Excerpts from the speech delivered by W F Duisenberg to the 66th Annual General Meeting of the Bank

The following are excerpts from the speech delivered by W.F. Duisenberg, Chairman of the Board of Directors and President of the Bank for International Settlements, to the sixty-sixth Annual General Meeting of the Bank held in Basle on 10th June 1996.

I would like to turn now to a review of recent economic and financial developments and to some of the issues which they raise. Speaking in the broadest terms, I think one can say -- with hindsight -- that global developments in the recent period have shown a number of positive features. Inflation has been subdued, economic growth in the developing world has held up well, and the prospects of a continuation or resumption of moderate growth in the industrial world appear to have improved. That said, however, it seems that public perceptions of the situation are less sanguine. One reason, I think, is the uncertainty and insecurity engendered by the major structural changes through which the world economy is passing.

Starting with the industrial countries, the overall rate of growth declined unexpectedly last year -- from about 2 3/4% in 1994 to 2 1/4%. In the United States, where some decline to a more sustainable pace was appropriate, the initial slowdown was nevertheless surprisingly sharp, though it has since been partially reversed. The Japanese economy has also begun to pick up, and growth there now seems more likely to be sustained. In Europe, on the other hand, the slowdown, particularly in Germany, has been more protracted, and signs of a resumption of momentum are as yet mixed. Partly as a result, unemployment remains high -- far too high -- in much of Europe, a situation for which unfortunately there are no easy remedies.

Outside the industrial world, although conditions vary widely, there have also been a number of positive developments. In much of central and eastern Europe the recovery from the shock of transition has quickened noticeably. In Asia, high rates of growth have continued. In Latin America significant growth was recorded despite the sharp adjustments forced on Mexico and Argentina. Even in those two countries, however, it was remarkable how rapidly policies of domestic retrenchment led to a turnaround of sentiment in financial markets and, more recently, to signs of economic recovery. In western and central Africa, a successfully managed devaluation has allowed growth to resume while inflationary pressures have been contained.

Inflation has generally remained well under control. Wage costs in particular have been remarkably well contained. Indeed in some major economies inflation has been less than anticipated and also less than would have been predicted on the basis of previous relationships with economic activity. Perhaps partly reflecting this, major financial markets have been relatively calm. For example, bond yields in the industrial countries reversed much or all of their sharp run-up in 1994 until they were checked in the early months of this year. One reason for this latter development was the emergence of signs of a stronger economy in both the United States and Japan. But, so far at least, the pattern of 1994 does not appear to be repeating itself, and there has been some narrowing of the risk premia demanded earlier of countries with a past history of inflation and budgetary or balance-of-payments deficits.

So far I have been suggesting that, seen objectively, recent developments can be viewed in a relatively positive light. Why then, at the subjective level, is the situation apparently seen differently? Why is the so-called "feel-good" factor absent, with a "feel-bad" factor even present in much of the industrial world? I would point to several elements which seem to me to be playing a role in this. In the background, there is continuing and rapid technological advance, which is bringing strong pressures for structural change. Allied to, and compounding, this is the successful -- and welcome -- emergence of new dynamic economies into the world trading system. In turn, the intensified competitive pressures to which all this gives rise have led to attempts to improve the flexibility of labour markets, to the introduction of new management methods and structures in industry and, regrettably, to growing concerns about whether good jobs can be preserved.

As to macroeconomic policies, there seems to be increasing acceptance around the world that fiscal consolidation has to be a primary objective. There is a growing recognition of the fact that as populations age, the public provision of pensions will have to be placed on a more sustainable financial footing if fiscal problems are not to become unmanageable. In the financial sphere it is clear that there is still further to go in some cases in the process of working out the stresses left behind by earlier excesses.

At all events, and whatever the validity of the individual factors which I have cited, they have two broad implications for demand growth in the near term. First, feelings of uncertainty and insecurity have increased, and such feelings are traditionally thought to depress spending propensities. Indeed, as one section of the Annual Report clearly demonstrates, there is some evidence that consumer spending behaviour has recently tended to be less buoyant than at comparable stages of previous cycles. This may have been one element in the unanticipated weakness of growth last year. Second, there seem to be also more positive influences capable of counteracting these forces. For example, the greater the demonstrated commitment to fiscal consolidation the greater will be the accompanying decline in interest rates. This would not only tend to cushion activity, as would any favourable confidence effects, it would also feed back positively into lower budgetary expenditure on debt service -- a kind of virtuous circle. Similarly, to the extent that stronger competitive pressures result in a lowering of certain input prices, profitability in the relevant areas should be enhanced, and with it the prospects for output, investment and jobs.

I have already noted, and welcomed, the unexpectedly favourable price performance in the recent past. It is nevertheless right that a central banker should question how firmly based and durable this situation is. On the demand side there would seem to be no obvious major risk at present, though I would draw attention to the continued buoyancy of the US economy and the possibility that the upswing might become internationally more synchronised -- welcome as that would be in some other respects.

Before closing, I should like to say a few words about the health and soundness of the international financial system. This is a particularly appropriate subject to discuss here in Basle. For not only do central banks individually have responsibilities in this area, but the rapid and continuing globalisation of financial markets also means that the policy issues concerned have to be addressed at the international level and in a cooperative fashion. And an increasing number of countries have also to become involved, as well as regulators and supervisors from outside the circle of central banks. To some degree this process has already begun, although it no doubt has much further to go.

I referred a little earlier to the relative calmness and the absence of serious crisis in the world's financial system over the last year or so. This was the more reassuring in that it came about despite the background of the Mexican crisis and well-publicised losses at some financial institutions. In part, no doubt, this was due to appropriate policy responses, for example in the international support for Mexico and in the combined monetary and exchange market action taken to prevent a serious misalignment of the yen. Other steps have also been taken, of a more preventive nature, in the fields of supervision, payment and settlement systems, disclosure and the gathering of new statistical material on derivatives market activity. In the forum of the G-10, consideration has also been given to more orderly procedures for working out sovereign liquidity crises. And discussions appear to be close to a conclusion concerning ways of expanding or backing up the General Arrangements to Borrow.

All this is very welcome; but I would caution against complacency. Change in the financial system is by no means over yet, while the level of understanding of new financial instruments is still not always what it should be. The possibility for market participants to make outright mistakes is still very much there. At the same time, we know that some banking systems remain fragile from the effects of past excesses. Finally, as some of the pressures in the exchange markets again demonstrated early last year, prices in financial markets can be subject to unpredictable pressures and swings, which inevitably pose risks for bona fide market participants. And, while the maintenance of a stable and credible macroeconomic policy background is certainly a necessary condition for avoiding such pressures, experience seems to confirm that it is not always a sufficient protection against them.

This implies that there is still more work to be done by the international community, particularly in the field of supervision. There is also a need for ongoing monitoring of financial markets and developments, especially as new sources of relevant and consistent information become available. The BIS will be one of the significant forums in which such efforts are likely to be pursued. One important step forward has already been taken in recent years with the organisation of meetings and discussions here in Basle amongst central banks from a larger number of countries than was traditional in the past -- including in particular many from emerging markets and other parts of the developing world. This is no more than a reflection of the fact of globalisation, and in this context it is entirely appropriate that we should come together to learn from each other. I would hope, too, that such new contacts and discussions will be the more fruitful given the traditions of discretion and informality which have long characterised the way in which the BIS has fulfilled effectively its basic mandate of fostering international monetary cooperation.