Since the prospect of Brexit emerged, financial markets,
notably sterling, have marked down the UK's economic
Monetary policy cannot prevent the weaker real income growth
likely to accompany the transition to new trading arrangements
with the EU. But it can influence how this hit to incomes is
distributed between job losses and price rises. And it can
support households and businesses as they adjust to such
profound change. Indeed, in such exceptional circumstances, the
Monetary Policy Committee (MPC) is required to balance any
trade-off between the speed with which it returns inflation
sustainably to the target and the support that monetary policy
provides to jobs and activity.
That is why last summer the Bank announced a series of
monetary and macro-financial measures to support the economy
during this transition. This stimulus is working. Credit is
widely available, the cost of borrowing is near record lows,
the economy has outperformed expectations, and unemployment has
reached a 40-year low.
As spare capacity erodes, the trade-off that the MPC must
balance lessens, and all else equal, its tolerance for
above-target inflation falls. Different members of the MPC will
understandably have different views about the outlook and
therefore on the potential timing of any Bank rate increase.
But all expect that any changes would be limited in scope and
gradual in pace.
From my perspective, given the mixed signals on consumer
spending and business investment, and given the still subdued
domestic inflationary pressures, in particular anaemic wage
growth, now is not yet the time to begin that adjustment. In
the coming months, I would like to see the extent to which
weaker consumption growth is offset by other components of
demand, whether wages begin to firm, and more generally, how
the economy reacts to the prospect of tighter financial
conditions and the reality of Brexit negotiations.
During the negotiating period, the economy will be
importantly influenced by the expectations of households, firms
and financial markets about the nature of both the transition
and the longer term economic relationships with the EU and
Markets have already anticipated some of the adjustment.
Depending on whether and when any transition arrangement can be
agreed, firms on either side of the channel may soon need to
activate contingency plans. Before long, we will all begin to
find out the extent to which Brexit is a gentle stroll along a
smooth path to a land of cake and consumption.
Whatever happens, monetary policy will be set to return
inflation sustainably to target while supporting as best it can
the necessary adjustments in the economy.
The Challenge of Global Imbalances
With many concerned that global trade is taking local jobs,
protectionist sentiments are once again rising across the
advanced world. Excessive trade and current account imbalances
are now politically as well as economically unsustainable.
Perhaps because imbalances ultimately reflect savings and
investment choices within a country, they are often described
as morality tales with the virtues of Swabian housewives
contrasted with the vices of the Anglo-Saxon rakes.
In fact, trade imbalances are natural features of an open
system and can be warranted by differences in demographics,
levels of development and expected paths for
For example, emerging market economies with young
populations and bright prospects should be expected to run
large deficits, as Canada did for decades at the turn of the
last century.4 In contrast, rapidly ageing countries
should run large surpluses, as confirmed by Bank
These are "good imbalances," and we need global trade and
financial systems that encourage and facilitate them.
There are also "bad imbalances" caused by domestic
distortions (for example, in the financial or social welfare
systems that affect savings and investment decisions); global
deficiencies (such as inadequate global safety nets which
encourage reserve accumulation); or mercantilist and
protectionist policies (which manage trade).
And that is part of what is occurring today, with Japan,
Germany and China running excess surpluses relative to
fundamentals; and the US and the UK running excess deficits.
And although the euro area excess surplus is relatively modest
relative to its GDP, in absolute terms it is at least as
important as those of Japan or China.6 So while the
distortions are few in number, those that exist are large in
scale and systemic in importance.
Such global imbalances matter for at least three
First, from the Lawson boom to the Tequila and Global
Financial Crises, a common lesson is that large current account
deficits are one of the most trenchant early warning signs of
financial instability.7 This is especially true when
deficits are accompanied by rapidly growing domestic
credit.8 It is dangerous to rely entirely on the
discipline of the domestic financial system. In each case, the
eventual large private losses weighed on public balance sheets
and growth for years.9
Second, when imbalances reflect unfair competitive advantage
– either through managed trade or managed exchange
rates – they can lead to protectionist backlashes that
leave everyone worse off.
And third, in the current environment of synchronised
weakness and limited policy space, it is not hard to imagine
this low inflation / low wage / low growth trap being sealed as
it was in the 1930s.
In this environment, the UK is running a historically large
current account deficit. On the positive side, the deficit is
funded in domestic currency and financial reforms have
increased the resilience of the UK system, thereby making
larger imbalances more sustainable. But the UK's deficit has
also been associated with markedly weak investment and latterly
with rapid consumer credit growth. This is not an imbalance
that is, as yet, funding its eventual resolution.
Moreover, despite the large depreciation around the
referendum, the extent to which the UK's deficit has moved
closer to sustainability remains an open question, one whose
answer depends crucially on the outcome of the Brexit
Most fundamentally, the UK relies on the kindness of
strangers at a time when risks to trade, investment, and
financial fragmentation have increased.
The world economy has been here before. In the 1930s
monetary policy was exhausted and fiscal policy was in
abeyance. The trap was sealed by a wave of protectionist
measures originating in the US and spreading to Europe. As
current and capital accounts closed, stagnation ensued.
What should be done to prevent history from rhyming?
In the simple world of the economist, the prescription is
straightforward. Deficit countries should loosen monetary
policy and tighten fiscal policy. Surplus countries should do
the reverse.10 If only the G20 would roll up its
sleeves, it could easily solve this economic
But such cures are prescribed in the abstract where policy
space is unconstrained – a situation far removed from
Monetary policy is still challenged by the lingering risks
of a global liquidity trap, with a very low global equilibrium
interest rate, r* – the interest rate central banks
must deliver in order to balance demand with supply and so
achieve stable inflation. Colleagues at the Bank estimate that
secular forces – which include demographics, the lower
relative price of capital, higher costs of financial
intermediation, and inequality – have reduced global
long-term interest rates by around four percentage points since
the 1980s.12 In addition, cyclical forces since the
crisis including high policy uncertainty and hedging of
disaster risk are exerting further drags on private investment,
not least through reinforcing the option value of
Fiscal space is limited in the wake of the financial crisis.
And the space that exists is often unevenly distributed
– with the euro area providing the classic
example.14 Given the heavy burden on European
monetary policy, the still sizable amount of slack in the euro
area, low European borrowing costs and aggregate fiscal space,
it is difficult to avoid the conclusion that if the euro area
were a country, fiscal policy would play a greater role in
promoting internal and external balance and the world would be
better off accordingly.
Moreover, as in the 1930s, theoretical remedies are
generally falling foul of the real world reluctance of surplus
countries to share the adjustment burden. Unlike deficits,
surpluses can be run for a very long time as they are not
hostage to changing preferences of investors and are only
gradually affected by their domestic impact.15
For these and other reasons, work at the IMF and the Bank
suggests that changing the macro policy mix in systemic
countries would at best reduce only about one third of their
Why not just leave the rest to exchange rates? This might
prove risky not just because exchange rates tend to move slowly
then significantly, but also because IMF estimates of the
required changes are greater than have occurred in any year
since the collapse of Bretton Woods.17
And since all countries cannot become more competitive at
the same time – it is a relative concept –
there is no avoiding it: higher global growth will require
comprehensive measures to boost productivity and with it, real
wages and demand. This means domestic policies to spur
innovation, technology adoption, and the reallocation of
Particularly important will be measures to re-start the
stalled 'diffusion machine'.18 While the most
productive companies have continued to innovate, others have
become slower at adopting those innovations. Speeding up the
rate of take-up of new inventions and processes – for
example through greater product market competition or
challenges to management to benchmark against best
practice19 – would provide a significant
boost to overall productivity growth.
And higher growth requires a new approach to trade policy.
Consider that Bank of England research estimates that up to one
half of the post-crisis productivity slowdown could be related
to the deceleration in global trade growth.20
It will not be enough for the G20 to 'resist protectionism'.
The G20 now needs to make 'trade work for all'. That includes
using e-commerce platforms to promote free trade for SMEs
across the G20,21 and it requires an urgent and
critical examination of trade in services.
In this context, Brexit in general and financial services in
particular will be key tests of the world's capacity to build a
path to stronger, more sustainable growth.
Levelling Down or Up: Managed Trade or Free
Trade in Services?
One cause of global imbalances is the uneven playing field
between trade in goods and services, with barriers to services
trade currently up to three times higher.22
Most of the world's major surplus countries, like Germany
and China, are net exporters of goods and benefit from this
asymmetry. Conversely countries with a comparative advantage in
services, like the US and UK, are more likely to run current
The G20 faces a choice – between levelling down by
putting more restrictions on goods trade, or levelling up by
liberalising trade in services.
Evidence from within countries suggests that there may be
substantial scope to increase trade in services if barriers are
removed. For example, in Canada – one of the few
countries to track trade flows within its borders –
services account for around 50% of all inter-provincial trade
compared with only 25% of Canada's international exports. If
Canada were able to replicate the pattern of trade within its
borders with other countries then services exports would
Reducing restrictions on services trade to the same extent
as those on goods have been over the past couple of decades
could reduce the excess deficits of the US by one third and the
UK by one half.23
Services liberalisation is also a more efficient form of
rebalancing because services industries tend to have higher
domestic value added, and jobs, than manufactured goods. The
lower import content of services compared with goods means
smaller changes are needed to address current account
imbalances.24 For example, a £10 billion
increase in UK financial services exports would reduce the UK's
trade deficit by £9 billion, whereas the same increase in
exports of autos would contribute £5.5 billion.
Of course, liberalising services is not straightforward, as
barriers are typically not tariffs but 'behind the border'
differences in regulatory standards and trading conditions.
This is where global standards and regulatory cooperation
Arguably the greatest possibilities are in financial
services given the major progress in financial reform. Indeed,
financial services could serve as a template for broader
services trade liberalisation. And with Brexit, we have the
coincidence of necessity and opportunity.
Since the crisis the G20 has agreed a series of new
international minimum standards to secure the resilience of the
banking sector, transform shadow-banking into resilient
market-based finance, make derivatives markets safer and end
too-big-to fail. Implementation is now being regularly assessed
and transparently reported by the FSB and IMF. The playing
field for cross-border activities is being levelled.
At the same time, supervisory cooperation has intensified.
Information is now readily shared through supervisory colleges.
And regular crisis management groups for systemic firms are
building confidence in how authorities will behave when things
In short, platforms are being created for deference to each
other's approaches when they achieve similar outcomes. With
robust standards consistently applied, wholesale financial
services could be brought more fully into bilateral trade
agreements, keeping the global financial system open and
resilient, and supporting greater trade, investment and
Let me use a specific example of CCPs in London –
although my points apply more generally and reciprocally to all
critical cross-border financial market infrastructure in the UK
Prior to the crisis, derivative transactions created a
complex, opaque – and dangerous – web of
exposures that helped turn a shock into a panic.
With the G20's encouragement, CCPs are now helping to
untangle this web and build resilience. Moreover, by netting
exposures across counterparties, currencies and products; CCPs
are supporting more liquid markets and are lowering costs to
end users. That means more resilient financing and better risk
management for business and households.
The UK houses some of the world's largest CCPs. For example,
LCH in London clears swaps in 18 currencies for firms in 55
jurisdictions, handling over 90% of cleared interest rate swaps
globally and 98% of all cleared swaps in euros. All currencies,
products and counterparties benefit from the resulting
economies of scale and scope.
Fragmentation of such global markets by jurisdiction or
currency would reduce the benefits of central clearing. EU27
firms account for only a quarter of global activity in cleared
euro interest rate swaps, and about 14% of total interest rate
swaps in all currencies cleared by LCH. Any development which
prevented EU27 firms from continuing to clear trades in the UK
would split liquidity between a less liquid onshore market for
EU firms and a more liquid offshore market for everyone
The potential for higher costs is not theoretical. In Japan,
for example, where the clearing of yen-denominated swaps by
certain Japanese firms must take place onshore, the difference
in price between the onshore and offshore markets has generally
been in the range of 1-3 basis points.
Such seemingly small price differences translate into
significant costs for users given the scale of activity in
these markets. Industry estimates suggest that a single basis
point increase in the cost resulting from splitting clearing of
interest rate swaps could cost EU firms €22 billion per
year across all of their business. Those costs would ultimately
be passed on to European households and businesses.
Moreover if the large stock of existing trades of EU firms
– tens of trillions of euros in size – was
trapped at a CCP which was no longer recognised by the European
Commission, those EU firms would face capital charges as much
as ten times higher than today unless and until they could move
Fragmenting liquidity would drive up costs somewhat in the
remaining market as well. On current volumes, almost 90% of
swaps are traded by non-EU firms and could remain in the main
UK-based liquidity pool. Given the size of this market, the
impacts could be expected to be much smaller, although not
Fragmentation is in no one's economic interest. Nor is it
necessary for financial stability. Indeed it can damage it.
Fragmenting clearing would lead to smaller liquidity pools in
CCPs, reducing the ability to diversify risks and diminishing
resilience. And higher costs would reduce the incentives to
hedge risks, increasing the amount of risk that the real
economy would have to bear.
The Bank of England fully recognises European concerns. I
know because I shared similar ones as Governor of the Bank of
Canada. These were addressed then through common standards and
cooperative supervisory oversight, allowing C$ clearing to move
to a more efficient and resilient hub in London. The Bank of
England also must concern itself with the resilience of CCPs in
other European and non-European jurisdictions that are used by
firms that we supervise. These CCPs must be subject to robust
regulatory standards and deep reciprocal supervisory
To address such issues, we can and should build on current
models to develop a new form of regulatory and supervisory
The European Commission's proposals announced last week
recognise the importance of effective cooperation arrangements
between the relevant EU authorities and their overseas
counterparts. They include potential provisions for deference
to the rules to which a CCP is subject in its home jurisdiction
in line with the intent of the G20.26
The Bank welcomes this. The Commission's proposals, driven
in part by Brexit, address an increasingly important and more
general issue in the regulation of the international financial
Elements of these proposals could therefore provide a
foundation on which to build robust cross-border arrangements
for the supervision of CCPs. This should be based on deep
cooperation between jurisdictions and authorities who defer to
each other's regimes where they meet international standards
and deliver similar outcomes.
Coming to an innovative, cooperative and reciprocal
agreement on central clearing would promote competitive
financing in the euro area and maintain the resilience of the
UK and global financial systems.
More fundamentally, it would be an early milestone in the
broader rebalancing of the UK, European and global economies.
And it would produce far superior outcomes to other elements of
the Commission's proposals, which would fragment global
clearing activity and raise costs and risks.
A decade of radical financial reform was not an end in
itself, but rather a means to serve households and businesses
better. We must ensure that the real economy reaps its full
benefits, including through freer trade in services and more
resilient financing of the investment needed to boost wages of
workers in all industries across the UK.
One million people across this country work in financial
services. The industry contributes 7% of output and pays taxes
that cover almost two thirds of the cost of the NHS. At a time
when the UK is running a 5% current account deficit, financial
services runs a 1.5% trade surplus with Europe alone. The
entire service sector runs a 5% surplus with the world and
employs 85% of UK workers.
We could take these realities for granted. And it would be
all too easy to give into protectionism. But as we learned in
the 1930s, that road leads neither to equity nor prosperity.
Raising barriers to trade disproportionately hurts the least
well off through higher prices and fewer
Escaping the low inflation / low wage / low growth trap
requires more than a textbook rebalancing of macro policies
across the major regions. It demands comprehensive structural
reforms and a new approach to trade policy. Such changes could
more than make up for the dramatic fall in the real incomes
that UK households have experienced in the decade since the
crisis.28 The Brexit negotiations will be the
- A Fine Balance by Rohinton Mistry.
- The sterling ERI has fallen close to 20% from its
November 2015 peak. Since then, UK-focused equity prices have
fallen by over 2%. In contrast, broader equity price indices
such as the FTSE 100 and S&P 500, which more heavily
reflect global economic considerations, are almost 20% and
40% higher respectively (in sterling terms). UK 10-year real
government bond yields have fallen 115 basis points; by
contrast 10-year real government bond yields in the US are
down by around 25 basis points only.
- Savings and investment imbalances will shift with changes
in relative prices, including changes in prices of final
goods and services, changes in nominal exchange rates,
changes in relative production costs (including unit labour
costs), and changes in the costs of trade. Lags and frictions
will mean that different components will shift at varying
speeds. This, in turn, can result in large adjustment costs
not present in economic models, which can make a laissez
faire approach risky.
- Canadian deficits averaged 8% of GDP in the thirty years
before World War I. 'Canada in a multi-polar world', speech
by Mark Carney, May 16 2011, available at http://
- See Lisack, N., Sajedi, R. and Thwaites, G. 'Demographic
trends and the real interest rate', Bank of England Staff
Working Paper forthcoming.
- Small economies hosting large financial centres like
Singapore and Switzerland are special cases for which it is
difficult to estimate 'norms'.
- Blanchard, O. and Milesi-Ferretti, G.M. (2011), '(Why)
Should Current Account Balances Be Reduced?', IMF Staff
Discussion Note, No. 11/03.
- Caballero, J. (2014) 'Do surges in international capital
inflows influence the likelihood of banking crises?' Economic
- For example, the IMF estimate that the output cost in
Mexico following the Tequila Crisis of 1994-96 was around 14%
(Laeven, L. and Valencia, F. (2012), 'Systemic banking crises
database: an update', IMF working paper). For the global
financial crisis, the cumulative loss of global output, when
compared to its pre-crisis trend, is of the order of 25% of
global output, while for the Lawson boom it is close to 10%
of UK output.
- More recently, attention has been paid to the need to
maintain appropriate macroprudential policies as well as
monetary and fiscal. See, for example, the IMF policy paper
(2011) 'Macroprudential Policy: An Organizing
- See speech by Mervyn King at the University of Exeter,
January 19 2010, available at http://
- See Rachel, L and Smith, T (2015), 'Secular drivers of
the global real interest rate', Bank of England Working Paper
- As Ben Broadbent has noted, as uncertainty rises, the
option value of waiting also rises – with a simple
model suggesting it can add around 10pp to the hurdle rate
that firms need to meet. See 'Uncertain times', speech by Ben
Broadbent at the Wall Street Journal, 5 October 2016,
available at http://
- For example, consider the following comparison between
the euro area and the UK. In the euro area, the private
sector continues to generate surplus savings of 5% of GDP.
Those must be recycled effectively to generate an expansion.
The UK no longer faces that challenge. Its private sector is
in balance. The euro-area unemployment rate of just over 9%
is twice that in the UK. Gross general government debt in the
euro area is roughly the same as in the UK and below the
average of advanced economies. The weighted average yield on
10-year euro-area sovereign debt is similar to that in the
UK, at close to 1%. And yet, the euro area's fiscal deficit
is half that in the UK. Its structural deficit, according to
the IMF, is around one third as large. It is difficult to
avoid the conclusion that, if the euro zone were a country,
fiscal policy would be substantially more supportive.
- See Blanchard, O. and Milesi-Ferretti, G.M. (2011),
- The macro policies included in the IMF's analysis are
fiscal, credit, foreign exchange reserves, the social safety
net (proxied by spending on health) and capital controls. For
Germany, for example, the IMF estimate that only 0.6pp of the
assessed 4.8% excess current account surplus is due to an
overly tight domestic policy mix relative to other countries
and a further 0.8pp is accounted for by the policy mix being
too loose elsewhere. In China, the IMF analysis indicates a
tightening of domestic policies is needed, which would
increase the current account surplus rather than reduce it.
For more detail, see the IMF's 2016 External Sector Report,
available at https://www.imf.org/external/np/pp/eng/2016/072716.pdf.
- See the IMF 2016 External Sector Report, available at
- See https://
- See the report written by the Productivity Leadership
Group, chaired by Sir Charlie Mayfield, (2016), 'How good is
your business really? Raising our ambitions for business
performance', available at:
- See 'The world trade slowdown redux', Bank Underground
blogpost, available at
and Frenkel, J. and Rose, A. (2000) 'Estimating the Effect of
Currency Unions on Trade and Output', NBER working paper No.
- As noted in 'The Spectre of Monetarism', speech given by
Mark Carney, Roscoe Lecture, Liverpool John Moores
University, 5 December 2016, available at http://
- Miroudot, S., Sauvage, J. and Shepherd, B. (2013),
'Measuring the cost of international trade in services',
World Trade Review, Vol. 12, Issue 4, pp 719-35.
- Roughly equal to 15%. These calculations are based on the
estimated effects of reducing services trade restrictions on
services exports reported in Nordås, H.K. and Rouzet, D
(2016), 'The impact of services trade restrictiveness on
trade flows', The World Economy, and the estimated mapping
between services trade restrictions and services trade costs
reported in Miroudot, S. and Shepherd, B (2016) ibid.
- In sterling terms. In percentage terms, the changes are
larger for services reflecting the fact that they start from
a smaller base.
- Requiring up to another €5 billon of capital.
- See, for example, the G20 Leaders' communique, Brisbane
Summit, November 16 2014, available at http://
- Fajgelbaum, P.D. and Khandelwal, A.K. (2016), 'Measuring
the Unequal Gains from Trade', Quarterly Journal of
Economics, Vol. 131, Issue 3, shows that past episodes of
trade liberalisation have disproportionately benefited poor
households, in every country, through reductions in consumer
prices and increases in product variety.
- As my colleague Andy Haldane noted in his speech
Productivity Puzzles (available at http://
if productivity growth in the second, third and fourth
quartiles of the distribution of UK firms' productivity could
be boosted to match the productivity of the quartile above,
then arithmetically that would deliver a boost to aggregate
UK productivity of around 13%. In the longer run, that
increase in productivity would be expected to flow through
fully into real wages. By contrast, the peak to trough fall
in real wages following the crisis was in the region of
This article has been adapted from Mark
Carney’s Mansion House speech, given in London on
June 20 2017. The full speech, with accompanying graphs, can be
freely accessed at: www.bankofengland.co.uk/speeches