Select Committee on Treasury Minutes of Evidence

Examination of witnesses (Questions 100-119)



Sir Teddy Taylor

  100. I have a brief follow-up question. Sir Alan referred to the misjudgment over the exchange rate being responsible for this minor difference in inflation. Do you think there is anything more we could have done with the exchange rate? We have read about these substantial interventions taking place; we also had the sales of gold which are designed to try and help the euro; and then we have just heard that 16 areas are issuing euro bonds. Is there anything more you could do to try and help the euro and to bring the exchange rate more in balance? We seem to be doing everything possible with intervention, selling gold and issuing bonds. What more could you do?
  (Sir Alan Budd) I do not think the Monetary Policy Committee could have done more about the exchange rate because, if it was uncomfortable with the high level of the exchange rate, then the way to get an exchange rate down is to cut interest rates. That is quite inappropriate, given the inflation objective that they had. They did from time to time contemplate intervention. It is not at all clear that that would have been effective. They had to live with a world in which sterling was strong and no doubt had lower interest rates during this period than would otherwise have been the case. I see no set of policy measures which would have allowed the Monetary Policy Committee to have brought sterling down and continued to achieve its inflation objective.

  101. One final point: should we really be so worried about it because the one thing, as someone who works with trade figures all the time, I have been amazed at is that since we have joined we have had a deficit of £155,000 million. Over the last six months, our trade with the EU has actually been positive. I just wonder why we should be worried about the euro a great deal when what has been an appalling deficit has suddenly turned into a balance.
  (Sir Alan Budd) It may be more appropriate for other people to answer that question. I tend to be someone who does not worry particularly about the exchange rate. Those who do worry about it would be better to explain that.
  (Professor Buiter) I do not worry about trading imbalances.
  (Mr Flemming) Some of the things from which you take comfort are things that we did not know in advance. As I mentioned, there have been a number of developments which have made what may, with hindsight, have been a slightly over-tight policy less painful than we would have expected. Some of those have been in the labour market and some of those have been in productivity and the ability of British industry to export, despite an apparent loss of competitiveness.
  (Professor Buiter) I agree there is nothing the MPC could have done to make for a more balanced external picture but the Government could have used its powers to announce an early, more competitive joining rate for the UK with the euro. That would have solved the exchange rate problem. That was not an option open to the MPC, of course.

  102. Do you think that would have worked?
  (Professor Buiter) Oh, yes.

Mr Fallon

  103. John Flemming, one of the criticisms of the first two years of the MPC is that they seemed to make a much larger number of small changes in rates compared to, say, the Federal Reserve or the German bank. Now we have been in a position where the rates have not changed for nearly a year. Do you think that indicates a change in approach to decision making from a rather proactive approach, if I can characterise it as that, to something a little more sluggish and reactive?
  (Mr Flemming) I think it is possible. My neighbours know better. One of the original members of the Monetary Policy Committee, Professor Charles Goodhart, believes quite strongly, and has given lectures and papers on the subject, that essentially every month they met the information would be slightly different from what it was the month before and that they should incorporate that information, as best they could in their judgment, as to the appropriate interest rate and that would almost certainly be different from the month before, and therefore you could essentially expect monthly changes. It is possible that there is a link between his departure—I do not know how much influence he exercised over his colleagues—and the greater stability. There are other hypotheses. Mr Barrell mentioned the possibility that they had all read an article published in The National Institute's Economic Review, or indeed that originally there was a sort of sitting on the edge of seats because of an anxiety. Nobody knew how easy it was going to be, if indeed it is easy, to stay within the 1 per cent band. The Deputy Governor wrote something to the effect that the new arrangements were going to breathe new life into the ability of people to write letters and, as has been pointed out, no letter of explanation has yet been written to the Chancellor. They have been much more successful in keeping it in a narrow band and that may initially have required a willingness to be proactive in order to establish a reputation. Once the reputation is built and if the markets believe that the MPC is capable of keeping inflation within a very narrow band around the target, then that will be built into a number of financial market reactions to events in a way which makes it easier for the MPC to achieve it without being so fidgety.

  104. Do you suspect that is what is now happening?
  (Mr Flemming) I would attach quite a lot of weight to that explanation, yes.
  (Professor Buiter) I find it very hard to explain a change from rather frequent change to what is now a year of constant interest rates. Since I actually think that constant interest rates have been pretty nearly right as far as I can tell, I cannot take issue with that. The difference in behaviour is noticeable.

  105. When did you leave the MPC?
  (Professor Buiter) At the same time as Charles.

  106. Do you think that has got anything to do with it?
  (Professor Buiter) I do not think so, no. The rates had already been constant for five or six months before we left.
  (Mr Barrell) I have a comment on what has happened. We have to remember it is a new framework and, although building up credibility is important to changing the environment, this was a new committee of people who had not, on the whole, been setting interest rates before. It received information that changed their decision and then noticed that very little happened as a response to their changes. In the first year or so the Committee may have been learning that small changes do very little. The evidence is that they probably just damped inflation movements a bit and damped output movements a bit but did hardly anything. After two years of realising that changing every month does very little, they probably, maybe subconsciously, decided that there was no point in changing unless there were significant news. I think we have to recognise this is a learning process for all the people involved and it was a completely new activity for many.

Sir Teddy Taylor

  107. With all this talk about minor changes, I wonder if any of these gentlemen have read this wonderful document which I receive called "The Lombard Street Research Committee Economic Review" which seems to be a very wise and influential publication. I always derive a great deal of knowledge from it. They are warning here that the talk about a cut in interest rates early next year is quite wrong. The prospect in early 2001 is not for a slow-down but for an upturn in UK demand growth. I wonder if in fact the various reports we have had of the growing self-confidence of the MPC and the possibility of another reduction in interest rates is more likely or do you think perhaps the Lombard people and their view might be right in saying that there will not be any changes, minor or major, in interest rates because of the upturn in demand?
  (Professor Buiter) Everything is possible but not everything is likely. That document is on my desk but I have not read it yet. Extrapolating from past experience, and you have just referred to recent monetary growth in the UK, that is an indicator and certainly that makes it interesting. There are indicators even now pointing in different directions—weak GDP growth in the last quarter on the one hand and retail sales slightly down but strength in services and stronger wage settlements. Again, things never point in the same direction. It is certainly possible that it will turn out that, rather than the cuts that people seem to expect, in due course an increase may be required. I do not think it is the most likely outcome but it is possible.

  108. You do not know. It may be right or it may be wrong?
  (Professor Buiter) I think most likely it is wrong.

  109. This is written by a professor, you know?
  (Mr Flemming) He is a one lecture a year professor, and a former student of mine. He is far too sensible to live on an academic salary. He has also been consistently concerned with a particular set of ideas. This question is rather similar to the question about the exchange rate. I believe that the Monetary Policy Committee has state-of-the-art forecasting models. The state-of-the-art is not terribly advanced and does take a very wide range of data into account, including movements in financial aggregates of the kind that Professor Congdon specialises in monitoring, and likewise in the exchange rate. His critique is not really a critique of their forecasting methods and it would be quite interesting to see an attempt to demonstrate that the Monetary Policy Committee in its forecasting gives too little weight to financial aggregates which could be used to produce forecasts. It is true that the most recent golden guru award, or whatever it is called, for forecasting went not to Professor Congdon but to Professor Minford, who has a somewhat similar approach.

  110. You may be right.
  (Mr Barrell) In terms of whether he is right or not, the passage by which he might achieve his conclusions would be different from ours by a very long way. Although inflation is currently dropping and although our growth may be slowing slightly, the Monetary Policy Committee makes it clear that it is supposed to look ahead not just to this quarter or even the next quarter. All the signs are that inflationary pressures are not declining in the UK in the medium term. They are not particularly rising but the exchange rate has dropped by some amount, especially against the euro. Any medium-term projection has inflation around the target by the end of the year. Therefore, there is no strong case for cutting interest rates. There is no strong evidence that the US is going into recession and therefore there is no strong case for an international reaction. The Monetary Policy Committee should stand ready but at the minute I would not argue that it has a case for cutting interest rates. However, it may have different information from the different models.

Mr Ruffley

  111. Could I put these questions to Sir Alan and then to Professor Buiter. Don Kohn in his report, when he talked about intermediate term research at the Bank, said that more such research stretching over more than one forecast round might allow a somewhat more thorough analysis of important topics. I wondered what your experience was of the sufficiency or insufficiency of such intermediate term research going beyond one forecast round.
  (Professor Buiter) There is in the Banks Monetary Analysis Unit and elsewhere a continued research programme, which deals both with short term cyclical and this longer term structural issue, so that is going on. Clearly, having more resources is always better than fewer resources but it is a question of prioritisation. Within the budget, both the money budget and the manpower budget they have available, the emphasis is not obviously wrong. It is true that the Federal Reserve, especially if you add in the regional reserve banks, has resources at its disposal that dwarf what the Bank of England has. The question may be asked as to whether that is a proper use of public money, if it is rather excessive. Perhaps some more resources for longer term structural analysis would be welcome but I would not take it out of current resources allocated to more cyclical or monetary issues.

  112. You do not think Don Kohn's comments are especially important?
  (Professor Buiter) They are important. I would just like some more resources. I do not think there is a mis-allocation of resources within the Bank. If you are talking about the total quantum, I think they could do with a little more.
  (Sir Alan Budd) I share that view put forward by Professor Buiter.

  113. Could I go on to ask you about longer term research issues? Do you think research on the new economy is being adequately addressed in terms of research?
  (Sir Alan Budd) I am not sure if I am in a position to know that. I have no doubt they are attaching very great priority to it but I do not know at this very moment precisely what research they are undertaking.
  (Professor Buiter) I am at least seven months out of date. When I was there, there were three members of the MPC alone—DeAnne Julius, Sushil Wadhwani and myself—who were actively researching, with our own dedicated support staff, new economy type issues. In MA as a whole there were also people working on all the relevant new economy issues underlying GDP growth rates and productivity, changes in market behaviour induced by a greater globalisation and sharpening competition to changes in the natural rate of employment. Certainly it is part of the research agenda.

  114. One important driver for inflation is what is happening to productivity. In the last Red Book and elsewhere the Treasury expressed some, I believe the word was "puzzlement" at what was happening to UK productivity. We heard of the US experience. I just wondered what your understanding was of the MPC's views on this important issue and what further work they were trying to do to solve what the Treasury describes as a puzzle.
  (Sir Alan Budd) The puzzle, as I am sure you know, was the low growth of productivity in the United Kingdom as recorded compared with this extraordinary high growth of productivity in the United States, as recorded. The MPC tried to understand why this was. It was extraordinary that there had been a period of recovery in the United Kingdom which normally brings with it measured productivity gains, and this had not happened. They spent a great deal of time looking at this. Subsequently, as I am sure you know, recorded productivity growth has picked up in the United Kingdom, so there is somewhat less than there previously was, but this would also be related to the sorts of new economy issues to which Professor Buiter was referring.

  115. Despite the pick-up, they acknowledge that in the Red Book. They go on to say that it is still puzzlingly low compared with the US experience. The reason I ask it is that, if we were to make any sensible analysis of what is going to happen with the inflation record of the MPC, one has to have a proper handle on productivity. I am sure you would agree with that.
  (Sir Alan Budd) Yes.

  116. I just wondered why the American experience is not mirrored here and whether or not that is not being addressed in more detail and more publicly by the MPC.
  (Professor Buiter) For 20 years US productivity performance was failing, even compared to the UK, and in the mid-Nineties it suddenly all came right. You will see in years to come how much of that, even if structural, will be sustained in the future or is, cyclical and/or one-off. The US miracle is a five-year miracle. One has to be very careful about over-emphasising it. Having said that, in these developments the US tends to be, at least one business cycle ahead of the rest of the world, including the UK. If there is a trickle down of new economy type developments or whatever, US productivity growth will move here. That is probably still to come here. I doubt that it would take on the magnitude we have seen in these five years in the US basically because there is no sign of the UK investment rate being boosted as much as the US investment rate. The supply of risk capital is very much more efficient in the US. Indeed as regards the supply of risk-takers and entrepreneurs, the US is much more of an entrepreneurial culture. When things come together in the US, advantage can be taken of that. Nevertheless, that is all consistent with 20 years of misery. I would not go overboard about the US miracle.

  117. Admirable in many ways though that view is, do you think it is a view that the MPC takes?
  (Professor Buiter) I think there are nine views on this in the MPC, literally. The views are all over the range and people actively research these issues. There are those who believe that the new Jerusalem is around the corner and those who are still worried about the old Jerusalem.

  118. Do you think research will be inclusive or persuasive in favour of one view or the other; i.e. that it is five-year led or that it is more long term?
  (Professor Buiter) It will take time. Nothing will ever convince those people who do not want to be convinced. It is a cumulative effect of the evidence.

  119. With respect, some body of research will be more persuasive one way or the other. It is not going to be evenly balanced.
  (Professor Buiter) We will find out and learn more. You cannot make inferences about trends on five years of data. Anybody who says you can is a fraud. It just cannot be done.

previous page contents next page

House of Commons home page Parliament home page House of Lords home page search page enquiries index

© Parliamentary copyright 2001
Prepared 28 March 2001