Over time, we would expect countries’ income levels to converge, as currently low income countries catch-up with their high income trading neighbours (Solow (1956)). This convergence process is a well-established empirical phenomenon (Barro (1991) and Mankiw, Romer and Weil (1992)). Accompanying this GDP convergence is likely to be catch-up in gross external balance sheet positions. As countries develop, so too does their integration into global capital markets, with higher levels of gross external assets and liabilities. Cross-country evidence bears this out. There is a well-defined empirical relationship between a country’s GDP per head and its gross external balance sheet position (Chart 16). BIS Review 174/2010  9  Taken together, these two factors imply a pattern of steadily rising gross capital flows over time, with growth strongest among countries catching up with their high-income trading neighbours. It is possible to calibrate these integration trends and project them forward to simulate future external balance sheets positions among the major economies. These simulations take as initial conditions cross-country GDP per capita, projected forward using a calibrated rate of growth convergence drawn from previous empirical studies and adjusted for known future changes in population growth. This gives a set of cross-country projections for GDP per capita. These are then translated into gross external balance sheet positions using historical relationships with per capita GDP. Chart 17 plots some projections of (the average of) gross external assets and liabilities relative to GDP for the G7 countries, China, India, Brazil and Russia. These projections go out to 2050.

Chart 5: Guidance has reduced the correlation between economic uncertainty and interest rate volatility 10  Economic uncertainty and option-implied volatility of 3 month rates 1 year ahead 3m rate standard deviation 180 160  2000-August 2013  140 120 100 80 60 40 August 2013 EU referendum  20  EU referendum - latest  0 -2  -1  0 1 2 3 Economic uncertainty (deviations from average)  4  5  Sources: Bloomberg Finance L.P., ICE, Bank calculations and Haddow et al, ibid. 10  The indicator of economic uncertainty is based on the principal component from seven measures of uncertainty: FTSE and sterling option-implied volatility, dispersion of company earnings forecasts and among forecasters’ growth projections, proportion of companies reporting that uncertainty is limiting investment, households’ unemployment expectations, and number of press articles citing ‘economic uncertainty’. See Haddow, A, Hare, C, Hooley, J and Shakir, T (2013) “Macroeconomic uncertainty: what is it, how can we measure it and why does it matter?”, Bank of England Quarterly Bulletin, 2013 Q2. 9  All speeches are available online at www.bankofengland.co.uk/speeches  9  The MPC is now in the process of reviewing the possible range for the equilibrium real interest rate in the medium term. This analysis reflects the importance of global equilibrium rates for the UK, and the possibilities that the global equilibrium real rate may rise as the global recovery proceeds and that domestic cyclical factors such as the pace of public and private balance sheet repair may shift.