Mr. George discusses international economic and monetary management and the implications of the present disturbances in Asia Text of the Henry Ford II Lecture delivered by the Governor of the Bank of England, Mr. E.A.J George, at Cranfield University Sch Management on 21/4/98.
It is a real pleasure to be back here at Cranfield to deliver this Henry Ford The Lecture - as you have just heard - commemorates an award made by the Ford Motor Compa in celebration of Henry Ford II's 60th birthday, to Cranfield School of Management. It w just two such awards to European business schools. And we have just seen evidence presentation of the Henry Ford Award - of the continuing close relationship between the Fo Company and the School of Management. The University has every reason to take pride in t that the achievements of the School are recognised by a great multinational company in the as I take pride in my own links with Cranfield.
Given the nature of the occasion, Mr. Chairman, I thought it might be appropri were to look beyond the narrow perspective of the monetary and economic situation in this though I will say something about that towards the end of my remarks - and focus on some aspects of the international economy. I will begin with a broad overview of the current i approach to overall economic management, then say something about the present disturbanc Asia, and finally about their implications for the prospects for the rest of the world.
Let me begin with just a few words about the process of international economi monetary management. I have just returned as it happens from the annual Spring Meeting IMF in Washington, where the Finance Ministers and Central Bank Governors from all around world gather to discuss current international developments. We all meet again every autu week, we debated much the same agenda in a variety of meetings - in the Group of 7 major in countries; in the Group of 10 - actually eleven - a somewhat wider range of industrial co the Interim Committee in which all IMF member countries are represented, in constituenci this time in a new ad hoc Group of 22 or 23 countries including a broad cross-section of emerging and transition countries. Invariably the journalists, who also gather in Washin reasonably ask, 'What exactly did you decide in all those meetings?' And almost invaria have to respond that 'We did not actually decide on anything - we agreed we should do some work and meet again for further discussions!' You could be forgiven for thinking that t process of reaching international agreement on anything moves at a snail's pace!
But even a snail can make remarkable progress if it keeps going. I am told quick species - I suppose they are the Model T snails - travel at a speed of three inches a 5 yards an hour. In that case a quick snail could have travelled quite easily from Cran borders of Scotland since the collapse of the Berlin Wall! And if you look back over a dec than at the outcome of just the latest meetings, then there really has been remarkable within the developing, emerging and transitional economies as well as the industrial world a broad international consensus on approaches to economic management. That consensus perhaps be summed up essentially as macro-economic stability and supply-side flexibility needs some elaboration.
On the macro-economic side we have learned - and it has taken some countries lo than others - that you cannot achieve what we are all trying to achieve - sustained growth, of employment and rising living standards - simply by pumping up demand in our econom through expansionary monetary and fiscal policies without regard to the underlying sup capacity of our economies to meet that demand. Short-term demand management through monet policy too often led just to accelerating inflation, which had then eventually to be br control through recession - an absolute recipe for short-termism in both financial and
behaviour. Equally, excessive public expenditure - which had ultimately to be financed higher taxation - imposed burdens on the private sector which weakened its capacity to employment and income and wealth.
So the emphasis now, more or less everywhere, is on effective price stability immediate objective of monetary policy - not simply as an end in itself but as a measu balance between aggregate demand and underlying supply in the economy as a whole, in ord moderate rather than aggravate the economic cycle, and so to provide the basis for su growth at around the underlying rate of growth of productive, supply-side, potential. emphasis now - again more or less everywhere - in relation to fiscal policy is to limit p borrowing, and the outstanding level of public sector debt, to levels that can be sustai future, without the need for increasing tax burdens or raising real interest rates on the p
These objectives of macro-economic policy - monetary and fiscal policy - wi familiar to you in recent years in this country; they are at the heart of the policies be Continental Europe by those countries that, in just under a fortnight from now, will agr ahead to Monetary Union; and they are the policies endorsed, too, by all the members of th the Madrid Declaration adopted at the IMF Annual Meeting in 1994 and expanded and upda eighteen months ago. Of course on occasion the flesh proves to be weaker than the spi achieving these macro-economic objectives is not easy in practise even as a technical matte intention - the international commitment to macro-economic stability - is clear and this in over time to mean a radical change - for the better - in the environment for private sec activity across the world.
Acceptance of the aim of macro-economic stability has brought into sharper focu structural, supply side, of the economy - that is the whole raft of influences that c underlying growth rate of capacity and thus the growth rate of aggregate demand that sustained.
In this context there is a strengthening international presumption in favour markets and free competition - both domestically and internationally - with a continui presumption against predatory trade or exchange rate manipulation. The argument is that un competition contributes to potential macro-economic growth through increased efficiency more effective allocation of productive resources.
This in itself is somewhat remarkable, given that, at the micro-economic competition invariably constitutes a threat to established producers - and their employees be tempted to make, often highly vocal, pleas for protection in one form or another to th governments. Consumers, who benefit from competition, tend to make less noise. The th protectionism is never, therefore, far away. But in fact the presumption in favour of com proved encouragingly robust. And that is not just in relation to international trade deregulation is increasingly in vogue in many countries; and there is much greater openne the world to inward investment and foreign ownership. I see the same presumption in fa competition, for example, in the global trend to privatisation, through which governme increasingly returned commercial activities, in which they have no necessary comparative ad to the market sector. At the same time, against the background of financial globalisatio has in the past few years increasingly focused on removing restrictions on the free flow again domestically and internationally - essentially on the grounds that this can further effective allocation of productive resources, increasing the benefits to be derived from co markets for goods and services. The IMF is in fact currently working on an amendment Articles of Agreement to give it a greater role in promoting the liberalisation of ext movements.
Of course, it remains true that market competition, and the supply capacity economy more generally, are inevitably influenced by virtually every other aspect of publ and will be affected to varying degrees by the particular social and economic judgements national politicians. This is true whether one is talking about direct public sector p education and training, for example, or incentives to saving and investment, or current or welfare provision, or the structure of taxation. And it is true equally of government in the form of regulation and social protection. But my strong impression is that there is awareness in many countries that policies in all these areas need to take account of supply-side effects, with an increasing bias towards structural reforms, in labour, produc markets, with a view to increasing employment and reducing distortions that impede ef resource allocation.
Now I do not pretend to you, Mr. Chairman, that the international policy con that I describe - particularly on the supply-side - is fully articulated; nor do I c subscribed to in its detail equally in every IMF member country. But it does represent a evolution in our collective thinking over the past decade or so towards a much more approach to economic management, which serves as a valuable framework within which countr performance can be assessed. The snail may have moved slowly but it has in fact tra considerable distance!
It has nonetheless still a long way to go. Its progress has been impeded in few years by the eruption of a number of financial disturbances - most recently in Asia drawn attention to continuing deficiencies in our approach to economic management; and we much of the time last week in Washington discussing what lessons we might learn from those
The storm last year in Asia struck essentially the ASEAN four - Thail the Philippines, Malaysia and Indonesia - spreading subsequently to South Korea and inter battering Hong Kong and elsewhere.
It is still not wholly clear - to me at least - quite why the storm struck sud it did. Most crises of this sort have their origins in some evident macro-economic policy least in hindsight there are usually fairly clear tell-tale signs of expanding fiscal def monetary policies, classically accompanied by evidence of imbalance in the form of acce inflation or a rapidly deteriorating balance of payments. There were such signs, per notably in Thailand; but they were not for the most part particularly pronounced in Asi through the first half of the 1990s, and in some cases for much longer, the countries in q been remarkably successful. They attracted, by their very success, huge inflows of capita rest of the world, where yields had fallen, in the hope of sustaining higher returns.
There is no question that this capital inflow made a very big contribution economic expansion in Asia; but with the benefit of hindsight, the accelerating scale of and particularly the forms that it took, became an important part of the problem. It was end productively employed. There was over-investment in some sectors; much went into ambi property development; and much went into financial rather than real assets. The hoped-f returns could not be maintained.
Again with the benefit of hindsight, it is possible to identify a number of weaknesses in the mechanisms for financial resource allocation in the recipient countrie was, for example, a general lack of reliable financial information, and a lack of tran relation to the financial position, of both public and private sectors. Complex and o between government, financial institutions and non-financial companies made it diffic outsiders to understand the real nature of their exposures. Financial markets were developed, leaving the system heavily dependent upon the banks. There was inadequate reg or supervisory oversight. There was widespread, often informal, government influenc
financial flows, which importantly also contributed to a perception that much of the borr implicitly under-written by the government. The list could go on.
The problem was compounded by the absence of any real perception of exchange ra risk. Borrowers were evidently confident that governments would maintain their exchange r against the dollar, even when it began to strengthen, so that unhedged foreign currency deb it at short-term, appeared to be a cheap alternative to domestic currency borrowing. The r build-up of short-term foreign currency liabilities, by banks and non-banks, which was appreciated, and which left the Asian economies especially vulnerable to a flight of cap event of a change in sentiment. The problem is that national authorities can create the currency, if they choose to do so, even if it leads to inflation, but they cannot simply currencies in the same way.
So, once the run started, it was violent and contagious. For a time around t last year there was a significant possibility of a chain of default emanating from Asia tha reverberated right through the global financial system. The immediate task was how to con risk.
Essentially there are two broad options for dealing with an external financia One is simply to allow financial markets - exchange markets, interest rates, and stock prices - to take the strain, and to seek to restore confidence, and moderate the impac movements, by restrictive macro-economic policy adjustment. The second is to limit the market impact and the extent of the associated macro-economic adjustment by providin arranging alternative external financing. In practice these options are not, of cour exclusive and the real question is the appropriate balance between them.
Where a country has transparently been pursuing an unsustainable macro-econom policy, most people find it easy to accept that that country should bear the burden and ad though that may be. Many people find this harder to accept where, as in the prese conventional macro-economic policies had, for the most part, been relatively responsible were certainly adjustments to macro-economic policy that needed to be made - a more f exchange rate regime in some cases, for example, or a somewhat tighter overall macro-ec stance, with perhaps some adjustment between fiscal and monetary policy. And, once the outflow had started, macro-economic adjustment had to be harsher than might otherwise hav necessary, in order to re-establish confidence. But there are real dangers in extre movements or in excessively severe macro-economic adjustment to contain them. That could a vicious circle of domestic default and systemic financial weakness in the affected cou that could have seriously adverse implications - in terms of both financial and knock-on-effects - for the global economy.
That, essentially, is why it may be in the self-interest of the international to attempt to mitigate the market and macro-economic adjustment pressures by providing fi support.
It is why the international community responded to the crisis in Asia by pr offering very large amounts of official assistance - $17 billion in the case of Thailand, $ Indonesia and $57 billion for South Korea.
But such official financial help cannot be unlimited and it cannot be provided strings. It, too, has real dangers. If it were too readily forthcoming it could enc hazard', especially by encouraging commercial lenders - particularly foreign currency cred the belief that they will be bailed out if things go wrong. That would be likely to add t of potentially volatile capital inflows next time around. Not surprisingly, too, there is
resistance in many countries, including notably the United States, to the idea th i.e., taxpayers', money should be used to bail out private creditors, especially foreign cred
External financing need not come solely from the public sector. Private f would, in principle, serve the same purpose, and in many situations market price adjustment sufficient to stem the capital outflow. But, given the extent of the loss of confidence case, organising private financial support meant in practice persuading existing creditor assets would be better protected if they were prepared to leave them in place, especial major creditors agreed to do the same and if official support was made available in paral this case, too, difficult judgements had to be made. There was a danger that, if private to be in effect coerced into staying put, they would immediately cut their positions elsew they still could, adding to the international contagion.
In fact, in the critically important case of Korea, the promise of massive support failed to restore market confidence. And when it became apparent that the offici financing was in practise available only as the very last resort we had to turn to the com lenders in the major creditor countries and persuade them to extend the maturity of thei was a dangerous moment. But their constructive response went a long way to resolvin immediate crisis and helped to restore greater financial stability to the region as a creditor banks are also now in negotiation with Indonesia's commercial debtors.
The discussion in Washington turned to preventative measures for the future .
It would have been understandable in the light of the Asian experience if th been some turning back from the path towards greater freedom of international capital mov and there was some suggestion of this. But on the whole the long term benefits of free ca were upheld, and the mood was to continue cautiously down that path, but to emphasise the n only for sound macro-economic policies which everyone accepts as a sine qua non, but also f to accompany capital account liberalisation designed to reduce the risks of volatility.
These related in part to the process of capital account liberalisation, where t good deal of stress on 'sequencing' - that is on liberalising potentially more stable, capital inflows initially, rather than short-term borrowing.
But they related particularly to three key conditions for living with freedom movements .
The first was 'transparency'. In a broad sense a need for greater transpare recognised in relation to public policy, to the relationship between the public and privat corporate governance and accounting and so on. In a narrower sense there was seen to be a greater and more timely disclosure of financial information generally, but especially in countries' true foreign exchange reserve positions and in relation to their short term e The general point is that we cannot reasonably expect markets to make a proper assessment risks of their lending if they do not have adequate information in accessible form. The that where they do have adequate information they can be expected to accept the penalty judgements prove ill-founded.
The second condition for more stable capital flows is stronger financial s That includes for example the broadening of capital markets so that the allocation of cap concentrated on local banking systems. It includes robust financial infrastructure - f payments and settlements systems. And it includes more effective financial regulat supervision. A key feature of future arrangements for me in this area is the encouragemen active management of short-term foreign currency assets relative to liabilities, by both
sector and the local banks, taking account of the nature of the exchange rate regime weaknesses in this area, above all, in my view that turned the Asian problem into a panic.
These various steps - which need a great deal of elaboration and refinemen themselves represent a huge agenda for the future. But however much we try to prevent a we need nevertheless to be prepared for them to happen. The third condition for living wi freedom of capital movements, therefore, is a more consistent view of how, when a crisis do the burden might be expected to be shared in the future between official and private sector
In this context, one thing seems clear: given the evidence of public resist cannot assume that massive official financing packages will in fact be deliverable in the f out private creditors. Various ideas have been put forward for involving the private maturity extension - within a formal legal framework or through official persuasion - and need to be elaborated and refined. But it might help to avoid inflows becoming excessive lenders clearly understood from the outset that they would be expected to carry a substant the load.
Mr. Chairman, the debate on all of these issues is still at a relatively early it is an important part of the present international monetary agenda and you can expect t debate crystallises, aspects of it will be gradually added to the policy consensus. Our sn moving forwards.
In the meantime, Mr. Chairman, the world too goes on. So let me conclude wi few remarks on the prospects for the global economy, bearing in mind the potential ec aftershock from Asia's financial disturbances.
In fact those prospects are less bleak overall than you might suppose.
The last few years have seen world growth at around 4%, against a longeraverage rate of just under 3½ % - with the improvement extending across both the industria developing countries as a whole and with stabilisation now in the transition economies. M inflation has declined almost everywhere.
The latest IMF projections suggest world growth of just over 3% this year - mor 1% less than was projected as recently as last October. The slowdown - and downward revi are heavily concentrated on the Asian countries themselves, notably Japan, which, becaus massive size of its economy has a large impact on world growth. Elsewhere among the industrial countries weaker demand from Asia is expected to be offset by relatively strong demand, so that overall output growth is not much affected - indeed it is expected to pic continent. A troublesome feature of these projected developments - coupled with recent e rate movements - is that they imply large external payments imbalances which will need carefully managed if they are not to lead to protectionist pressures and exchange market vo
Against that background the G7 surveillance discussion focused particularl Japan, where financial fragility - in the wake of the bubble and subsequent collapse of as continues, which is itself acting as a drag on the domestic economy and which is compound loss of both consumer and industrial confidence. Both the financial fragility and th economic weakness are now aggravated by the problems elsewhere in Asia. Everyone at the me welcomed the Japanese commitment of public funds to strengthen the financial system and the announcement of large fiscal stimulus to strengthen domestic demand led growth, which will reduce Japan's external surplus and also to strengthen the Yen.
In relation to the other major industrial countries there was general puzzleme persistent strength of equity markets and about the implications if it were to continue does not.
Particular points made in relation to continental Europe were that it is i there, too, that the gathering recovery - hitherto driven largely by external demand increasingly be based on sustained growth of domestic demand; and that continuing str reforms will be necessary to combat persistent high unemployment - especially now in the co monetary union. In the United States and this country, on the other hand, which both grew last year on the back of domestic demand, the emphasis was on a need for vigilance - as al stay on a non-inflationary path so that sustainable growth can be maintained.
The IMF's analysis of this country's position, Mr. Chairman, is in fact very s our own. We both recognise that aggregate demand growth needs to moderate quite sharp inflation is to be held to the Government's target over the next two years or so. We clearly seeing a weakening of net external demand in response to the sterling's exa appreciation - particularly against other European currencies - since the autumn of 1996 a response to the Asian crisis. However undesirable that may be in terms of the balanc economy - and I am very sensitive to the hammering being taken by the internationally sectors - it does provide a little more time to bring about the necessary moderation of th domestic demand growth, which we expect to occur as a result of both the fiscal and m tightening already in place, and in the absence this year of 'windfalls' from demutualisa critical judgement relates to the precise timing and pace of this moderation of domesti growth, and whether it will be sufficient to prevent a pick up in inflation as the dampeni the strong exchange rate and weaker external demand wear off.
Now - although there are some encouaging signs - frankly no-one can know t answer to that question with any great confidence - we are not blessed with perfect foresig IMF says in one of its documents prepared for the recent meetings: 'Striking the right b monetary policy in this environment is a difficult challenge.' Well you can say that a hardly surprising against this background that there should be disagreement within the Policy Committee as to whether or not a marginal further tightening of monetary po necessary-in fact I would normally expect there to be disagreement when we are close to w need to be. But we are all unambiguously clear about where we need to get to in terms of and it is unrealistic in the circumstances - indeed in any circumstances - to expect us to happen to interest rates in the future.
Mr. Chairman, the overall prospect for the world economy - and indeed our domestic economy - is for continuing growth with low inflation, and we do I think have vision of where we want to go and the policies to take us there. But there are certainly immediately painful blackspots - internationally and here at home - and there are some f rocks and potential whitewater further ahead. Navigating through them will not be easy. I that our snail is able to swim.