Yet even that was insufficient to save the world economy from the “Great Recession”. And the recovery from recession has been both slower and lower than almost anyone expected. Neglect of the credit cycle has shown itself to be anything but benign. The lesson from all of this is very clear. As policymakers we must do a much better job of taking prompt corrective action to lean against financial swings which, if allowed to persist, would otherwise put at risk the financial system and wider economy. We need to build defences to protect against the collateral damage from financial flood. We need to be popping, not mopping. Fortunately, that is exactly what is now happening. Regulators globally are pursuing a wholly new approach. It goes by the name of macro-prudential policy. And here in the UK, it is the responsibility of the Bank’s new Financial Policy Committee (FPC). Among the FPC’s tasks is to lean against pro-cyclicality in the financial system. That means smoothing out the stomach-churning highs and lows in the credit and asset price cycle, which have characterised the past. As evidence of this approach, consider the FPC’s recent actions in the UK residential property market. This market has defrosted at pace over the past twelve months. The financial stability risks from this re-heating may not be immediate, but nor are they hypothetical. Take the position of UK households. Despite some post-crisis deleveraging households’ debt burden, relative to income, remains high at around 140% – almost three times its level in 1980.

BIS Review 159/2010  3  In the third quarter, while energy prices followed a horizontal course due to the developments in oil prices, the inflation trend in core goods excluding food, energy, alcoholic beverages, tobacco and gold maintained its low level. Meanwhile, the decline in annual services inflation became more marked than expected. Services prices excluding food and transportation, the sensitivity of which is relatively higher against demand, recorded its lowest level (Figure 10). The steady downward tendency in core inflation indicators continued in the third quarter due to this beyond expected slowdown in services prices (Figure 11). The reverberations of the strong course of the Turkish lira on core goods prices were also influential in this development. In this respect, the underlying inflation implied by the core indicators continued to slow down and followed a course consistent with the medium term targets. Accordingly, the gap between Turkish core inflation indicators and those of other developing economies continued to narrow in the third quarter (Figure 12). Medium-term inflation expectations, which displayed a downward trend from the second quarter in the framework of these developments, registered a limited decline in the third quarter (Figure 13). Core inflation indicators that steadily went down despite the rise in consumer inflation prevented deterioration of the medium-term expectations in this period. While recent inflation expectations showed a limited quarter-on-quarter decline, it appears  4  BIS Review 159/2010  that despite longer maturities, expectations are not differed from their previous quarter level so far (Figure 14).