In the baseline scenario of this Report, the sum of the effects of the catastrophe, the changes in conjunctural data and other specific elements shapes a scenario where inflation will converge to 3% sooner than was forecast in December. The change in the medium-term inflation scenario is determined by the effects of the earthquake and tsunami on productive capacity and by the persistence and magnitude of a potential contraction in private consumption. In the baseline scenario, annual CPI variation will exceed 3% in the second half of this year, standing around 4% for a few months. It will later fluctuate around 3% through 2011 until the end of the relevant projection horizon, which is currently the first quarter of 2012. Annual CPIX1 will show a more gradual convergence to 3% (table 2). All this within a substantially more uncertain setting than before. This scenario rests on other working assumptions. First, it is assumed that in the long term the real exchange rate (RER) will be similar to its current level. This assumption is made considering that, with the nominal exchange rate and parities prevailing at the statistical closure of this Report, the RER is consistent with its long-term fundamentals. Another working assumption is that inflationary pressures from the labour market will generally not experience any significant change with respect to current indicators. Finally, the external scenario will continue to add momentum to the economy and imported inflationary pressures will remain contained.

But another strand in the debate draws the opposite conclusion from the crisis – focusing on the risk that central banks might lend “too little”, too rarely or too late, amplifying what might begin as short-term liquidity shortages into deeper or more persistent solvency concerns, and subsequently causing financial institutions to over-insure, reducing their capacity to lend. The main policy conclusion from this way of thinking is that central banks need stronger toolkits for detecting and responding to liquidity crises. These (deliberately stylised) perspectives seem diametrically opposed. National debates have tended to lean one way or the other, depending on each country’s specific crisis experiences. But, in truth, it is vital we pay heed to both. Without an effective LOLR framework, economies cannot hope to foster strong and sustainable growth over the long run. History shows that, sooner or later that growth, and the employment it supports, will be threatened by an unexpected withdrawal of liquidity from key parts of the financial system, unconnected to the underlying quality of real assets in the economy. Historically that liquidity risk resided primarily in the banking sector. But as economies migrate towards more market-based forms of finance, liquidity risk is increasingly likely to originate (or be concentrated) elsewhere: including broker-dealers, central counterparties (CCPs), or traded instruments themselves. The herd mentality that can develop during crises can sometimes only be tamed by well-designed intervention – be it covert or overt – using a credible backstop. Countries lacking such backstops are likely to sustain large-scale, and preventable, economic damage.