Monetary Policy and the Financial System

In this speech, Paul Tucker, Executive Director for Markets and Monetary Policy Committee (MPC) member, discusses the challenges that the turmoil and fragility across financial markets has posed to monetary policy and financial stability. On monetary policy, the conditions were not favourable to a 'business as usual' approach to demand management; alongside the downside risks to demand from tighter credit conditions there were upside risks to inflation over the medium term stemming from the rise in commodity prices and the decline in the exchange rate. The broad policy strategy was to offset some but not all of the adverse shock to demand. If implemented successfully that strategy would enable the Bank to provide durable support to demand and activity. If, by contrast, the inflation genie threatened to escape from the bottle then policy would need to be tightened. On the financial system, the process of deleveraging in the financial system was not complete, and there was a risk that credit creation could be further impaired. In tackling these issues, he notes that the technology for central bank liquidity insurance - an important facet of the de facto Social Contract existing between the banking system and the authorities - had broken down since the summer, due to the stigma on borrowing from central banks' standing facilities. Central banks needed to innovate and reform the way in which they provided such insurance. Morebroadly, he suggests that a renewed debate is needed on policies to tame the credit cycle, but cautions there are formidable obstacles in finding a solution