Productivity and Inflation: a Paradox

In his Budget speech, Mr. Lawson drew attention to the greatly improved record of productivity growth in UK manufacturing:
"During the 1960s, and again in the 1970s, growth in manufacturing productivity in the UK was the lowest of all the seven major industrial countries in the world. During the 1980s, our annual rate of growth of output per head in manufacturing has been the highest of all the seven major industrial countries."
Ironically this success in regard to productivity may cause a problem in regard to inflation if the UK moves to a fixed exchange rate policy within the EMS. In this Viewpoint we report the consequence of such a move and also describe the possible required rise in the exchange rate if price stability is to be attained. We show that price stability requires the exchange rate to rise (i) to offset world inflation and (ii) to compensate for the productivity gap between the traded and non-traded sectors.