It could set in motion a complex of effects on aggregate supply and demand, on inflation, equity prices and interest rates. Just to give a few examples, let me briefly mention the following effects: First, a positive productivity shock raises the economy’s potential growth rate. It also affects aggregate demand through new, profitable investment opportunities, higher equity prices and expectations among households of higher permanent income. One question for policymakers is whether the demand effects are so powerful that they have the potential to outpace the growth of aggregate supply in the short and medium perspective. Second, there could be temporary disinflation effects at work if the increase in productivity is unexpected initially. If wages are slow to adjust, higher productivity growth lowers unit labour costs and thereby reduces price inflation. Here again there are important questions for policymakers. Should this effect be allowed to result in a temporary reduction of price inflation or unemployment? Third, an increase in the trend rate of productivity growth could also result in a higher equilibrium real interest rate, when the output gap is closed, in order to balance saving and investment. Fiscal policy and the development of public financial balances could at least partly offset this effect, as could the economy’s degree of openness. All this implies that monetary policymakers, also in Europe, could face quite a few challenges. One of them is to identify structural changes and distinguish these from cyclical variations. Another challenge is to detect the magnitude of the effects.
Less extreme is the euro zone, where, after a period of slow growth in the area as a whole, recovery is now well established. The internal imbalances in each country - differences between growth of domestic demand and the supply of output - are the mirror image of the external imbalances - current account surpluses and deficits. Widening imbalances are unlikely to be sustainable for long. But the extent to which they will be self-correcting, or will require policy adjustment, depends in large part on why they have arisen. This is my second question - why have the imbalances arisen? Sustained current account deficits can reflect profitable investment opportunities that exceed the supply of domestic savings so that it is necessary to borrow from abroad. And the most popular explanation of the recent rapid growth in domestic demand, especially in the US, is as the consequence of a rise in productivity growth, and investment opportunities, reflecting the so-called “new economy”. It has been pointed out by several economists, including Alan Greenspan and my colleague John Vickers, that an increase in trend productivity growth might increase demand by more than it raised supply initially, as firms invest in new technology and consumers anticipate higher future incomes and spend today out of this revised estimate of their “permanent” income. Hence new information technologies, because they raise  BIS Review 34/2000  2  potential future output in the economy, would add to demand today.