In theory, a rise in inflation in our trading partners driven purely by looser monetary policy would not have the same impact because it would be offset by a strengthening of sterling’s exchange rate. 10 The impact on inflation of a period of slower productivity growth depends on what it does to demand and on how easily wage growth falls in response. If people recognise the drop in productivity growth, and demand growth falls alongside it, and/or if nominal wage growth is reasonably flexible and can accommodate the decline in the warranted real wage without unemployment having to rise, it needn’t result in higher inflation. But if demand fails to decline or if there’s resistance in real wages inflation is likely to rise. 9  15  All speeches are available online at www.bankofengland.co.uk/news/speeches and @BoE_PressOffice  15  tighter than the rate of unemployment alone would suggest. Though this assessment is necessarily preliminary, the news since the end of the furlough scheme does not look to have changed that picture. In October, claims for unemployment benefit fell again and survey indicators of labour market conditions tightened further. Although it’s made little contribution to higher inflation so far, the risks to future inflation from the tight labour market may well be more significant. Developments in domestic costs tend to be more persistent than those in tradable goods prices (Chart 6 is one indication of that).
I do understand these concerns. Let me assure you now that I will not bore you with a recollection of past events. I intend my exposé today to be forward-looking, as should the exposé of any central banker. I want to discuss what lessons for the future we can draw from over-optimistic expectations related to so-called regime shifts, such as the supply-side shock of a perceived “new economy”, and the subsequent financial boom and bust cycle in asset prices. How should monetary policy-makers deal with the resulting financial imbalances and reconcile monetary stability with financial stability? In my presentation today, I shall first briefly discuss the challenges that have been presented by the new environment for monetary policy-makers, in particular by the “new economy” and the growing importance of capital markets. Then, I shall look at what I call the excesses of this new environment, which for me are the speculative boom in asset markets and evidence of a corporate culture infatuated by short-term considerations. Finally, I shall look at the financial stability concerns and conclude by presenting some lessons for the future. The paradigm of the “new economy” Without a doubt, the world has experienced overwhelming progress in technology and productivity over the previous century, resulting in enormous growth in economic activity and individual wealth. It has been calculated that the industrialised countries were about 20 times better off at the end of the 1 20th century than they were a hundred years earlier.