will bear the full brunt of past lending mistakes by banks. rather, there is sharing of losses between shareholders and the government – or coinsurance – with the government providing, at a price, insurance against only extreme outcomes for the banks. that can be to the advantage of all of us if banks help to underwrite the economy through the agreed lending targets and government underwrites the balance sheet of the banks. the insurance policy will be most cost - effective for taxpayers if all the major lenders sign up to lending targets. nevertheless, the problems in the financial sector mean that 2009 will be a difficult year for all of us. a pronounced contraction in spending and output is underway. as expected, output in the uk economy fell in the third quarter of 2008, but the downward momentum intensified in the fourth quarter. manufacturing output is falling, and the key service sector surveys have reached record low levels in recent months. total output in the fourth quarter is expected to have fallen sharply. in the first half of this year, the rate of contraction is likely to continue to be marked, and our trading partners are experiencing similar problems. but the very significant policy actions taken in recent months will eventually stimulate a recovery in demand, output and employment. bank rate has fallen from 5 % to 1½ %. and, as i have explained, the monetary policy committee has a range of options to stimulate the economy further if required. fiscal policy has been eased. the banking system is receiving massive support to cope with the need to restructure its balance sheet. that will take time, but time is a great healer, even of banks. since the summer, the exchange rate has fallen by almost 20 % ; and oil prices have fallen by around two - thirds, both of which will boost demand. no one can know at what point the impact of all this stimulus will have a visible effect on activity ; the lags in economic policy are notoriously long and unpredictable. but welldesigned policies implemented within a consistent policy framework will eventually work. 1. ten largest monthly falls in uk equity prices percentage change on a year earlier south sea aug - sep 1720 black monday oct - nov 1987 south sea sep - oct 1720 10 se p - 10 o ct 2008 10 sep - 10 oct 2008 oil shock & secondary bank crisis nov - dec 1973 oil shock & secondary bank crisis jul - aug 1974 france fall to germany jun - jul 1940 oil shock & secondary bank crisis feb - mar 1974 unexpected rate hike aug - sep 1981

dividing line between helping to oil the wheels in markets which are temporarily impaired, and artificially supporting markets in which there is no underlying demand. that is why, as federal reserve chairman bernanke said in london last week, central banks will look to intervene only in markets that “ normally play major roles ” in the functioning of the financial system. therefore, the bank will need to be satisfied that there is a genuine private demand for an asset in normal conditions before it would be eligible for the asset purchase facility. we are aiming to complement and stimulate private demand, not substitute for it. the bank is actively considering in which markets targeted purchases might stimulate new issuance. one example is the corporate bond market. spreads on high quality corporate bonds have more than doubled since early september to an average of over 5 percentage points. despite innovation in financial markets this is the highest spread since the mid - 1970s. the bank estimates that a significant element of this spread represents an illiquidity premium which could be reduced somewhat by increasing activity and liquidity in the market. commercial paper is another case where purchases might help, although that market is considerably smaller in the united kingdom than in the united states. in each case the bank will keep the market fully informed, and more details will be published at the end of the month. it will be a matter of weeks not days before a programme of purchases can begin, but it will be weeks not months. there is another reason to tread carefully. such asset purchases involve taking more credit risk onto the public sector balance sheet. that is why the bank will consider purchasing only high quality assets. despite the existence of a range of unconventional instruments, monetary policy is likely to be more effective when the banking system is working normally. so the first priority for policy is to fix the banking system so that it can resume its normal lending function. the contraction of lending to ordinary viable businesses – your businesses – is threatening to drive the economy further into recession. the package of measures announced yesterday by the chancellor are not designed to protect the banks as such. they are designed to protect the economy from the banks. in particular, the asset protection scheme aims to remove a degree of uncertainty about the future losses banks will make. it also has the effect of reducing the amount of capital banks need to hold against their risky assets. both effects will serve to strengthen and underpin banks'balance sheets and so support their lending to the real economy. to be clear, the scheme does not mean that the taxpayer