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The Importance of Macroeconomic Frameworks for Economic Stability Dave Ramsden 11 January 2006 Why does stability matter? Higher living standards Higher economic growth via Better resource allocation Decisions taken for the long-term Clearer relative price signals 2 UK has moved from one of the least stable to the most stable economy in the G7 and OECD G7 4 1970s OECD 9 G7 5 1980s OECD 17 Stability of the output gap 4 10 7 23 5 10 1 1 Stability of inflation 6 18 5 17 7 20 1 1 Stability of real GDP growth 1990-1997 G7 OECD 5 17 1998-2004 G7 OECD 1 2 3 GDP and inflation volatility in the G7 – 1997-2005 2.0 Standard deviation Lower GDP growth volatility GDP Growth Volatility Japan 1.5 1.0 USA France Canada Italy Germany UK Lower inflation volatility 0.5 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1 Inflation Volatility 4 GDP growth has risen as GDP growth volatility has fallen Lower GDP growth volatility GDP growth volatility 3.0 2.5 2.0 1.5 1.0 1980s 1970s 1950s 1960s 1990-1997Q2 1997Q32005Q3 Higher GDP growth 0.5 1.5 2.0 2.5 3.0 3.5 Average GDP growth 5 Both inflation and inflation volatility have fallen Lower inflation volatility 7 Inflation volatility 6 5 4 3 1970s 1980s 1950s 1990-1997Q2 2 1997Q32005Q3 1 1960s Lower inflation 0 0 2 4 6 8 10 12 14 Average Inflation 6 Why has UK stability improved? • • Key lesson from pre-1997 is the importance of having credible macroeconomic frameworks. Before 1997, macroeconomic policy was characterised by: inappropriate objectives; poorly specified objectives; a failure to look forward; unclear and inconsistent roles and responsibilities; and Politicisation of monetary policy decisions. 7 Principles of UK fiscal framework Transparency in the setting of fiscal policy objectives Stability in the fiscal policy process and in the way fiscal policy impacts on the economy; Responsibility in the management of the public finances; Efficiency in the design and implementation of fiscal policy and in managing both sides of the public sector balance sheet; and Fairness, including between generations. 8 Fiscal rules Golden rule: over the economic cycle, the Government will borrow only to invest and not to fund current spending Sustainable investment rule: public sector net debt as a % of GDP will be held over the economic cycle at a stable and prudent level (40%) 9 Performance of fiscal framework meeting the golden rule 3 Per cent of GDP 2 1 0 -1 -2 -3 -4 Introduction of new fiscal framework -5 Projections -6 Average over 1986-87 to 1997-98 cycle Average over 1997-98 to 2008-09 cycle -11 10 20 -10 09 20 -09 08 -08 20 07 20 -07 06 20 -06 05 20 -05 04 -04 20 03 -03 20 02 20 -02 01 20 -01 00 20 -00 99 -99 19 98 19 -98 97 19 -97 96 19 -96 95 -95 19 94 19 -94 93 19 -93 92 19 -92 91 -91 19 90 19 -90 89 19 -89 88 19 -88 87 19 19 86 -87 -7 Current budget surplus 10 Public sector net debt 0-1 1 20 1 9-1 0 20 0 8-0 9 20 0 7-0 8 20 0 6-0 7 Introduction of new fiscal framework 20 0 5-0 6 20 0 4-0 5 20 0 3-0 4 20 0 2-0 3 20 0 1-0 2 20 0 0-0 1 20 0 9-0 0 19 9 8-9 9 28 19 9 7-9 8 19 9 6-9 7 19 9 5-9 6 19 9 4-9 5 19 9 3-9 4 19 9 2-9 3 19 9 1-9 2 19 9 0-9 1 19 9 9-9 0 19 8 8-8 9 19 8 7-8 8 19 8 6-8 7 19 8 Performance of fiscal framework – net debt 44 Per cent of GDP 42 40 38 36 34 32 30 Projections 26 11 Principles of UK monetary policy framework Clear and precise objectives (a 2% annual rise in CPI inflation) Full operational independence for the Bank of England’s Monetary Policy Committee (MPC) Openness, transparency and accountability Credibility and flexibility 12 Performance of monetary policy framework 10 RPIX Inflation Expectations 9 RPIX Inflation 8 CPI Inflation 7 CPI Expectations Per cent 6 Introduction of new framework 5 4 Introduction of new CPI target 2.5% RPIX target 3 2 Introduction of inflation targeting Target range 2 per cent CPI target 1 0 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 13 Summary • • • • Important to get the principles right in macroeconomic policy frameworks. Precise form of rules differs between countries according to national circumstances Credibility is achieved by having rules underpinned by the right objectives and ensuring that the rules are met Credibility ensures that macroeconomic frameworks play a full role in contributing to stability. 14 Role of GES and HMT economists • • • Macro stability also helps allocate resources within government GES - 900 economists working in 32 departments 100+ economists in HM Treasury – increasing proportion looking beyond macro policy. Analyse evidence to inform policy Advise on choices & alternatives Make a difference on important issues 15 Role of OECD and EU • • • • Economies of scale Learning from the experience of other countries OECD pioneers of micro peer review EU peer review, Lisbon Strategy 16