Mr. George comments briefly on the global economy and on recent economic
Speech by the Governor of the Bank of England, Mr. E.A.J.
performance in the United Kingdom
George, at the Dinner with the Lord Mayor for Bankers and Merchants of the City of London on
11/6/98.
The past year, since we last enjoyed the generous hospitality of the Mansion House,
on this great City of London occasion, has been a testing time. It has been characterised by major
imbalances in both the global economy and here in the United Kingdom - which have complicated
the task of policy-makers everywhere, including the task of the Bank of England's now legitimised
Monetary Policy Committee.
Internationally there has been good news in the enviable performance of the United
States - Goldilocks - economy, with continuing robust domestic demand growth and further falls in
unemployment, with so far remarkably little inflationary pressure. To the extent that this
performance can be sustained, it provides substantial underpinning for the global economy as a
whole.
And there has been encouraging news, too, in the re-emergence of domestic demand
growth in the Continental European countries as they prepare to take the final step to monetary
union. That is a promising context for the launch of a strong, credible, currency and I wish the
European Central Bank every success in its historic task. Domestic expansion with monetary
stability within Europe is in the interest of us all.
Elsewhere though the international situation has been decidedly less benign. A
combination of financial fragility and weak business and consumer confidence has weighed heavily
on the Japanese economy, and on the Yen; and the financial thunderstorms, which broke initially last
year over a number of other countries in Asia, are still intermittently rumbling around the region and
elsewhere. The economic fallout from these developments poses a serious downside risk to the
growth of world activity and threatens the emergence of potentially large international payments
imbalances. It is a dangerous environment.
All of this has prompted a far-reaching re-examination of the international monetary
structure, and in the meantime it presents the international monetary authorities with some difficult
immediate management challenges. It also, of course, represents an uncertain international
background for the conduct of monetary policy in this country.
Our own overall economic performance over the past year was again very
encouraging. Output growth (on the latest data, to the first quarter of this year) was 2.9%
significantly above the rate of inflation (measured by the GDP deflator) for the fourth time in the
past five years - which I think is unprecedented in post-war British experience. On this basis over the
past five years annual output growth has averaged some 3.1% while annual inflation has averaged
2.2%. And unemployment - on the conventional claimant count basis - fell further last year, to 4.8%
on the latest figures, the lowest since the summer of 1980.
The task, of course, is to sustain this pattern of relatively steady growth with low
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 - and I
mean no-one, whatever they may claim - knows with any great precision just where current demand
and output is in relation to the underlying supply capacity of the economy, there is no doubt that we
are now at least much closer to full capacity output than we have been - and the actual rate of growth
over the past year was, on almost anyone's calculation, above the rate of underlying capacity growth.
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 accelerate
and we would then need to impose an abrupt slowdown on the economy to bring it back under
control - to meet the Government's inflation target. It was, of course, to avoid accelerating inflation
and the associated need for an abrupt slowdown that the members of the Monetary Policy Committee
last year had no difficulty in agreeing upon a significant policy tightening.
But there was - and is - a significant complication. The aggregate position takes no
account of the serious imbalance within the overall economy between external and domestic
demand. The internationally exposed sectors of the economy were already confronted last year with
an exaggeratedly strong exchange rate, particularly against the core European currencies - which
could only be partly explained by cyclical and monetary policy differences. It appeared to have a
good deal to do with market scepticism - I would argue misplaced scepticism - about the prospective
strength of the euro. The internationally exposed sectors faced a further battering as a result of the
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 demand
and output in the exposed sectors of the economy - particularly large parts of manufacturing industry
and agriculture - which is contributing to a sharp deterioration in our balance of payment and a fall
in the net external component of aggregate demand.
At the same time, the strong exchange rate, and the weakness of world commodity
prices, is having a direct dampening impact on costs and prices in this country - particularly at the
wholesale, producer, level but also affecting retail prices.
Meanwhile the domestic economy has been unsustainably strong. Private
consumption, in particular, was growing at an annualised rate of over 5% last summer, and still
growing at an annualised rate of 4% by the first quarter of this year. This compares with a
longer-term trend rate of some 21⁄2%. But for the dampening impact of the external influences on
aggregate demand and on costs and prices, this could already have resulted in accelerating inflation.
The complication for monetary policy, in this situation of external/domestic
imbalance, has, of course, been that a tightening of monetary policy to slow the pace of the domestic
economy would have been likely to aggravate the appreciation of the exchange rate, intensifying also
the restraining external demand and price effects, and putting even more intense pressure on the
internationally exposed sectors.
Now, there is no question but that the strength of the domestic economy must
moderate further - as indeed we expect that it will. But the external influences - which we can
anyway not do much about, but which will in time wear off - made this moderation of domestic
demand growth less immediately urgent than it would otherwise have been. In these circumstances,
with some evidence that growth in the domestic economy was in fact slowing, and given the evident
pressures on the internationally exposed sectors, we needed, in my view, to be more than usually
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: just how
much shelter the external situation would in fact give us, and for how long; and just how much time,
therefore, we had to bring about a sufficient slow down in domestic demand to prevent inflation
accelerating and the economy from overheating. Now these are immensely difficult judgements.
They depend in part upon one's perception about the starting position - that is how close we are to
full capacity utilisation to begin with. And they depend upon not just the direction, but the rate of
change and the timing, of changes in the different components of aggregate demand. It is hardly
surprising that the various members of the MPC should - within this common framework of
analysis - reach, essentially marginally, different conclusions, reflecting their individual judgements
as to the balance of risks. Indeed it would have been incredible if they had not reached marginally
different conclusions. What is unusual - and what outside observers are I think still getting used to
is that different possible interpretations of the data and different possible judgements are openly
displayed in the minutes of our meetings, which also record the way in which each member votes.
Some people now seem to find this open discussion of alternative views confusing.
My own view is that it can only contribute to the effectiveness of monetary policy if the public at
large better understand the nature of the issues and the uncertainties surrounding them. But our
procedures have had one, by me at least, unforeseen, and I think regrettable, consequence, in that it
has focused excessive attention upon the way in which individual members of the Committee vote
leading to their over-simple categorisation as either hawks or doves. It is as if their judgements were
expected to be consistently instinctive rather than objectively based upon their individual,
open-minded, assessment - reached after careful analysis - of the most recent information available
at the particular time. As a result serious economic commentary seems - perhaps temporarily - to
have ceded some ground to ornithomancy - which, as of course you know, is the ancient practice of
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 further rise in
interest rates - which proved once again that "Hell hath no fury like a wrong-footed financial
commentator"! It should not have been such a great shock. In the Inflation Report which we
published a month ago we set out the analysis as I have described it to you this evening, and we drew
attention to the fact that the outlook for monetary policy remained finely balanced - as it has clearly
been for some months. We drew attention also to the major uncertainties surrounding the central
inflation projection. These uncertainties included both the level of the exchange rate and
developments in the labour market. It was - as we explained in our press notice last Thursday - the
subsequent "news" essentially on these fronts, and particularly the sharp acceleration in private
sector earnings growth, that caused the Committee to conclude that the necessary slowdown in
domestic demand growth had become more pressing. The interest rate decision showed simply that
what were always fine judgements changed with the facts - as I can assure you they will in future, in
either direction.