• Global growth will remain rapid over the next two years, with world GDP rising by 4.8 per cent in 2006 and 4.5 per cent in 2007.

• China's growing weight in the global economy is a key reason why interest rates have been unusually low.

• The US economy will grow by 3.3 per cent this year and 2.9 per cent in 2007.

• Japan will expand by 2.9 per cent in 2006 and 2.3 per cent next year.

• The Euro Area will grow by 2.1 per cent this year and 2.0 per cent in 2007.

In the first half of this decade, the world experienced a period of low short and long-term interest rates. Shortterm rates have risen from these low levels, first in Canada and the United Kingdom, then in the United States and finally in the Euro Area. Long-term rates, by contrast, remained low, suggesting that holders of longterm debt expected the rise in short-term rates to be only temporary. Only in the past few months has the apparently anomalous pricing of long-term debt started to disappear. But with interest rates on long-term debt similar to short-term market rates internationally, the market does not yet show that the traditional upwardsloping yield curve and, on this basis, long rates remain depressed. They are also markedly below the levels of two to three years ago.

Our estimates indicate that global output increased by 4.7 per cent in 2005. This followed an expansion of 5.2 per cent in 2004, and we expect further annual rises of 4¾ and 4½ per cent in 2006 and 2007, respectively. Global growth averaged just less than 3½ per cent per annum between 1975 and 2003, and exceeded 4½ per cent in only five of these years. We have not seen an extended global expansion of the magnitude expected for 2004–7 since the early 1970s. While growth in the OECD economies is expected to average 2.9 per cent per annum between 2004 and 2007, which is slightly higher than the average annual rate of 2.7 per cent experienced in 1975–2003, the bulk of the recent global strength comes from outside the OECD, as illustrated in figure 1. The acceleration of global growth can be attributed partly to developments in formerly centrally planned economies, such as Russia and other regions of the former Soviet Union. Severe recessions in these regions associated with the introduction of market forces and economic transition restrained world growth in the early 1990s. A strong rebound in these economies since the late 1990s has recently been further strengthened by rising prices for oil and gas. The former Soviet Union supplied 14 per cent of global oil in 2005 and holds over 30 per cent of proven global natural gas reserves. The high oil price is also expected to support growth in OPEC member states as well as other oil producing nations in South America and Africa. However, output growth in these regions has historically been relatively volatile, and the outlook for these economies remains a risk to our central forecast for world growth.

The Institute periodically reviews the accuracy of its macroeconomic forecasts. Pain et al. (2001) compare the performance of NIESR output forecasts to a naïve forecast that uses a simple rule to predict growth next year. They find that between 1980 and 2000 the National Institute forecast performed better than a naïve, or random walk, forecast in two years out of three. Poulizac et al. (1996) consider a sequence of quarterly economic forecasts published by NIESR between 1982 and 1995 (beginning with that produced in February for the growth of GDP and inflation in the following year and finishing with the forecast produced in November for growth in the current year). They show how the reliability of the Institute's forecast improves as the forecast horizon approaches and conclude that errors to GDP and inflation forecasts are normally distributed. In a similar vein, Mitchell (2005) shows that the Institute's point forecast of inflation is reliable whilst its measure of uncertainty has been exaggerated.

Following a period of weakness, economic growth has been sustained for three quarters only a little below trend and appears to be gaining momentum (figure 1). We expect to see a further acceleration in growth, resulting in growth per annum of 2½ per cent this year and 2¾ per cent per annum in 2007 and 2008. Robust growth ahead is supported by the strength of external demand and small improvements in UK competitiveness. Demand is also supported by sharp rises in equity prices over the recent past. On the supply side, strong labour force growth is central to the near-term outlook.

In the 15 years to 2000 UK business investment rose quite substantially in real terms. Having shown little deviation from an average of 7¼ per cent over the period 1965–85, the real share of business investment in GDP measured 10¾ per cent in 2000 (see figure 1). One of the factors contributing to this increase was the sharp fall in the relative price of investment goods, the scale of which is illustrated by the altogether different trends in real and nominal shares of business investment in GDP.

Perhaps the most striking feature of macroeconomic policy of the past twenty or thirty years has been the emergence of a consensus that monetary policy should be delegated to an independent authority. The world has moved from a situation in the 1960s and 1970s where there were very few independent central banks — in Europe the main example was the Bundesbank of course — to one now where independence is almost standard. Indeed with the foundation of the European Central Bank and the eurosystem the Bundesbank model has effectively come to dominate European monetary policy. The collection of papers in this issue of the Review consider this move in policy setting from a number of diverse perspectives including the move to inflation targeting as well as central bank independence. They assess the effectiveness of this move, describing how an independent monetary authority actually does operate, as well as how it might utilise information more effectively

This article reviews the empirical evidence and theoretical arguments for central bank independence, including political economy considerations. It concludes that the optimal institutional framework to keep inflation lastingly under control is based on granting independence to central banks and establishing price stability as the overriding objective of monetary policy. This framework — combined with appropriate appointment procedures, a sound governance structure and a well-defined monetary policy strategy of the central bank — would ensure price stability. Finally, public support for central bank independence also matters. In this respect, the central bank has a special role in nurturing a stability-oriented culture in society.

This article assesses the new monetary policy regime introduced in the UK in 1997. It discusses the original remit given to the Bank of England, how it has been interpreted by the Bank and the conduct of monetary policy by the Monetary Policy Committee (MPC) subsequently. The article draws heavily on my experience as Specialist Adviser to the House of Lords Select Committee on Economic Affairs over this whole period. I conclude that the MPC has been very successful in fulfilling its remit, but that a puzzle remains at the heart of the policy over whether the way inflation targeting has worked in practice is consistent with how it is said to work in theory.

Monetary policy should be guided by macroeconomic models with limited nominal rigidity; ‘New Classical’ or even for some issues just plain Classical (i.e. with no nominal rigidity at all) models are perfectly adequate for understanding various aspects of the economy that have previously led economists to believe in a high degree of nominal rigidity. On UK data these models account for the facts of inflation persistence and exchange rate ‘overshooting’; their impulse responses are in line with the data; and a typical example, the Liverpool Model, is marginally accepted in its entirety by the data since 1979. Such models suggest that no increased macro instability would result from taking the rigours of monetary policy one stage further from inflation targeting and ensuring that the price level itself is returned to its long-run preset target path — so that the value of money over long periods of time would be utterly predictable.

At the dawn of the 21st century, property and equity ownership are spread more broadly across the population than they once were. One consequence of this is that asset price booms and crashes now have a direct impact on general welfare. The fact that bubbles distort nearly all economic decisions gives policymakers a stronger interest in asset price stability. In this article I examine the theoretical and empirical case for the existence of equity and property bubbles, and then summarise the economic distortions that they create. The evidence suggests increasing our attention to property prices. I go on to discuss the possible policy responses, including examining the consequences of changing the way in which housing is included in standard aggregate price measures.

This article argues that an independent central bank is not in itself sufficient to ensure the long-term success and stability of the economy. While there are strong academic arguments for making the central bank independent, these arguments are often developed in a closed economy setting. Where trade is important and the economy is open, making the central bank independent can lead to a strategic interaction between the bank and the fiscal authorities which can produce serious imbalances in the economy over time. In particular, the analysis below suggests that there could be excess demand in the non tradable sector combined with a recession in the sectors of the economy open to trade. Our contention is that the UK economy exhibits all the signs that we would expect to see if this argument were relevant.