expectations, increasing the persistence of inflation. in uk - weighted terms, global output is estimated at 2 % below potential. yields on sovereign bonds remain exceptionally low. in the six months to january, estimates of the equity risk premium rose by over 100bps in the uk and the euro area back to levels last seen in the heart of the crisis – december 2008 for the uk and june 2012 for the euro area. in addition, the probability of large declines in equity prices implied by options prices rebounded during 2014. discussed in carney, m ( 2015 ), “ fortune favours the bold ”, lecture to honour the memory of the honourable james michael flaherty, p. c., iveagh house, dublin. interpreting these trends is not straightforward. household surveys may reflect consumers ’ assessments of the most frequently purchased items, for example, rather than the whole cpi basket. and financial market measures reflect not only expectations about future inflation, but also investors ’ required compensation for inflation risk – the inflation risk premium – and, in the uk, the wedge between cpi and rpi inflation rates. bis central bankers ’ speeches 4. what if inflation is slow to return to target abroad? protracted global weakness could heighten the challenge of returning inflation quickly to target in the uk. that ’ s because weak global conditions would tend to push down on the equilibrium interest rate that would maintain demand in line with supply and inflation at the target. this equilibrium rate has likely been falling for the last three decades and turned sharply negative in the downturn. 13 this meant central banks had to turn to unconventional policy tools to stimulate their economies in order to return inflation to target. in the cases of the uk and the us, these measures have been effective in supporting domestically generated inflation. although the equilibrium rate might be turning positive in the uk as domestic headwinds have abated, it ’ s likely still to be negative in many countries, reflecting an excess of saving over investment, in particular in the euro area. in this regard, the ecb ’ s recent moves to reduce its main refinancing rate to 0. 05 %, its deposit facility rate to – 0. 2 %, and to commence large - scale asset purchases are both timely and welcome. in an environment of low rates everywhere, even bank rate of ½ % might look high - yielding. and the fear of a bad outcome abroad could trigger safe - haven capital flows into the uk that push the value of sterling higher, making

likely to remain so in the future. it may do that explicitly by taking a view on the level of the nairu, or it may do it implicitly by producing a forecast for inflation. in practice, we focus directly on an inflation forecast. but the need for policymakers to focus on the level of unemployment and the level of output each time they assess the stance of monetary policy is unavoidable. alan greenspan has to do it. mpc members have to do it. knowing that the growth rate of gdp is ( or is likely to be ) above or below its trend rate of increase is of little value unless one also knows where the level of output is relative to potential. this is a basic, but fundamental, point. if, for whatever reason, the level of unemployment is below the natural rate, a rise in unemployment is unavoidable. that may be undesirable. but any attempt to avoid it will simply result in a longer, or more pronounced, correction at a future date. in order to hit the inflation target the mpc needs to minimise deviations in the level of output from potential, not in the growth rate of output from its trend. the need to focus attention on the level of economic activity is of course well understood by the academic community. it is now standard practice in the literature on monetary policy to assume that the authorities seek to minimise a social loss function, defined in terms of the deviation of the level of output or unemployment from their equilibrium values, and in terms of the deviation – 6 – of inflation from its desired value. but if this is so obvious, why, in discussions of the economic conjuncture and economic policy, is so much attention placed on growth rates rather than on levels? why are commentators and pundits so concerned with whether economic growth is going to be above or below its trend rate, or even whether it is likely to be above or below zero? that is not what matters for economic policy nor, more importantly, for social welfare. an excessive focus on growth rates of output and employment, rather than on their levels, may reflect a rather natural, but dangerous, optimism about the degree of spare capacity in the economy. after all, is not the belief that we could always achieve lower unemployment without an increase in inflation the mark of a kinder, gentler, altogether more civilised approach to economic policy? or is it simply wishful thinking? as greg mankiw put it