without leading to a pickup of inflation? or is there a risk that the apparent insensitivity of inflation to movements in the economy is only temporary, and might lead to mistakes in monetary policy if low inflation were taken for granted? to answer those questions, i want to consider three possible explanations for why inflation has not so far risen despite substantial falls in unemployment and spare capacity. first, reforms enacted over the past twenty - five years have made the labour market more flexible and lowered the rate of unemployment consistent with stable growth in money wages. incentives to work have increased - through initiatives like the new deal and the working tax credit. benefits paid to the unemployed have fallen relative to earnings. and the share of wage settlements covered by collective bargaining has fallen sharply. those reforms, and a steady growth in total money spending, ensured that unemployment fell in almost every quarter since 1992 while wage inflation remained broadly stable. moreover, changes in unemployment have resulted in smaller movements in the rate of wage increases than in the past. it is possible that migrant labour may be easing the bottlenecks and skill shortages in what is undoubtedly a tight labour market. reports from our business contacts around the country, collected by our agents, suggest that migrant labour is indeed relieving some of those shortages, more so in recent months with recruitment from the new members of the european union. migrant workers are employed in fish processing here in the south - west, and even in the production of cornish pasties, as they are in an increasingly wide range of industries in manufacturing, construction and services. that may be suppressing signs of underlying wage pressure that would otherwise have become evident by now. second, an increase in the pace of productivity improvement may have made it possible for output to grow more rapidly without adding to inflationary pressure. on the face of it, however, there is little evidence for this hypothesis. productivity in the private sector - measured as output per hour worked has grown at an annual rate of around 2 ½ % since 1995, around the average rate in the period 1980 - 1995. in the united states, private sector productivity growth increased from 1 ½ % in the earlier period to almost 3 % after 1995. it is striking that productivity growth in the private sector was higher in britain than in the united states for most of the past quarter of a century, although our level of productivity remains inferior. only in the past few years has american productivity accelerated. no such change is yet visible in the official data for the united kingdom. it

is possible that the effect of productivity improvements, especially the temporary boost to profits, was obscured by the impact of the rise in sterling since 1996 and by global competition which have lowered prices and compressed margins. so it is too soon to dismiss the possibility of an acceleration in productivity similar to that experienced in the united states. indeed, productivity growth has increased to more than 4 % over the past year. revisions to the official data and the volatility of measured productivity - reflecting the business cycle - make it extremely difficult to infer changes to long - term growth rates. the absence of any compelling evidence for a rise in underlying productivity growth suggests that this is an unlikely explanation for consistently low inflation over the past decade. third, the new monetary policy framework - a symmetric inflation target and the transfer of interest rate decisions to an independent bank of england - has helped to anchor inflation expectations to the target. it is less likely now that a shock to inflation would lead to a further and persistent deviation of inflation from target. there is a belief that inflation will soon return to target. as a result, a surprise movement in inflation is expected to be temporary and so less likely to lead employers and employees to adjust their desired prices and wages. and there is convincing evidence that changes to inflation are much less persistent under the new monetary policy arrangements. so there you have it : three possible explanations for the recent low and stable level of inflation despite falling unemployment and rapid output growth. but this is no time for complacency or hubris. part of the improved short - run trade - off between growth and inflation may reflect temporary factors. inflation may have been close to target because of one - off explanations, such as increased competition that temporarily depressed retail prices relative to costs, or larger flows of migrant workers that have temporarily held down wage inflation. and even if inflation expectations are well anchored to the target they will remain so only if interest rates continue to be set to keep inflation close to the target. the 1980s provided a stark example of a rapid acceleration of prices with few early warning signs. from 1983 onwards, rpix inflation was stable - relative to recent experience at that time - with most of the outturns in the 3. 5 % to 5. 5 % range until mid - 1989, and wage inflation was high but not on any clear upward path. within a year, and despite a 6 percentage point increase in interest rates between 1988 and 1989, rpix inflation reached 9 % and wage inflation exceeded 10