Andrew Sentance: The challenges of the "New Global Economy"
Speech by Mr Andrew Sentance, External Member of the Monetary Policy Committee of the
Bank of England, at the Jersey Chamber of Commerce, St Helier, 25 May 2011.
All speeches are available online at www.bankofengland.co.uk/publications/speeches.
* * *
I would like to thank Adrian Chiu for research assistance and I am also grateful for helpful comments from other
colleagues. The views expressed are my own and do not necessarily reflect those of the Bank of England or other
members of the Monetary Policy Committee.
It is a great pleasure to have this opportunity to speak here today at your Annual General
Meeting lunch and I am extremely grateful to Ray Shead and the Jersey Chamber of
Commerce for inviting me and helping to arrange this visit. For you here in Jersey, this event
is a first - as I believe it is the first major speech which a member of the Bank of England
Monetary Policy Committee has given in Jersey or any of the other Channel Islands.
Hopefully I am blazing a trail for my MPC colleagues to follow in the future! For me, however,
it marks the close of a chapter. This is my last public speech as a member of the Bank of
England Monetary Policy Committee (MPC), as my term in office comes to an end this
month.
I have spent just over four and a half years as a member of the MPC and it has been a most
eventful period to be involved with economic policy-making. My period on the Committee has
been dominated by the global financial crisis and the major global recession it triggered in
late 2008 and early 2009. However, the global recession is now behind us, even if we are still
feeling some if its after-effects. Since the second half of 2009, the world economy has been
in a recovery phase and the UK and most other European economies have shared in this
return to growth. Indeed, the growth of the UK economy has tracked very closely the average
performance of the European Union through the recession and into the early phases of the
recovery, as Chart 1 shows. And current forecasts point to a continuation of this pattern this
year and next.
Chart 1 - UK and EU output growth, 1997-2012
Percentage change in real GDP
5
4
3
2
1
0
-1
-2
UK (exc. oil and gas) *
-3
EU-27 *
-4
-5
-6
1997 1999 2001 2003 2005 2007 2009 2011
*:2011 and 2012 are IMF forecasts. Forecasts for the UK do not exclude
oil and gas.
Source: ONS, IMF World Economic Outlook
In the UK, the rate of growth which we have seen over the early stages of recovery has not
been spectacular, but that is not unusual in the early period of a return to growth after a
major economic downturn. It is also not surprising that there have been variations in growth
across different sectors of the economy and that confidence still remains fragile in the
business community and among consumers. It is normally only 2-3 years into the recovery
phase of the economic cycle that perceptions of improving economic conditions begin to
catch up with the reality of a return to growth.
This strong correspondence between economic growth in the UK and elsewhere in the EU
shown in Chart 1 should not be a great surprise. It reflects the close economic links which
have grown up over the centuries and which have been reinforced by the development of the
European Union and the Single European Market. But this close link between economic
growth in the UK and elsewhere in Europe is an example of a much more general
phenomenon. We now live in a highly integrated global economy. And economies which are
very open to trade and investment - like the United Kingdom, and indeed Jersey - are
strongly influenced by international economic trends.
During my time on the MPC, the growth and inflation performance of the UK, and hence our
monetary policy judgements, have been heavily driven by global developments. Both the
financial crisis and the recession which followed it were global economic events. No major
economy in the world was unaffected by the financial turbulence and the dramatic downturn
in world economic activity in late 2008 and early 2009. And on the inflation front, we have
seen major global forces operating too, with the inflation rate in the UK and other countries
being significantly affected by large price swings in global energy and commodity markets.
The global economy is now much more integrated and interdependent than at any time in the
history of the world. Four main forces have come together in the past two decades to create
the "New Global Economy" of the 21st Century. First, new technologies have had a major
impact, notably the development of global information technology, media and
communications networks. Second, barriers to trade have been reduced, with most of the
world's nations now participating in a liberal and open trading system. The World Trade
Organisation now has 153 members, covering 97% of the world's population. Third, political
change has extended the global market economy to large parts of the world which were
previously closed to international trade and investment - including China, India and the
former Soviet Union economies. And fourth, there has been a tide of deregulation of markets
- including financial markets - in many countries, and as markets have been deregulated,
they have also been opened up to international competition.
In today's speech, I want to highlight some of the key features of this highly integrated
economic system and discuss some of the challenges it may pose in the future. In particular,
I will discuss how the changing shape of the world economy affects the task of national
monetary authorities, such as the MPC. In other words, how can economic policy-makers
maintain stability when we are constantly in danger of being buffeted by powerful global
economic forces?
The rise of Asia and the changing shape of the world economy
A key feature of the new global economy we now inhabit is the increasing economic strength
of the Asia-Pacific region. Chart 2 shows that the top ten economies in this region - led by
China, Japan and India - have already overtaken both the European Union and the United
States in their share of world economic activity. This compares with the situation thirty years
ago when these economies were collectively just half the size of the European economy, and
about two-thirds the size of the United States.
Chart 2 - The rise of Asia
Percentage share of world GDP, at current market prices and exchange
rates
40%
US EU-27 Asia-pacific G10 *
35%
30%
25%
20%
15%
10%
5%
0%
1980 1990 2000 2010
*: Includes Australia, China, India, Indonesia, Japan, Malaysia,
Singapore, South Korea, Taiwan Province of China and Thailand.
Source: IMF World Economic Outlook
What has been the basis of the recent economic strength of the Asia-Pacific region and what
might this suggest about its future development? Economic historians can point to estimates
of world economic activity before the industrialisation of Europe and the United States which
suggest that Asia accounted for about half of world GDP in the 18th century.1 So in one sense
the growing economic strength of Asia might be seen as a restoration of the balance of the
world economy which existed before the industrial revolution. But a better explanation is
needed of why this might be happening now and how far it has to run in the decades ahead.
Japan has been an industrial power since the late 19th century. But the rapid progress of
continental Asian economies in recent decades can be seen as the product of three
overlapping phases of development. The foundation was provided by what became known
as the "East Asian Economic Miracle" - the rapid development of four "tiger economies" -
Singapore, Hong Kong, Korea and Taiwan - in the 1970s and 1980s. By pursuing export-led
growth, based on high levels of savings and investment, enhanced levels of education and
stable macroeconomic policies, these economies achieved strong productivity growth and
began to catch up rapidly with western economies and Japan, particularly in the
manufacturing sector.2
The second phase of development occurred when a wider group of economies - with much
larger populations - began to pursue similar policies. In the 1980s and 1990s, Malaysia and
Thailand sought to emulate the export-oriented success of the "tiger economies" while China
and India pursued market-oriented reforms and opened up their economies to international
trade. After the shock of the Asian crisis in the late 1990s, strong growth continued in the
2000s with China emerging as a major global economic and industrial power.
We are now in a third phase of rapid economic growth in Asia in which there is more
emphasis on the growth of domestic demand and self-sustaining growth, particularly in the
larger economies in the region. With an expanding middle class and rising living standards,
domestic consumer demand can provide a much stronger engine of growth. And a number of
Asian economies - including China - are also investing heavily in public infrastructure. The
sharp fall-off in export markets in the recent global recession has given added impetus to the
desire to expand domestic demand and this provided an important platform for the recovery
of Asian economies from the global recession.
Chart 3 - Shares of world GDP and population
2010 figures
GDP at market prices Population
Apac
EU-27,
EU-27,
G10*,
26%
Apac
7%
46%
G10*,
US, 5%
27%
US,
23%
Other,
Other,
24%
43%
*: Apac G10: Asia-Pacific G10, including Australia, China, India,
Indonesia, Japan, Malaysia, Singapore, South Korea, Taiwan Province of
China and Thailand.
Source: IMF World Economic Outlook, World Bank and Eurostat.
The pattern of the past thirty years has, therefore, been of a successful Asian model of
development spreading out and encompassing a wider range of countries with larger
populations and becoming more self-sustaining. The most likely scenario is that this pattern
will continue over the next 20-30 years as the strong economic fundamentals which have
supported high rates of growth in recent decades continue to enable productivity levels and
living standards to catch up with the West. As chart 3 shows, the ten leading economies in
the Asia-Pacific region are home to nearly half of the world's population. And yet they still
account for only just over a quarter of world GDP. This shortfall largely reflects the relatively
low average living standards in India and China, which together account for over a third of
the world's population.
Chart 4 - Long-term economic and demographic projections for
Asia
Percentage share of world output and population
60%
Output
Population
50%
40%
30%
20%
10%
0%
2010 2050
Source: Asian Development Bank
Even if growth slows down somewhat from the very strong rates seen in recent years, the
economic contribution of the Asia-Pacific region is likely to rise to match its share of world
population. Chart 4 shows recent projections from the Asian Development Bank which point
to the Asian share of world output rising to around 50% by 2050, much closer to its
population share. To achieve this will require average GDP growth rates for Asia of 5-6% in
the next twenty years and 4-5% in the period 2030-2050. This does not appear
unreasonable in the light of the track record of rapid growth in the past two decades and the
strong economic fundamentals of the leading economies in the region.3
What might this imply for the economic performance in the rest of the world economy - and
in particular economies like the UK and Jersey? Fortunately, the economic performance of
different regions and countries across the world is not a zero sum game. There are
opportunities created by the opening up of new markets as well as competitive challenges to
established industries. We have already seen quite a bit of economic restructuring in the US
and Europe - particularly in manufacturing industry - in response to the development of
lowcost competition based in China and other Asian economies. We should expect this process
of structural change to continue as the leading Asian economies continue their development
in the decades ahead. The key for economies like the UK, other European economies and
the United States to prosper and succeed in this new world economic order is to have the
right supply-side policies which help businesses to remain competitive and adapt to changing
market conditions. To support high living standards, western economies will need to stay
ahead of the game by upgrading their levels of education of skills and maintaining a business
climate which is conducive to enterprise and innovation. Flexible labour markets are also a
key ingredient in ensuring that a high level of employment can be sustained against the
background of structural change and increasing global competition.
Pressure on energy and commodity markets
There are two other wider challenges raised by the changes we have seen in the global
economy in recent decades. The first is the pressure that strong growth in Asia and other
rapidly growing emerging market economies is placing on the markets for energy and other
natural resources. We have already seen this pressure reflected in a strong upward move in
global energy and commodity prices since the early 2000s, as Chart 5 shows. After a brief
respite during the financial crisis, this upward pressure on energy and commodity prices has
resumed as the world economy has bounced back from recession. The oil price is back
above $100/barrel, and while there has been a modest correction in commodity prices over
the past month, this seems likely to be a short-term pause in the upward trend rather than a
fundamental readjustment.
Chart 5 - Real oil and commodity prices since 1980
Deflated by US consumer price index; 2000=100
350
S&P GSCI Agriculture and Livestock index
S&P GSCI Industrial Metals index
300
Brent crude spot price
250
200
150
100
50
0
1980 1985 1990 1995 2000 2005 2010
. Source: IMF and Thompson Datastream
It is no coincidence that this upward pressure began to emerge in the early 2000s and has
continued for the best part of a decade now. The rapid growth we have seen in Asia and
other emerging market and developing economies has been very resource-hungry. The
effects of this can be seen in the pattern of global energy consumption, shown in Chart 6.
Until the early 2000s, energy consumption in the advanced OECD economies and in the
non-OECD developing and emerging market economies rose at a similar rate, with the
OECD economies accounting for the majority of demand. In the wake of the strong growth in
the 2000s, this position has been reversed with the non-OECD now the dominant contributor
to world energy demand. For example, China's share of global oil consumption has risen
from 6% to 11% in the past decade alone.4
Chart 6 - Global primary energy consumption
Million tonnes oil equivalent
6500
OECD
6000
Non-OECD
5500
5000
4500
4000
3500
3000
2500
2000
1980 1983 1986 1989 1992 1995 1998 2001 2004 2007
Source: BP Statistical Review 2010
This pattern of upward pressure on energy and commodity prices has been particularly
noticeable since the mid-2000s and it has had a significant influence on inflation in many
countries - particularly affecting the prices of goods. The so-called "China effect", through
which the shift of production to low cost countries held down the prices of global
manufactures and traded goods in the late 1990s and the first half of the 2000s, has given
way to a period of higher global inflation, driven by rising energy and commodity prices.
Chart 7 shows how this has affected the rate of inflation in goods prices in the UK, which has
picked up significantly in recent years - whether measured in terms of manufactured
products at the factory gate or the goods which enter into the consumer basket.
Chart 7 - UK goods price inflation
Annual percentage change in prices
10
Manufactured goods producer prices
8
CPI goods inflation
6
4
2
0
-2
-4
1997 1999 2001 2003 2005 2007 2009 2011
Source: ONS
One of the key challenges facing the MPC and other monetary authorities around the world
is judging how far this surge in energy and commodity prices has yet to run and how
farreaching its consequences might be. The tendency so far in many countries, including the
UK, has been to treat this phenomenon as a series of one-off shocks. But the driving force
behind it - strong growth in Asia and other emerging market economies - is proving quite
persistent - as Chart 8 shows.
Chart 8 - Emerging market growth remains strong
Annual percentage growth rates of real GDP
10
Advanced Economies *
8
Emerging & Developing
Economies *
6
4
2
0
-2
-4
1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012
*: 2011 and 2012 growth rates are IMF forecasts.
Source: IMF World Economic Outlook
This raises the possibility that some key commodity markets, including the market for oil,
could be in a structural position of scarcity for some time yet, leading to further significant
upward price movements. For example, in its recent World Economic Outlook, the IMF
published an analysis suggesting that current trends in the oil market - with supply unable to
keep up with strong demand - could lead to a further 200% rise in oil prices from current
levels over the next 20 years.5 Of course, there is great uncertainty around such predictions.
But my judgement would be that this IMF analysis is likely to be directionally correct, even if
we can't be precise about the exact timing and scale of upward price movements.
This upward shift in energy and commodity prices cannot carry on indefinitely, of course.
Eventually, rising prices should choke off demand - both by encouraging more efficient use
of resources and possibly by squeezing growth in consuming countries. Over a period of
time, high prices may also encourage investment in new sources of supply. But while we are
in this phase of strong energy and commodity price growth, there is also the risk that the
inflationary trend could become embedded in the rate of increase of wages and prices more
generally. That is a risk that cannot be dismissed lightly, given the experience of the 1970s
when this did indeed happen.
Managing global volatility
Before discussing how monetary authorities should respond to this risk, I would like to
highlight one other key feature of the modern global economy - which is the way in which the
linkages and dependencies between different economies around the world have increased.
The international trading system has supported the development of integrated global supply
chains in many industries, with the power to transmit shocks to demand and business activity
very rapidly around the world. The financial system has also become a powerful mechanism
for transmitting shocks and disturbances. And global media, communications networks and
the internet result in the rapid transfer of news and information around the world.
The financial crisis and the recession which followed demonstrated very vividly the power
and speed of these mechanisms to transmit economic volatility rapidly across borders and
around the world. And the conclusion I would draw is that these interdependencies and
linkages have greatly increased the potential for global economic shocks and volatility of
various different kinds. In an ideal world, we would develop stronger international
mechanisms for dealing with these potential sources of economic fluctuations. And there has
been a renewed emphasis on various forms of economic co-operation in recent years,
including the development of the G20. But the difficulties of establishing and operating
frameworks for international co-operation mean that policy frameworks for managing global
economic volatility are likely to remain inadequate and imperfect for some time to come. As a
result, economies which are very open to international trade and business like the UK are
likely to have to live with more economic volatility than we would ideally like.6
Implications for monetary policy
So, let me sum up my analysis so far. I have identified three potential challenges arising from
the "New Global Economy" which is shaping the world of modern business and having such
a powerful influence on open international economies like the UK and Jersey. The first is a
shift in the centre of economic gravity in the world economy towards Asia - which is likely to
become the dominant region in the world economy in the first half of this century. That
creates market opportunities for other economies as well as competitive threats, and is likely
to result in further structural change as businesses adjust to changing patterns of demand
and supply. Supply-side policies - focussing on skills, enterprise and innovation - are the
key to maintaining growth and employment in the face of these structural adjustments. The
two other challenges I have identified - a prolonged period of upward pressure on energy
and commodity prices climate and an increase in global economic volatility more
generally - have more significant implications for monetary policy in an open internationally
focussed economy like the UK. So how should monetary policy respond?
Chart 9 - UK output and inflation since 1997
Annual percentage change in real GDP and consumer prices
6
4
2
0
-2
GDP growth
-4
CPI inflation
-6
-8
1997 1999 2001 2003 2005 2007 2009 2011
Source: ONS
One reaction to my analysis could be that we have to accept a lot more volatility in growth
and inflation, and simply grin and bear it. To some extent this will be true if the global shocks
are big enough and very sudden, as we discovered in late 2008 and early 2009 when we felt
the full force of the global financial crisis. But even in these circumstances, monetary policy
played an important role in stabilising the economy and heading off a downward spiral in
demand and the associated deflationary threat. In the decade before the recent global
turbulence, there were also significant fluctuations in the international climate, including the
impact of the Asian Crisis, the "dotcom" boom and bust in the US, and global geo-political
turbulence in the early 2000s. In response to these fluctuations, the MPC did respond by
adjusting monetary policy and succeeded in keeping UK growth steady and inflation low and
stable, as Chart 9 shows, albeit in a more benign global environment than we have seen
recently.
Chart 10 - Monetary policy, the global economy and inflation
Impact of monetary policy
Cost of imports
Exchange rate
Domestic demand
UK inflation
Global economy Demand
Expectations and
credibility
Pricing climate
In the future, we may not be able to achieve the high degree of stability for growth and
inflation that we saw in the MPC's first decade. But our experience also suggests that we are
not powerless to act in the face of significant global economic changes either. Chart 10
illustrates the main channels through which monetary policy can stabilise an open economy
like the UK in the face of fluctuations in global demand or prices. The stabilising role of
monetary policy operates through three main channels - the exchange rate, demand
conditions and by influencing inflation expectations and enhancing the credibility of the
monetary framework. And even though monetary policy will affect the growth of the economy
in the short-term, the overall objective for UK monetary policy is and should remain price
stability. That is because stable prices provide the best climate for growth, investment and
business success in the longer term.
The price stability objective provides the ultimate benchmark to guide how policy should
respond to changes in the economic climate. So it is not right to argue, as some people have
done recently, that because inflationary risks and pressures arise from the global economy
they should be ignored by the monetary authorities.7 In the UK and in many other countries,
monetary policy responds to global shocks and influences all the time. Nor is it correct to
argue that inflation generated by import prices is outside the control of monetary policy.
Monetary policy affects the exchange rate - which in turn can offset or reinforce our
exposure to rising import prices. And the demand climate and the price expectations of firms
can affect how much of this imported inflation comes through to the consumer. Yet in the UK,
monetary policy has not only accommodated a large part of the recent surge in energy and
commodity prices but also allowed a very significant sustained fall in the value of the pound,
which has aggravated the rise in UK relative inflation relative to our peer group of other
European economies.8
Rather than dismissing the impact of global influences on domestic inflation, monetary
authorities need to assess how far they pose a threat to price stability - either in the direction
of persistent inflation or persistent deflation. In the UK, we took the view in late 2008 and
2009 that the threat of deflation was the biggest risk in the wake of the global financial crisis,
and cut interest rates to historically low levels, supported by direct injections of money into
the economy through the policy of Quantitative Easing. But the world inflation climate has
become much more inflationary now, both through the direct effect of rising energy and
commodity prices and through a turnaround in global demand. While the global demand
environment remains buoyant, we should not regard energy and commodity price
movements as one-off shocks, as the inflationary pressure from the world economy may well
persist for quite a while. And persistent above-target inflation carries other risks for price
stability in the UK - to the credibility of our policy framework and to expectations of future
inflation. Indeed, Chart 11 shows that UK services sector inflation has been running at
around 4% for much of the past decade, and has not shifted downwards to offset rising
goods prices. This raises the possibility that in the services sector, high inflation expectations
have already become engrained.
Chart 11 - UK goods and services inflation
Annual percentage change in consumer prices
7
Goods inflation
6
Services inflation
5
4
3
2
1
0
-1
-2
-3
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
Source: ONS
For these reasons, I have been arguing for the past year that the MPC should embark on a
policy of gradual interest rate rises and that delaying this process exposes us to greater
inflationary risks in the future - which would not be good for economic growth in the medium
term. Continuing to accommodate inflation makes it more likely that a future sharp policy
correction will be needed, particularly if persistent high inflation becomes embedded in wage
and price-setting. That not only poses a threat to the recovery further down the track, but it
could erode the hard-earned credibility of the UK monetary policy framework - which would
be very damaging for economic growth over the longer-term.
Here in Jersey you are in a monetary union with the UK. So you too have a strong interest in
the MPC getting its policy judgements broadly correct. Though I am leaving the MPC at the
end of this month, I do not think the issues I have raised today in this speech will go away
with my departure. Global economic issues will continue to have a major economic impact on
growth and inflation performance in the UK and here in Jersey - as many of you will know
from your own business experience.
I hope I have shed some light today on some of the important changes in the global economy
and how they affect the conduct of UK monetary policy. Despite the turbulence we are likely
to continue to experience in the global economy, I trust you will be able to steer your
businesses successfully through it. And as I come to the end of my shift at the helm of the
UK economy, I hope that my colleagues on the MPC will not allow the UK economy to be
blown too far off course by global inflationary winds before taking the necessary corrective
monetary policy action, which is long overdue.
References
Asian Development Bank (2001). Asia 2050: Realising the Asian Century, May 2011
Hume, M. and Sentance, A. (2009). "The Global Credit Boom: Challenges for
macroeconomics and policy", Journal for International Money and Finance, Volume 28, Issue
8, Pages 1426-1461
International Monetary Fund (2011). "Oil scarcity, Growth, and Global Imbalances", World
Economic Outlook April 2011, Chapter 3
Kemp, J. (2011). "Globalisation, commodities and inflation",
http://www.commoditiesnow.com/reports/general/4653-globalisation-commodities-and-inflation.html
Nomura Global Economics
Llewellyn, J., and Santovetti, L. (2010). "The Ascent of Asia",
Report, February 2010
Maddison, A (2007). Contours of the World Economy,1-2030 AD: Essays in
MacroEconomic
History, Oxford University Press
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Engineers' Association Annual Conference, April 2009
Sentance, A. (2009b). "Energy and Environmental Challenges in the New Global Economy",
speech to British Institute of Energy Economics Sustainable Energy Seminar, September
2009
Sentance, A. (2011). "Key issues for UK Monetary Policy", speech at pro.manchester
members' lunch, April 2011
World Bank (1993). "The East Asian Miracle: Economic Growth and Public Policy", World
Bank Policy Research Report