News Release
Speech by DeAnne Julius: "Back to the Future of Low Global Inflation"
20 October 1999
Delivered as the Maxwell Fry Global Finance Lecture at the University of Birmingham
In her lecture DeAnne Julius argues that in changing times old paradigms can be misleading, while some elements of the so-called 'new paradigm' growth theories are modern incarnations of earlier economic trends. She particularly warns against using the paradigms and parameters of the 1970s and 1980s, when global inflation was high, to shape views about the present and projections for the future.
Dr Julius says that as an MPC member she spends most of her days thinking about the demand side of the economy. However, in her lecture she instead considers some of the longer term changes now affecting the supply side of the global economy and, within that, the UK.
She observes that,
"…The supply side changes in our economies today which are likely to affect inflation prospects over the next decade are broadly similar to those at work during the 50 years that ended with the First World War."
In her view three factors - intensified international competition or 'globalisation', the spread of new technologies, and greater price transparency - constitute the key supply side changes that will affect global inflation outcomes.
"…They share two characteristics. First, the direction of their impact on UK inflation, at least over the medium-term, is downwards. But second, the size of their impact will be very difficult to discern until many years hence. This is because they are gradual, structural changes whose effect on economic statistics will be overlaid with, and obscured by, the cyclical surges and slowdowns to which we devote so much time and attention. In other words, if we place too much faith in econometric models calibrated from the 1970s and1980s, we won't know what's hit us until it's too late!"
"If global competitive forces bear down on domestic prices more strongly, then in the short-to-medium term domestic inflation will be lower and output growth higher. If those same forces drive improvements in domestic productivity, then a more permanent shift can be made to a higher growth path consistent with low and stable inflation."
Dr Julius believes that,
"…there is considerable evidence in the UK to suggest that long-term structural changes are bringing effective downward pressures to bear on prices and margins, even during times of relatively robust demand." But she believes that we won't know for at least ten years as to whether these pressures are feeding through to a supply-side improvement: "Productivity improvements take time to germinate and statisticians take even longer to confirm them."
Dr Julius then outlines the implications for policy-makers of the supply-side changes and the uncertainties they introduce.
"First, be sceptical of forecasts. They are necessarily built upon the behavioural relationships of the past. Many of these will persist into the future. But in the case of global inflation, the 1970s and 1980s were particularly unfortunate decades. Historically calibrated models of the UK are likely to pose particular risks in this regard because of Britain's exceptionally poor inflation performance during the 1970s and 1980s..."
"Second, listen and learn from real-time experience. If model-based forecasts are highly uncertain and potentially misleading, then it is especially important to seek out complementary sources of information and interpretations of economic developments from those actually in the thick of the action…"
"Third, pay special attention to prices. Economists are trained to think of prices as information signals. They are sensitive indicators, revealing even small shifts in supply or demand. They are readily observable, unlike output gaps, natural rates of unemployment or trend productivity…"
"Fourth and finally, be pre-emptive, but delicately so . If one has reason to believe that the economy is in a period of transition and that the global trends from the 70s and 80s no longer provide a confident grounding for forecasts, then one needs to tread carefully… Aggressive patterns of policy change, or activist attempts to fine-tune the future carry particular risks during such junctures. This is not a new insight in response to a new paradigm. It is another example of applying the lessons of the past…"
She concludes,
"To avoid the policy mistakes of the past, one should be open-minded about the paradigms - new or old - that will shape our future."
Note for Editors
Dr DeAnne Julius is a member of the Bank's nine-person Monetary Policy Committee which sets UK interest rates in order to meet the government's inflation target. She was appointed to the Committee by the Chancellor of the Exchequer in September 1997 and was previously Chief Economist of British Airways PLC and, prior to that, of Shell International.
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