mervyn king : jackson hole conference - remarks to the central bank governors ’ panel remarks by mr mervyn king, governor of the bank of england, at a symposium sponsored by the federal reserve bank of kansas city, jackson hole, wyoming, 27 august 2005. * * * jackson hole speakers normally draw out the lessons of economic theory for one specific area of policy. but this year we are trying to distil lessons from the practice of monetary policy in the united states - over an extraordinarily successful quarter century under the leadership of alan greenspan – for the theory of monetary policy. at most celebrations of a long and successful career, invited speakers talk at length and the great man himself is allowed a few minutes at the end. it is a remarkable tribute to alan that on this occasion the tradition has been turned on its head. we all remain intrigued by what he has to say. in the few minutes i am allowed, i want to describe the three important lessons that i have learnt from alan during my time at the bank of england. first, to be a successful central banker requires an extraordinary degree of objectivity. the key is to recognise that economics tells you how to think, not what to think. it is not a set of settled conclusions about issues. above all, it is vital never to confuse the world with a model. the whole point of a model is to abstract from a wide range of factors in order to think clearly about one particular issue. let me describe an example of what i shall call “ the greenspan approach to economics ”. it concerns the ‘ lucas critique ’. robert lucas ’ 1976 paper encouraged economists to construct models which incorporated explicit optimising behaviour by households and firms. unfortunately, some of them urged policy - makers to apply the lessons from their models as literally as the enthusiasts of the engineering approach to macroeconomic policy had done so in the 1950s and 1960s. the greenspan approach to economics would advise great caution. the insight of the lucas critique is that we need to think about the responses of rational households and firms when analysing the consequences of alternative policies. but the likelihood that any particular model captures how the real economy would respond to a given change in policy is vanishingly small. lucas did not pretend that there existed a single “ true ” model from which could be drawn unequivocal predictions about the impact of policy changes. the second lesson from alan ’ s time at the federal reserve is that empirical knowledge is not confined to the eco

movements would be short - lived and therefore not relevant from a monetary policy perspective. looking through such volatility, however, upside risks to price stability at the policy - relevant horizon are alleviating. the remaining upside risks relate to an unexpected increase in commodity prices, as well as in indirect taxes and administered prices, and the emergence of broad - based second - round effects in price and wage - setting behaviour, particularly in economies where nominal wages are indexed to consumer prices. the governing council calls for these schemes to be abolished. it is imperative to ensure that medium to longer - term inflation expectations remain firmly anchored at levels in line with price stability. turning to the monetary analysis, the annual growth rates of broad money and credit aggregates, while still remaining strong, continued to decline in september. taking the appropriate medium - term perspective, monetary data up to september confirm that upside risks to price stability are diminishing but that they have not disappeared completely. a closer examination of the money and credit data indicates that the recent intensification of financial tensions has already had an identifiable impact, particularly in the form of outflows from money market funds and greater inflows into overnight deposits. however, the full impact of investors ’ uncertainty on their portfolio allocation behaviour is still to be seen in the coming months. both portfolio shifts between non – monetary and monetary assets and shifts between different types of monetary assets can therefore not be ruled out in the period ahead. hence, such effects will need to be taken into account when assessing monetary growth and its implications for price stability over the medium term. there is also some evidence in the september data that the recent intensification of the financial tensions has triggered a slower provision of bank credit to euro area residents, mostly taking the form of smaller holdings of securities. at the same time, for the euro area as a whole, up to september there were no indications of a drying - up in the availability of bank loans to households and non - financial corporations. in particular, the maturity composition of loans suggests that non - financial corporations continued to obtain funding, also at relatively long maturities. however, more data and further analysis are necessary to form a robust judgement. to sum up, the intensification and broadening of the financial market turmoil is likely to dampen global and euro area demand for a rather protracted period of time. in such an environment, taking into account the strong fall in commodity prices over recent months, price, cost and wage pressures in the