk for less compensation. Appetite for risk taking has increased. Now, coming closer to home, consider this:  2  That confidence is also apparent in measures of interest rate volatility implied by options and in the pricing of credit default swaps. These model assessments are submitted to Credit Benchmark, to whom I am grateful for permission to use the data (www.creditbenchmark.com) 3  4  All speeches are available online at www.bankofengland.co.uk/speeches  4  As I noted back in February, the premium on a basket of sterling-denominated investment grade bonds is close to zero.4 (slide 6)  While the average sterling-denominated investment-grade corporate bond has got riskier in recent years, with a longer duration and lower credit rating, this basket has a fixed composition. And the compression of the yield premium has been even more pronounced at the riskier (‘high yield’) end of the market. The focus of explanations of these developments, globally and in the UK, is often on QE.