financial system, this may be more realistic. there may be less need to fine - tune the regulatory engine and correspondingly less need for the tug - of - war between regulator and regulated that has characterised the past few years. a robust banking system ought also to be less prone to credit booms and busts, thereby reducing the need for discretionary macro - prudential actions to lean actively against the wind. regulation would be handed back to the risk managers. in this world, the operational activities of central banks could also return to a more even keel. wider collateral, longer tenors and new counterparties were necessary ingredients during crisis. but a return to more conventional operations – short - term lending against government collateral to banking counterparties – may be sufficient to oil the wheels in normalised market conditions, as it was for hundreds of years prior to the crisis. market - making, at least beyond short - term money markets, would be a last resort. as for central bank transparency, with monetary, regulatory and operational policy no longer hyperactive, it is conceivable central banks could retreat from centre stage. central banks could migrate to the back pages of newspapers. like good children, they would be relatively rarely seen and infrequently heard. central bank - watchers would find something better to do with their lives than hang on to every gubernatorial semi - colon. for a central banker, this sounds like the good life – a low - intervention, low - visibility world. in some respects, it would be back to the future. the issue is whether this world, however desirable, is realistic. there are some reasons for doubt. financial system reinvention one of the likely consequences of the crisis, and the resulting regulatory response, is that the financial system will reinvent itself. financial activity will migrate outside the banking system. and with that move, risk may itself change shape and form. what previously had been credit and maturity mismatch risk on the balance sheet of the banking system may metastasize into market and illiquidity risk on the balance sheets of non - banks. this could have important implications for the stability of the financial system and the broader economy. with more activity outside the banking system, and with the banking system itself better protected, the financial system and economy may become less prone to the low - frequency, high - cost banking crises seen in the past. but that is not the end of the story. risk, like energy, tends to

every day. some of the important risks that could affect all instruments – from terrorist attacks, invasion of computer systems, or even the consequences of a flu pandemic – are almost impossible to quantify, and past experience offers little guide. be cautious about how much you borrow is not a bad maxim for each and every one of us here tonight. ignore the unsolicited emails that rain down on us offering unwanted credit. i received one last week that began, “ we have the solution, mervyn, for your bankruptcy ”. the development of complex financial instruments and the spate of loan arrangements without traditional covenants suggest another maxim : be cautious about how much you lend, especially when you know rather little about the activities of the borrower. it may say champagne – aaa – on the label of an increasing number of structured credit instruments. but by the time investors get to what ’ s left in the bottle, it could taste rather flat. assessing the effective degree of leverage in an ever - changing financial system is far from straightforward, and the liquidity of the markets in complex instruments, especially in conditions when many players would be trying to reduce the leverage of their portfolios at the same time, is unpredictable. excessive leverage is the common theme of many financial crises of the past. are we really so much cleverer than the financiers of the past? concerns about the rate at which credit is being created extend to monetary policy. as i said last week in cardiff, it would be optimistic in the extreme to suppose that the rapid growth of money and credit could be dismissed solely as a positive shock to the demand for money. the spread between interest rates paid by households and businesses and interest rates available in the money market has fallen. this has been one of the factors behind the strength of demand in the uk economy over the past year. despite greater availability of labour, businesses have not expanded employment sufficiently to prevent stronger demand from increasing capacity pressures. such pressures encourage businesses to raise prices. and that is exactly what the business surveys suggest has been happening. that underlying upward pressure on inflation has in part been hidden by the volatility of domestic energy prices. but it is why we have raised interest rates four times and by 1 percentage point in all over the past year. our central view remains that inflation will fall back this year as the rises in domestic gas and electricity prices last year drop out of the annual comparison, and the recent cuts in prices feed through to household bills. but