By the third quarter of this year, the economy had grown for thirty-three consecutive quarters since its trough in the second quarter of 1992. Such a long period of expansion inevitably raises questions about its sustainability. Chart 1 compares the paths for the level of output from the last two business cycle troughs in 1981 and 1992.

It now seems likely that the economy will grow by just over 3 per cent in 2000, although the fuel crisis has obscured the picture to some extent. The latest retail sales figures indicate strong growth in high street spending, with the three months to September 1.6 per cent higher than the previous three months and 4.3 per cent higher than the same period in 1999. Second quarter government consumption increased by 1.9 per cent to recover from the fall in the first quarter. This accelerated growth is needed to meet spending targets. Our forecast is for an overall 2 per cent growth rate in the current year rising to 4 per cent next year. Gross fixed investment was some 6 per cent higher in 1999 over the previous year, and we are forecasting this to slow to 21h per cent for the current year, rising to 5 per cent for the next two years. Inventory accumulation should recover from the de-stocking evident last year.

Global demand has risen significantly this year, with GDP growth projected to have accelerated to 4¾ per cent per annum (on a purchasing power parity basis) from 3½ per cent per annum last year and 2½ per cent in 1998. This will be the fastest rate of global growth seen since 1984. These peaks in the rate of global economic expansion coincide with those for growth in the United States, indicating the extent to which the world economy depends on the health of the American economy. Virtually all economies are likely to enjoy faster growth this year than in 1999, as indicated by Chart 1. Output growth in the OECD is projected to have accelerated from 3 per cent last year to between 4¼-4½ per cent this year. Growth in the non-OECD countries is projected to have accelerated from 3¾ per cent last year to between 5-5¼ per cent this year. The growth of world merchandise trade volumes is estimated to be over 12 per cent this year, more than twice the rate seen in 1998 and 1999.

The sustained increase in the price of oil has generated considerable concern about the impact of higher oil prices on the world economy. The price of oil has risen from $11 a barrel in the first quarter of 1999 to around $31 a barrel in the third quarter of 2000, and is now at a 15 year high in real terms. Global demand has been increasingly strong and supply has been restricted. Economies with a strong dependence on imported oil, for instance in East Asia, have been growing strongly, and the world upturn has been sharper than many anticipated. Between 1998 and 1999 world oil demand rose by 1.6 per cent to 74.8 million barrels a day, and it is anticipated that demand will have risen again this year by 0.8 million barrels a day. Between 1998 and 1999 OPEC output fell by 1.2 million barrels a day, and non-OPEC supply was constant.

Economic growth has been exceptionally robust in the United States this year, with GDP forecast to rise by 5¼ per cent. This would be the fastest rate of growth since 1984. The acceleration in the growth rate this year is particularly unusual given the duration of the present economic expansion. Although there remain few signs of an abrupt slowdown, the present situation cannot be sustained indefinitely since the growth rate of aggregate demand is well above that of potential supply, even allowing for some improvement in the underlying rate of productivity growth.

There are new monetary and fiscal frameworks in place for the countries in the Euro Area. The European Central Bank has a remit to maintain price level stability in the medium term, and it has developed a two pillar strategy, with interest rates being set in relation to a reference value of M3 and general (inflationary) conditions. We discuss an ideal type representation of this framework and examine the potential effects of a fall in the euro. Fiscal policy in Europe is now based on guidelines from the Stability and Growth Pact and we discuss the role of commitment in this framework as well

This article challenges the conventional wisdom that price level targeting necessarily increases the volatility of inflation and economic activity. It shows that the optimal policy under commitment for a society that cares only about the variability of output and inflation involves only a limited degree of base drift. The result crucially depends on the importance of forward-looking behaviour and on the credibility of the commitments. The case for price level targeting is strengthened when the possibility of a binding lower bound on nominal interest rates is considered. This may be increasingly relevant in a low inflation environment. This justifies renewed interest on price level targets in the context of thinking through how to prevent and respond to deflationary risks.

This paper discusses the role of forecasts in the control of inflation. Much has been made of variations on the so-called Taylor rule for inflation control. Forward-looking Taylor rules are reconciled with optimal control using a class of rules described as error-correcting Taylor rules.

Now that the budget deficits in the Euro Area are approaching balance, the Stability and Growth Pact (SGP) looks like a largely non-constraining institutional framework with little impact on national fiscal policies. This article challenges this view and argues that the implementation of the SGP ‘at cruising speed’ is faced with a number of outstanding issues: safeguarding the automatic stabilisers under the SGP; coping with the consequences of the asymmetric nature of the SGP for the co-ordination of macroeconomic policies; and ensuring the long-run sustainability of public finances. It concludes that enlarging the scope and enhancing the credibility of the stability and convergence programmes to become a true instrument of fiscal policy coordination in the Euro Area would be a first step in lifting the uncertainties surrounding the implementation of the SGP.

The policy regime in Europe has put the economy on ‘auto-pilot’. We investigate different designs for the required feedback mechanisms. The uncertainty facing an economy depends on the pattern of shocks it faces, the response of the private sector to those shocks and also the policy reactions of the authorities. Two ‘ideal type’ policy regimes are investigated, and inflation targeting is compared to nominal aggregate targeting. In general it is suggested that targeting a nominal aggregate reduces the variability of the price level, and stabilises the price level more quickly over time. Inflation outcomes are also less variable for the Euro Area, and they are less asymmetric when a nominal aggregate is targeted. The new European fiscal framework requires that countries set deficit targets close to balance. We show that there is plenty of space for automatic stabilisers to work, but the room available depends in part on the monetary policy framework chosen.