mervyn king : a tale of two cities speech by mr mervyn king, deputy governor of the bank of england, at cardiff business school, cardiff university, 18 june 2001. * * * vice - chancellor, ladies and gentlemen, it was once said that economic forecasters are the unfathomable in pursuit of the unpredictable. as a student i found this odd. whenever england played wales at rugby the result was wholly predictable. the reason was simple. my fellow - student, gerald davies, ran faster than englishmen, even when he carried the ball and they didn't. economics is, unfortunately, less straightforward. yet any decision that involves an elapse of time between its implementation and its effects requires a forecast. time lags are the essence of the transmission mechanism of monetary policy. and that is why the monetary policy committee spends much time thinking about the likely future path of the economy. the severe limits on our ability to anticipate future events means that forecasts can be no more than a description of the relative likelihood of a range of possible outcomes. anyone who presents you with a point forecast for the future path of the economy is either concealing the most interesting part of their analysis, or suffering from self - deception. so the monetary policy committee presents forecasts in terms of probabilities. and it is the balance of risks to the economy which determines monetary policy. so what are the balance of risks to the british economy at present? overall, the past five years have been a period of remarkable stability for the uk. annual gdp growth has averaged 2. 8 %, and there have been 35 consecutive quarters of positive economic growth. since the mpc was set up in may 1997, inflation has averaged 2. 4 %, very close to our target of 2½ %, and been in the remarkably narrow range of 2 % - 3 % in 43 out of the past 49 months. this degree of stability reflects well on the new framework for monetary policy in this country. but if i focus today on the risks ahead, it is not simply because as a central banker i know that to every silver lining is attached a cloud, but because the small deviations of inflation from the target over the past four years give a misleading impression of the greater volatility of inflation that we might reasonably expect to see in future. there are two sources of uncertainty facing the uk at present, one domestic and the other international. both are related to imbalances. the correction of

this in mind. we also need to be careful not to underestimate the consequences of our actions. focusing only on direct channels, the effects that one would expect to ripple back to the united states from problems in one or two emes typically look quite small. but, when all of the indirect channels of feedback are aggregated properly – which admittedly is difficult to do – the effects may be considerably larger. my point is that we tend to underestimate these feedback effects. for most of us, the market volatility of this past spring and summer still remains fresh in our minds. eme financial markets were hit hardest, with declines in equity prices, a widening in sovereign debt spreads, and a sharp increase in foreign exchange rate volatility. in the u. s., we saw a spike in treasury yields, with 10 - year rates rising by roughly 100 basis points from early may to early july, and rising by roughly another 30 basis points before peaking in early september. most commentary has focused on the shift in expectations with respect to u. s. monetary policy – and, in particular, to uncertainty about the timing and implications of fed tapering – as the catalyst for these moves. this focus seems generally right, although other factors also played a role. market participants also had to evaluate the possibility that growth in china and other emes might be slowing even as growth in the u. s. and other advanced economies bis central bankers ’ speeches was picking up. the subsequent market movements as investors withdrew funds from eme investments were an abrupt shock for emes generally, especially after the long earlier period of abundant liquidity and ample inflows. from one perspective, the unconventional nature of recent u. s. monetary policy adds little that is fundamentally new to the challenges now facing emes. these policies simply represent a way of easing, driven by our coming up against the zero lower bound. central bankers have managed differences across countries in cyclical positions and policy stances many times in the past. but, from another perspective, we have less experience operating with unconventional monetary policy and this creates more potential uncertainties. this puts a premium on continued dialogue among central bankers, between central bankers and the market, and keen listening skills on our part. in my view, the fact that our large scale asset purchase programs affect the size of term risk premia globally is important. this set of monetary policies affects financial asset prices in a different way compared to changes in short - term interest