Speaking at Mansion House last night, Sir Mervyn King said that raising interest rates significantly in the aftermath of the financial crisis would have resulted in a weaker economic recovery and further falls in output than have been seen.
And he says that while such a policy may have brought inflation closer to its 2% target today, it would not have prevented the squeeze on living standards arising from higher oil and commodity prices and government austerity measures.
King says that the MPC’s mix of tight fiscal and loose monetary policy is necessary to rebalance the economy, and to change this broad policy mix would make little sense.
He says: “Of course, at some point, bank rate will need to rise to more normal levels in order to ensure that inflation returns to its 2% target.
“The MPC is watching extremely carefully for any signs of a pick up in domestically generated inflation and it will take action as soon as it is appropriate to do so.
“So far, subdued rates of increase in average earnings, as well as remarkably – some might say disturbingly – low growth rates of broad money have provided strong signals that inflation will fall back in due course.”
King also warned that the UK faces at least another three years of economic pain before a recovery begins.
He says: “The world economy is adjusting from an unstable disequilibrium to a new equilibrium.
“In more biblical language, failure to tackle the imbalances during the seven years of plenty before 2007 threatens seven lean years thereafter for at least part of the world economy.”