, if a wage - price spiral takes place, this will likely cause a sizable increase in medium - to long - term inflation expectations and high inflation could become chronic. for this reason, the european central bank ( ecb ) has also been aggressively raising policy rates. in the meantime, the united kingdom appears to be moving into a tough situation. on top of the surge in energy prices, it has encountered a grave labor shortage amid the pandemic, due in part to a decline in immigrants following brexit. this has been accompanied by a surge in wages and is beginning to induce a wage - price spiral. until lately, the bank of england ( boe ) was out ahead of the federal reserve in implementing aggressive monetary tightening. yet, in late september 2022, the u. k. government announced a large - scale fiscal stimulus package featuring massive tax cuts, and this in turn engendered a sharp interest rate hike. furthermore, even though monetary tightening has pushed up interest rates in the country, the british pound hit its lowest level against the u. s. dollar since the adoption of the floating exchange rate system. to address the market turmoil, the boe is taking action to ensure financial stability by, for example, carrying out temporary purchases of long - dated u. k. government bonds and postponing the beginning of the planned gilt sale operations. such market turmoil was largely unthinkable until quite recently ; i now consider it necessary to keep a close eye on its impact, particularly on the u. k. economy and global financial and capital markets. as i have described, risks to the global financial and economic environment surrounding japan have rapidly become skewed to the downside. crude oil prices, which had seen a surge until lately, have recently shown signs of a decline ( chart 13 ). i believe that this most likely reflects concern over the risk of a slowdown in the global economy. history suggests that there is considerable risk in making a shift toward monetary tightening in such cases where the possibility of " a storm landfall " cannot be ignored. in the current situation where downside risks are significant, i believe that any move to revise the direction of monetary policy toward tightening should be considered with caution. foreign exchange rates next, i will touch on foreign exchange rates. i am closely monitoring the effects of exchange rate movements on economic activity and prices. in light of these movements, let me share what approach i think monetary policy should take. first, monetary

as a useful cross - check to the outputs of the more structural model. 12 the distinguishing feature of the model suite is the emphasis placed on the feedback effects induced by market liquidity risk and funding liquidity risk and their interactions in a network context. in addition, the potential feedback to the macro economy from the behavioural responses of banks individually and collectively to an impairment of their balance sheet position ( eg, through a “ financial accelerator ” effect ) will be incorporated explicitly. the development of the suite is at an early stage but preliminary results from prototype work seem to promise some useful insights. chart e shows an illustrative distribution of future uk bank system assets from the prototype model ( the right - hand panel expands the lower tail of the distribution ). notice that the distribution is explicitly bi - modal – as one might expect of a system where losses on interbank exposures, and pressures on asset prices and market liquidity from failing firms, may be transmitted through the financial network and may trigger a cascade of defaults. our suspicion is that the firesale of assets by institutions facing default is the source of much of the action here, but more research is needed to be properly certain and before we can ascribe quantitative meaning to the distribution. 13 chart f illustrates how such distributions might also be tracked over time and compared in successive financial stability reports. when operational, such distributions should help guide judgements on how overall financial system vulnerability is changing. but the approach should also provide considerable additional information on pressure points within the system and on the channels of transmission and potential contagion. 14 i believe that this broad approach offers an important step forwards in the development of an analytically and empirically robust framework for financial stability work. of course it is analytically hugely challenging – modelling non - linear tail events with endogenous strategic interactions is always going to be tough! the results will inevitably be subject to major uncertainty. but the approach does start to provide a consistent and coherent framework which should substantially improve the value of top - down stress tests and of risk assessment work. 15 a particular “ operational ” aim is to use the results to help improve the focus of risk reduction work and crisis management planning, for example through the identification of “ weak points ” in the financial system and through improved assessment of the impact of policy interventions. an important element of risk reduction work is to influence the behaviour of financial firms. “ bottom - up ” or firm - level stress - testing practices have developed rapidly in recent