rachel lomax : current monetary policy issues speech by ms rachel lomax, deputy governor of the bank of england, to the hull & humber chamber of commerce, hull, 22 november 2007. i am very grateful to gareth ramsay for his help in preparing this speech, and to several other colleagues at the bank of england for useful comments. * * * tonight i want to talk about the current issues confronting the monetary policy committee. it ’ s hard to tell the story of an economy as open as the uk without starting with global developments. that ’ s not a point i need to labour here in hull, the gateway to europe, and home to a brand new world trade centre. and it ’ s never been more true than today. the past 4 years have seen the fastest growth in the world economy since the early 1970s 1. but even more striking than its pace has been the change in the balance of global growth, with emerging economies contributing nearly three quarters of the increase in world output 2. this has become even more pronounced over the past year, as chinese growth has picked up even as the us economy has slowed. the world ’ s economic see - saw has tilted. that ’ s the new reality behind two dramas that have held the world ’ s attention since last august : the turmoil in financial markets ; and the renewed surge in energy prices. both these developments are highly unusual and very recent. no - one knows how they will play out. so you would be right to take all forecasts – including our own – with a large pinch of salt. but the mpc has to take a view, when it sets interest rates. my aim tonight will be to share some of that thinking with you. financial market developments let me start with the problems in global financial markets. over the course of the summer, growing arrears in the us sub prime mortgage market triggered a global loss of confidence in the valuation of securities backed by bundles of mortgages and other loans. how could a relatively limited problem – confined to the bottom end of the us housing market – spark a global financial crisis? it ’ s a good question. the short answer goes as follows. investors had come to rely too heavily on the ability of rating agencies to value what had become exceedingly complex financial instruments. the realisation that their faith had been misplaced cast doubt on the value of a wider class of asset backed securities. many of these were embedded in ever more complex, highly leveraged, investment vehicles. this

the flexibility of goods and labour markets ; and by raising the skills of the workforce through education and training. lord haskins has just been talking to you about the supply - side of the economy, and it is fundamentally important, because it is our supply - side performance essentially that determines the rate of growth that we can hope to sustain. it is hugely more complex than macro - economic management, being affected as it is by the whole range of public policy issues, often involving difficult political judgements on how to strike the right balance between social and economic considerations. i will have little more to say about the supply side. my involvement is on the macro - economic side. macro - economic management can do relatively little directly to contribute to improvement on the supply side, but - if we succeed in maintaining stability we can nevertheless contribute to more rational economic decision - making by the private sector, based upon real rather than purely nominal considerations ; and that can help improve our supply - side performance indirectly. as the emphasis of macro - economic management - overall fiscal policy and monetary policy taken together - shifted towards stability, a growing distinction emerged between the role of overall fiscal policy, which is set for the medium term, and a more specific role for monetary policy, which became the principal instrument for shorter - term stabilisation. this distinction crystalised first with the adoption of an explicit inflation target as the objective of monetary policy, following our exit from the erm in 1992, and subsequently, in 1997, when the bank, through the monetary policy committee, was given independent operational responsibility - legitimised through transparency and public accountability for the achievement of the government's inflation target. it is important to understand, however, that the stated aim of consistently low inflation is not simply an end in itself : low inflation is a measure - a barometer if you like - of our success in keeping overall demand in the economy in line with supplyside capacity, so that the underlying aim is economic stability in that much wider sense. now it has to be said that this emphasis on low inflation as the objective of monetary policy was not without its critics. some people argued that " any fool can control inflation simply by holding back growth and employment. it is a recipe " they said " for economic stagnation ". well that has not been our experience since inflation targeting was introduced. in fact we've experienced the longest period of continuous and relatively stable quarter by quarter growth since quarterly records began, with average annual growth at around 3