• • New public expenditure plans will keep interest rates and the exchange rate higher than previously expected.

• • Public sector net borrowing will run at over 1 per cent of GDP in the next three fiscal years.

• • The risk of joining EMU at an uncompetitive exchange rate has risen.

• • The economy will stall in the second half of 1998.

• • The slowdown will curb inflation which should fall to 2.1 per cent by the end of this year and meet the target of 2.5 per cent in 1999.

• • The Asia crisis will cut world trade growth by over a third in 1998.

• • The Japanese economy will contract by 1 per cent this year, prolonging the slump in the worst affected parts of South-East Asia.

• • A strong monetary stimulus and a restoration of confidence in the banking system are required to stimulate demand in Japan.

• • The risk of a Chinese devaluation has risen.

• • The EU will be the strongest performing region in the OECD in 1999 with growth of just over 2.5 per cent.

• • US consumer price inflation will rise sharply in 1999.

Two of the most significant policy changes made by the government since coming to office are the transfer to the Bank of England of the power to set interest rates and the announcement of large increases in public spending following its Comprehensive Spending Review (CSR). The unexpectedly fast growth in future public spending is bound to have an immediate and important bearing on the setting of interest rates. As such, the development of the economy over the coming years will be affected by the interaction of these two separate policy changes.

The government's Economic and Fiscal Strategy Report (EFSR), published on 11 June, set out its fiscal strategy and its overall spending plans for the years ahead. Strategically, the government stressed the distinction between current and capital spending and committed itself to borrowing no more than what is necessary to finance capital investment over the economic cycle. It also committed itself to maintaining debt at prudent levels, thereby limiting the amount that it is prepared to spend on capital items.

We devote the bulk of this fiscal report to an alternative analysis of government expenditure, arguing that the distinction between consumption and capital investment, which the government is keen to make on the expenditure side, should also be made on the revenue side. It is possible to distinguish taxes paid out of consumption from those paid out of saving and thus to calculate the extent to which the government adds to consumption or saving in the economy as a whole. From a macroeconomic perspective this is much more important than whether the government achieves any particular target values for the public sector net cash requirement (the old PSBR). One might also question whether there is any merit in the ‘golden rule’ that public borrowing should not exceed public net investment over the cycle if public borrowing is kept down through the imposition of taxes which are paid mainly out of saving. Logically the government ought to be more concerned about its impact on the level of saving in the economy as a whole than about whether it follows the golden rule. However we begin by providing our independent assessment of the budget situation from the conventional perspective.

Developments in the Asian economies have clearly begun to be felt in the wider global economy in recent months. It has always been expected that the OECD economies would be affected by the aftermath of the capital market turmoil last year, although the timing and magnitude of the impact was difficult to predict. Domestic demand in the affected Asian economies has proved much weaker than expected, with the effects magnified by a continued downturn in Japan. GDP fell by 5¾ per cent in Korea in the first quarter of this year and by 1¼ per cent in Japan. The aggregate volume of merchandise imports in Asia is expected to decline by around 5½ per cent this year, with falls of up to 25 per cent in countries such as Korea, Thailand and Indonesia. This largely accounts for our projected decline in world trade growth to under 6 per cent this year from an estimated 9¾ per cent in 1997.

Economic activity accelerated sharply in the United States at the beginning of this year. GDP rose by 1¼ per cent in the first quarter, to a level 3.8 per cent higher than a year earlier. This was the fastest quarterly growth for two years. The acceleration in growth was unexpected given that the present cyclical expansion has now lasted for over seven years. Private sector demand is still continuing to be supported by the sustained appreciation in equity prices over the past three years, and the appreciation of the dollar has helped to hold down the inflationary pressures that are being built up as the labour market begins to tighten. The unemployment rate fell to 4.3 per cent in April, the lowest rate since 1970.

Activity picked up markedly in the EU area last year; growth was estimated to have been 2.6 per cent compared with 1.8 per cent recorded in 1996. However the aggregate movement masks some significant divergences in economic performance. Growth was relatively modest, at between 2–2½ per cent in Germany, France and Austria, whilst Italy and Sweden recorded growth rates below 2 per cent for the second year running. The fastest growth was achieved in the Irish Republic where output expanded by over 10 per cent last year, following cumulative growth of 27 per cent in the previous three years. Finland also recorded rapid growth of nearly 6 per cent and nearly all the remaining EU countries enjoyed growth rates of 3 per cent or above. Outside the EU, activity remained robust in Norway, Poland and Hungary but was markedly weaker in the Czech Republic and Switzerland. Indeed real GDP has barely changed in Switzerland since 1990, partly reflecting the strength of the Swiss franc, although there are now signs that growth will be stronger in 1998 as the franc has depreciated since the end of 1995.

No one can deny the outstanding success of the East Asian economies in the last two decades of rapid economic growth backed by surging capital inflows. Key questions posed by the current crisis are: what went wrong, and why? how to fix it? and, how to prevent a recurrence? To answer them, the article begins with a brief overview of recent developments in the miracle economies of East Asia, focusing mainly on Korea, Indonesia and Thailand. We focus too on some of the shadows that came to darken the glittering success story—on declining competitiveness and growing financial vulnerability; and on regulatory failures in banking. Then we take a leaf from Charles Kindleberger's book (1996) on Panics, Manias and Crashes and discuss—with historical precedents—various types of financial crisis: speculative attacks on pegged exchange rates, asset bubbles, stock market crashes and bank runs. Based on the distinction between illiquidity, due to a shortage of cash, and insolvency arising from a failure of economic prospects, we go on to outline three main views of the current crisis.

First that it was simply due to reversal of capital flows, to a failure of collective action on the part of creditors which could and should have been solved by supplying extra liquidity—or by forcing creditors to roll over their loans. Second the view that the miracle had grown into a bubble that had finally had to burst: so the problem was essentially one of insolvency. Finally the view that we prefer, that the panic was not wholly groundless (and rescue efforts were bound to be difficult) mainly because weak regulation combined with implicit deposit guarantees had left local bankers free to gamble with the money that global capital markets had poured into their parlours. Panic set in when foreign depositors realised that there were not enough dollar reserves left for the guarantee to be credible. This account (championed most notably by Paul Krugman of MIT) involves both illiquidity and insolvency and helps to explain why the IMF was unwilling simply to throw money at the problem.

Why did the crisis spread like wildfire around the region? Was it because a bank run due to shaky fundamentals in one country was imitated elsewhere, as investors joined the herd heading for the exit? This and other accounts of contagion are discussed before turning to ideas for crisis prevention and management, and a brief account of future prospects for the region. The article concludes by outlining immediate steps to resolve the current financial crisis and by proposing international monetary reforms to prevent a recurrence.

With a view to raising the attainments of pupils at the early stages of their schooling, detailed recommendations (‘strategies’) for teaching numeracy and literacy have been issued by the Department of Education and Employment. Among the important recommendations (clearly stated in the Preliminary Report of the National Numeracy Task Force) are that, in the central and greater part of each lesson, the children in a class are to be divided into a number of sub-groups according to their ability. Some reliance for the success of this recommendation has been placed in official circles on a Canadian research study (a ‘meta-analysis’) summarising a great many earlier studies; the present article argues that the Canadian study was seriously flawed, that in reality such grouping of children within a class is often likely to be to the detriment especially of low-attainers (for example, summer-born boys), to lead to an increased disparity of attainments within the class, to a more difficult task for the teacher, and to a lower rate of progress by the class as a whole.

The Boskin Commission has claimed that the US Consumer Price Index (CPI) is currently overestimating the true rate of inflation by 1.1 percentage points per annum. This article assesses the evidence for this conclusion and its implications for the measurement of past and future US economic performance. If Boskin is right, US GDP growth in the period 1970 to 1996 has been underestimated by about 0.9 per cent per annum. Some at least of the methodological changes recommended by Boskin will probably be adopted. As a result US GDP growth will appear to rise, eventually by as much as 0.5 per cent per annum, even though no genuine improvement in economic performance has actually occurred. Boskin has implications for the UK too. Recent evidence suggests that use of a formula recommended by Boskin for averaging price quotes together can by itself reduce UK inflation by 0.4 per cent per annum.

Under the Government's New Deal proposals to help create jobs for the young unemployed, employers are offered marginal employment subsidies. Such interventions involve relative changes in the firm's fixed and variable labour costs. In turn, cost changes have implications for both employment and hours of work. This study examines possible strengths and weaknesses of employment policies that are designed to price young unemployed into jobs by reducing related labour costs. It focuses on one such intervention, the major restructuring of employers' National Insurance Contributions (NICs) in the 1985 Budget. This is then linked to the New Deal measures.

The decision by the EU Council of Heads of State or of Government at the beginning of May, that eleven Member States would form an Economic and Monetary Union on 1 January 1999, occasioned little surprise: financial markets and economic commentators had become increasingly convinced over the preceding months that EMU would start on time with a membership extending beyond the six ‘core’ countries—France, Germany, the Benelux countries and Austria—to include also Finland, Ireland, Italy, Portugal and Spain. What was not widely expected was that the ECOFIN and HoSoG Councils on 1–2 May appear to have spent little time debating the economic case for including each of the eleven countries but to have been preoccupied instead with a heated political row about who should be appointed President of the European Central Bank.

This note assesses the possible consequences that this cavalier approach to the vital question of membership of monetary union might have for the conduct of policy in Stage 3 and the future viability of EMU. It examines the economic evidence that had been presented to the Councils to see whether their judgement that the economies of all eleven countries are sufficiently convergent is warranted. It also considers whether the unseemly compromise through which the dispute about the ECB Presidency was resolved will prejudice the political independence of the ECB in its conduct of monetary policy.