Wednesday, February 27, 2008

[Latest Global Dollar Liquidity measure: +11.3% annual growth rate; latest Endogenous Liquidity Index: -43.7%]

Rachel Lomax, Deputy Governor for Monetary Policy at the Bank of England, was certain to make headlines with her speech at the Institute of Economic Affairs (*). According to Lomax, "this must surely be the largest ever peacetime liquidity crisis". Now, that's a statement! And she added, for good measure: "There may be more shocks to come". Aside from the journalistic excitement created by these lines, and bearing in mind that Ms. Lomax does not deal with the still booming macroeconomic global liquidity, the really important part of the speech deals with the outlook for inflation expectations and their impact on monetary policy:

If people put their trust in the regime, or a ‘credible central bank’, they are unlikely to revise their expectations about future inflation much, especially if the nature of the current situation is well and honestly explained, including how long it will take inflation to return to target. But if they forecast future inflation using simple rules of thumb based on past actual inflation rates, anything that dislodges inflation from target will affect what people use as their best forecast for future inflation ... In the context of the current outlook, the real risk facing the Committee is that a further period of above target inflation, prompted by a cost shock over which it has no immediate control, will lead people to revise their expectations about future inflation, and to act accordingly. This will make it more costly to bring inflation back to target.

Interesting stuff indeed. I guess well' have to closely watch ... inflation breakevens.

(*) Speech (pdf); Bank of England asbstract; Angela Monaghan: "BoE fears largest ever peacetime liquidity crisis", The Telegraph

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