Mr George elucidates the new monetary policy arrangement in the United Kingdom and in the euro-zone  (Central Bank Articles and Speeches, 18 Jan 99)
Central bank: boe | Type: speech | Date: 1999-01-18

## Mr George elucidates the new monetary policy arrangement in the United Kingdom and in the euro-zoneSpeech by the Governor of the Bank of England, Mr E A J George, at The Chartered Insti Bankers in Glasgow on 18/1/99.Mr President, Secretary of State, Lord Provost, my Lords, Ladies and Gentlemen.It would be a masterly understatement to describe the past two years, since the last CI Dinner, as eventful.Here

in Scotland, following the referendum and last year's legislation, you are now preparing for the elections to the Scottish Parliament in May.In my own neck of the woods, we have seen responsibility for the implementation of mo policy devolved upon the Bank's new Monetary Policy Committee.And elsewhere in Europe, 11 countries have merged their separate currencies into th euro, thereby passing responsibility for monetary policy from national authorities t European Central Bank.These are truly historic events.I have no wish to become embroiled in the matters of Scottish politics this evening than happy to leave that to the Secretary of State.

I simply wish you all well, and loo developing a constructive dialogue with the new Parliament as we have with the Sc banking and business communities.

But let me say a few words about the new monetary p arrangements here in the United Kingdom and in the euro-zone.The real significance of those arrangements - in both cases - is that in introducin respective governments confirmed their common commitment to achieving and maintaini effective price stability in their respective currency areas.

That role for monetary simply an end in itself, in some abstract, doctrinaire way.

On the contrary it reco consistently and reliably low inflation, into the medium and longer term, is a necessar the end of sustainable growth of output and employment, which are, of course, the tr things of economic life that we are all seeking to achieve.Our own new legislation defines the MPC's objective as to maintain price stability and to that, to support the Government's economic policy, including its objectives for g employment.

The Maastricht Treaty defines the primary objective of the European Central as to maintain price stability, and without prejudice to that objective to support economic policies of the European Union.There are significant differences between the two statutory frameworks.

In our case, fo the precise definition of the stability objective is determined by the Government; an much more rigorous requirements for transparency of the MPC process and public accounta for MPC decisions.

I am convinced that our arrangements are wholly appropriate t particular circumstances.

But the essence of what we and the ECB Governing Council mandated to do is very much the same.It involves in effect aiming to keep overall, aggregate demand in the economy (as a who or less continuously in line with the underlying overall capacity of the economy (as ameet that demand.

Effective price stability is essentially a measure of our success i economic stability in that much broader sense.It is a limited role.

Neither we nor the ECB can do very much directly to affect the supply side of the economy which depends upon its structural characteristics, and abo today's world, on the efficiency and flexibility of goods, capital and labour markets policy cannot substitute for supply-side reform, but by maintaining price stabilit indirectly, help markets to function more effectively.Nor can either the MPC or the ECB do much directly to influence the pressures on par firms or particular sectors or regions of the economy; we and they can only influ monetary situation in the economy of our respective currency areas, as a whole.

W essentially one instrument:

the short-term interest rate.

But, again, if we are s achieving overall stability, that will also contribute over time to a more rathe favourable operating environment for the different component parts of the economy.

But the most that either we in the MPC or the Governing Council of the ECB can hope to do.The fact that we both have essentially the same objective - and are subject to limitations - does not, of course, mean that we can adopt the same policy stance - the of short-term interest rates, as some commentators have recently, and oversimpli suggested.

We start from different positions, and our respective economies are subject different, as well as many of the same, influences.

That was an important economic rea the Government decided, rightly in my view, not to participate in the first wave of union - despite the attraction, in the right circumstances, of nominal exchange rat across the European continent.

It was, I know, a matter of regret to many of our partners; but there was also a sense of relief, because many of them recognised that ou economic situation would have complicated European monetary management had we joine from the outset, as it would have complicated monetary management in this country.In our case, the UK economy has grown at an average annual rate of around 3% now for th six and a half years (to the third quarter of last year).

That is well above any plausi the underlying rate of growth of capacity in the economy as a whole - which is t estimated at some 2-2½%.

So what we were in fact doing over this period was ste reabsorbing the economic slack created by the recession of the early 1990s.

In the labo this was reflected in a rise in employment of some 1.65 million to an all-time high on figures (for the three months to last November) of 26.6 million.

It was reflected, too the rate of unemployment from a peak of 10.6% (on LFS figures) to the current rate o which is the lowest rate for almost 20 years.

As far as the regional impact is concern note that over this period unemployment in Scotland - though still higher than in the whole - has also declined - to 7.6% on the latest LFS data, compared with a peak of 10. on a claimant count basis it, too, is currently lower than for 22 years.These developments in the labour market produced only a fairly gradual pick up i settlements and earnings growth compared with past periods of labour market tighte though we have, of course, been unsighted on what has happened to earnings growth recently.

And underlying retail price inflation - on the Government's inflation targe (RPIX) - averaged some 2¾% a year through the expansion, and is currently exactly on ta 2½%.By the time of your last dinner it was already becoming clear that overall output grow to moderate if we were not to run into overall capacity constraints and a pick-up in inexaggeratedly strong exchange rate against the core European currencies - reflecting market misperceptions about the prospective strength, or rather weakness, of the euro moderating external demand, especially for manufacturing output, while at the same exerting a restraining price effect on domestic inflation.

But domestic demand g including demand for services - continued to accelerate through 1997, and that w background to the tightening of monetary policy in 1997.

We could not avoid that tig despite the uncomfortable sectoral imbalance within the economy.

To have done so would have said elsewhere, have put the whole of the economy - including the internationally sectors we would have been trying to shelter - at risk of accelerating inflation, so have helped even those sectors in anything other than the short term.Meanwhile, in the euro-zone things were very different.

Demand and output growth in the continental economies remained generally fairly sluggish for much of the period, onl starting to pick up towards the end - helped by relatively weak exchange rates.

Unempl which is much the most urgent and important issue confronting Europe, actually increas despite some improvement over the past year or so, it remains at or close to double di all the largest euro-zone countries.

Inflation against this background remained low, te - as did interest rates.

The position is complicated in the euro-zone by a reviving pol about just how much of the unemployment reflects supply-side weaknesses requiring stru reforms, and how much it reflects inadequate overall demand.

The outcome of that debate crucial to the future evolution of the euro-zone.

But in the immediate situation th reason to suppose that continued growth of demand and output was inconsistent with ef price stability in the zone as a whole.So much for our different starting points.

But over the past year, the world - and world - has changed quite dramatically for both of us in that we have both been affect international economic slowdown.This started, in fact, with the financial disturbances in Asia in the latter half of 19 late as the beginning of last summer it seemed as if it might have only limited imp overall world economy.

The IMF, for example, was still then projecting 3-3¾% world grow 1998 and 1999 respectively - which was certainly a setback compared with their forecast 4% just six months before - but it was hardly catastrophic.Since last summer it has become increasingly clear that things are likely to be signifi than that.

The financial collapse in Russia, deepening recession in Japan, the long b sudden defeat last week - in Brazil's attempt to hold its exchange rate, and fluctuat possible knock-on effects on the major countries' financial markets all contribut increased sense of financial fragility, which has not been easy to contain.

We can, I avert a more general international financial upheaval (and the financial markets' resp latest developments in Brazil, as well as the beginnings of a recovery in capital flo countries in Asia, are reasonably encouraging in this respect).

But, we are nevertheles see a pronounced slowdown of world economic activity.

The IMF has cut its latest (Dece forecast for world growth to less than 2¼% in 1998/1999.

And the risks almost certainl on the downside.

That's still not global slump or recession.

But large parts of the wor are in fact in recession and the prospect for the world as a whole turns very much happens in the major industrial countries.In essence, what we are seeing is a sharp cutback in capital flows to much of the emerg and to some of the transition economies, enforcing on those countries a corresponding c domestic demand and creating the need for an urgent improvement in their current accouncounterpart is a sharp decline in net external demand in the industrial countries, whic offset by action to stimulate domestic demand in those countries, could lead to weakeni activity and price deflation.In fact to varying degrees - reflecting differing assessments of how far their particu area is expected to be affected by the slowdown in external demand, and different start in their assessment of trends in domestic demand, and of how close they were initial capacity, in their respective overall economies - both the UK and the euro-zone, as w US, have acted fairly aggressively to reduce interest rates since the autumn; and Japan to more active fiscal stimulus.

And if the global economic prospect, and net external the industrial countries, were to deteriorate further, then it would be right to conte moves in the same direction - consistently with our aim of effective price stability. trying to do, as I said earlier, is to keep aggregate demand in line with the supply ca economies.

We have no interest in the creation of unnecessary spare capacity in our e as a whole or in a fall in the underlying general price level.But what this will inevitably mean is a worsening of the balance of payments on current of the industrial countries, individually and collectively, reflecting the imbalan external and domestic demand growth in our economies.

That imbalance clearly will need reversed at some point as the flow of international capital is restored to a more susta The pressures can in the meantime be mitigated by official international financing, b flows may take a while to settle down.

For the time being, though, the directly and internationally exposed sectors, not just of the UK economy but throughout the industr will continue to operate in a highly competitive environment.All in all this is an uncertain and difficult prospect.

It will be an exceptionally cha for both international and domestic monetary policy management in both the UK and the zone as well as in the rest of the industrial world.

And it will, I know, be a challeng many of you - even though the excessive strength of the exchange rate has now started But our economy as a whole starts from a position of relative strength compared with and our own financial underpinnings, including both corporate and personal sector sheets, are relatively robust.

We are currently seeing an overall slowdown - as we nee That slowdown could go further.

But I would frankly be surprised if it developed into protracted recession - that certainly is not the most probable outcome; it is not outcome; and it is one which the MPC will certainly seek to avoid - always consisten achieving our inflation target.Mr President, I can promise you that the next two years will be eventful.

The only othe is that we will be confronted by the millennium.

But I would hope that by the time we this Dinner again the situation will be both clearer and calmer.In the meantime, I thank you once again for your excellent hospitality and I ask you and to join me in a toast to the health and prosperity of the CIB in Scotland.