mervyn king : what fates impose - facing up to uncertainty speech by mr mervyn king, governor of the bank of england, at the eighth british academy annual lecture 2004, london, 1 december 2004. the references can be found on the bank of england ’ s website. i am indebted to david aikman, gertjan vlieghe and tony yates who worked closely with me on the subject of this lecture over a long period. they should truly be regarded as co - authors. i am also very grateful to john campbell, gerd gigerenzer, robert may, jim poterba and many colleagues at the bank for helpful comments and discussions. i would like to thank tony leandro ( actuarial profession ), the met office, helen bray and adrian gallup ( both of the government actuary ’ s department ) for help in gathering and interpreting data used in this lecture. kath begley provided excellent research assistance. * * * “ what fates impose, that men must needs abide ; it boots not to resist both wind and tide ”. ( william shakespeare, henry vi part 3, act iv scene 3 ) 1. introduction my subject tonight is risk : how we think about, how we talk about, and how we manage risk. so let me start by thanking all of you for coming and taking the risk of spending an hour with a central banker. few writers have put central bankers in their place, but one of them was nancy mitford, whose centenary we celebrated last sunday. in the pursuit of love and love in a cold climate she describes the marriage of linda, the heroine, to the son of the governor of the bank of england. the marriage between linda and the incredibly boring tony is doomed from the outset. as lady montdore explained, “ bankers don ’ t seem to be much to look at - so extraordinarily unsuitable having to know them at all, poor things, let alone marry them ”. i don ’ t suppose lady montdore would have come to this lecture, but if she had i would point out to her that life is full of surprises. risk, luck, fate, uncertainty, probability theory - we all have names for the game of chance. most decisions in life involve risk. sometimes we embrace it, as when we enjoy a bet on the grand national, and sometimes we avoid it, as when we insure our houses against fire. the playing of the hand we are dealt

all, the bank of england ’ s target. a year ago inflation was bang on the 2 % target. the latest figure – for april – is 2. 8 %. in recent months inflation has been volatile, rising to above 3 % in march, when i had to write an open letter to the chancellor, and subsequently falling back. the number for may, to be published tomorrow, is awaited with interest. many column inches have been devoted to these short - run movements. but, because it takes some time before changes in bank rate affect inflation, it is important that the monetary policy committee look through this short - run volatility and try to understand where inflation might be heading in the medium term. that poses a real challenge. none of us can foresee the future. to assess the likelihood of different possible outcomes for inflation, we examine all the available information – official statistics, business surveys, and reports from around the country, including those from our team in wales. then we make a judgement about the outlook for inflation. that judgement cannot be made on the basis that just because certain developments seem to have forecast inflation in the past they will do so again. such correlations are not stable over time. we have to try to discover the driving forces behind the mosaic comprising all the different pieces of information that we examine each month. to understand what is likely to happen in the economy, we have to behave like the child who cannot stop asking “ why? ” why is output growing so steadily? why did recorded employment fall last quarter? why are money and credit rising so rapidly? why have oil prices picked up? and each answer inevitably provokes another question “ why? ” so setting interest rates is not straightforward. our job, in fact, is rather like taking part in a “ spot the ball ” competition. although the western mail and the south wales echo stopped running such competitions in 1992 – at the same moment that the inflation target was being introduced – i am sure many of you will remember that in those competitions the key piece of information, the location of the ball or, in our case, the outlook for inflation, is missing. you are shown the position of the players from which you have to deduce the position of the ball. that is no easy matter. to pinpoint the ball you need to ask : why is that player jumping? or why is that player looking there? only when you have identified the factors to which the players are responding can you try to spot