Archive for the ‘Economics’ Category

Last week, in an event organised by the IEA, my colleague from the IIMR, Tim Congdon, and myself stressed that annual money growth (broadly defined) must return to under 5% to bring inflation down to 2% a year. According to the latest monetary data available, the US, the Eurozone and the UK do not fulfil this condition. As reported by IIMR in its January 2022 money update (see table below), broad monetary growth in the US has accelerated in recent months, with an annual 9.8% rate of growth of M3, a figure well above that compatible with 2% price stability. In the Eurozone, monetary growth (M3) has also accelerated recently and is also too high (7.3% annual growth). The same applies to the UK (6.9% annual growth in broad money), though in this case the rate of growth of M4x has decelerated in the last few months.

Broad monetary growth world-wide

See IIMR January 2022 money update at https://mv-pt.org/monthly-monetary-update/

Here you will find two videos with our inflation forecasts for the US and the UK. In both cases, we use the quantity theory of money as the theoretical benchmark to make our analysis and projections of inflation for 2022- 2024. As Milton Friedman put it, there are “long and variable” lags between money growth and inflation. This is why, even if money growth fell to under 5% a year in the next few months, these lags mean that 2022, and probably 2023, will see inflation in the 5 per cent – 10 per cent area. This is because of the excess in money balances created in 2020 and 2021. Bringing inflation back to the central bank definition of price stability is a task for the medium term. Of course, ultimately the rate of inflation in the next two or three years will very much depend on the reaction central banks will take in the next few months to the current inflation episode.

We used this same approach in a report written for the IEA in the spring 2020 when Tim Congdon and myself anticipated an inflation boom in the US in 2021-2023. A key element in our analysis and forecasts is that changes in money velocity revert to their mean, as the data shows (see below the reversion to the mean pattern observed in the US in the last century). This means that the surge in the demand for money (and thus in money velocity) in 2021 will gradually cease as it has started to happen and eventually return to its 2019 levels, therefore pushing spending and prices up. More details in the presentation on the US below.

Castañeda, Cendejas, Congdon (2021). Presentation at IIMR 2021 conference. See https://youtu.be/cmhcLljq-Vk

The video presentation on the US inflation forecast comes from our contribution to the IIMR 2021 conference (“The 2020 money supply explosion and ensuing inflation”) and our comments on the UK from a recent interview we had with the IEA Head of Public Policy, Matthew Lesh.

Comments welcome.


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These are some of the main questions addressed in a paper just published in the Journal of Policy Modeling, written with my colleague Jose Luis Cendejas (Universidad Francisco de Vitoria, Spain).

Title of the paper: ‘Macroeconomic asymmetry in the Eurozone before and after the Global Financial Crisis: An appraisal of the role of the ECB’.


‘The launch of the euro in 1999 was assumed to enhance macroeconomic convergence among EMU economies. We test this hypothesis from a comparative perspective, by calculating different indices to measure the degree of macroeconomic dispersion within the Eurozone, the UK and the USA (1999–2019). We use common factor models to produce a single index for each monetary area out of different measures of dispersion. These indices can be used to inform on the degree of optimality of a monetary area. Our results show that macroeconomic dispersion in the Eurozone increased notably even before 2007 and it took significantly longer to return to pre-crisis levels, as compared to the UK and the USA. The paper shows the critical role played by the ECB’s asset purchases programmes in reducing macroeconomic divergences among EMU member states since 2015.’

Fig. 1. Overall indices of dispersion for the Eurozone, the UK, and the US. 1999 = 100. The higher the figure the higher dispersion is. You will find individual dispersion indices for 12 macroeconomic and monetary indicators for each economic area in the paper.

The paper can be accessed freely on the following link for the next 50 days: https://www.sciencedirect.com/science/article/pii/S0161893821001009?dgcid=author

Comments and feedback most welcome.

Juan Castañeda

PS. Special mention to Professor Pedro Schwartz, with whom I started to work in this area years ago and have published on the topic before (see here and here).

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In a recent forum held by the ECB (ECB Forum on Central Banking 2021: Part 4 – Panel 1: The future of inflation, see min. 15:40 – 26:20), Professor Charles Goodhart criticised central banks for relying too much on what he called the ‘bootstrap theory of inflation’, one that affirms that ‘as long as inflation expectations are anchored inflation will also remain anchored’. Therefore, this theory mainly explains inflation according to changes in inflation expectations. Charles Goodhart also summarised the reasons why we shouldn’t rely too much on such a theory of inflation. In what he referred to as the absence of a general theory of inflation by central banks and other policy actors and international organisations, there seems to be a preference for a ‘bits and pieces’ approach to inflation; one that incorporates inflation of commodities, inflation in services, shipping shortages, … among many other indicators, without the proper analytical theoretical framework to support it. In his brief presentation Charles Goodhart stressed the need to incorporate supply side factors in the explanation of inflation trends in the long term. Do not miss it. In just 10 minutes he summarises the poor state of macroeconomics as regards the explanation of inflation, which can lead to also very poor policy decisions.

In my opinion, there is such a general theory of inflation/deflation; one that links changes in the amount of money broadly defined and changes in the price level over the medium to the long term. I don’t claim that this theory can explain every single change in inflation, particularly on a monthly basis, but indeed it does explain changes in inflation trends. The ECB should rely much more on its own monetary pillar to explain changes in inflation in the right time horizon (1-2 years). It missed an excellent opportunity to do so in its recent review of its monetary strategy.

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Video of the presentation to the Centre for Global Finance (SOAS, University of London) on 12/5/2021, via webinar.

Summary points:

  • The monetisation of enlarged budget deficits, combined with official support for emergency bank lending to cash-strained corporates, has led to extremely high growth- rates of the quantity of money (broadly defined) in leading economies, which are incompatible with price stability over the medium term. The excess in money balances by financial companies in 2020 has already led to a big bounce-back in financial markets and asset price inflation. In addition, once lockdowns are over and the pandemic is under control, the excess in money holdings by households and non-financial companies will result in higher nominal spending and output, and eventually CPI inflation.
  • In sharp contrast with the aftermath of the Global Financial Crisis, the central banks’ response to Covid-19 crisis has resulted in an expansion of their balance sheets but also critically of bank deposits, and thus of the amount of money in the economy broadly defined (M3 in the USA). It is changes in the latter what explains changes in inflation over the medium term, and central banks should pay more attention in monitoring changes in broad money as effective leading indicators of inflation in 1-2 years.
  • We are already seeing a significant increase in commodity prices, industrial prices and also in CPI prices in the USA. The extremely high growth rates of money seen in the USA since March 2021 (the highest rate in modern peacetime, over 25% year on year in 2020) will end up in an inflationary boom over the next few years. The duration and scale of the boom will be conditioned by the speed of broad money growth in the rest of 2021 and in early 2022; thus, on the reaction of the US Fed to rising CPI inflation in the rest of 2021 and 2022.
  • The quantity theory of money provides a valid theoretical framework which relates trends in money growth to changes in inflation and nominal GDP over the medium and long term. More details on this analysis on the report by myself in collaboration with my colleague T. Congdon (IIMR) (https://iea.org.uk/publications/33536/), published in the spring 2020 by the IEA. More up to date data can be accessed at the IIMR website.

Video available below (on CFG’s YouTube channel) :

With thanks to the CGF for hosting the webinar.

Comments welcome.

Juan Castañeda

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At a time when major central banks are reviewing their policy strategies (the US Fed already did so in September 2020, see George Selgin‘s excellent analysis here), there is always the temptation to call for an extension of the remit of central banks, to go ‘bold’ and ‘modern’, which effectively means to go beyond maintaining price stability. As the leading British economist, Charles Goodhart (LSE), has put it before, if you want to know what major central banks will do in the future, check what the Reserve Bank of New Zealand (RBNZ) is doing now. Well, the RBNZ is already giving us a hint about what’s coming. As announced few days ago, the bank has been instructed by the government to consider ‘how it can contribute to the Government’s housing policy objectives, consistent with its financial stability objective of promoting a sound and efficient financial system.‘ In the reply of the RBNZ to the government’s instructions, the monetary authority makes it clear that this ‘requires the Bank to have regard to the impact of its actions on the Government’s policy of supporting more sustainable house prices, including by dampening investor demand for existing housing stock, which would improve affordability for first-home buyers‘.

Since the very launch of ‘inflation targeting’ as a policy strategy by the RBNZ in 1989, followed by many other central banks in the 1990s, the definition of what price stability means and how to measure it have been at the core of the policy and academic debates and discussions. At the time it was decided to measure price stability in terms of a consumer price index (CPI), which excludes asset prices. Of course, monetary policy decisions do affect asset prices (see a recent paper on it here, by Tim Congdon, IIMR); but adding asset prices to the remit of the central bank would mean that we know in advance what the long term equilibrium of asset prices is, that compatible with macroeconomic and financial stability. In real time, under uncertainty, we can identify trends and changes in asset prices which we may believe are not compatible with financial stability, but we can only know for sure ‘ex post’. Even if such a target for asset prices were easy to identify in real time, having both a CPI target and another one in terms of ‘sustainable house prices’ may become am impossible task for the central banks to achieve when both price indices move in opposite directions. For example, the aggressive response to Covid-19 crisis by major central banks since the Spring 2020 has resulted in an extraordinary increase in the amount of money broadly defined in major economies, indeed led by the USA; which has first affected asset prices, very much on the rise since then. However, CPI prices have not increased much yet (here we explain why CPI inflation will very likely increase later in 2021, particularly in the USA). At this juncture, should a central bank have a dual-price mandate, which prices should be prioritised?

The answer is very straightforward if central banks were to adopt a simpler and more effective policy strategy. By maintaining a moderate and stable rate of growth of money (broadly defined), central banks will be contributing to both CPI price stability and financial stability, but over the medium to the long term (approx. 2-3 years). Before the outbreak of the Global Financial Crisis in 2008, we observed a higher than 10% annual rate of growth in the amount of money in the Eurozone, while CPI inflation was still quite moderate. My colleague Pedro Schwartz and myself very much raised our concerns about this situation in 2007, in this report for the ECON Committee of the European Parliament. We didn’t know the extent of the crisis that was coming, but we knew that that rate of growth of money from 2004 to 2007 was not compatible with macroeconomic and financial stability. Of course, no one really paid much attention to it. As we estimated it at the time, following a price-stability rule would have meant a much lower rate of growth of money (broadly defined, by M3 in the Eurozone, see the red line below), around 5% – 6% per annum. The actual rate of growth of money in the Eurozone in 2007 (see the blue line below) doubled that benchmark rate compatible with price stability. M3 growth rates in the Eurozone are again in the double-digit territory (see IIMR February 2021 report here) and this can only mean higher inflation once the economy goes back to ‘normal’ (i.e. the demand for money reverts to levels closer to pre-crisis levels) and agents start to get rid of their excess in money holdings. We will see.

Source: Schwartz and Castañeda, 2007. https://www.europarl.europa.eu/cmsdata/178681/20071220ATT16955EN.pdf. You can find more details in the report on the calculations of the benchmark rules we used to assess the rate of growth of M3 in the Eurozone.

Let’s task central banks with what we know they can achieve. Central banks are very powerful policy-makers but they cannot do it all, and they shouldn’t either. Adding more tasks to their remits, be it an extra target in terms of asset prices, jobs creation, or contributing to a more green economy, among others, would put central banks in a very difficult technical and institutional position; one where they wouldn’t be able to achieve their mandate and they will be more exposed to political pressures. Let’s leave all the ‘extras’ for parliaments to deal with, if they like. This arrangement will preserve central bank independence and enhance their effectiveness in achieving monetary stability and financial stability, no more no less. Here you can find more details on this all in a 2020 report I wrote for SUERF on the ECB 2020-21 policy review strategy.

Thank you. Comments welcome.

Juan Castañeda

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Dear readers and blog followers,

Please, find below a unique Christmas card with a very relevant message, as sent by the Institute of International Monetary Research earlier this week. The card has a text from the Spanish scholastic, Martín de Azpilicueta (School of Salamanca), who alerted to the effects of the over-issue of the currency and the subsequent danger of inflation back in the XVI c. in Spain. I wish current regulators and monetary-policy makers read him much more often.

Merry Christmas to you all.


Estimado lector y seguidor de este foro,

Es un placer poder despedir este año con una felicitación Navideña como ésta, tan única y apropiada para estos tiempos que corren, enviada por el Institute of International Monetary Research esta semana. Contiene una cita del gran escolástico Navarro, Martín de Azpilicueta (Escuela de Salamanca), quien ya alertara de los peligros de la sobre-emisión de moneda y de la inflación subsiguiente a mediados de la España del siglo XVI. Ojalá le leyeran más los reguladores y hacedores de la política monetaria en la actualidad.

Muy Feliz Navidad a todos.

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Central banks are not just interest rate setters: an introduction to modern central bank roles

This is the online presentation I made at the 2020 Freedom Week (by the Adam Smith Institute and the Institute of Economic Affairs) on August 21st. It is an overview of the major roles undertaken by modern central banks in our economies, which involves much more than setting the policy rate. Actually, since the outbreak of the Global Financial Crisis what leading central banks have been doing is to act as ‘bank of banks’, ‘bank of the government’ and, as regards monetary policy, to engage in asset purchase operations (i.e. Quantitative Easing). Once policy rates were brought down to the effective lower (nominal) bound, central banks have used outright asset purchases to be able to affect macroeconomic outcomes. Contrary to a very popular misperception, in purely fiat monetary systems, central banks cannot run out of ammunition, even when nominal policy rates are zero or close to zero. In this presentation, I briefly discuss (1) what central banks do as providers of services to the banking sector and to the government, as well as (2) the importance of monetary analysis to understand the effects of changes in the amount of money on inflation and output over the medium to the long term. This is at the core of what we do at the Institute of International Monetary Research.

I hope you find it a good introduction to central bank roles in modern economies. As ever, comments welcome.

Juan Castaneda

PS. If only for enjoying James Gillray‘s caricatures as a means to explain money and central banking, it may well be worth watching.


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A rule-based monetary strategy for the European Central Bank: a call for monetary stability

This is the paper I wrote on the current review of the ECB strategy, just published in SUERF Policy Note series (Num. 192, September 2020). As you will see in the summary below, I discuss different alternatives to reform the current strategy of the ECB, including the adoption of a (1) higher inflation target, (2) price level target, (3) average inflation target or (4) a nominal income rate target in line with a stable growth of money. I explain in the paper why I favour number 4, so that the ECB aims at maintaining a stable rate of growth of broad money, compatible with a stable rate of growth of nominal income over the medium term. This strategy would allow the ECB to accommodate to supply shocks much easier and without the need to intervene in the market: in case of a positive supply shock, prices would tend to fall in a growing economy, thus resulting in a more stable rate of growth of nominal income. Under this strategy, the central bank would not need to offset such fall in prices by an increase in the amount of money but to do nothing (G. Selgin explains this point masterly in his pamphlet, ‘Less than Zero’). This means that the amount of money in the economy would not be as pro-cyclical as it has been in the last 15 years; with too much money growth in the expansionary phase of the cycle and too little during recessions. The stability in the rate of growth of money, broadly measured, would become key to maintain a stable nominal income growth throughout the cycle.

The ECB will announce the outcome(s) of the review of its strategy in 2021. The choices made by the ECB will surely shape the bias of monetary policy in the Eurozone for one or two decades. Other major central banks are conducting similar exercises. The US Fed just announced its new strategy (see G. Selgin excellent analysis on it here) and the Bank of England’s strategy is also currently under review.

Clearly, ‘inflation targeting’, at least as applied in the years running up to the Global Financial Crisis, is not the best policy strategy to maintain both monetary stability and financial stability over the long term. Central banks should not just take the ‘easy’ option and adopt a higher inflation target or an (asymmetric and vague) average inflation targeting (AIT) strategy. The latter seems to be the option taken by the Fed. And I say ‘seems’ because it did not make it clear in the announcement made last week. How many years will the Fed use to average inflation around? And will it react equally to long periods of inflation and to long periods of disinflation? If a symmetric AIT, the Fed would both (1) adopt a below target inflation rate after a period of too much inflation, and (2) an above target inflation rate after a period of too little inflation. However, it seems unlikely that the Fed would systematically target a lower rate of inflation (lower than 2%) when inflation has reigned over a long period of time. In the current juncture these options (the outright increase in the inflation target or the average inflation target) may well give central banks room to be more inflationary in the next few years, but they will also likely harm their credibility if they cannot contain the growth of inflation in the future. We will see in the next few months/years how the Fed effectively applies his new AIT strategy. My fear is that, in the absence of enough information communicated to the market to assess its policies over the long term, the Fed has just adopted a strategy to be more inflationary in the next few years.


Summary of the paper on the ECB strategy review (full paper at https://www.suerf.org/policynotes/16571/a-rule-based-monetary-strategy-for-the-european-central-bank-a-call-for-monetary-stability):

‘The 2020-2021 review of the ECB strategy will shape monetary policy in the Eurozone in the years to come. Crucially, it will also determine the scope and capabilities of the ECB within the ever-evolving architecture of the euro. As in the aftermath of the Global Financial Crisis and the subsequent Euro Crisis, Member States are discussing new mechanisms to enhance economic recovery and further integration which, one way or another, will involve the support of, or the coordination of fiscal policy makers with the ECB. The impact of the new ECB strategy in the current debate about the future direction of the single currency should not be overlooked. In this note, we offer a proposal for the reform of the ECB strategy incorporating the lessons learned in the recent crises. We discuss several options for the ECB and set up a rule-based strategy suitable to operate in an environment of persistently low inflation and near zero interest rates. Under our proposal, monetary stability becomes the guiding principle for providing macroeconomic stability over the medium and long term, as well as for enhancing the transparency of the ECB communication policies.’


Comments and feedback welcome.

Juan Castaneda


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Moneda, precios y el monetarismo en Europa

Aquí podéis encontrar la charla que tuve el placer de dar a mis amigos y colegas del Centro Hazlitt de la Universidad Francisco Marroquín (UFM), en Guatemala (Marzo 2020). El tema era la vigencia (o su no vigencia) del monetarismo como perspectiva y escuela de análisis económico en Europa. Como comprobaréis, soy muy pesimista en mi presentación; sobre todo en lo que se refiere a la explicación de la inflación en los modelos económicos predominantes en las ultimas tres/cuatro décadas. A pesar de ello, reivindico el uso de un análisis monetario riguroso (de la oferta y de la demand da dinero) si queremos explicar tendencias en los precios en el medio y largo plazo; una afirmación que me parece obvia, pero que en el entorno académico actual resulta tristemente revolucionaria … . Además, si bien soy muy crítico con el estado de los modelos macroeconómicos en lo que respecta a la explicación de la inflación, soy más optimista por lo que en la práctica los bancos centrales hacen cuando se enfrentan a una crisis financiera. Hemos visto cómo a partir de 2009/10 (o más tarde en la Eurozona), los bancos centrales recurrieron a operaciones de compra de activos (‘expansión cuantitativa’ o QE en sus siglas en inglés) para evitar la caída de la cantidad de dinero. Querían evitar con ello caer en el mismo error en el que cayó la Reserva Federal de los EEUU en los años 30 del siglo XX. Pareciera como si, por la vía de los hechos, los bancos centrales estuvieran persiguiendo una política monetaria encaminada a lograr la estabilidad del crecimiento del dinero (‘a la Friedman’).

Asimismo, también comento en algún detalle en la presentación algunas de las críticas más habituales que se hacen al monetarismo desde distintas perspectivas teóricas: como (1) la (supuesta) necesidad de imponer la estabilidad en la demanda de dinero (o de su inversa, la velocidad de circulación) para su validez en la práctica; o (2) el no tratamiento de los efectos reales que las variaciones en la cantidad de dinero traen consigo a medio y largo plazo. Como veréis en este video, intento demostrar que ambas críticas no son ciertas o están basadas en supuestos erróneos, y que la ecuación cuantitativa del dinero sigue siendo un esquema teórico válido para explicar variaciones de los precios y de la actividad nominal a lo largo del tiempo. Eso sí, no debería utilizarse esta ecuación y los supuestos en los que se basa, de una manera miope y mecanicista; eso sería un error grave. Hay muchas variables que afectan a la inflación en el corto plazo que están fuera del alcance de esta ecuación y de lo que los banqueros centrales pueden aspirar a controlar. Además, hay un grado indudable de incertidumbre y de retardos en la transmisión de las variaciones de la cantidad de dinero en los precios y la actividad económica; de ahí que sea mejor hacer análisis en el medio y largo plazo o en tendencia.

Aquí tenéis la grabación de la charla, que fue seguida de un coloquio con los miembros del Centro Hazlitt de la UFM que resultó muy provechoso e interesante. Muchas gracias a los asistentes y especialmente a Daniel Fernandez y a Clynton López, por su amable invitación a participar en estos seminarios. A ver cuándo podemos repetirlo!

Juan Castañeda


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On the economic effects of the policy responses to Covid-19

Today the Institute of Economic Affairs (IEA, London) has just published a report by my colleague Tim Congdon and myself (Institute of International Monetary Research and University of Buckingham) on the debate on the expected inflationary vs. deflationary consequences of the current crisis. Of course there are many unknowns yet and we should not claim or have the illusion that we can forecast exactly inflation rates in the next 2-3 years. But what we can attempt is to do ‘pattern predictions’ (see Hayek’s 1974 Nobel lecture speech). Based on the monetary data available and the theoretical body linking changes in the amount of money to price changes over the medium/long term, we have observed in the last two months an extraordinary increase in the amount of money in most leading economies (certainly in the USA, with a rate of growth of money, M3, of 25% in April 2020). This comes from the implementation of quite significant asset purchases programmes (i.e. Quantitative Easing) and the (partial) monetisation of very much enlarged government deficits; a trend that will most likely continue for the rest of the year. It is both the extraordinary money growth rates seen recently, along with the expected persistence in monetary growth in 2020 what support our forecast of an inflationary cycle in the US (and in other leading economies, though to a lesser extent) in the next 2-3 years. The diagram below from the report says it all (see page 8).
More details in the report (IEA Covid-19 Briefing 7, June 2020) at:
https://iea.org.uk/themencode-pdf-viewer-sc/?file=/wp-content/uploads/2020/06/Inflation_the-new-threat25787FINAL.pdf. Also, the webinar presentation of the report with my colleagues Geoffrey Wood and Tim Congdon will be available soon at the IEA’s website/YouTube channel.
Money growth (M£) in the USA
Juan Castañeda
Summary of the report (in pages 4-5):
  • The policy reaction to the Covid-19 pandemic will increase budget deficits massively in all the world’s leading countries. The deficits will to a significant extent be monetised, with heavy state borrowing from both national central banks and commercial banks.
  • The monetisation of budget deficits, combined with official support for emergency bank lending to cash-strained corporates, is leading – and will continue to lead for several months – to extremely high growth rates of the quantity of money.
  • The crisis has shown again that, under fiat monetary systems, the state can create as much as money as it wants. There is virtually no limit to money creation. The frequently alleged claim that ‘monetary policy is exhausted at low (if not zero) interest rates’ has no theoretical or empirical basis.
  • By mid- or late 2021 the pandemic should be under control, and a big bounce-back in financial markets, and in aggregate demand and output, is to be envisaged. The extremely high growth rates of money now being seen – often into the double digits at an annual percentage rate – will instigate an inflationary boom. The scale of the boom will be conditioned by the speed of money growth in the rest of 2020 and in early 2021. Money growth in the USA has reached the highest-ever levels in peacetime, suggesting that consumer inflation may move into double digits at some point in the next two or three years.
  • Central banks seem heedless of the inflation risks inherent in monetary financing of the much-enlarged government deficits. Following the so-called ‘New Keynesian Model’ consensus, their economists ignore changes in the quantity of money. Too many of these economists believe that monetary policy is defined exclusively by interest rates, with a narrow focus on the central bank policy rate, long-term interest rates and the yield curve. The quantity theory of money today provides – as it always has done – a theoretical framework which relates trends in money growth to changes in inflation and nominal GDP over the medium and long term. A condition for the return of inflation to current target levels is that the rate of money growth is reduced back towards annual rates of increase of about 6 per cent or less.

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