to the banking sector, with the counterpart assets being long - term and equity - like. annex 2 : monetary policy and long - term forward rates this annex summarises recent work in the bank for paul tucker ’ s speech to the society of business economists on national balance sheets and macro policy : lessons from the past. the spot nominal interest rate on a ten - year zero - coupon government bond can be thought of as the average of the short - term interest rates expected to prevail over the ten year period, plus a term premium ( which is often thought of as compensating investors for uncertainty around those short - term interest rates ). comparisons between yields on government bonds of different maturities can be used to identify a sequence of forward rates ( ie the expected short rates at each point in time plus a forward term premium associated with that maturity ). using the information from the yields on inflation - linked government bonds, expectations of nominal short - term interest rates and forward premia can be broken down further into the expected future inflation rate ( and an associated forward inflation term premium ) and the expected future real interest rate ( together with the associated forward real term premia ), equation ( 1 ). ftnominal ( n ) = ( et [ rt + n ] + rptreal ) + ( et [ πt + n ] + rptπ ) ; where ftnominal ( n ) denotes the n - period ahead forward interest rate prevailing at time t ; et [ rt + n ] and et [ πt + n ] the expectations for the real interest rate and the rate of inflation at that point and rptreal and rptπ the corresponding forward real and inflation term premia. in principle, then, there are two broad channels through which a decision by monetary policy makers to change their policy rate could affect longer - term interest rates, such as the 10 - year government bond yield. first, the decision could change market participants ’ expectation of either real interest rates or inflation. it is worth noting two standard bedrocks of monetary economics here. first, longrun neutrality : that, in the long run, monetary policy changes do not have a bearing on real quantities and relative prices ( such as the level of economic activity or the real interest rate ), but rather affect only nominal variables. second, if a monetary regime is credible, those longterm nominal variables should be “ anchored ” around a level consistent with policy - makers ’ objectives. in

those flows have made a difference? had the west ’ s current account deficits been financed by inflows of equity, would the eventual “ adjustment ” have been less destructive? the flows were, of course, of debt. the accumulated “ excess ” savings in the east were largely held in official, risk - averse portfolios, notably central bank fx reserves. their investments concentrated on fixed - income instruments : initially government bonds, but later mortgage and some corporate securities ( broadly matching the composition of capital flows into the us, chart 6 ). combined with demographic shifts in the west pushing pension funds into fixed - income, this might have increased global demand for bonds relative to equities, driving down credit and term premia ( relative to equity risk premia ). for a while there was probably excess – that is to say, unsatisfied – demand for bonds, and that in turn probably had two effects. the generation of new types of supposedly “ safe ” bonds through securitisation and, in particular, eventually synthetic securitisations. 8 separately, there was arbitrage across asset classes, effected by firms borrowing to buy back their own equity and to acquire others via leveraged buy - outs. in summary, while the ex ante global savings / investment imbalances plausibly drove down equilibrium world risk - free interest - rates, the precise composition of the resulting capital flows will have affected risk premia too. monetary policy, international banking flows, and global liquidity the other story aired about macro drivers is the possible role of monetary policy and private sector credit creation. and that too points to a role for risk premia. against the grain of established thinking, and now famously, raghu rajan argued at jackson hole in 2005 that the federal reserve ’ s commitment at the beginning of last decade to keep policy rates low for a prolonged period had fuelled financial risk taking. 9 while this is now see borio and disyatat ( 2011 ), “ global imbalance and the financial crisis : link or no link ” ; and cecchetti ( 2011 ), “ global imbalances : current accounts and financial flows ”. the gross foreign assets of each country ’ s residents, summed across all the countries in the world. see cabellero ( 2009 ), “ global imbalances and financial fragility ”, american economic review papers and proceedings, vol 99, no. 2, may 2009, pp.