I will return to banks' capital adequacy later but  BIS Review 4/2001  1  first I want to say a few words about our perception of the US economy and the implications for the UK. US Economy: Soft or Hard Landing? The dramatic improvement in US economic performance through the 1990s, in terms of growth and productivity, gave rise to a sharp increase in expected returns to investment and, as a result, increased domestic and foreign demand for US assets. Investment has been particularly concentrated in ICT (information, computers and telecommunications), much of it financed by borrowing on the strength of projected future profits. However, growing uncertainty over the size and permanence of these productivity gains, and about the long run growth of GDP and profits, has fuelled the recent increase in market volatility. In addition, there have been more immediate worries about the impact of a cyclical downturn in productivity and earnings. Another area for debate has been the implications of any reversal in capital flows. As I have noted, buoyant earnings expectations drove up equity prices and encouraged high rates of investment. But alongside the rapid rise in the market value of US household wealth in relation to income came a sharp fall in domestic savings. The gap between savings and investment - manifested in an external current account deficit which has risen to an unprecedented rate of 4½% of GDP - has been filled by large capital inflows.
The fact that the US has enjoyed an unparalleled period of strong and continuous growth during the nineties owes a great deal, of course, to the policies of the US authorities. They have had to steer a difficult path between maintaining conditions conducive to growth while not being seen to underwrite the risks of "irrational exuberance" in security markets or lax lending standards by banks. This balance became especially difficult to strike towards the end of last year in the face of sharply lower corporate earnings projections and widening spreads on higher risk borrowings. As some lower-rated companies found access to the capital markets increasingly difficult, and as banks tightened credit standards, liquidity fears for some borrowers intensified. These factors, together with a sharp downturn in business optimism and mixed economic data, added to growing fears of a recession this year. Such a climate of uncertainty calls for clear signals from the authorities and over the past two months the Fed has responded in a decisive fashion. The adjustment in the policy bias and recent cut in rates have increased the probability of a soft landing and will, from an international perspective, reduce the risk of a sharp reversal of capital flows into US markets. The combination of a slower growing - but still expanding - US economy and a weaker dollar should provide a more sustainable pattern of current accounts and capital flows, reducing the risk of instability in financial markets in both the US and abroad.