mervyn king : the monetary policy committee - five years on speech delivered by mr mervyn king, deputy governor of the bank of england, to the society of business economists, at the royal college of pathologists, london, 22 may 2002. i would especially like to thank claire lombardelli, james proudman and james talbot for their expert help in conducting and analysing the experiment reported in this paper. i have also benefited from useful comments from charlie bean, mark cornelius, spencer dale and peter rodgers. richard geare provided help with the data. * * * five years ago, the power to set interest rates in this country was given to a new monetary policy committee ( the mpc ). that decision is still widely regarded as the most important taken by the incoming new labour government. at the time, the decision to create the mpc was controversial. that is hardly surprising. few decisions have as much economic impact as the level of short - term interest rates. they attract the interest of politicians and the media, yet when the mpc sets interest rates, it acts independently of government. the government sets the target, but the committee sets interest rates to meet that target. compared with many other countries central bank independence in the uk is relatively recent, although not unprecedented. the most famous cartoon of the bank of england - gillray ’ s the old lady of threadneedle street - shows pitt, prime minister at the time, ravishing an old lady personifying the bank - whose dress is made of one pound notes. the pitt government had made repeated demands on the bank of england for gold to pay for the wars against france. eventually, the fall in the bank ’ s reserves forced it to suspend convertibility of its notes into gold, and low denomination notes were issued for the first time. the gillray cartoon - which appeared in may 1797 was the origin of the moniker, the old lady of threadneedle street. was it mere coincidence, or divine retribution, that it was exactly two hundred years later, to the very month, in may 1997, that the bank of england regained its independence? in an age when governments are increasingly held responsible for more and more aspects of our lives, there are not many examples of major decisions being delegated to a non - political body. the monetary policy committee has broken new ground in british constitutional history. only three months before the mpc was set up, peter hennessy described the british system of government as dependent upon “ a handful of

demographics, tax policy, housing supply and inflation are likely to play a role. but today i want to highlight two key factors that may have played a particularly important role in shifting the ratio of credit to gdp during the upswing of the last cycle. first, the level of long - run real interest rates and second, credit supply conditions, including credit spreads. long - term interest rate the long - term real interest rate is crucially important both to the level of debt and to the price of the assets it finances. structural changes in real interest rates are perhaps the most important factor in driving a shift in the sustainable level of debt. the real long - term interest rate is, of course, determined by structural features of the economy, not by central banks. enduring changes in the level of real interest rates and in the cost of credit intermediation by lenders alter the sustainable level of debt service of borrowers. and changes in the interest rate also affect the net present value, and hence the price, of housing assets. all else equal, lower rates will increase both the price borrowers can afford to pay and the net present value of houses. there has been a substantial fall in the long - term real interest rates of around 4. 5 percentage points over the past 30 years ( chart 4 ) ; this trend has occurred across countries. the structural decline in real rates pushed up on house prices in particular given the inelastic supply. it has also made a larger debt stock easier to service. this fall in real rates was clearly an important factor over the period in driving the high rate of credit growth relative to gdp and the consequent increase in the level of household debt to income. looking forward, to the extent that the fall in interest rates was the result of structural factors that are likely to last for a long time, the increase in the level of household debt is more likely to be sustainable. and indeed, recent work in the bank of england suggests that much of that fall could well be due to persistent structural factors ( chart 5 ). 7 these factors include a slowing in the underlying global economic growth rate, the rise in saving due to demographic forces, lower desired investment given a lower relative price of capital, changes in the income distribution, excess saving in emerging markets and declining public investment. rachel and smith ( 2015 ) attempt to decompose the substantial fall in real rates over the past 30 years. although acknowledging significant uncertainty, they account for around 400 basis points of that fall