Since the latterpart of 1988, theprimarypolicy objective has been to heqd off a rise to double digit inflation. T o this end, interest rates have been raised from 7112 per cent to 14per cent, while the public sector is running a large fiscal surplus. Despite this apparently very tight policy stance, policy is deficient in a crucial respect: it lacks credibility. The all too public divisions within government have weakened the efficacy of monetary policy, especially in financial markets. .The ongoing uncertainty over who is in charge of the conduct of policy -No. 10 or No. 11 -further undermines confidence. The most urgent priority must be to reassert clear priorities and guidelines. In this Viewpoint, we consider how best to restore the credibility of monetary policy. There are two main possibilities: first, t o reassert the Mediultt Term Financial Strategy (MTFS) in an appropriate form; or to join the (Exchange Rate Mechanism of the) European Monetaty System (EMS). We argue that it will be very hard t o derive credibility benefits from a reassertion of tlie MTFS: because of tlte itijlation record of tkepast decade atid the twists and tunts of past versions of the MTFS, a mere restatement will not resolve the uncertainties that result from known differences within the government. In particular, any restatement will rely 011 discretion and judgement in its implementation and this will weaken its beneficiol effects on expectations.Instead we argue that entry into the EMS offers a tougher and more credible commitment for monetary policy. The Chancellor has been pushed to rule out UK entry until the second harfof 1990 at tlte earliest, but tlie government should make a virtue of this by announcing a finn dale for entry next yeor. In the interim, it should encourage a debate about the appropriate rate for entry, a debate which will increasingly guide the foreign exchange market. The government should make it clear that i n choosing this rate it will d o so with the commitriient to low inflation very much in mind, favouring a high exchange rate. Once in the EMS, tlie government slioirld rule out the possibility of devaluing the pound in an EMS realignment. This provides a firm noti-discretionary anchorfor botli nionetary policy and inflation expectations. With this commitment, the principal gain from EMS entry will be establishing a regime of low inflation for the n u t decade: in this, choice of the exchange rate will be less crucial than tlte fact of entry.
Relative to what we expected following the collapse in the oil price, growth in the OECD economy was disappointing last year and, with activity still not registering a convincing pick‐up, we have lowered our forecast for 1987–88. Previously we argued that the sharp drop in oil prices from around 27 a barrel in 1985 to an average of 15‐16 last year represented a significant boost to real incomes in the oil‐consuming countries. Notwithstanding the corresponding real income loss to the oil producers, we expected OECD demand to rise sharply in the course of last year, with clear benefits to output becoming apparent by the end of the year. In the event this analysis, though correct in outline, has apparently underestimated the negative elements ‐ tighter fiscal policy, the failure of consumers in some countries to obtain the terms of trade gains from lower oil prices and/or currency appreciation, the offset to domestic demand from falling exports. Consequently, we now expect OECD output to rise by only 3 per cent p. a. over the next two years. The corollary of this is that inflation is also unlikely to record a marked increase and this enhances the prospect of sustained output growth in the medium term. The forecast combines steady output growth of around 3 per cent p. a. with inflation stable in the 3–4 per cent range.
In our assessment macroeconomic policy is now tighter as consequence of the Budget than we had assumed in February. We interpret the Budget speech as indicating higher interest rates (tighter monetary policy) and, in consequence, a stronger exchange rate. On this basis we find that the prospects for inflation are slightly better than before, though output is weaker. Additionally we forecast a PSBR in 1985‐6 of £ 63/4bn, below the official forecast of £7.1bn but in line with our February forecast. Of £7.1bn but in line with our February forecast. Because output is lower, however, this implies a tighter fiscal policy. The other main change to our forecast is unemployment. The changes to National Insurance Contribution scales represent a very cheap way of reducing the cost of employing the lower paid, and we estimate that these measures, together with the extension of the Youth Training Scheme and Community Programme, will create an extra 375,000 jobs and training places by 1988. However these effects are partially offset by the effects on output of the higher interest rates and higher exchange rate that we are now forecasting. When account is also taken of the increase in labour supply that follows any increase in employment, the net effect on unemployment is to reduce it by 300,000 by 1988 compared with our February forecast.
World output, which was strengthening immediately prior to last October, appears to have barely suffered in the short term from the stock market crash. Apart from an early reaction by US consumers ‐ since reversed ‐ demand is proving robust and in early 1988 OECD industrial production is, we estimate, 6 per cent up on year‐earlier levels, with GNP more than 4 per cent higher. Indeed such is the strength of activity that the present balance of risk is not that recession is imminent but that inflation may pick up again. In the United States, where activity rates are at their highest level for eight years and unemployment is at a fourteen‐year low, monetary policy has been tightened and interest rates are moving higher. The Bundesbank is keen to follow suit and the BoJ is keeping the situation under review. Nevertheless, with wages in most countries still adjusting to the low inflation rates of the last two years, there is little evidence yet that prices are accelerating. We expect to see world interest rates edging higher in the second half of the year as recorded inflation picks lip. But we believe that underlying inflation remains low and that, even on the assumption that oil prices return to 18 a barrel, OECD consumer price inflation will peak early next year at a little over 4 per cent. Tighter monetary policy is also expected to hold back demand over the next 12 months. Consequently, we expect some weak‐ ness in output in the first half of next year but discount the possibility of a severe recession. GNP growth in the OECD area is forecast to decline from the 3 per cent rate of 1987–8 to a little over 2 per cent next year and to a sustainable 2½ per cent p.a. over the medium term.
In recent speeches Treasury Ministers have coined a new slogan. They argue that inflation is not an alternative to high unemployment but a fundamental cause of it. They use this slogan to attack those who suggest that thefight against inflation should be slackened ‐ at least briefly ‐ in order to reduce unemployment. In this Economic e iewpoint we examine the arguments about the relation between inflation and unemployment. We suggest that although inflation may be a cause of unemployment in the long term there is an inescapable short‐term choice to be made between reducing unemployment and reducing inflation. We explain why this choice arises and also discuss the longer‐term effects of counter‐inflationary policies. Finally we examine the record of this Government's policies so far.
Abstnrct Some of the results ofa cornputer simulation on the effects ofadesirable adjustment of the Japanese industrial structure are described. The simulation model is based on an LP calculation under certain constraints of energy consurnption, using the abbreviated industrial input-output table for 1979. The objective functien of this LP model, which the author refers to as a welfare function, is selected to be maxirntzed by the output yector of domestic indttstries under some possible constraints.
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