in cushioning the fall in demand. but the deficit now looks set to be around 12 % of gdp this year, which is unsustainable in the medium term. that creates a difficult balancing act. cutting spending and / or raising taxes is likely to result in lower domestic demand, though a failure to do so may lead long - term interest rates to rise, also hitting demand. the recent depreciation of sterling appears to owe something to heightened fears about the uk ’ s fiscal prospects. fortunately, all political parties recognise the need to put in place a credible plan for the consolidation of the public finances over the medium term, even if their preferred routes to doing so differ. finally, question marks remain about the durability of the recovery in the rest of the world and particularly in the uk ’ s main export markets. some of the advanced economies face headwinds similar to those facing the united kingdom. the fate of the euro area, the destination of more than half our exports, is particularly important. the recovery there all but stalled in the fourth quarter and business surveys point to only moderate growth in the first part of this year. moreover, greece and some other euro - area countries face significant fiscal challenges. the necessary fiscal consolidations are likely to depress overall euro - area demand unless offset by demand expansion elsewhere. but as i noted, there are also reasons to be cheerful. two factors in particular should provide a boost to the demand for uk goods and services. first, there is a substantial policy stimulus still working through the economy. bank rate remains at a historical low of 0. 5 %, while the bank has bought some £200 billion of assets, mainly gilts, financed by the issuance of central bank reserves ( think of these as bank of england ious that are held by the commercial banks ) – so - called “ quantitative easing ”. even though we have called a pause in our asset purchase programme, the effects of past purchases will continue to work through the economy for some time to come. the aim of quantitative easing is to boost the supply of money, push up a wide range of asset prices and facilitate finance through the capital markets, thus raising nominal demand in the economy. how well is quantitative easing working? chart 3 shows, for the two days following each successive announcement about the scale of the asset purchase programme, the movements in : average gilt yields ; the expected average level of bank rate over the same maturity ( from overnight indexed swap rates ) ;

1 and 2 document that evidence of this type of correlation is more pervasive than studied in their paper. a detailed discussion along these lines of the impact of a fall in the volatility of inflation and output growth on the bond term premium can be found, e. g., in plosser ( 2007 ). if one believes that the main reason for the observed decline in macroeconomic volatilities – and, indirectly, for low risk compensations and high prices in asset markets – is that policy regimes have become more stable, more predictable and confidence - inspiring, then prospects for market participants and policymakers alike will be brighter. we all know that the institutional roots of the great moderation are significant, as studies done at the ecb and elsewhere have shown. 9 we know that policy statutes – disciplining monetary policy and the fiscal authority – have been carefully crafted in many countries to make sure that stable policy conditions are put in place and are there to last. so, if all this is true, one could perhaps confidently extrapolate the moderate macroeconomic volatilities of the past into the future. and, in so doing, one would equally be reassured that the down - trends in risk compensation that we have observed for so long – beyond short - run ups and downs – would not be reversed in a sustained manner. but the same line of causation could be less reassuring from another angle. the same studies that have found an important role for policies in the great moderation of the last two decades cannot certainly rule out that “ good luck ” might have exerted a reinforcing influence. more moderate exogenous shocks might have contributed – more or less accidentally – to smoothing economic fluctuations. in the terms of our picture, this would be equivalent to say that the moderation in some non - policy factor driving activity might have been responsible for the fall in inflation and consumption variability. to the extent that this interpretation has some merit, a less fortunate string of shocks could always bring more ample swings in economic conditions – looking forward – than we have grown accustomed to from past experience. and this could entail repercussions for the valuation of investment risk in various financial markets. in this case a return to historical valuations for risk would imply large negative returns for a possibly extended period of time. 1. 2 the price of risk : what is structural and what is transient? it is important to understand that the close co - movements that appear when comparing