37  Monetary policy makers must also take into account how potential structural changes in the labour market and pricing dynamics that result from the Fourth Industrial Revolution might affect the evolution of inflationary pressures. These considerations can be illustrated using the Phillips Curve diagram. Until the productivity and creativity effects catch up with the displacement effect, increased automation will impart disinflationary pressures through a reduction in businesses’ demand for labour relative to supply. Even if the transition happens relatively quickly and smoothly by historic standards – taking 30 years and with a relatively quick rate of new job finding among those displaced by technology – total hours worked could be 2 per cent lower throughout, equivalent to a 2 percentage point increase in the unemployment rate or a 5 percentage point rise in the underemployment rate. 38  34  The Fourth Industrial Revolution could also affect the transmission of monetary policy through its effects on the financial sector. For example, advances in technology and data availability could lead to greater competition in the financial sector, potentially strengthening the pass-through of changes in monetary policy into the interest rates faced by households and companies. 35 If automation increases the level, but not the growth rate, of productivity, it will only raise capital relative to output temporarily. This effect will be reinforced by an increase in the capital-output ratio during the job destruction phase, as labour is displaced by automation.

This observation, combined with the increased securitization of real estate into diversified national portfolios, gave buyers – and those rating the securitizations – confidence that the “real estate cycle risk” was substantially mitigated through diversification. But, as Figure 7 shows, the assumption that a geographically diversified portfolio of real estate assets would avoid price declines proved wrong. While prices nationally had not experienced a substantial decline in the past, for three years the U.S. has experienced substantial and sustained declines in prices. Some of my colleagues point out, probably appropriately, that given the historical data the failure to anticipate nationwide house prices falling is largely understandable. It was certainly very widespread. What may be more surprising is that in the 2005 timeframe, when many were expecting house prices to slow down or flatten, there was not much by way of risk mitigation undertaken. Myth 2 – Triple-A mortgage securities carried little risk The securitization market – that is, the market for securities based on various slices of pooled mortgages – grew dramatically over the past decade. One reason for the growth in securitization was investor interest in, and demand for, securities with little credit risk but returns above those of Treasuries. Many buyers of such securities felt sure of two things. First, that national real estate prices were quite unlikely to fall – in other words, our Myth 1. Second, that even in the highly unlikely event that the price of a national portfolio did fall, they would be protected by the structure of the securitization.