News Release
Governor's Speech at CBI Annual Conference
12 November 96
The Governor restates the case for aiming for permanent price stability in order to achieve lasting economic stability in a broader sense - a sustainable balance between demand and supply. Commenting on the present conjuncture, the Governor says:
"We take the view that, while there is still no doubt some degree of spare capacity in the economy, the accelerating upswing will need to moderate if it is not to put the inflation target at risk further ahead. That is why we welcomed the recent modest rise in interest rates. It may well be that some further rise will become necessary in due course - and that was the conclusion in our latest Inflation Report. But by acting promptly to begin gradually easing back, the Chancellor has helped to limit the extent of the rise that may ultimately become necessary, and improved the prospect of lasting expansion.
The position is complicated by the erratically sharp appreciation of sterling through the autumn, which probably has as much to do with developments abroad as in this country. It is suggested that this made the rise in interest rates unnecessary. The problem with this is that the stronger exchange rate does nothing directly to restrain the domestically-driven upswing in demand. It may affect our net trade position - if indeed sterling persists at the recent level, which is uncertain - and we certainly recognise that concern; and it should help to dampen inflation at least in the short-term. We take account of these influences, of course, in our inflation forecast and in our policy advice. But there cannot be any automatic offset against interest rates - certainly no simple rule of thumb. Nor can the exchange rate become an excuse for overriding the inflation target. We have been down this road before - in 1987 for example. The objective of monetary policy can then become unmanageably blurred."
On the prospect for EMU, the Governor says the economic case "depends essentially upon whether, in Monetary Union, the different member countries would find that the single monetary policy - the single interest rate - was, consistently, at least broadly compatible with their national economic situation.
If it worked well in this respect, then there would be real advantage, in terms of intra-regional exchange-rate certainty in a single currency, as well as lower transactions costs. But if domestic policy needs were likely to diverge in a major way, so that the single policy was too expansionary in some countries but too deflationary in others, that could give rise to serious tensions, including possibly persistently higher unemployment in some areas and pressure for protection. In that case it would be better for everyone if we all continued to pursue stability-oriented macro economic policies and structural flexibility independently, outside Monetary Union."
The convergence criteria were conceived to reduce the risk of starting EMU from position of substantial divergence. "They were intended to ensure that at least a minimum degree of genuine, sustainable, convergence has been achieved before Monetary Union goes ahead. I doubt whether the architects of the Treaty envisaged the present hectic dash for the line - the chosen calendar deadline; and I doubt whether they envisaged either that some of the runners might be tempted to take artificial stimulants in order to get there! The decision when the time comes will be for Europe's politicians. I can only hope that they weigh the economic risks seriously. If they disregard them, there can be no assurance that Monetary Union will lead to the political cohesion that they have in mind."
The Governor adds that we must be prepared for 1 January 1999 whatever the outcome. The Bank is workig closely with the City to ensure that wholesale financial markets are ready, and he welcomes the initiative taken by the CBI and the British Chambers of Commerce, in conjunction with the Bank, to arrange a series of workshops around the country to discuss the practical issues.
Full text of the speech is available from the Public Information and Enquiries Group 0207 601 4878.
