The UK’s current account position creates some additional vulnerability, but recent developments in overall corporate debt are neutral (though with a caveat I’ll come on to explain), and household developments slightly offsetting. Rather, the underlying level of economic vulnerability has returned to a standard level after a long period in the aftermath of the financial crisis in which it was subdued as debt levels fell back. That’s consistent with the Financial Policy Committee’s judgement that the degree of underlying economic vulnerability is at a standard level. That judgement drives our assessment of how resilient the financial system needs to be, in particular how large should be the buffers of capital banks run with. 10  All speeches are available online at www.bankofengland.co.uk/news/speeches  10  Chart 13 ‘Adding up’ the impact of debt vulnerabilities on the possible damage caused by a 1-in-20 economic earthquake  Notes: Figure based on Aikman et al. (forthcoming). The black line ‘adds up’ the combined impact of each vulnerability indicator at time t on the 5th percentile of real GDP growth cumulatively over the next three years. For example, the point labelled 2005q1 shows the estimated impact of these vulnerabilities on the left tail of GDP growth over the period 2005q1-2008q1. The decomposition uses full sample coefficient estimates (based on 16 advanced economies 1980-2017), applied to the UK data. Each indicator enters relative to its UK historical average, so that if credit growth and the current account deficit were at their average levels, the bars would be zero.

It may be added that if housing prices had not been included in the CPI, the rate of inflation would have exceeded 10% in the recessionary year of 2001, which would have demanded even tougher measures on the part of the Central Bank than were applied then. Standard & Poor’s recently upgraded its credit rating for the Republic of Iceland, which now has very good ratings from the three main sovereign ratings agencies, i.e. Standard & Poor’s, Moody’s and Fitch. All the agencies keep a very close watch on economic developments in Iceland. Because Standard & Poor’s has recently upgraded Iceland’s sovereign rating, it is interesting to examine the main points in its rationale, both the positive factors that support the rating and others that are identified as potentially weakening it. The agency says that its upgrade reflects significant and sustained improvements in the resilience and structure of the Icelandic banking sector. Improved regulation and supervision leave the financial sector much more resilient. The recent entry of the commercial banks into the Icelandic mortgage market provides the private financial sector with additional domestic stability and profitability. Public finances continue to be healthy and Iceland boasts stable and flexible political institutions. However, the agency also points to very high and rising levels of net external debt throughout the economy, high current account deficits and relatively poor external liquidity. Adherence to the government’s medium-term fiscal framework is central to maintaining the ratings and further unforeseen adjustment would need to be accommodated through fiscal policy, not monetary policy.