Knight vision: TIE's contributing editor Klaus Engelen interviews , Malcolm Knight the new General manager of the Bank for International Settlements.

• Author: Engelen, Klaus
• Position: Malcolm Knight - Interview

TIE: Do you share the view of other central bankers and economists that the global economy is recovering?

Knight: I think we are seeing signs of a strengthening and broadening out of the recovery in the world economy. Of course, the degree of uncertainty that existed a year ago at the geopolitical level and the concerns about the risks associated with corporate disclosure scandals and the profitability of fixed investment have dissipated. In line with these developments, there are signs of strengthening not only in the United States but also in other countries. In the United States, some of the factors that led the growth of economic activity to accelerate to a very high rate by the third quarter may not necessarily endure. These include the impact of recent U.S. tax reductions and refunds on consumption spending, the additional cash that consumers obtained from home equity withdrawals in the early part of the year, the continuation of large financial incentives to purchase automobiles, and so on. The effects of these factors on consumption should dissipate in the U.S. economy going forward. But on the other side, fixed investment in the United States strengthened in the third quarter. As regards stockbuilding, the latest indications are that inventory investment was positive in September. So the U.S. economy seems to be strengthening.

At the same time, there are also signs of strengthening in Asian economics. In China, for example, aggregate demand has grown more rapidly than output, so that the external current account surplus has declined markedly. In that sense, China has also been contributing to the strengthening of global demand. The same is true for a number of other Asian economies. And although the picture is still mixed in the euro zone, we are seeing signs there of an improvement in business sentiment and activity.

TIE: How sustainable are the forces of recovery in the U.S. economy?

Knight: I think the strengthening of activity in the United States is likely to prove durable into 2004 and 2005 as well. What we should see is a strengthening of investment spending that offsets the slowing of consumption growth. Government spending is also likely to remain strong, so that disposable income growth will be quite rapid. All in all, demand growth in the United States looks like it will remain quite durable.

The other thing that is important to remember is that productivity growth in the United States has continued to be very strong over the past two years even in conditions of relative weakness in the global economy. And that means that a further strengthening of demand in the United States call be met by rising supply without putting a lot of pressure on U.S. prices.

TIE: So are you saying that loose monetary and fiscal policies in the United States are doing the trick?

Knight: I believe that accommodative fiscal and monetary policies can be quite effective in strengthening demand at times when the economy is weak and has a large output gap. If you take the last two years, the fact that monetary policy was relaxed significantly in a number of countries, so that interest rates came down markedly, was a key factor responsible for the strengthening of housing markets, and also for strong growth of demand for consumer durables. That helped to sustain economic activity during a period when investment spending was very weak. Likewise, although the recent shift towards higher fiscal deficits in the United States and several other industrial countries has strongly underpinned aggregate demand and economic activity in the short run, the key will be to ensure that macroeconomic policies operate in a sustainable fashion over the longer term. Monetary policy nowadays is unambiguously dedicated to maintaining low, stable, and predictable inflation. That means it can be relied on to stimulate activity when demand is weak. But it also means that monetary policy needs to tighten at times when economic activity is pushing against capacity. Similarly, as I said, in recent months fiscal stimulus has been quite effective in strengthening aggregate demand in the United States and other countries as well, but budgetary policy must also be set in a context where markets are convinced that fiscal sustainability will be maintained in the longer term.

TIE: But is that a realistic assumption?

Knight: Over the past several years, there has been a very large change in the fiscal position of the United States, from a small surplus--about one percent of GDP in 2000--to a substantial deficit at the present time. Part of that deficit has come from the fact that economic activity has been weak. But part of it is structural and is related to strong spending, including military spending and tax reductions. Over time, it will be necessary to bring this structural fiscal position into equilibrium in order to ensure that it is sustainable. And that will require policy measures going forward. But for the present, I think that the U.S. fiscal position has contributed positively to the signs of strengthening that we are currently seeing.

TIE: What does this mean for Europe's Stability and Growth Pact?

Knight: The spirit of the Stability and Growth Pact is to endeavor to ensure fiscal sustainability in the longer term, and that is absolutely essential for making good fiscal policy. The precise role of the Stability and Growth Pact is a matter for the EU countries themselves to determine.

TIE: Do you see any looming risks that could jeopardize recovery of the U.S. economy?

Knight: There are always downside risks. The first type of downside risk one worries about is that, while there has been some strengthening of fixed investment, it is not yet strong enough to push the economy back up towards full potential output--until very recently we have been looking for the kind of strengthening in business confidence that is needed to sustain fixed investment. Secondly, until recently inventories were still declining in the United States, even though they were already at low levels. So indications of inventory rebuilding, which are apparent in the September 2003 data, appear to be an important positive sign. And thirdly, another risk element is that the United States has a very large external current account deficit. In conditions where productivity growth is very...