. and in europe, too, the prospects are clouded by pressure to bring budget deficits down sufficiently to meet the maastricht convergence criteria this year, notwithstanding the weakness of the domestic economies, and in an environment of longer term structural inflexibility. these divergent developments go a long way towards explaining recent differences in the behaviour of both bond markets and exchange rates. in both the united states and the united kingdom the sustained expansion of domestic demand and of ouput has generated market expectations of an essentially cyclical rise in short - term interest rates. sluggish economic activity elsewhere, on the other hand, means not only that short - term interest rates are significantly lower in japan and the core european countries ; but it also means that they are thought, by the market, to be less immediately likely to rise. this cyclical difference in the short - term interest rate prospect largely explains the pronounced yield differential between the us and the uk and the other countries at the very short end of the curve. out to 2 years, for example, whereas yields in the us and uk are within ½ % either side of 6 %, yields in germany and france are below 3½ %, and they are below ½ % in japan. these differences in the short - term interest rate prospects feed through into yield differentials on longer term bonds, and changes in them also help to explain the recent movements in exchange rates. but rather more interesting is the relative slopes of the yield curves further ahead, us and uk yields are only about 1 % above present short - term yields, at + / - 7 % ; but they are 3 % or more above present short term yields in germany and france, also at + / - 7 % ; and they are 3 % higher than short - term yields even in japan, at 3¾ %. the implication is that, if you abstract from immediate cyclical influences, longer - term economic performance - and particularly performance with respect to inflation - is not expected to be very different between the major countries, though japan remains an outlier. it is difficult to know what interpretation to put on this observation. the fact that the yield curves in germany and france are practically identical is consistent at least with emu going ahead - at least with a narrow membership. but the steep rise in implied future yields five years ahead suggests that inflation is expected to be higher in the medium term. that could be associated with expectations of softer macro - economic discipline, perhaps more specifically reflecting market uncertainty about

was not at all surprising. you had all heard that sort of optimism from the authorities before! but the fact is that since around the time of that first euromoney congress bond yields have nevertheless trended fairly consistently lower, and are now in many cases close to or even below the low point they had reached around the end of 1993. real yields, again measured by our own indexed gilts have fallen back to a little more than 3¼ % ; and the first us indexed bond issue yields much the same. and nominal yields have fallen by 200 basis points or more in continental europe and japan - though rather less in the united states and the uk. there has been more excitement in the foreign exchange market, with the dollar in particular first weakening against the yen and the major continental currencies until the spring of 1995 and then progressively recovering. these developments were certainly influenced by the factors which i mentioned a moment ago. in particular they have been influenced by the continuing broadly - based consensus - in countries all around the world, and across a large part of the political spectrum within countries - on the importance of macro - economic policy discipline. macro - economic policy is no longer seen as an instrument for short - term demand management, which can be used to trade - off the conflicting demands of growth and stability in the short run. it is now much more widely understood and accepted that the rate of growth that can be sustained, or the level of employment that can be achieved and maintained in anything other than the short run, depend fundamentally on the structural, supply - side, characteristics of the economy, and not just on the level of demand. so today ’ s orthodoxy ascribes to macro - economic policy the job of keeping demand in line with the capacity of the economy to meet that demand in the medium and longer term. within this overall framework, monetary policy is allocated the specific task of achieving and maintaining effective price stability. this is not, as some commentators still seem to suggest, simply some doctrinaire end in itself. inflation is seen rather as a symptom of imbalance between demand and supply in the economy. so what we are essentially aiming to do through monetary policy is to anticipate the emergence of that imbalance and head it off before it becomes entrenched. if we are successful in that, inflation will be lower, there will be less need for violent interest rate movements than in the past, and the economy will grow at a steadier, and more sustainable