§ Monetary policy will continue to play a central role. Further reductions in monetary growth are needed to achieve still lower inflation.
§ Over the 12 months to mid-February the growth of sterling M3 has been well within the 7 to 11 per cent. target range, with M1 at the top of the range and PSL2 a little above it. While in the early months of the target period most measures of money showed signs of accelerating, since the summer growth in all the target aggregates has been comfortably within the range. And nominal interest rates have continued to decline in line with falling inflation.
§ Other evidence confirms that monetary conditions are satisfactory. The effective exchange rate has remained fairly stable, despite the international uncertainties which I have described.
§ If monetary policy is to stay on track, its practical implementation must adapt to changes in the financial system and in the significance of different measures of money. There is of course nothing new in this. Over the years we have more than once altered the target ranges and aggregates to take account of such changes. But the thrust of the strategy has been maintained.
§ One important development has been the decision to give a more explicit role to the narrow measures of money. Sterling M3 and the other broad aggregates give a good indication of the growth of liquidity. But a large proportion of this money is in reality a form of savings, invested for the interest it can earn. In defining policy, it is therefore helpful also to make specific reference to measures of money which relate more narrowly to balances held for current spending.
§ It was for this reason that M1 was introduced as a target aggregate, but it has not proved entirely satisfactory for that purpose. With the rapid growth of interest-bearing sight deposits, M1 has become an increasingly poor measure of money held to finance current spending. The signs are that this will continue.
§ Other measures of narrow money have not been distorted to the same extent. In particular, MO, which consists mainly of currency, is likely to be a better indicator of financial conditions than Ml. There is also the new aggregate M2, which was specifically devised to provide a comprehensive measure of transactions balances. This may also be a useful guide but, being new, still needs to be interpreted with particular care.
§ In the past two years, it has been possible to set a single target range for both broad and narrow measures of money. But this will not normally be the case; for narrow monetary aggregates tend in the long run to grow more slowly than broader measures. Thus, this year's Red Book sets out two separate—though overlapping—ranges.
§ The target range for broad money will continue to apply to sterling M3 and for the coming year will be set at 6 to 10 per cent., as indicated in last year's MTFS. The target range for narrow money will apply to MO and for next year will be set at 4 to 8 per cent. [Interruption.] Opposition Members ought to sit quiet. They have a lot to learn.
§ To avoid any possible misunderstanding, let me stress that the use of MO as a target aggregate will not involve any change in methods of monetary control.
§ The two target aggregates will have equal importance in the conduct of policy. And the authorities will continue to take into account other measures of money, especially 290 M2 and PSL2, which include building society liabilities, as well as wider evidence of financial conditions, including the exchange rate. As in the past, monetary conditions will be kept under control by an appropriate combination of funding and operations in the money market.
§ So far as funding is concerned, the public sector's borrowing requirement, as I shall shortly explain, will be significantly lower in the coming year. In financing it, the role of national savings will remain important. This year's national savings target of £3 billion is likely to be achieved: the target for the coming year will again be £3 billion.
§ Precise monetary targets for the later years will be decided nearer the time. But, to give a broad indication of the objectives of monetary policy, the new MTFS, like previous versions, shows monetary ranges for a number of years ahead. These ranges are consistent with a continuing downward trend in inflation: they demonstrate the Government's intention to make further progress towards stable prices.