Summary of Dr Sushil Wadhwani's remarks to the Edinburgh University Economics Society on 21 November 2001
The Outlook for the Global Economy
Business confidence has declined very significantly in recent months, but global stock markets appear to believe that a recovery is around the corner. In the US, the key downside risks are that the ongoing deterioration in the labour market might impact further on savings behaviour, and weak profitability might keep layoffs high. On the other hand, a possible upside risk is that the post-11 September decline in confidence proves to be relatively transient.
Do Current Stock Market Valuations Pose a Risk to the Global Economy?
On the basis of current expectations of earnings growth, it is possible to justify current levels of stock prices. However, long-term expectations of earnings growth are still at a level that has been unusual over the last 125 years. Moreover, there is also a significant mismatch between what the stock market is likely to deliver and what survey evidence implies that individual investors expect. None of this is inconsistent with a significant move up in equity prices if, say, clear signs of an economic recovery do emerge. If, though, the recovery is delayed, we might see a downward valuation adjustment in the stock market. In any case, expectations about long-term earnings growth and stock market returns are likely to need to moderate over the longer-term, and that is likely to accompany a downward valuation adjustment.
Uncertainties Relating to the Supply Potential of the Economy
We have to make difficult judgments about the level of spare capacity. The recent upward revisions to the capital stock have increased the measured degree of spare capacity in the Bank's core model, and partly explain why the November 2001 Inflation Report projection was consistent with less inflationary pressure than the preceding projection, even though the GDP outlook in the two projections differed little. Although the revised measure of capacity utilisation has reduced the size of the errors made in forecasting prices in the past, the previous tendency to over-predicting prices persists. This may be because of an intensification in competitive pressures. Major uncertainties remain, but it is my view that we are possibly overstating the degree of medium-term inflationary pressure.
