there are good reasons to believe that a substantial margin of spare capacity opened up during the recession and remains today. output fell precipitously through the second half of 2008 and into 2009 and, despite the recovery in recent quarters, the level of output remains around 10 % below that implied by a continuation of its pre - recession trend. the precise degree of spare capacity is difficult to judge since it depends on the extent to which the recession damaged the supply potential of our economy. 4 some of the channels through which recessions in the past have impeded supply growth appear, thus far at least, to have been less damaging than we initially feared. despite a larger fall in output, the fall in employment, although substantial, has been less than in past recessions. likewise, the pickup in company liquidations has been relatively muted. it is likely that the financial crisis and the reduced availability of credit have affected supply in other ways, such as making it harder for smaller or more entrepreneurial companies to raise funds for investment or expansion. but even so, demand has probably weakened by substantially more than potential supply, implying a large degree of slack both in the labour market and within companies. consider each in turn. slack in the labour market has contributed to the muted growth in earnings seen over the past 18 months or so. annual private sector earnings growth has averaged a little below 1 1 / 2 % since the start of the recession, around a third of its rate in the five preceding years. but the impact of this weak pay on companies ’ costs has been offset by businesses appearing to hold onto more staff than warranted by the lower level of output. the corollary of the resilience in employment has been a sharp drop in labour productivity. as a result, growth in labour costs per unit of output has remained relatively firm, although it has fallen back as productivity has begun to recover. companies that have spare capacity within their business should be able to use these underutilised resources to increase output relatively cheaply. as such, spare capacity within see benito et al ( 2010 ) for a discussion of the impact of the financial crisis on supply. companies should, at the margin, push down costs and prices. but reports from our network of agents suggest that some companies responded to the sharp fall in output by temporarily decommissioning some of their capacity in order to reduce their cost base. 5 companies mothballed production lines ; cut back on capital leases ; reduced the number of shifts and

andrew bailey : speech at the lord mayor ’ s banquet speech by mr andrew bailey, deputy governor of prudential regulation and chief executive officer of the prudential regulation authority at the bank of england, at the city banquet, london, 16 october 2014. * * * lord mayor, thank you once again for inviting us round to dinner. events at the mansion house never cease to be special, with an aura that sets them apart. it is a true story from some years ago that a very senior official from another country came to a lunch at the mansion house, at which he spoke, and after which he came to visit the then governor of the bank. he had been impressed by the grandeur of the surroundings, the food and drink, the speeches ( in plural ), but he had just one question for the governor. how does anyone make money in the city if that is how they carry on? the governor was wise and slightly avuncular in his answer, to the point of remarking that it is not a question that anyone in the city would ask. lunches may have become shorter, but dinners remain a place to take stock over good food and wine and with good company. and, for martin and me it is a chance to take stock after just over eighteen months of the new arrangements. the pra is responsible for the prudential supervision of banks, insurers and major investment firms. we take all of our responsibilities very seriously, as of course we should. across the board, there have been developments over the last year that give me a sense of cautious satisfaction – by the way, that is at the happier end of the spectrum of emotions for a central banker seriously, i am afraid that we must not get carried away here. we are in many ways in the second phase of the financial crisis. the first phase was a prudential one, while the second phase has revealed past misconduct. fixing the financial system requires more than just fixing capital and liquidity standards. standards of governance, conduct and the right incentives structures are all extremely important. after commenting on two material development this year i want to use the rest of my time to set out four areas where we are either taking action, or watching very carefully to determine whether action may be required. let me start by describing two developments which point to some cautious satisfaction. first, the capital position of uk banks has strengthened. market conditions have supported actions to raise capital and reduce non - core assets, and