MPC members clash on effects of new economy on inflation

Two members of the Monetary Policy Committee, making separate speeches last night, reached opposing conclusions about the implications of the new economy for interest rates.

Speaking on whether the internet revolution meant that rates should be lower than they might otherwise have been, John Vickers said probably not, while DeAnne Julius concluded they probably could.

Ms Julius said the strong pound would join the technological forces in bearing down on inflation. She said sterling was almost certainly overvalued, but warned: "Locking in low inflation is also likely to lock in strong sterling for the foreseeable future."

Speaking to the Chartered Institute of Bankers in Newcastle, she added that the internet would tend to reduce prices and costs, and also profit margins. It would be good for consumers but could prove difficult for many established businesses, she predicted.

On the brighter side, Ms Julius said that although there could be a short-term surge in demand, higher productivity growth would help to keep inflationary pressures in check. "On average, during the period of higher sustainable economic growth, interest rates will be lower than they otherwise would need to be in order to keep inflation on target."

Her MPC colleague, addressing the Society of Business Economists in London, agreed that higher productivity growth was likely to result from the internet revolution. But he argued that it would boost demand as well as supply in the economy, with no clear implication for inflation and interest rates.

Mr Vickers said he was a "cautious optimist" about the new economy, and estimated that it might boost trend productivity growth by as much as half a point to 2.5 per cent. However, both investment and consumer demand could be expected to increase, as well as potential supply. Interest rates might even need to be higher than otherwise to induce enough saving for investment in the new technologies. "If information technology is bringing a supply-side revolution, cannot monetary policy be eased for a while? That simply does not follow," he said.

Ms Julius admitted in her speech that there was a possibility of a short-term stock-market and investment boom or a consumer spending binge induced by new-economy euphoria. That could "unbalance the economy in an inflationary direction," she said.

Mr Vickers pointed to the same danger, which was also recently raised by Alan Greenspan, chairman of the US Federal Reserve. The MPC member said the best way to give growth a chance - a phrase coined by Sushil Wadwhani, fellow MPC member, who in a recent speech came down on the same side of the new-economy debate as Ms Julius - was to keep inflation low and stable. Monetary policy must target inflation, not growth.

The moral was, Mr Vickers concluded: "We can but wait and see, so neither an ostrich nor a lemming be."