Podium: The storm clouds have lifted
Eddie George From a speech by the Governor of the Bank of England to the annual banquet of the Bankers Club in London
Wednesday 03 February 1999
The members of the governing council of the ECB - individually and collectively - are committed to the view that effective price stability is a necessary condition for the sustainable growth of output and employment. So, too, are we in this country.
In this sense price stability is not simply an end in itself. Our aim, like yours in the Eurozone, is to keep aggregate demand in the economy broadly and more or less continuously in line with the underlying capacity of the economy to meet that demand. Consistently low inflation is the measure of our success in achieving that aim. There is not much that either of us can do through monetary policy directly to affect the underlying rate of growth of productive capacity. That is determined by the structural, supply-side characteristics of the economy.
Demand management, including monetary policy, cannot substitute for the structural reforms that are needed to improve the flexibility with which the economy as a whole responds to change. However we can, through monetary policy, aim to create an environment of stability - avoiding either excessive or deficient demand. That is the best help that we can give.
Assessing the prospective pressure of demand is extraordinarily difficult. It is especially difficult as a result of the uncertainties created by the recent turbulence in the world's financial markets.
The immediate international priority was to contain the financial contagion - and there was some progress in this direction following the initial shocks in Asia. But after a series of new shocks during the summer - Russia, LTCM [long-term credit management], the deepening recession in Japan and the worsening position in Brazil - the prospects, at around the time of the IMF meeting in Washington last autumn, were looking bleak.
The atmosphere among commercial and investment bankers - particularly in the United States - was as nervous as I can remember.
Now, you will rarely hear a central banker predicting fine weather - and I have no intention of breaking that convention. However, the darkest storm clouds have lifted a little since the Fund meeting.
Vigilance remains the watchword. But the risks of general, widespread, international financial disturbance have certainly receded.
But we are now having to cope with the economic consequences of the earlier financial disturbances. The inevitable counterpart of recession in much of the rest of the world is a sharp slowdown of net external demand - particularly for manufacturers - in the industrial world. That has been reflected in growing weakness and falling business confidence. The prospect for growth in world economic activity has already roughly halved - from its trend rate of around 4 per cent. And unless this fall in net external demand is offset by stronger domestic demand growth in the industrial counties, the outlook will be dismal.
Happily we start from a position of relatively low inflation throughout the industrial world and, faced with weakening external demand, we can afford to see higher offsetting domestic demand growth without jeopardising price stability. Indeed, we need to see higher domestic demand growth than we would otherwise, if overall demand is not to fall short of underlying supply-side capacity, so exerting an unnecessary and unwanted further downward pressure on domestic prices. We need it, too, to offset the effects of weak world prices and lower exchange rates in many emerging market producers on our own domestic price level.
All we can realistically attempt is continuously to reassess the aggregate prospects for our separate economies in the light of the continual stream of new information. In that light we must be prepared to contemplate the further easing of monetary policy if overall demand seems likely to fall short of what we had previously anticipated, or, in due course, to move to tighten policy if domestic demand grows too rapidly, or the world economy begins to recover.
By the time we next meet together for this great annual occasion, Y2K [the year 2000] will be behind you, and if you have survived that then you can survive anything.
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