| Straight talking from bankers’ bank |
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| The annual report of the Bank for International Settlements released in early June contained fresh, plain, and even humorous statements about the international economy, rewarding traders, the euro and capital markets. The following are edited highlights. |
The surprising ’90s of ‘stunning advances’
A decade of tumultuous economic developments ended with a year full of surprises, the majority of them welcome.
Inflation stayed very low in most industrial and emerging market countries, while economic growth remained high in the United States, picked up in Europe and began to recover later in the year in Latin America. The turnaround in the fortunes of several crisis-hit East Asian countries was nothing short of remarkable, and China and India continued to expand at high rates. Even in Japan there were signs that the worst might be over.
The prevailing spirit of optimism was materially supported by recognition that the last decade had established a number of desirable trends. Technological advances were stunning and measured productivity in the United States increasingly seemed to reflect their influence. Furthermore, assuming adequate flexibility in labour, capital and product markets, there was no obvious reason why these transferable technologies could not bear fruit elsewhere.
Indeed, this logic may have underpinned the infatuation with ‘new era’ stocks on a global level. In addition, deregulation and privatisation proceeded apace, promising not only a more efficient allocation of resources, but also (through financial markets) new means to discipline irresponsible governments.
Whatever the reason, the commitment to sound monetary and fiscal policies was widespread in both industrial and emerging market economies. Finally, it had become increasingly accepted that well functioning markets require a comprehensive infrastructure of legal, institutional and governance systems.
Ironically, as history has repeatedly shown, even well founded optimism has the insidious tendency to transform itself into excess. The probability of this happening seemed to increase during the period under review. The near universal underestimation of the strength of the expansion in the English speaking countries and of the recovery in East Asia suggests that the underlying causes of this good performance remained less than completely understood.
Mutual re-inforcement
However, one disconcerting observation was that the various economic and financial forces at work seemed unusually interrelated. For example, in the United States rising stock prices (especially in the high-tech sector) added to personal wealth and facilitated business financing, contributing in turn to stronger consumer spending and investment respectively. Higher demand and capital deepening raised measured productivity, which enhanced optimism about future profits, further supported stock prices, and so on. Clearly, mutually reinforcing processes of this sort can exaggerate both financial market and real fluctuations, particularly if accentuated by supportive exchange rate shifts.
A further reason for tempering optimism is that many of the imbalances and structural deficiencies which had characterised the global economy in the previous few years came no closer to being redressed. Indeed, in some respects they worsened.
Nevertheless, the fact that these [inflationary] pressures remained relatively muted confirmed the powerful effect of such underlying disinflationary forces as technological change, deregulation, excess capacity and fiscal restraint in many countries.
US success should spread
There seems to be a widespread perception that the global economy now stands on the brink, but the brink of what remains the question. Many now see better economic prospects than at any time since the early 1980s. Part of this is pure extrapolation, but advances in technology and continuing deregulation are further reasons for expecting rapid growth along with continuing low inflation. Indeed, as such structural developments increasingly spread throughout the global economy, the remark able success enjoyed by the United States over the last few years seems likely to be more broadly shared. A prolonged boom in a more market-driven world economy can thus by no means be ruled out.
The US dollar also appears to be stronger than is compatible with the stabilisation of longer term external debt ratios. Given the increased extent to which projected returns on equity have driven international capital flows in recent years, the possibility of a simultaneous adjustment in both markets would seem greater than historical correlations might indicate. The likely implication of such an outcome would be slower demand due to wealth effects, even as inflation rose.
Inflation targeting and fiscal policy
Emerging market countries face a sharply exaggerated version of the trade-off confronting industrial countries that target inflation. If they set their targets too ambitiously, they will lose credibility if targets are missed. Conversely, if they set more realistic goals these may be judged to be unambitious and the regime will enjoy no credibility in the first place.
When it comes to the need for sound fiscal policies, however, no exercise of judgement is required. Without such policies, history teaches us that any regime aimed at controlling inflation is doomed to failure. |
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| Article appeared in the June 2000 issue.
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