The Rt Hon Sir Edward George: A brief review of economic and financial
developments in the UK
Speech by The Rt Hon Sir Edward George, Governor of the Bank of England, at the Finance and
Leasing Association Annual Dinner, London, 24 March 2003.
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Mr Chairman, my Lords, Ladies and Gentlemen,
I must confess that I was surprised when I discovered that it was seven years since I last spoke at this
Finance and Leasing Association Annual Dinner.
I'm delighted to be with you here this evening.
On that earlier occasion - in 1996 - I emphasised the corrosive and debilitating effect of high and
variable inflation that we had experienced in this country over much of the previous 50 years.
I stressed the damage that this had done to our economy - the pervasive uncertainty and
unpredictability, and the short-termism that it induced, in personal and business as well as financial
behaviour, the incentive to borrow and spend rather than save and invest, the masking of real price
signals as the guide to efficient resource allocation, and the masking, too, of productive inefficiency
that was too easily covered up by generally rising prices and earnings.
But I suggested that the tide had already then finally begun to turn. I drew attention to the growing
constituency in support of stability in this country - as a necessary condition for sustainable growth -
after our particularly bitter experience of boom and bust in the late 1980's and early 1990's.
I was able to point to the preceding four years - during which inflation had averaged just under 31⁄4%,
compared with almost 10% over the previous 20 years. I was able, too, to point to sixteen consecutive
quarters of positive economic growth. And I was able to point to a continuing, relatively steady fall in
unemployment from its peak - in terms of the claimant count measure - of almost 10% in 1993.
Then I held out to you the prospect of continuing stability - with low inflation and sustained economic
growth - as far ahead as I could see.
You didn't believe a word of it! You listened - very courteously, as I would expect from the members of
your very professional association - but you listened with a good deal of scepticism, which, I confess, I
could perfectly well understand. As I left that evening, one of your members said to me "I do hope
you're right, Eddie, but we've heard it all before. We'll believe it when we see it!" I suspect he spoke for
most of the rest of you.
Well, tonight I can tell you that inflation - on the Government's target measure - has averaged just
2.5% over the past 10 years. We have now had 42 consecutive quarters of positive economic growth -
which is much the longest period of continuous growth since quarterly data became available in 1955.
And unemployment has continued to decline fairly steadily to just over 3% - its lowest rate for more
than a quarter of a century.
Now don't get me wrong. I'm not for a moment suggesting that we have finally reached the promised
land. I'm very well aware that there are many people in this country - no doubt including many here
tonight - for whom economic life is still pretty tough. My post bag never let's me forget that!
For most of the time since I last spoke to you we have in particular been confronted with a very difficult
international economic and financial environment. This began with the Asia crisis. But it was followed a
couple of years later by a sharp economic slowdown, into mild recession, in the major industrial
countries. And that was accompanied by a sustained fall in global equity markets from their
"irrationally exuberant" peaks - aggravated and protracted by the threat of terrorism following 9/11 and
by corporate governance and accounting failures in the United States. Most recently, of course,
uncertainty surrounding the possibility of war with Iraq has weighed heavily on sentiment.
All of this, together with the persistent weakness - until relatively recently - of the euro exchange rate,
has made conditions intensely difficult for internationally-exposed business in the UK, including much
of the manufacturing sector; and that, in turn, has been reflected not just in weak net external demand
but also in declining business investment in this country and elsewhere in the industrial world.
It's made life pretty difficult, too, I have to say for those of us involved in macro-economic
management!
Macro-economic policy - that's to say monetary policy and overall fiscal policy taken together -
operates, directly, on the demand side of the economy, aiming essentially to keep aggregate - external
and domestic - demand growing broadly in line with the underlying supply-side capacity of the
economy to meet that demand. Stable, low, inflation is in fact essentially a measure of how far we are
successful in that.
There has been very little, quite frankly, that either we at the Bank, through monetary policy, or the
Chancellor could do to influence the international environment. The problems originated abroad and
we could not avoid their effects. What we could do - and what we have tried to do - was to seek to
offset those effects, and compensate for the external weakness, by stimulating domestic demand here
in the UK. Given weak business confidence, that meant essentially, in the case of monetary policy,
encouraging the growth of consumer demand - by cutting interest rates to their lowest level in
40 years.
In the event we managed - just about - to avoid recession over the winter of 2001/2002 but we did so
but at the cost of growing imbalances within the economy between domestic and external demand on
the one hand and, domestically, between consumption and investment on the other. Essentially we
took the view that unbalanced growth was better than no growth at all - which was the only other
option we had.
This "two speed" economy has, I know, been reflected in the pattern of your own activity as FLA
members, with consumer finance volumes growing strongly in recent years where business volumes
have been relatively flat. In the past year alone new business written to consumers was nearly three
times that written to business customers.
Now clearly the imbalances can't go on increasingly indefinitely. The build-up of household debt and
the related strong rise in house prices we saw last year in particular must begin to moderate at some
point. So much of the recent debate has been about whether the eventual adjustment will occur
gradually, within the context of continuing overall expansion, or more abruptly in which case the overall
expansion could prove more difficult to sustain.
On the macro-economic data it seems clear that the global economy in fact bottomed out around a
year or so ago, and that we have since seen the beginnings of a recovery, notably in the US, on which
so much of the rest of the world currently depends. And it is also clear that monetary policy generally -
and in some countries also fiscal policy - remains supportive. On that view, and given the recent
moderate decline in sterling's effective exchange rate, it is reasonable to look forward to a gradual
improvement - and I emphasise gradual improvement - in the external environment which would
clearly be very helpful from a UK perspective.
I don't deny that there are downside risks to this scenario. The Eurozone has for example recently put
back its projected expansion until later this year. And financial markets, and both business and
consumer sentiment, have recently been severely affected by uncertainty over Iraq - though financial
markets, certainly, now that the war has started, have factored in its rapid conclusion. I hope they
prove to be right - for more than purely economic reasons.
Notwithstanding these risks, I still think that the most likely outcome is that we will see a gradual
pickup in the pace of global recovery over the next year or two - which is the view shared by the Monetary
Policy Committee in our February Inflation Report and by most other economic commentators.
On that basis we would also expect to see a gradual recovery in domestic business investment as we
go through this year and into next. And, while fiscal prudence is clearly important for the stability and
efficiency of the economy over the medium term, the Chancellor's projected increase in public
spending is in my view positively welcome in the immediate situation confronting us. Taken together,
these developments should accommodate the moderation in the rate of growth of consumer spending,
which we anticipate and may now be beginning to see.
In the meantime we have seen a rise in the rate of inflation - to 3% on the target measure - driven
notably by last year's sharp rise in house prices and by the rise in the oil price in the run up to the
invasion of Iraq. And it may well rise somewhat further, for example, as a result of the prospective rise
in Council Tax and the somewhat weaker exchange rate. But most of these influences at this stage
seem likely to be largely one-off effects on the level of retail prices, rather than persistent influences on
the rate of inflation. There is no significant evidence at this point of continuing, second-round, effects,
for example in the labour market, so that inflation seems likely to fall back to the 21⁄2% target rate in the
course of next year.
On this basis - and although the MPC will of course be monitoring the inflation prospect very carefully -
we concluded at our most recent meeting that policy should remain on hold.
Mr Chairman, you can see that I meant it when I said earlier that we haven't yet reached the promised
land! We have in fact been going through a difficult patch, and we remain heavily dependent upon
developments abroad which are beyond our control. Certainly we face risks and uncertainties in the
short term. But it is important that we don't exaggerate those risks and allow them to cloud our
judgement. The more likely outcome in my view - looking ahead over the next couple of years - and
reflected in the Inflation Report - is for inflation close to target with growth close to trend - and with the
imbalances within the economy beginning to adjust.
In any event I am totally confident that Mervyn King, my successor from July, with his Deputies,
Andrew Large and Rachel Lomax, and with the MPC, will be ready to adjust policy in either direction
as the prospect changes, and that they will be as totally committed as I have been to maintaining
stability and hitting the Government's inflation target, as a necessary condition for sustainable growth.
That will provide the best possible context for the continued development of your business, and the
important contribution that you make to the economy.
I, myself, of course, will be looking for a new lease of life in retirement! I'm not aware that it's a lease
product any of you actually provide. Given our ageing population perhaps you should develop one -
though you'd better be careful how you market it! In any event I wish you well.