Quarterly Bulletin Summer 2001 Bank of England Volume 41 Number 2 Bank of England Quarterly Bulletin Summer 2001 Summary 143 Recent economic and financial developments Markets and operations 145 Box on comparison of survey and market interest rate expectations 150 Box on hedge fund activity in the foreign exchange market 158 Reports The Bank of England inflation attitudes survey 164 The London Foreign Exchange Joint Standing Committee: a review of 2000 169 Over-the-counter interest rate options 172 Box on types of interest rate option 176 Research and analysis Explaining the difference between the growth of M4 deposits and M4 lending: implications of recent developments in public finances 183 Box on the cash flows involved in a government receipt of £100 million under both cash management arrangements 186 Using surveys of investment intentions 189 Can differences in industrial structure explain divergences in regional economic growth? 195 Has there been a structural improvement in US productivity? 203 Summaries of recent Bank of England working papers Sticky prices and volatile output 210 ‘Oscillate Wildly’: asymmetries and persistence in company-level profitability 211 Investment-specific technological progress in the United Kingdom 212 Research and analysis (continued) The real interest rate gap as an inflation indicator 213 The structure of credit risk: spread volatility and ratings transitions 214 Ratings versus equity-based credit risk modelling: an empirical analysis 215 Stability of ratings transitions 216 Consumption, money and lending: a joint model for the UK household sector 217 Hybrid inflation and price level targeting 218 Crisis costs and debtor discipline: the efficacy of public policy in sovereign debt crises 219 Leading indicator information in UK equity prices: an assessment of economic tracking portfolios 220 Summaries of recent External MPC Unit discussion papers Core inflation in the United Kingdom 221 Speeches International efforts to improve the functioning of the global economy Speech by the Governor, given to the Swiss Institute of International Studies at the University of Zurich on 7 May 2001 222 Monetary stability as a foundation for sustained growth Speech by Ian Plenderleith, Executive Director and member of the Bank’s Monetary Policy Committee, given at the National Association of Pension Funds Investment Conference on 14 March 2001 229 The ‘new economy’: myths and realities Speech by Sushil B Wadhwani, member of the Bank’s Monetary Policy Committee, given as the Travers Lecture at London Guildhall University on 20 March 2001 233 The impact of the US slowdown on the UK economy Speech by Sushil B Wadhwani, delivered to the Bank of England’s North East Agency contacts in Newcastle on 22 February 2001 248 Volume 41 Number 2 Printed by Park Communications © Bank of England 2001 ISSN 0005-5166 Quarterly Bulletin—Summer 2001 Markets and operations This article reviews developments in international and domestic financial markets, (pages 145–63) drawing on information from the Bank of England’s market contacts, and describes the Bank’s market operations in the period 1 February to 11 May 2001. Reports The Bank of England inflation attitudes survey. As part of a new regular series, the (pages 164–82) market research agency NOP undertook a survey of public attitudes to inflation for the Bank of England in February. The results show that, given a choice between higher interest rates or higher inflation, four times as many people would prefer interest rates to go up, rather than prices. Other results suggest that most people are aware that the Bank, rather than the Government, now sets interest rates. 55% are satisfied with the way the Bank is doing its job; just 10% are dissatisfied. Most people are aware that inflation is low, but only one in three knows that it is currently between 1% and 3%. However, very few expect inflation to rise sharply in the year ahead. The London Foreign Exchange Joint Standing Committee: a review of 2000. This article gives an overview of the role of the London Foreign Exchange Joint Standing Committee, and reviews the work undertaken by the Committee during 2000. Over-the-counter interest rate options (by Richhild Moessner of the Bank’s Gilt-edged and Money Markets Division). The Bank of England’s Monetary Policy Committee uses market expectations of future interest rates to inform its policy decisions. Interest rate expectations can be inferred from a range of financial instruments, including interest rate options. This article surveys the structure and use of the over-the-counter (OTC) interest rate option market. It discusses what information OTC interest rate options may contain about market interest rate expectations, additional to that available from products traded on exchanges. It also considers the linkages between OTC interest rate option markets and the markets in the underlying assets. Research and analysis Research work published by the Bank is intended to contribute to debate, and (pages 183–221) does not necessarily reflect the views of the Bank or of MPC members. Explaining the difference between the growth of M4 deposits and M4 lending: implications of recent developments in public finances (by John Power and Peter Andrews of the Bank’s Monetary Assessment and Strategy Division). The growth of sterling lending by UK monetary financial institutions to the UK private sector has substantially exceeded the growth of UK private sector sterling deposits over the past two years. This article considers the possible influence on this growth differential of two events in the past financial year: the unexpected extent of the Government’s cash surplus; and the assumption by the Debt Management Office of responsibility for government cash management. The article also describes how the gap between sterling lending and deposits was financed over the past two years. Using surveys of investment intentions (by Jens Larsen of the Bank’s Monetary Assessment and Strategy Division and Rain Newton-Smith of the Bank’s Structural 143 Bank of England Quarterly Bulletin: Summer 2001 Economic Analysis Division). Business investment is an important component of aggregate demand in the UK economy. But it is volatile and difficult to predict. Surveys of investment intentions provide a timely and useful source of information on future investment plans, and can be used to forecast changes in business investment. This article describes a model that uses surveys of investment intentions to forecast business investment, and compares its forecast performance with the business investment equation in the Bank of England’s macroeconometric model. Can differences in industrial structure explain divergences in regional economic growth? (by Beverley Morris of the Bank’s Conjunctural Assessment and Projections Division). During the early to mid-1990s, the pace of economic growth in the South was broadly comparable with that in the rest of the United Kingdom. During 1996–98, however, the pace of activity in the South strengthened considerably relative to the rest of the country. This article investigates one possible explanation for divergences in growth between the two regions—namely differences in the relative importance of the manufacturing and service sectors. The results suggest that such differences in industrial structure do not account for the majority of the regional divergences in growth. Rather, it appears that they are explained mostly by a pick-up in population growth and stronger service sector activity in the South relative to that in the rest of the country over the period. Has there been a structural improvement in US productivity? (by Stuart Berry of the Bank’s International Economic Analysis Division and David England of the Bank’s Monetary Assessment and Strategy Division). Annual labour productivity growth in the United States has averaged 2.8% a year since 1996, compared with an average rate of 1.6% during the preceding 25 years. This marked increase in productivity growth has been a key component of what many commentators have suggested is a ‘new economy’. Given the US slowdown since the second half of 2000, a key question is the extent to which these gains reflect structural improvements, rather than cyclical factors. The evidence so far points towards a large role for structural improvements in productivity. If these gains prove to be more cyclical, however, this would have important implications for corporate performance, financial markets and, ultimately, output and inflation. The contents page, with links to the articles in PDF format, is available at www.bankofengland.co.uk/qb/m01qbcon.htm Authors of articles can be contacted at [email protected] The speeches contained in the Bulletin can be found at www.bankofengland.co.uk/speech/index.html 144 Markets and operations G This article reviews developments in international and domestic financial markets, drawing on information from the Bank of England’s market contacts, and describes the Bank’s market operations in the period 1 February to 11 May 2001. G Private sector forecasts for short-term growth prospects in the G7 countries were revised down during the period. World equity markets fell sharply until late March but recovered somewhat thereafter. G Official interest rates were reduced by 100 basis points in the United States, by 75 basis points in the United Kingdom, and by 25 basis points in the euro area. The Bank of Japan also eased its monetary policy during the period. G Short-term interest rate expectations fell in the United States, the United Kingdom and Japan, but were broadly unchanged in the euro area. Uncertainty about the short-term outlook for future changes in monetary policy increased in these areas. G US and European government bond yields beyond two years’ maturity rose as market participants became more confident that the reductions in official rates would limit the extent of the global slowdown. G The dollar appreciated against the other major currencies during the period.