here and elsewhere, and the realisation that substantial adjustments to balance sheets were called for. so it should not be surprising that the recovery since the middle of 2009 has been so muted. monetary policy can – up to a point – play a smoothing role in such circumstances by encouraging households and businesses to bring forward spending from the future to the present. and other, more targeted, central bank policies can help unblock dysfunctional markets or else, as with the funding for lending scheme, support the supply of credit. we stand ready to take further such action should it be warranted. but such policies cannot – and should not seek to – prevent the necessary de - leveraging and rebalancing of production away from non - tradables towards tradables. that is a real process that takes time and means that the recovery is likely to remain somewhat subdued by historical standards. thank you! see bean et al. ( 2011 ). bis central bankers ’ speeches annex the model used for the simulations is standard in the monetary policy literature and comprises just two equations. the first is the demand for goods and services ( a dynamic is curve ) : xt = etxt + 1 – ( it – ett + 1 – rt ), where xt is the output gap, t is the deviation of inflation from target ( the inflation gap ), it is the nominal policy rate, rt is the natural real rate of interest, and et denotes a rational expectation. this makes the level of demand today a decreasing function of present and future expected real interest rates. a fall in demand can then be simulated by reducing the natural real rate of interest, rt, which is then allowed to unwind gradually. the second equation describes the supply side and embeds within it an assumption that prices are sticky ( a new keynesian phillips curve ) : t = ett + 1 + xt. this makes inflation an increasing function of present and future expected output gaps. in the baseline model, = 0. 6 ; = 0. 025 ; and =. 99 ; in the low interest elasticity variant, = 0. 2. the loss function that the policy maker wants to minimise takes the form : vt + etvt + 1 + 2etvt + 2 +..., where vt = t2 + xt2 / 6. under a nominal gdp target, the above expression for vt is replaced by : vt = ( yt – y * t ) 2, where

year earlier - 4 ( a ) nominal gdp expected 2 years earlier - 6 ( a ) sums the monetary policy committee ’ s mean forecasts for real gdp and inflation. the committee ’ s forecast for rpix inflation is used prior to february 2004, adjusted for the difference in the inflation target. bis central bankers ’ speeches chart 2 : revisions to nominal gdp growth percentage changes on a year earlier - 2 - 4 initial estimate latest - 6 - 8 chart 3 : nominal gdp shortfall indices : 2008 q1 = 100 nominal gdp trend shortfall bis central bankers ’ speeches chart 4 : response to a large fall in demand output gap policy rate inflation gap - 5 - 10 - 15 - 20 per cent ( annualised ) per cent ( annualised ) percentage points 5. 0 4. 5 4. 0 - 1 3. 5 - 2 3. 0 - 3 2. 5 - 4 2. 0 - 5 1. 5 - 6 1. 0 - 7 0. 5 - 8 0. 0 quarters quarters inflation targeting ( with commitment ) 26 31 quarters inflation targeting ( discretion ) nominal income target chart 5 : response to a large fall in demand with a low interest rate elasticity output gap policy rate inflation gap percentage points per cent ( annualised ) per cent ( annualised ) 8. 0 7. 0 - 2 6. 0 - 4 - 2 5. 0 - 6 4. 0 - 4 - 8 - 10 3. 0 - 6 2. 0 - 12 - 8 - 14 - 16 - 10 quarters 0. 0 quarters inflation targeting ( with commitment ) 1. 0 inflation targeting ( discretion ) quarters nominal income target bis central bankers ’ speeches