mervyn king : monetary policy developments speech by mr mervyn king, governor of the bank of england, to the cbi dinner, nottingham, 20 january 2009. * * * certain truths are self - evident. one is that financial markets and the economic outlook can change quickly and in surprising ways. you in the nottingham business community know that only too well. in line with businesses across the united kingdom, your economic fortunes have changed markedly over four months. before last september, the world economy was slowing and at home the monetary policy committee published a central projection of falling output in the united kingdom in the third quarter. inflation, though, was still rising. but after the failure of the american investment bank lehman brothers, there was a widespread collapse of confidence in the banking systems of the industrialised world. that led to an unprecedented and synchronised downturn in business and consumer confidence around the world. our business contacts at home and abroad, and my international counterparts, started to report that orders and confidence had, in the same telling phrase, “ fallen off a cliff ”. global equity prices fell more in the month following the failure of lehman brothers than in any but a handful of months in the bank of england ’ s 300 year history. chinese electricity production, having risen steadily at 15 % a year, fell in november to a level 8 % lower than a year earlier – the steepest fall on record. car sales in brazil contracted by a quarter compared to a year earlier. in japan, industrial production fell by 8. 5 % in just one month in november, and in germany, the value of exports declined by over 10 %. in the united states, over a million jobs were lost in the final two months of last year – the fastest rate of job losses in over 60 years. and in the united kingdom, manufacturing output contracted at its fastest rate since 1980. trade was badly affected – the baltic dry index, an indicator of demand to ship materials around the world – fell at the fastest pace on record in october. for the world economy as a whole, consensus forecasts of growth in 2009 have been revised down from 3 % to just 1 % since september. 1 see charts below. sources : chart 1 : composite indices from global financial database, comprising of : east indies share for 1693 ; bank of england and east indies shares from 1694 to august 1711 ; bank of england, east indies and south sea shares from september 1711 to january 1811 ; rostow's total

been reduced, equity has increased, and liquidity is strong. corporate and household debt levels are falling. the regulatory framework for banking operations has also been improved based on the experience gained from the financial crisis, both with implementation of international rules deriving from the important cross - border collaboration that developed during the crisis, and with implementation of rules based more iceland - specific risk. a good example of this is the new liquidity rules adopted by the central bank in december, which are based on the basel iii principles but include special ratios for foreign - denominated liquidity. there are a number of tasks ahead, however, as regards the implementation of rules such as the basel iii capital adequacy rules and special prudential rules that are to be adopted before the capital controls are lifted, so as to address foreign exchange risk and volatile capital movements more effectively. an effective financial system is an important ingredient of economic progress. it is therefore important to ensure that the regulatory framework does not impede the system ’ s effectiveness unduly. regulatory provisions may not go further than is needed to safeguard against actual risk. this is why accurate risk analysis is so important. for this reason, among others, the bank has emphasised working effectively with financial institutions on drafting rules. the capital controls and their removal remain the most important risk to financial stability in iceland. the bank has presented an in - depth analysis of the problem we face, and updated figures related to it will be included in the upcoming issue of financial stability. the big bis central bankers ’ speeches picture has changed little in the recent term, however. iceland is facing a balance of payments crisis and this is the main reason for the capital controls. it means that borrowers other than the sovereign and the central bank have limited access to foreign capital markets. at the same time, the foreseeable current account surplus over the next several years will not be large enough to cover contractual foreign debt repayments, other things being equal. furthermore, volatile isk assets held by non - residents currently total perhaps a fifth of gdp and could rise to almost half of gdp if the failed banks ’ isk assets are recovered in full and paid out to creditors. iceland has no excess foreign exchange revenues with which to unwind these isk positions, however. the solution lies in spreading out repayments of foreign loans, solving the isk problem related to the settlement of the failed banks ’ estates in a manner that does not exacerbate the balance of payments