every day. some of the important risks that could affect all instruments – from terrorist attacks, invasion of computer systems, or even the consequences of a flu pandemic – are almost impossible to quantify, and past experience offers little guide. be cautious about how much you borrow is not a bad maxim for each and every one of us here tonight. ignore the unsolicited emails that rain down on us offering unwanted credit. i received one last week that began, “ we have the solution, mervyn, for your bankruptcy ”. the development of complex financial instruments and the spate of loan arrangements without traditional covenants suggest another maxim : be cautious about how much you lend, especially when you know rather little about the activities of the borrower. it may say champagne – aaa – on the label of an increasing number of structured credit instruments. but by the time investors get to what ’ s left in the bottle, it could taste rather flat. assessing the effective degree of leverage in an ever - changing financial system is far from straightforward, and the liquidity of the markets in complex instruments, especially in conditions when many players would be trying to reduce the leverage of their portfolios at the same time, is unpredictable. excessive leverage is the common theme of many financial crises of the past. are we really so much cleverer than the financiers of the past? concerns about the rate at which credit is being created extend to monetary policy. as i said last week in cardiff, it would be optimistic in the extreme to suppose that the rapid growth of money and credit could be dismissed solely as a positive shock to the demand for money. the spread between interest rates paid by households and businesses and interest rates available in the money market has fallen. this has been one of the factors behind the strength of demand in the uk economy over the past year. despite greater availability of labour, businesses have not expanded employment sufficiently to prevent stronger demand from increasing capacity pressures. such pressures encourage businesses to raise prices. and that is exactly what the business surveys suggest has been happening. that underlying upward pressure on inflation has in part been hidden by the volatility of domestic energy prices. but it is why we have raised interest rates four times and by 1 percentage point in all over the past year. our central view remains that inflation will fall back this year as the rises in domestic gas and electricity prices last year drop out of the annual comparison, and the recent cuts in prices feed through to household bills. but

from earlier in the year, we should not take much solace from that. after a very weak first half, when growth was less than one percent, economic activity has strengthened somewhat and inflation pressures are starting to ease. growth in the third quarter is currently estimated 2. 5 percent, and recent indicators suggest growth in the fourth quarter could be somewhat higher. however as we look toward 2012 the u. s. economy continues to face several obstacles to a robust economy. accordingly, i expect growth of about 2. 75 percent for 2012, not much higher. we also continue to face significant downside risks, mostly related to the stress in the eurozone. we cannot be satisfied with the current state of the economy or the outlook for the next few years. the economy is operating far below its productive potential – leaving the levels of output, income and employment much lower than they would be if the economy ’ s unused resources were put back to work. one summary statistic says it all – the unemployment rate is unacceptably high at 9 percent. imbalances and deleveraging so why has the u. s. recovery been so underwhelming? i think the answer lies in the nature of the boom in credit and housing, and the collateral damage that the bust caused to household balance sheets and to the financial system. recoveries that take place in the aftermath of severe financial shocks and big declines in asset prices that were mainly funded by debt require highly indebted borrowers to deleverage, or in other words, pay down their debts. these shocks and asset price declines, in turn, generate large losses for the financial sector that tightens credit availability and further restricts demand. with weak demand comes weak income growth. meanwhile, financial and economic volatility and the uncertainty this creates about prospects for future incomes causes those who retain access to credit to hold back. what we have learned, i think, is that the power of these economic forces is even stronger than we had previously understood. and, in such circumstances, although a stimulative monetary policy is essential for recovery, it may not be sufficient. to illustrate the problem, let ’ s begin by examining net debt flows in the private nonfinancial and government sectors over the last 10 years. as can be seen in chart 1, borrowing by the bis central bankers ’ speeches private nonfinancial sector rose rapidly from 2003 to 2006 and remained high until the crisis hit. then borrowing turned negative as new