eddie george : sterling strength, the euro and uk monetary policy speech by the rt hon eddie george, governor of the bank of england, to the leeds and bradford chartered institute of bankers and bradford chamber of commerce, bradford, on 11 april 2000. * * * it ’ s a real pleasure to be here in yorkshire and i am greatly honoured to have this opportunity to speak to such a large and distinguished audience. i am honoured - but also, i must confess, somewhat daunted. i am acutely aware of the fact that, while there are some parts of the region that are economically - doing extremely well, other parts, particularly those most exposed to international competition, are under the hammer. that ’ s true of course of the uk economy as a whole. i ’ m equally aware that the suffering sectors ascribe their pain to the strength of sterling, particularly against the euro, which is certainly a contributory factor ; and that they ascribe the strength of the exchange rate to our domestic monetary policy and to the monetary policy committee. i should like to address some of these concerns this evening and then go on to say a few words about the great euro debate. let me begin with some comments on the very profound changes that have occurred, gradually over a long period, in the approach to economic management in the uk and in our more recent economic performance. for most of the first half of my own working life - through the 1960s and much of the 1970s - the essential emphasis of economic management in the uk was on short - term aggregate demand management, with too little regard to the structural, supply - side capacity of the economy to meet that demand. monetary and fiscal policy were used in combination to try to maintain an appropriate balance between what were seen as conflicting objectives of growth and full employment on the one hand and price stability and balance of payments equilibrium on the other. slow growth and high unemployment were typically met with monetary and fiscal stimulus. as the symptoms of imbalance inevitably emerged - in the form of external deficits or accelerating inflation - attempts were made initially to suppress those symptoms through various forms of direct control ( for example, foreign exchange controls or credit ceilings or prices and income policies ) but as demand pressures built up macroeconomic policies had eventually to be thrown sharply into reverse. this was the go - stop policy cycle that resulted in the exaggerated boom - bust economic cycle, which was for a long time a pronounced characteristic of british economic performance. such macroeconomic instability was disruptive in

has its effects, which is approximately 18 – 24 months. making projections is always difficult, but especially so in a period of economic recovery after a crisis like the one we have just passed through. these estimates are based on economic models that were mainly drawn up with pre - crisis data, so it is unclear if the parameters and correlations are still valid. i ’ ll try to give some examples, without going into detail. an initial element of uncertainty is the productive potential, both in terms of level and growth. can it be assumed that a crisis like the one we have been through had no effects on the potential level of economic activity and the growth rate? the implications for monetary policy are very different depending on the answer given to this question. the economic policy mistakes that risk being made if a wrong answer is given also differ. bis central bankers ’ speeches for example, if it is considered that the crisis has had a limited effect on both the level and potential growth rate of the economy, the output gap will be estimated to be very large and the risks of deflation may be considerable. this hypothesis justifies a very expansive monetary policy and fiscal policy, in order to fill the output gap as quickly as possible, with few risks that could have inflationary effects. in other words, the wider the estimated gap, the more reason for keeping the interest rate at very low levels, even close to zero, for an extended period of time, until the economic system returns to levels close to full employment. if the crisis had the effect of reducing economic potential in terms of level and growth, the accumulated gap is less than when compared with the previous case and will tend to fill up more quickly. in this case, if monetary policy remains accommodative for too long and does not adjust in advance, it risks being late and not countering inflationary pressures in time. if this delay materialises, the central bank then has to raise interest rates to a greater extent, with potentially recessionary effects. an overestimation of the potential growth rate of the economy also affects the ability of the central bank to properly calibrate the setting of its policy. in principle, as the economy gradually starts to grow above potential, and closes the output gap, the monetary stance should be gradually adjusted through a progressive increase in the interest rate, taking into account the lags with which monetary policy affects inflation and growth. otherwise, with the same interest rate, an increase in the rate of growth in economic