Mr. George comments briefly on the global economy and on recent economic performance in the United Kingdom  (Central Bank Articles and Speeches, 11 Jun 98)
Central bank: boe | Type: speech | Date: 1998-06-11

Mr. George comments briefly on the global economy and on recent economic performance in the United Kingdom Speech by the Governor of the Bank of England, Mr. E.A.J George, at the Dinner with the Lord Mayor for Bankers and Merchants of the City of Lond 11/6/98.The past year, since we last enjoyed the generous hospitality of the Mansion on this great City of London occasion, has been a testing time.

It has been characterise imbalances in both the global economy and here in the United Kingdom - which have complic the task of policy-makers everywhere, including the task of the Bank of England's now leg Monetary Policy Committee.Internationally there has been good news in the enviable performance of the U States - Goldilocks - economy, with continuing robust domestic demand growth and further unemployment, with so far remarkably little inflationary pressure.

To the extent t performance can be sustained, it provides substantial underpinning for the global econo whole.And there has been encouraging news, too, in the re-emergence of domestic dem growth in the Continental European countries as they prepare to take the final step to union.

That is a promising context for the launch of a strong, credible, currency and European Central Bank every success in its historic task.

Domestic expansion with mo stability within Europe is in the interest of us all.Elsewhere though the international situation has been decidedly less beni combination of financial fragility and weak business and consumer confidence has weighed h on the Japanese economy, and on the Yen; and the financial thunderstorms, which broke initi year over a number of other countries in Asia, are still intermittently rumbling around th elsewhere.

The economic fallout from these developments poses a serious downside risk growth of world activity and threatens the emergence of potentially large international imbalances.

It is a dangerous environment.All of this has prompted a far-reaching re-examination of the international m structure, and in the meantime it presents the international monetary authorities with so immediate management challenges.

It also, of course, represents an uncertain inter background for the conduct of monetary policy in this country.Our own overall economic performance over the past year was again ver encouraging.

Output growth (on the latest data, to the first quarter of this year) significantly above the rate of inflation (measured by the GDP deflator) for the fourth past five years - which I think is unprecedented in post-war British experience.

On this ba past five years annual output growth has averaged some 3.1% while annual inflation has a 2.2%.

And unemployment - on the conventional claimant count basis - fell further last year on the latest figures, the lowest since the summer of 1980.The task, of course, is to sustain this pattern of relatively steady growth inflation into the medium and longer term.

And that task has certainly become much tougher.At the aggregate level - looking at the economy as a whole, while no-one mean no-one, whatever they may claim - knows with any great precision just where current d and output is in relation to the underlying supply capacity of the economy, there is no do are now at least much closer to full capacity output than we have been - and the actual ratover the past year was, on almost anyone's calculation, above the rate of underlying capaci So we have been at greater risk of overheating than for some time.The consequence - if we were to overheat - is quite clear.

Inflation would ac and we would then need to impose an abrupt slowdown on the economy to bring it back u control - to meet the Government's inflation target.

It was, of course, to avoid accelerat and the associated need for an abrupt slowdown that the members of the Monetary Policy Comm last year had no difficulty in agreeing upon a significant policy tightening.But there was - and is - a significant complication.

The aggregate position account of the serious imbalance within the overall economy between external and dom demand.

The internationally exposed sectors of the economy were already confronted last ye an exaggeratedly strong exchange rate, particularly against the core European currencies could only be partly explained by cyclical and monetary policy differences.

It appeared good deal to do with market scepticism - I would argue misplaced scepticism - about the pr strength of the euro.

The internationally exposed sectors faced a further battering as a economic impact of the developments in Asia and elsewhere - which I mentioned earlier.These pressures have had - and are having - a seriously depressing effect on and output in the exposed sectors of the economy - particularly large parts of manufacturin and agriculture - which is contributing to a sharp deterioration in our balance of paymen in the net external component of aggregate demand.At the same time, the strong exchange rate, and the weakness of world commod prices, is having a direct dampening impact on costs and prices in this country - particu wholesale, producer, level but also affecting retail prices.Meanwhile the domestic economy has been unsustainably strong.

Privat consumption, in particular, was growing at an annualised rate of over 5% last summer, growing at an annualised rate of 4% by the first quarter of this year.

This compare longer-term trend rate of some 2½%.

But for the dampening impact of the external influe aggregate demand and on costs and prices, this could already have resulted in acceleratingThe complication for monetary policy, in this situation of external/dom imbalance, has, of course, been that a tightening of monetary policy to slow the pace of t economy would have been likely to aggravate the appreciation of the exchange rate, intensif the restraining external demand and price effects, and putting even more intense pressu internationally exposed sectors.Now, there is no question but that the strength of the domestic economy moderate further - as indeed we expect that it will.

But the external influences - whi anyway not do much about, but which will in time wear off - made this moderation of do demand growth less immediately urgent than it would otherwise have been.

In these circums with some evidence that growth in the domestic economy was in fact slowing, and given the pressures on the internationally exposed sectors, we needed, in my view, to be more than confident in our judgement as to the need to tighten policy further.The questions with which the MPC has been struggling this year then are: jus much shelter the external situation would in fact give us, and for how long; and just how therefore, we had to bring about a sufficient slow down in domestic demand to prevent i accelerating and the economy from overheating.

Now these are immensely difficult judgem They depend in part upon one's perception about the starting position - that is how closefull capacity utilisation to begin with.

And they depend upon not just the direction, bu change and the timing, of changes in the different components of aggregate demand.

It i surprising that the various members of the MPC should - within this common framework analysis - reach, essentially marginally, different conclusions, reflecting their individu as to the balance of risks.

Indeed it would have been incredible if they had not reached different conclusions.

What is unusual - and what outside observers are I think still gett is that different possible interpretations of the data and different possible judgement displayed in the minutes of our meetings, which also record the way in which each member voSome people now seem to find this open discussion of alternative views confu My own view is that it can only contribute to the effectiveness of monetary policy if th large better understand the nature of the issues and the uncertainties surrounding them procedures have had one, by me at least, unforeseen, and I think regrettable, consequence, has focused excessive attention upon the way in which individual members of the Committee leading to their over-simple categorisation as either hawks or doves.

It is as if their ju expected to be consistently instinctive rather than objectively based upon their i open-minded, assessment - reached after careful analysis - of the most recent information at the particular time.

As a result serious economic commentary seems - perhaps temporar have ceded some ground to ornithomancy - which, as of course you know, is the ancient prac divining the future by observing the behaviour of birds - especially their flight patterns!This I suspect contributed to the surprise reaction to last week's furthe interest rates - which proved once again that 'Hell hath no fury like a wrong-footed commentator'!

It should not have been such a great shock.

In the Inflation Report wh published a month ago we set out the analysis as I have described it to you this evening, a attention to the fact that the outlook for monetary policy remained finely balanced - as i been for some months.

We drew attention also to the major uncertainties surrounding the inflation projection.

These uncertainties included both the level of the exchange developments in the labour market.

It was - as we explained in our press notice last Thur subsequent 'news' essentially on these fronts, and particularly the sharp acceleration sector earnings growth, that caused the Committee to conclude that the necessary slowd domestic demand growth had become more pressing.

The interest rate decision showed simply what were always fine judgements changed with the facts - as I can assure you they will in either direction.