Interest rates must focus on the economy-wide inflation target. But macroeconomic stability benefits all sectors of the economy. That stability, upon BIS Review 111/1999  4  which the aspirations of parliamentarians, both at Westminster and in Edinburgh, depend, is fundamental to the future prosperity of the United Kingdom. And to maintain stability, interest rates will sometimes go down and sometimes go up. For a quarter of a century, my generation – the inflation generation – suffered from the instability created by high and unpredictable inflation. To the next generation, I would like the Prime Minister, whoever he or she is at that point, to be able to say, “You’ve never had it so stable, not just for one year, or two years, or even three, but for a whole generation.” It is well known that many, if not most, of the great British economists were Scottish. One of the few English economists to rival the Scots was John Maynard Keynes. His view was that, “If economists could manage to get themselves thought of as humble, competent people, on a level with dentists, that would be splendid!”. So perhaps the fate of the MPC is, rather like dentists, to perform an important service but one which does not make people happy. Regular monitoring and early treatment, while rarely pleasurable, prevent more unpleasant symptoms later. So it is with a pre-emptive monetary policy.
Only a further sharp rise in sterling, and further falls in commodity prices, could maintain these rates of decline of import prices and their benign effect on retail price inflation. And we see that these effects are now coming to an end. Import prices are beginning to rise, partly because of the recent rise in oil prices, but also because the rate of decline in other prices is slowing with sterling no longer appreciating as fast as it was. BIS Review 111/1999  2  It was possible to allow domestic spending in the economy to grow rapidly in recent years because the appreciation of sterling led to weak net trade. In real terms, the deficit in trade of goods and services has deteriorated sharply. But just as the one-off effects of lower import prices will not continue to hold down retail price inflation, so the rapid growth of domestic spending is itself unsustainable. In 1998 the increasing trade deficit reduced output growth by more than 2%. So modest output growth in the economy as a whole was consistent with rapid final domestic demand – that is spending by households, governments and business on consumption and investment. But the pace at which the trade position is deteriorating is itself now moderating, and final domestic demand grew at 4½% in the first half of 1999.