But I think it begs a lot of questions around two things which are important drivers of growth in the longer run. One is trade, the openness of the economy, and the rest, technology, because I think ultimately technology is the ultimate driver of growth in the long run. And it is quite possible that, and we've seen this before in British history, that we've been between periods of what we tend to call general purpose technology and innovation. So we had that period I was talking about in the past was the sort of ICT internet period. The question is what's going to be the next one? Most likely it's AI and robotics, but you know, this question about the rate of growth in the economy and the impact of that, to my mind, is critical.
Very interesting. Thank you. And well, as Lord said, we've come back to you, but let me hand over to Lord Burns next question.
Afternoon. You've just mentioned the issue about the second round effects of an increase in oil prices. In the past, I would say that the second round effects have generally been substantial and often underestimated, and that's been particularly the case when the economy has been running hot, had an expansion of demand and also monetary growth. And the key policy judgment that you set out in your monthly report is that you think that the present conditions with weak demand and a weak labor market may possibly lead to the second round effects being smaller than has been the case in the past, although if stretched out, I think your report goes on to say they could even be that much higher. Some commentators, as I notice, are worried that the consequences of this approach is likely that policy tightening would be too late again, as has often been in the past, as one waits to see the evidence unfold, and by the time the evidence unfolds, it's a bit too late.
Yeah, so you're right. I agree with you. You can't wait for the hard evidence of second round effects to be with you because it will be too late at that point if they are larger. So, it is going to have to be a judgment. It always has to be a judgment. I would say two things about the current situation. One is going into this, we were seeing softening of the labor market. We were seeing something of an output gap opening up, we thought. Softening of the labor market we saw in, for instance, behavior of vacancies. We saw it in private sector wage settlements converging back down to a point where it looks reasonably consistent with the inflation target. Latest numbers do. I do make the point about private sector advisedly. That was very deliberate to say that because there is a gap. And there is a widening gap if anything between the private sector and the public sector. But private sector settlements which we tend to look at more because they obviously feed more directly through into pricing. So, there is that body of evidence. And certainly when we go around the country, when I go around the country, and this was in commentary on things that happened last year, such as the national insurance change, firms saying that they were having to take more of it on their margins rather than on prices. Now, the second thing I would say on this is that a little bit depends on where you start. And different members of the MPC will have different views on this. But in my view, we have already tightened for the reason that we were expected to cut rates this year pre-the-conflict. And I think that was reasonable. I was thinking perhaps one or two cuts this year and the market was pricing one or two cuts in. That's off the table. As a result of the inflation consequence of the outbreak of the conflict. And the most obvious illustration of this is mortgage rates. So, the two and five-year mortgage rates are up pretty much 1%. So, there has been a tightening of financial conditions. So, I'd put those two things together to sort of, in a sense, I hope help with answering your question, which is so I fully agree with you. You can't wait for the second round effects. I think there is evidence of softening. But, I do think we actually have a bit of time not least because we have in effect tightened policy.
The report also you set out, you know, where the risks lie in getting to an extent in too much. And people are very interested in this, the degree of flexibility that's built into the current remit. And I have a sort of broad question. I mean, do you think the amount of flexibility that you have within the remit is just right for the kinds of circumstances that we face, the extent to which you, the judgment about how rapidly one seeks to bring inflation rate back down to target?
Well, I think it is important to have that flexibility. Now, it's quite interesting. I made some remarks on this in a speech in Reykjavik last Friday. There are sort of two, oversimplifying a bit, there are two forms of remit that exist in this world. One is what we tend to call the dual mandate, the sort of thing the Federal Reserve has where there's a price stability part to it and there's an employment part to it and they sit on the same level. They're not weighted explicitly. That's a matter of judgment. And we of course only have the former at the top level. But then as you rightly say, we have this language about what we tend to call the trade-off language, which is as you said the speed at which we can bring inflation back to target when we face the sort of situation we face today. I think maybe because I'm more used to it, but I think our version has merits. I think it isn't of course completely prescriptive. It leaves judgment, but I think it creates more of a framework for the decision-making than the dual mandate structure, which I just do think leaves it very open what the weights are on those two things. So, I think it has the benefit of causing us to need to be much more, in a sense, considered and explicit in terms of saying how we're actually using that language and how we're using that part of the remit. And this is clearly a moment to do so. So, at the moment I would say if it is the case that the second-round effects are going to be muted, then this part of the remit will be critical to the response.
And final question, you're worried that, I was looking at the three forecasts that you make and I think to me, you know, the three as the second mandate set out the end result of this is going to be that for almost the whole of the 2020s, so we're going to have had an inflation rate above 2%. I'm trying not to say this personally. Is that allowed? Personally, but do you think that this in any way, and in fact for really quite a lot part of the time we will have turned out to have been about 3%, does this throw any doubts on this set of arrangements that we have?
Well, I'll take that in two parts, I think. What it does illustrate is that we had a period obviously from the very early days of this regime and the pre-financial crisis period, which was a period of very good conditions, the nice period as Mervyn King called it. And it hasn't been like that recently. Indeed, arguably since the financial crisis, but certainly recently we've had a whole series of shocks. Some of them global, one or two of them not. And they've been mostly negative supply shocks, which have pushed inflation up, which are the harder ones to deal with obviously in a monetary policy framework. Now, first of all, I think the general answer to the question is that any framework has to deal with the more difficult conditions. I mean, it is no good if it can deal with times when life's easy, but it can't deal with the harder conditions. So, that has to be true. I don't think it's an argument for saying if you just raise the inflation target to 3% everything would be okay. I don't think that's the answer to that question. I think that would be too simple an answer, a simplistic answer to it. But I think it does come back to this question that it puts us in the position where we have to focus more on how we manage the path back to target. And of course, ultimately get there because we've got to give the public confidence that the target is for real.
Thank you. Baroness Wheatcroft.
Thank you. You talked about that you're already effectively tightening by not cutting rates. And mortgage rates have responded and property prices have to a certain extent. But, other asset prices really have not come down very much at all. And I just wonder whether you were surprised, I don't suppose you were, by the remarks of the Deputy Governor last month when she was really quite outspoken about concerns over asset prices.
I wasn't surprised at all. Yes. Not at all. I mean, let me say there are really two stories going on in the world economy at the moment. So, we've talked about obviously the impact of the conflict in the Gulf, the effect on energy prices. So, that is the first story. The second story is the, if you like, the AI tech story. Much bigger story in the US, but it's having sort of again repercussions for the rest of the world. And our institutions are investing in these things. Yeah. And this I think is the way to square what otherwise appears to be the paradox that we're seeing in financial markets. Because what we're seeing is that, if you look across the major markets, take it in three parts. The impact of the Gulf and the energy shock is almost entirely focused on particularly debt markets and particularly government bond markets and yields. Exchange rates are actually relatively little affected. Now, that is not illogical if this is a global shock. And then the third one is sort of risk markets or equity markets and credit spreads, which if you spend your life only looking at those, you would not realize there was any event going on in the Gulf. Now, that I think, as I say, the way to square those two because otherwise you think this is very strange is you've got these two big developments going on. So, Sarah's comments were really addressing the question of asset values in equity markets and credit spreads and saying what are the risks around those and should we, how worried should we be that they seem to be in a sense ignoring everything else that's going on around them. And there are risks there. I think the, I mean you might say well there's a set of risks from the Gulf because this thing could become big enough to in a sense dominate the AI type story. I think the second thing is that there are, I mean I'm actually quite a believer in the AI story as an economics proposition. So, I'm not saying this to sort of undermine AI. I think it is actually very important. But obviously the job of equity markets for instance is to value the future stream of earnings. So, to value the future productivity gains from this thing. And they could get it wrong in a number of ways. So, they could get it wrong in, well, think of three ways. One, obviously they could just overvalue the whole thing and we could still have a very positive benefit from AI but they could get it wrong in terms of the degree. Two, everybody is currently priced to be a winner. In the sense that, and you look back at history, actually everybody usually isn't a winner actually. That's a fairly unusual state of affairs.
So, are you predicting the equivalent of the dot com crash?
Well, not quite, because in the dot com bubble you had people with no earnings and no prospect of earnings. I'm making a slightly more modest point that if you look at something like the internet, for instance, and you look back at who the original sort of big pioneering names in the internet, well, they're not necessarily the ones who are here today. So, pricing everybody today to be a long-run winner isn't really consistent with history. The third one, which I think is important, is that again, I'm drawing on history. These, going back to what I was saying earlier about technology, these what I call general purpose technology innovations, so things like electricity, internet, tend to take longer to come through into the productivity and economic growth stories than people predict. So, there's a famous comment by Sir Bob Solow that you can see the computer everywhere except in the productivity series. There's a famous story that, you know, it is from Edison first doing a power station to US productivity was about 50 years. You know, it was eight decades between James Watt inventing a steam engine and it coming through in what we think was UK productivity. And that's because it usually involves a lot of other innovations to sort of go with the initial thing. Now, I think AI will be a lot quicker than that, the world's moving a lot faster than that, as we've seen with AI at the moment. But, it could well be that the markets are too optimistic about that speed of possible productivity gains.
And the scale of the investment that companies like Anthropic or even Space and AI are making?
Yeah, I mean, it's huge. Yes, I mean, it does require very substantial and that is taking place, very substantial scale investment. So, just to put that back in the context to what Sarah said, there are substantial risks there. Yeah.
