) so, if there ’ s any uncertainty about future returns – if you know that you might come to regret the decision – you have to be extra sure before you actually take the plunge. it ’ s no longer enough that the expected income from the project covers the initial cost. it has to do so by a potentially wide margin, a margin economists call the “ option value of waiting ”. there are lots of decisions in life that have these characteristics. moving house, taking a new job, even getting married – these are all things than can be delayed but cannot be easily reversed. and it makes intuitive sense that, in the presence of uncertainty, there ’ s value in keeping one ’ s options open. how much might that option be worth, when it comes to investment decisions? quite a bit, it turns out. based on a simple stylised model, chart 4 plots the additional hurdle required of irreversible investments against the variability of annual growth in the returns they generate. for individual firms, earnings vary considerably from one year to the next – the standard deviation of annual growth has on average been as much as 40 % points ( chart 3 ). if this is a guide to the uncertainty firms feel about returns on new investments then, on the basis of the model in chart 4, you might expect an additional hurdle of 10 % points or more, over and above the normal cost of funding. in steady state, the ratio of capital to investment is 1 / ( g + δ ), where g is trend growth and δ is the rate of depreciation. in advanced economies, and recognising that a substantial proportion of capital is the value of land ( which doesn ’ t depreciate ) g + δ is unlikely to be more than 7 % - so the value of the capital stock is generally more than 15 times the annual rate of investment. in 2015, according to official ons estimates, the ratio was 23. financial options are instruments that give the owner the right to buy or sell an underlying security at a fixed, so - called “ strike ” price. when the security ’ s spot price rises above the strike an option to buy is said to be “ in the money ”. but that doesn ’ t mean it ’ s rational to exercise the option straightaway, because there ’ s a chance the spot price could rise further. the more volatile the series, the greater that chance and the more valuable the option. in just the same way,

. all speeches are available online at www. bankofengland. co. uk / publications / pages / speeches / default. aspx one can ’ t say for sure why pessimism has grown, though a long period of weak productivity growth, across the developed world, can ’ t have helped. nor is it hard to see sources of downside risk. but one thing that ’ s unlikely to have been the primary cause of this divergence is monetary policy. that ’ s because an independent easing in policy – that part of it unrelated to declines in the neutral interest rate – tends to push up all prices of all assets, risky as well as risk - free. that was certainly the case after the mpc ’ s decision in august, just as it was when the committee first undertook qe in 2009 ( chart 13 ). as charlie bean explained in 2012, the direct impact of qe on pension funds – particularly those who were in balance on the eve of the financial crisis – therefore looks to have been relatively small. indeed if the mpc and other monetary authorities hadn ’ t eased policy – if they had failed to accommodate the forces pushing down on the neutral real rate – the performance of the economy and equity markets, and the long - term prospects for pension funds, would probably have been worse. chart 12 : risky assets have under - performed chart 13 : easier monetary policy supports prices of risky as well as risk - free assets note : * equity yields have been adjusted for leverage. source : thomson reuters datastream source : thomson reuters datastream concluding remarks this talk has been all about rational responses to higher uncertainty : how it raises the bar for decisions that are costly to reverse and – particularly when skewed towards downside risks – how it widens the gap between yields on risky and risk - free securities, contributing to the decline in the neutral real rate of interest and worsening the accounting deficits of pension funds. as charlie explained, qe probably has acted to raise the absolute deficit of schemes that were under - funded to begin with. but the more important problem has been the under - performance of risky assets ( see also footnote 9 ). all speeches are available online at www. bankofengland. co. uk / publications / pages / speeches / default. aspx but human instinct in this area isn ’ t always so rational. we ’ re prone to over - interpret noisy events, seeing structure and determination when, very often, there isn