mervyn king : monetary policy developments speech by mr mervyn king, governor of the bank of england, to scottish business organisations, edinburgh, 20 october 2009. * * * two years ago scotland was home to two of the largest and most respected international banks. both are now largely state - owned. sir walter scott would have been mortified by these events. writing in 1826, under the pseudonym of malachi malagrowther, he observed that : “ not only did the banks dispersed throughout scotland afford the means of bringing the country to an unexpected and almost marvellous degree of prosperity, but in no considerable instance, save one [ the ayr bank ], have their own over - speculating undertakings been the means of interrupting that prosperity ”. banking has not been good for the wealth of the scottish – and, it should be said, almost any other – nation recently. over the past year, almost six million jobs have been lost in the united states, over 2½ million in the euro area, and over half a million in the united kingdom. our national debt is rising rapidly, not least as the consequence of support to the banking system. we shall all be paying for the impact of this crisis on the public finances for a generation. the united kingdom faces two fundamental long - run challenges. first, to rebalance the economy, with more resources allocated to business investment and net exports and fewer to consumption. that is consistent with the need – now widely accepted – to eliminate the large structural fiscal deficit and to raise the national saving rate. it is part of a need for a wider rebalancing of domestic demand in the world economy away from those countries that borrowed and ran current account deficits towards those that lent and ran surpluses. second, both the structure and regulation of banking in the uk need reform. banks increased both the size and leverage of their balance sheets to levels that threatened stability of the system as a whole. they remain extraordinarily dependent on the public sector for support. that was necessary in the immediate crisis, but is not sustainable in the medium term. these two challenges are interrelated. in creating the crisis, imbalances in the world economy led to unusually low real interest rates and large net capital flows from the emerging market economies to the developed world. that provided the fuel which an inadequately designed regulatory system ignited to produce the financial firestorm that engulfed us all. if our response to the crisis focuses only on the symptoms rather than the underlying

part of the range. important elements to consider are the strength of consumption and the recovered dynamism of investment. private - sector expectations have internalized this higher growth expectations in their 2007 gdp projections. the aggravation of natural gas restrictions, combined with low rainfall, has increased the risk of energy shortage and higher costs. for the moment, the impact is believed to be nonsignificant, except obvious effects on electricity, gas and water, and have concentrated mainly in smaller value added from electric generation. however, this is an element of risk in the internal scenario that must be monitored with special care, in particular because of its medium - term implications. regarding inflation, the main development of the past few months have been sharp rises in the prices of non - perishable foods ( i. e. grains, powdered milk and others ) and of fuels, which combined with the also sudden increase in the prices of perishable foods, have resulted in a major rise of measured cpi inflation, way above projections in may ’ s monetary policy report. as a result, cpi and cpix variation stands at 3. 2 % per annum, while cpix1 inflation stands at 3. 5 %. the rebound of cpix1 inflation has reflected the sharp increase in the prices of some non - perishable foods, the cpix has been influenced by the above plus the rise in electric rates, and the cpi by all the above plus the rise in prices of fuels and perishable foods. the different measures of trend inflation have risen in recent months, in line with the reduction in output gaps and the upturn of the prices of foods. in contrast, labor cost pressures are limited despite the strong increase in the wage index. short - term inflation expectations have also changed, and there is widespread belief that inflation will be, in the short term, higher than foreseen in may ’ s monetary policy report. short - term inflation expectations one year ahead are close to 4 %. over a longer horizon, expectations remain well anchored to 3 %, reflecting the credibility of the central bank ’ s commitment with target inflation. long - term interest rates have increased recently, partly because of the rise in international rates for the same maturities and because of stronger growth rates. meanwhile, nominal rates have been also influenced by higher observed inflation. growth rates of monetary and credit aggregates have moderated but are still high. despite these changes in the margin, financial conditions are still positive.