Select Committee on Treasury Minutes of Evidence

Examination of witnesses (Questions 180-187)



  180. Do you agree, Sir Alan, that we could have had lower unemployment?
  (Mr Flemming) It is indisputable, but the important thing is the reference to the hindsight. The record essentially reveals that. If there is any kind of trade-off between unemployment and inflation, and all of us believe that there is, of some kind or another, then the fact that we have been low on the inflation side means that we could conceivably have had more employment. But all of us, I think, have shared responsibility and have not used hindsight to criticise.

  181. Did no-one say that at the time, Mr Flemming?
  (Mr Flemming) No.

  182. Did no-one say it?
  (Mr Flemming) Let me just explain why. None of us have said that the Monetary Policy Committee made a mistake other than with hindsight. The resilience of the over-high exchange rate is something that has surprised us all, and it is that sequence of surprises which has given rise to this track record when, if you read it backwards, you say it could have been otherwise. But none of us here would have advocated a significantly different policy, because we all shared the mistake.

  183. You are saying that it was a mistake with hindsight, that unemployment could have been lower, and no-one saw that at the time? No-one?
  (Mr Flemming) I am not sure about seeing it. There are almost invariably differences of opinion, and there may have been someone. I do not think I know of anybody, and certainly the consensus was very strong, because the strength of sterling was a mystery, and it remains to some extent a mystery even now. It was seen by everybody as being higher than they expected it to be, and therefore they were expecting a correction to come in, and they were expecting the exchange rate to come down, and that meant that they were expecting a source of upward pressure on inflation to enter the picture, and for that reason they would all have gone along with the Monetary Policy Committee's decisions.
  (Mr Barrell) I think we have had remarkably close control over the things we can control. Macroeconomic aggregates are very hard to control. That we would say we might have had a little bit more employment if monetary policy had been slightly looser must be true, but, to the degree we can control things, nobody would say that the gains would be significant. The Monetary Policy Committee is living in a new environment where it is not meant to be fine-tuning the economy to get us to full employment and get another 10,000 people in jobs, or get 10,000 people out of jobs. The new framework is supposed to be part of long-term stability. Here I think monetary policy does have a role in the growth process. The thing that might slow down our growth is if interest rates are very variable and if inflation rates are very variable. An over-active Monetary Policy Committee, trying to hit exactly, period by period, full employment, might destabilise the economy and reduce long-term prospects for growth by discouraging investment. The new framework is meant to be forward-looking and stable.

  184. Of course, I understand the new framework, but it would be a perfectly proper thing for somebody to be worried about the level of unemployment in the economy, and to want it to be lower, and to be concerned about the level of employment within the economy and to want it to be higher.
  (Professor Buiter) Temporarily.

  185. That is a perfectly proper thing. Who in this system—clearly it is not the Monetary Policy Committee—has the duty of being concerned about that?
  (Mr Barrell) That is relatively clear. First, in some sense, the Chancellor, but secondly, in some sense, the whole Cabinet through its policies for employment and growth. No one department controls employment and no one department controls growth. The policy is to encourage participation, and that is much more important than anything the Monetary Policy Committee can do. So what I think the Government is doing is focusing on using the right tools for the problems it faces. I hope I am not sounding like an advocate of government policy. I am saying they seem to be aiming the policies in the right way. Monetary policy is a medium term thing. Persuading people they might like a job or enabling them with the skills that they need to get a job, that is a different problem. We can do a lot with microeconomic policies for unemployment. We cannot do much in the medium term, especially with monetary policy, if anything.
  (Professor Buiter) We must be in danger of over-estimating what anybody can do about employment or unemployment. Even the government as a whole, with its massed departments, has only a very limited lasting effect on employment. The one thing we have learned, whether you talk about monetary policy, conventional fiscal demand management or active labour market policies—new deal, old deal; it does not make any difference—is that it has very little effect. Economic processes in a very limited way are influenceable and steerable by economic policy. Yes, monetary policy can have a temporary effect on employment. Probably, in most people's view, we could have had, with the benefit of hindsight, a very small and temporary positive effect on employment. Basically, we are driving the natural rate below its equilibrium level temporarily, getting inflation back up to target, and then letting unemployment go up again. We are talking about something temporary and something small. What is really surprising is the degree of precision with which the target has been met, through a combination of luck and wisdom, and how this target has, over a number of years now, been consistent with this very high level of employment and low levels of unemployment. I think that is much more important than trying to micro-manage the employment rate, because we cannot do that reliably, and by actively trying to do so, we could get back into the old game of promising or pursuing things that we know we cannot deliver.

  186. I take your point that we have been through a very fortunate period, but thinking about it in the longer term, and taking into account periods that may be less fortunate than the ones we are in, who would you see, Professor Buiter, in the system of monetary policy-making, fiscal policy-making that we now have in this country, as having the duty of being concerned about levels of unemployment and levels of employment?
  (Professor Buiter) I do not know what "being concerned" means. I am concerned about unemployment. Everybody is concerned. The question is: what can you do about it? Who has the instrument? Who has the tools? There are no tools, fiscal, monetary or regulatory, that have major, predictable effects, except that it is very easy to come up with things that will really screw things up. You could regulate the economy out of existence. It is easy to think of extreme negatives. But in an economy that is basically reasonably well managed on average, there is very little you can do to have a significant effect on the equilibrium unemployment rate. You can try to influence and stimulate the efficiency of which labour market makes matches between what employers need and worker supply. In the long term you can try through educational policy to get a better match of skills and demand. But to over-estimate what anybody can do about employment and unemployment is just not helpful. It comes out of the economy as a whole. Governments are bit players in this.
  (Mr Flemming) Coming back to the question that Mr Cousins put, putting it in terms of who in the macro arena should do it, I believe that as much of it as possible should be done automatically. That is done in the case of the Monetary Policy Committee because of the influence . . .

  187. It is done automatically?
  (Mr Flemming) Yes, and in the case of fiscal policy, it should be done largely through automatic stabilisers. Historically, it is the case that automatic stabilisers, the tendency of the budget to go into deficit when there is recession, have owed quite a lot to redistributive policies, progressivity of income tax, level of benefits to the unemployed and so on. It is possible that if those policies now deliver less stabilisation than they used to or less stabilisation then we would like, it might be appropriate to build in an element of discretionary supplementation of diminished stabilisation coming from the so-called built-in stabilisers, in which case, it would be a Treasury job. But it would be highly desirable to make it as little discretionary as possible and as automatic as possible, and then one is left outside the macroeconomic complex with the active labour market policies designed to try and reduce the non-accelerating inflation rate of unemployment, make the labour market work better and so on.

  Chairman: Thank you very much indeed.

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