City AM interview Paul Fisher of the Bank of England
Senior Bank of England official Paul Fisher was interviewed on Wednesday 22nd February 2012, by Allister Heath and Julian Harris from City A.M. The edited transcript is as follows:
Paul, would you like to start with how you see the outlook at the moment?
I think it continues to be a story where the outlook for the economy is incredibly uncertain.
If anything I feel slightly more comfortable about the inflation outlook than the outlook for growth, because what we’ve seen over the last year or so is that the outlook for output has changed a lot but our outlook for inflation has stayed relatively constant so there’s a bit of a disconnect going on between what’s happening with economic activity and what’s likely to happen to the inflation rate.
But I think we have to continue to set policy to meet our remit and I think the main issue is that’s what we’re doing and our remit involves not just targeting two per cent inflation but trying to do so in a way that avoids unnecessary volatility in output and employment and that’s what we’ve been trying to do for the last two or three years and what we’ll continue to do.
Do you think in some sense the second part of the remit has become more emphasised compared to in the past?
I think people have realised that it’s there, I mean, that section of the remit has actually been there since the beginning, so fifteen years it’s been there, because we anticipated there would be these sorts of shocks hitting the economy – cost shocks, supply-side shocks which give you a very difficult trade-off. If you get fluctuations in demand it’s relatively straightforward in terms of – it pushes inflation and demand up so you tighten policy to bring the two back in to some sense of long run trend and inflation to target.
But when you have a cost shock or a supply-side shock and it pushes output and inflation in different directions, that’s always a difficult problem and no amount of fiddling with the target or with a measurement of inflation or anything else is going to make that an easy problem, and you just have to try and look through short term fluctuations and bring inflation back to target at the right pace.
Of course that’s a different remit to the Federal Reserve’s, but how different is it in practice?
I think, when you actually look at what central banks do, it’s remarkably similar in terms of their approach to dealing with these problems. I actually prefer our formulation, because I think it’s a bit clearer. In the long run we know we can control the inflation rate; we may not have perfect control short run or even year to year but we know we can do enough to pull inflation back.
We know also that in the long run monetary policy doesn’t affect output and employment, it only does in the short run – and so to have a policy which gives them equal weight and ignores the time dimension is for me a bit of a muddle.
Our policy, although it’s much clearer, is still difficult enough for people to understand – and it’s the time dimension which I think is crucial to understanding how the remit is meant to work.
If monetary policy’s effective in the short term but some kind of classical dichotomy holds in the long term, when does the short term stop being the short term and become the long term?
Exactly! [But] if you have very sharp fluctuations in output and employment you can cause long lasting damage to the system. We know for example that if young people are out of work for a long time it makes it difficult for them to get back into the labour force; we know that very sharp contractions can make even quite good businesses end up going bust. And so that’s the sort of collateral damage you’re trying to avoid when you say you want to avoid unnecessary volatility in output and employment.
And I think to a certain extent there has been some success in that. It’s very difficult for people to see it but the unemployment rate is much lower than you would have expected given the fluctuation we’ve had in output. And the number of companies that have gone bust is much smaller than we were expecting, again given the size of the recession. More companies went bust in the early 1990s when the change in output was only half the size, and so we think monetary policy has been supportive to help shut off some of those negative effects from growth even though we’ve been pursuing the inflation target as per the remit.
If the reason why monetary policy doesn’t work in the long run is that forces re-adjust and that supply and demand kick in, is there any argument that monetary policy can delay this adjustment?
First of all, monetary policy does work in the long run on inflation [rather than output] – but if there are real adjustments to take place, they’re going to take place regardless of what we do with monetary policy and the question is whether they happen in an orderly fashion or a disorderly fashion. And you could say much the same about Greece – it’s got to make an awful lot of readjustment and the question is how orderly can those adjustments happen?
The way I increasingly think about it, over the last few years, is that prior to the crisis kicking in, a lot of balance sheets got out of equilibrium – people didn’t realise it at the time – households were borrowing too much, the government’s fiscal position was getting out of sync [and] the banks had their balance sheets out of sync. So what’s had to happen during the recession is that people have started to move those balance sheets back towards some sense of where they think they need to be in the long run, and what monetary policy has done with low interest rates is been able to allow people to choose the speed with which that happens, and not force it to happen in a very sudden way. So you’re right, in a sense you smooth it out, but also by avoiding that unnecessary collateral damage from a sharp adjustment, the total reduction in output and employment should be less as a result.
Are you explicitly, or at least implicitly, adjusting monetary policy to counteract a tightening in fiscal policy – so are you looking at these things in the aggregate or are you just doing what you’re doing without looking too much at what’s happening to fiscal policy?
It’s not sort of part of a conscious thing “oh we must offset fiscal policy”. But fiscal policy is one of the things which we factor into the outlook for inflation, as we do with the exchange rate, as we do with developments in Europe and with everything else – it all comes together into terms of an overall outlook. And then we set monetary policy accordingly. So it’s a sort of an automatic response to what we think the impact of fiscal policy is on the economy.
Are you concerned about the recent money supply dip?
I do place quite a lot of weight on the money indicators as useful, [as an]other way of looking at the economy away from the more traditional sort of models we have – but you shouldn’t place any weight on one quarter’s fluctuations. All sorts of funny things can happen on a single quarter; transfers between two particular types of institution either inside or outside monetary statistics can affect that so I’m not too worried at the moment. If that were to continue for several quarters then I would start to get very worried but at the moment it’s just one quarter’s fluctuation. We’ll see what happens.
And the same is true for most of the other indicators, you have to look through the short term fluctuations.
I think what is happening at the moment is a lot of people are sitting on money balances, not sure what to do with them because of the degree of uncertainty. Once we can get a recovery firmly established, there’s no reason why people shouldn’t start putting that money to work, whether it’s investment balances held by firms, or cash balances held by financial market investors or households building up their money balances; so I think that quite a lot of people at the moment are not putting money to work because just the degree of sheer uncertainty about the outlook.
How firm a plan do you have for how you reverse QE at some point?
Very firm. We have discussed processes for reversing QE. Now at the moment it’s all presumptive, ie. we have a plan but the plan could easily change depending on the conditions. But the plan, which we have mentioned publicly, is that we will wait until the first rise in interest rates and then when we were sure that we wanted to withdraw the stock of asset purchases on some sort of sustained basis – at least three months, more like six months’ worth of sales – then we would begin that programme of asset sales. But we wouldn’t want to sell asset for a couple of months, then stop, wait six months and then start again.
You want to be able to set out and say “right we’re going to be doing this over a period of time” to give some certainty.
And its effects so far…?
Well, you’ve hit on the problem of course which is in economics, macro economics in particular, we can’t run controlled experiments, so we can’t say what would have happened without us doing the QE programme, and so we can never be very sure. Estimates of the impact of QE on gilt yields tend to focus on announcement effects but this time round people have expected us to make the change for some months before we actually made it, so we probably were having an impact without doing anything, without saying anything at that point; but one thing I would say is, if we had said at the time we restarted QE back in October, that gilt yields would be at their current level, I think we would have grabbed that as an outcome. We would have said “that’s great”, if that’s where gilt yields are going to end up then that would have been, from my personal perspective at least, a sensible outcome from the programme.
Now in fact those gilt yields may be at that level partly because of what the government’s doing with fiscal policy, partly because of what’s happening in Europe, and partly because of QE – we don’t know how to divide it up. The actual level of gilt yields, the way it’s shifted, since September/October time, is quite satisfactory.
It’s satisfactory because of the monetary transmission mechanism, or because of the knock-on effect from, for example, the corporate bond markets?
Yes, in a range of ways, when we change bank rate, a lot of people forget the arguments we use on QE are actually very, very similar to when we change interest rates. When we change Bank rate very few people actually have financial instruments that are at Bank rate, they may be linked to Bank rates, or maybe more loosely connected with Bank rate, but we actually try to affect a whole range of interest rates across the economy just by changing Bank rate, and the same is true with QE, to the extent that we are doing it to effect gilt yields which is just one of the channels. There will be more transactions directly in the gilt market, but an awful lot of rates in which people will borrow or lend will be prices marked off of the gilt rate. So by changing what we would call the risk-free rate you will have an impact on interest rates throughout the economy.
If we have this meeting again in two or three years time, will we be as interested in interest rate decisions, or will we spend all of our time talking about macro-prudential changes?
The governor famously said that it would be good if monetary policy were boring, and I hope we can get back to that stage. I even more hope that we can get financial policy back to being boring – in the sense that we don’t have a permanent state of financial crisis that we’re trying to deal with. The idea of macro-prudential policy is really to stop problems developing and putting defenses so that if we do get shocks to the system, it is better able to cope. That sort of policy setting shouldn’t be headline news all the time. But the problem we have is, in a sense, that when things get relatively safe, people stop paying attention to those sorts of policy measures, and what we want to do in the future is make sure we carry on with the process of making the financial system safer, and making it more resilient, even when the economy itself is not showing signs of financial distress. So I hope it will be of interest to those in the financial sector, and some of it may be of interest beyond that, but you hope it gets to a stage where it’s not front-page news.
If you were to change capital requirements, or change mortgage deposit limits for example, there obviously would be a lot of interest.
Yes, and we are just coming up to the meetings in March, in which the FPC will take a view on where we think we should have statutory powers of direction of macro-prudential instruments, and things like loan to value ratios are on that list for consideration – we haven’t yet decided which ones.
We published the discussion paper in December which set out the broad spectrum of tools, and we are looking for a relatively short list, which the FPC will recommend to the government that we have under statutory direction. So you are looking at things which are efficient, which are effective, which we actually have the power to do in the UK, and which will form some sort of convenient set so that they don’t all do the same thing – we don’t want nine powers to change capital requirements. So we want a range of things that will have different impacts.
Are you actually going to be allowed to change capital requirements under EU rules?
I hope so. We are getting reassuring noises that the regulations won’t prevent us from doing that but it may be something we will have to continue to watch and advocate for – that we can set requirements over and above the minimum level specified in the Basel arrangements.
The logical conclusion ought to be you should also be able to set them below?
Well, you want to be able to run capital buffers up during the good times and reduce them in the poor times … But it has to be symmetrical in some sense if you’re going to put things up, you’ve got to be able to put them down.
You think it won’t be symmetrical then?
Well, my fear about symmetry is not so much about what as regulators we will be allowed to do, it’s what the behavioural responses from the banks [will be]. I think we can make a bank hold more capital. Can we make it hold less capital? It’s a bit harder, that’s all about stopping the bank deleveraging which is a different conversation. You can say to the bank “your capital requirements are now two per cent lower” – you can’t necessarily make them use the capital up.
Are you happy with the Basel capital limits, general speaking or do you think they should be much higher?
The UK has generally been arguing for it to be on the tough side of capital requirements, because partly we think it’s within the banks’ own interests. What is happening in the debate at the moment is everybody’s focusing on the costs of regulation, the costs of holding more capital, the costs of holding more liquidity, and they can’t quite see what the benefits will be once we get to a level where everyone can perceive that the banking system is safer, there’s less chance of public money being used to bail people out … At that point people’s confidence in banking systems should start to come back, their funding costs would go down, their ability to rebuild their business models should improve.
How would you describe the current state of the banking system? Presumably it is not fully recovered.
The banking system is not homogenous, particularly in a country like the UK. We have six major lenders to the UK economy, and they are all quite different, both in terms of their business models, their structures, and they are in different places in terms of liquidity and capital. I think it is fair to say they are a much better position now than they were, and we’ve worked quite hard, both the FSA and the bank in various dimensions to try and improve their liquidity and capital positions, and they themselves have been working very hard. It’s not easy for me to give an international comparison because I am not as intimate with what is happening in overseas jurisdictions as here, but Moody’s the other week pointed out that they thought UK banks were in a better position relative to continental ones, for example…
Do you think some banks have got out of these problems now and can just get on with it?
I don’t think anyone is quite meeting all of the capital and liquidity conditions and have got all of their business models sorted out in quite the way they would like to. We have been arguing not to water-down the requirements, but to give the banks a sensible long period of time to adjust, so that we don’t continue to have a vicious circle coming down on the economy now, so we are not expecting the banks to jump immediately. I expect the better banks to move quicker, and try and gain a competitive advantage out of that – that would be capitalism at work. But the potential shocks that are still out there mean that every bank still has its fragilities. The nature of a business model of a bank is that you have to take risks, and there is always some level of risk which would sink the best financial institution in the world.
I remember years ago people saying deposit-taking was riskier than borrowing in the money markets, which they thought were more stable and rational, and obviously that hasn’t turned out to be the case.
That liquidity risk is fundamental for banking. When you come down to it … the one fundamental thing that banks do is take deposits and provide payment services for people and their business model involves taking short-term deposits and lending longer term. If you just take the most basic retail bank which gets deposits from individuals and lends some mortgages, you’ve got a liquidity mis-match, and that is inherent in what they do. That’s why we stand ready as lender of last resort, to provide liquidity insurance under stress, and if a bank is to remain solvent, we will happily stand and provide plenty of liquidity to the system, to individual banks to do that. If a bank, however, has made bad business decisions and is going bust, we are not there to prop it up. It’s always a grey area, there’s always a judgment that has to be made at the time. But in some sense it is important that the banks use our facilities early enough for us to say “yes, you’re solvent viable,” and not leave it until the last minute.
So it’s now past 9.30am and the MPC’s minutes have been released, so let’s talk about QE again.
We’ve now set up a programme for purchases for the next three months. We can, of course, revisit it at any month, we’ve always made that clear – we can either stop, or we can do more, and we consider that every month. People think we’re locked in for a period of time, and we’re not. Let’s assume we complete the £50bn over the next three months, at this moment in time I would have a completely open mind going into the next round as to whether or not we would want to do more QE or not. That’s me personally. When we did the programme in October, I always thought it was more likely we would do more than not, because the risk at that time was of the economy slipping back into a severe recession, we could see what was likely going into the late months of the year, and the risk was that slide would carry on going.
That downward slide doesn’t seem to be crystalising, that is as good as you could say at the moment, but it was still worth doing a bit more QE, trying to make sure that risk is off the table, and then we will see in the May round, and we may get surprises, positive or negative before then which causes us to change our mind, but at the moment I would have a completely open mind going into the next round whether or not we need to more or whether we could stop.
The economy obviously shrank in Q4, but do you think it is growing in Q1?
It is too early to tell. We have had some positive indicators the purchasing managers’ indexes, but they are just on set of particular indicators, they haven’t always been consistent with the GDP outlook. So I think our forecast, which is for underlying growth this year to be pretty flat, below trend, may be averaging a small positive number. That seems to me to be consistent with what we are seeing and hearing with the economy overall, and, of course, you are then vulnerable to downward shocks pushing you back into recession, and there are also upside risks if things continue to improve. So we try not to give running commentary on quarter by quarter, what we might expect is some bounce-back from Q4 in Q1, and then some negative impact from the Diamond Jubilee holiday effect, and so you can get sucked into trying to explain small quarterly movements. The underlying position seems to be that the economy is flat to small-positive at the moment, and we expect it to stay that way really until the consumer gets going again; we’ve had very weak consumption growth for about five or six quarters in a row … and a lot of recovery will be dependent on consumption growth returning.
Why do you think it will return sooner rather than later, is it because you think inflation will fall?
Well we don’t think it will be that soon, we are looking towards the second half of the year at the earliest, and part of that is getting some real income growth back from inflation rate coming down, with wages gently picking up – not to particularly high levels, no further rises in things like Value Added Tax, the government’s tax plans are pretty well set up now, so I think people are getting a bit more certainty. I think quite a lot of what we saw last year was the product of a lot of people being uncertain; uncertain about their real incomes, uncertain about their jobs, uncertain about what was going to happen in Europe, so if those uncertainties start to diminish, people may at least not want to keep increasing their precautionary savings balances.
Obviously you mentioned the possibility of shocks, and by definition can’t be predicted, but were you referring in part to what might or might not happen in the Eurozone, for example?
Yes, that is one thing, and again, potential for it to go in both directions, we could have something quite negative happen, while we could see the crisis increasingly get resolved.
Do you think it looks like it is getting resolved?
I think they are continuing to take one step at a time, and try and get through it. And you will find in financial markets more generally, people are very reluctant to predict what may happen in terms of politics, difficult though it is, it is easier to understand the economics of the situation than it is to understand the politics, and the Greek situation has got much more to do with politics than economics, so it is just impossible to know how it is going to come out, how the Germans are going to react, how the Greek people are going to react, and how the politicians are going to react on particular days.
And I suppose with the oil price creeping up, you’ve got all this stuff going on in Iran, that should be another shock.
That’s a more specific shock that we are concerned about. The last thing we need at the moment is another upward cost shock coming from oil prices, on top of what we have had in the last few years. Just as we see inflation starting to fall back towards target, it’s halfway back from its peak, we don’t want it to be blow off course again, upwards, from a shock like that. But if it happens, it will be completely out of our control and we will just have to deal with it.
You mean potentially by continuing to loosen monetary policy.
Well it is not obvious. When you see something like the oil price go up, if it’s in a sustained way, that means we as a country are worse off, and then you have to work out what is the appropriate monetary policy response to that. You can’t use monetary policy to change the real price of oil, and so again we have to try and look through to see if it is a temporary effect on inflation or a permanent effect, and make the right decision.
A permanent upward one-off increase in prices.
Yes, and we hope that is not the case, because the oil price has remained at quite an elevated level.
The American economy seems to be getting better, do you think they are getting out of their rut?
Well they had a smaller hit to total output than we did, and partly that’s because the financial sector is less important in the US than it was here so it is not surprising. I think there is still a big debate to be had about what equilibrium levels of employment and growth are in the US. I think they thought initially that they would be able to return to the same tread-path of growth as they had pre-recession, I think that is less certain now, so there’s still a debate there, but they do seem to be recovering quicker than Europe is, that’s for sure.
And the UK’s recovery.
We seem to be a long way away from that very long-run trend and we don’t know whether that’s a permanent deviation away, or just something temporary. If it is temporary, that’s relatively good news because it means there is potential for a lot of growth in the future. It doesn’t look and feel that way at the moment it looks like we may have shifted the level of output at least. There is no reason to think that the trend rate of growth is any different.
Really? There is no reason to think that?
No, I mean fundamentally, trend growth depends on productivity and population growth, and we aren’t suffering a slow-down in population growth that some other countries are, we’ve been a bit more open to workers coming from the rest of Europe and there’s no real reason to think that technology growth and multi-factor productivity growth should have changed. If you look around there’s still lots of potential for new technology to be exploited in manufacturing, and especially in services. So, at the moment, the jury is out on that.
So, just before, you were saying about having an open mind about QE going forward, are there any other points you want to highlight?
I voted for £50 billion. There was a 7-2 split with two members voting for £75bn, and I was in the £50 billion.
How much does that actually matter given that you can just add more QE later? Is it just about the volume of QE per month that would change?
You have to look at a range of things including what signals you are giving to people. None of us believe that we have to do what the markets are expecting but people will take different signals, and for me, there’s certainly a risk that doing a larger amount would have indicated that our outlook on the economy was worse than it really is, so that’s one factor. And again, I think £50bn puts us in a better place to have that free choice when it comes to make… I mean £25bn is neither here, nor there, really, in the course-tuning operations that we’re doing.
So basically having £50bn makes your range of choices larger?
Exactly. You can keep on going without putting a dent in the programme, or you can stop if you think the outlook has changed sufficiently. If you look at our inflation forecast with the £50bn, we were just about back to being evenly balanced around the inflation target by the end of the horizon. The degree of uncertainty is so huge that there’s plenty of room for small differences around that.
From what you said before, and what you’ve published previously, you’re basically saying that you could not put up interest rates while still with QE going, is that correct?
Well, technically you could, but I think you would have to have some idea that QE and interest rates had such completely different effects that the combination made sense. Personally I don’t. I think that QE and changing bank rate have very similar effects in terms of monetary conditions, and so you have to have a very particular reason for wanting to put more cash out into the system.
We could do it technically, there’d be no problem, the current arrangements we’ve got, where we changed our operating framework for the duration of QE. Once we start putting Bank rate up, we are intending to return to our previous operating regime, but again, that is a decision that we could change at the time if we wanted to and we are putting in place preparations so that we can.
What about buying assets other than gilts?
People suggest it, but you never hear a very good reason why we should do it. If we buy gilts we will affect the prices of all our other assets in the economy, so what’s the particular reason for buying other assets? Now we are actually still operating, in a small way, in the corporate bond market. We still are offering to buy and sell sterling corporate bonds every week. In fact, what is happening is that we’re selling more than we are buying because there is strong demand out there for corporate bonds which is what we hoped would be one of the consequences about doing gilt purchases, and the market is not operating very well, the banks aren’t holding very large inventories of corporate bonds, and so our stock of corporate bonds is actually in high demand. It would be completely counter-productive for us to go out and buy a lot when the private sector actually want to themselves go out and buy a lot of corporate bonds.
Did you buy corporate bonds with the aim of affecting the microstructure of the corporate bond market, or because of liquidity?
Well when we started, corporate bond spreads were very wide and the absolute yields were high, so there was clearly a big liquidity premium built in. So our idea was to act as a back-stop purchaser in order to reduce those extra wide spreads, and that was quite successful, corporate bond spreads came down really very quickly during 2009.
What sort of volume did you actually buy of those?
We got up to about, a stock of purchases of £1.7 billion at the peak.
So you thought that had an effect?
Well, the corporate bond market is not that liquid because most of the investors are buy-and-hold investors, so it was quite a sizeable amount in that space. It’s not unusual for corporate bonds, the typical trades would be one or two million at a time as people moved their portfolios around a bit. So then, once we had put those operations successfully and spreads had come down, we then started to offer the bonds for sale as well as purchase, and over the last year or so, we’ve actually sold quite a lot of the bonds off.
But basically speaking, you are not convinced there is an argument for switching out of large scales of purchases of gilts to large scale purchases of…
Of what? That is the question! So I think there are two things going on here, one is quantitative easing, where gilts have the benefits of being a deep liquid market, they affect the prices of everything, we aren’t putting public sector money at risk by taking private sector credit risk, and we can get an exit strategy that is relatively straightforward. And if you compare that with the problems of buying large scale purchases of other instruments, and it is very tricky, you are putting public money at risk, the exit strategy isn’t clear. The US I think are expecting to sit on their portfolio of mortgage-back securities until they mature because it would completely destroy the market if they went back and sold large quantities of RMBS [residential mortgage-backed securities] back into the market, and so we think this is the right policy for now, not to say never do anything else, because one thing you have learned after the last three or four years is that you should never say you’re never going to do something. And if we were following the policy and it clearly was not being effective, then we would have to reconsider. But remember, our ultimate objective is to hit inflation target, one of the main purposes of doing QE was to prevent deflation, we have been successful in preventing deflation, and so at the moment I don’t see any reason to change policy, but I would never say that we have never change to do something else.
Presumably you have never thought of other crazier things like helicopter-style monetary easing or anything like that.
[Laughs] No, well the key point is, we are not spending money, we’re injecting money into the economy in return for assets, and we expect to be able to reverse that, we aren’t giving money away, that would be quite wrong. Not that I’m saying it is for governments to give money away, but you know what I mean. Spending public money is for the government, not for us.
Are you comfortable there is still a distinction between monetary policy and fiscal policy, even though you are buying so many of the gilts?
Yes, we are quite clear what our responsibilities are for and throughout this crisis, it is amazing how people have, on one hand complained about the bank having too much power, and on the other hand wanted us to take responsibility for things which are clearly outside our remit, and we have had a very precise idea of where those boundaries lay, and what point something should pass over from the government. I think it’s important we stick to what it is our job to do and do not try and exceed our powers.
Do you feel slightly daunted by the amount of powers you might have, though?
I do not feel daunted, it is a big challenge, we are going down a direction further and faster than other countries – other countries are doing similar sorts of things, but nobody has quite gone to the situation of having a committee like this with statutory powers to make independent changes, so it’s a great challenge to see if we can make it work. It won’t be perfect, we never claimed we could abolish business cycles through monetary policy, and we won’t abolish credit cycles through macro-prudential policy, what we are trying to do is, maybe we can lean against the wind a bit, but really what we are trying to make the system more resilient to shocks, that is the main purpose. And an awful lot of what is happening around the globe can be couched just in terms of trying to prevent a situation where public money has been used again to bail out the financial sector, and if you wanted to understand any particular policy that is going on at the moment, that is the glasses to see it through.
How interested are you in resolution mechanisms for financial institutions?
It is very important part of the thing. It’s not something I have personally been working on, but it is part of the things that the financial policy committee will take an interest in. We have to be able to allow banks to fail, and that is the problem. That is why public money has been injected around the globe into so many institutions.
Well there was no Plan B, no proper bankruptcy scheme for these massive institutions. Given the importance of that seems to be a crucial element, do you think people are a bit slow on it?
Some bits are in place. Everything can always be improved, some bits are in place and other bits are not yet. The special resolution regime here, there is one, we have used it for Dunfermline for example and some small banks… we won’t know how it works for a large bank until we get the chance to use it but let’s hope we don’t.
But presumably you would have to run dry-runs? Let us say one bank had a £30 billion loss, what happens then?
As you would imagine there is quite a lot of thought being given to what would happen if a particular bank went bust, what would we actually do, do we have enough powers? And because each individual bank is in such a different place, the answer is different for each of the major banks. And we are still working hard on them to improve their recovery and resolution plans – their own plans and what they would be. And that goes for bits of the infrastructure, not just for banks, we want to see the major part of the financial infrastructure having a plan for what it would do if it got stuck. Because the people who know the business best are the people who run it, and there is only so much you can do from outside. But I was involved a little bit at the margin with the aftermath of Lehman’s and talking to the administrators, and it was such a mess. We mustn’t allow banks to get into that position again.
I am quite puzzled that no one thought what might happen if something like that was to happen … the concept that a large institution could fail and it would be quite nice to resolve it doesn’t seem that complicated.
People had thought about it but it was never top of the priority list to actually fix. People were doing other things. The FSA, who had come under a lot of criticism, they were being put under huge political pressure on consumer protection and mis-selling stuff, or enforcement issues. They weren’t under political pressure to improve supervision or resolution regimes, and so we have a chance now. There are not many silver linings in a financial crisis like this, but we do actually have a chance to make a difference that will be there for the next generation in terms of trying to get the financial architecture right whilst it is fresh in everybody’s minds what can go wrong and how big the problems are. We have to then not miss the opportunity to get the financial system into a better place.
Going back to the Eurozone, what is your view on the long-run future for the euro?
It’s very difficult to predict, they have to come to a way of addressing the long-run issues that are involved in a monetary union and the lack of competitiveness that some of them have got into after 10–12 years, they have to put in place long-term structures to try and avoid this. All the focus over the last year or so has been on short-term responses, it sort of moved out to medium-term responses in terms of fiscal consolidation, but the real answer here lies in the long-run structures. And you now begin to see much more talk in communiqués of structural reforms, political reforms, much more talk of the need to move to fiscal and political union as well as monetary union, and those are the sorts of big issues which Europe is going to have to address.
Do you think they will?
I think, well they have to. The lesson from this exercise in Europe is that the economics will win out. You can’t just have the monetary union, then say that’s good we can all import German competitiveness, you actually have to work hard to deliver German levels of competitiveness.
Then you’ve got a problem if people don’t actually want that.
Well, it was a stated reason for joining the Euro was that everybody would be able to latch on to Germany’s economic success, but the single currency, like any monetary policy, doesn’t deliver you real economic adjustment in itself. The real economic adjustment comes from doing real things, and so it is the mirror image of what we were talking about earlier – adopting the Euro is just a monetary policy thing, it doesn’t change the real economy in itself, that requires real behaviours, and that’s what they’ve missed over the last twelve years and which now has to be put in place.
Any last message for our readers?
I think the main message is that we are sticking very much to our remit, we are determined to bring inflation back down to two per cent, that is our operational target and we are determined to get there. We will be blown off course from time to time by shocks, and if we are, we just have to act in the best way to bring inflation back down again. What has happened over the last couple of years should really imbed in people’s minds why we have an inflation target, and why we should be committed to getting inflation back down to two per cent again.