Select Committee on Treasury Minutes of Evidence

Examination of witness (Questions 188-199)




  188. Mr Kohn, thank you very much for coming. May I say how grateful we are to you, particularly as we know you have flown across the Atlantic especially to see us which I have to say in all my experience on the Treasury Committee certainly is the first time anyone has shown such enthusiasm. Thank you very much indeed. It is very kind of you. Of course we know you anyway from our own visits to the Fed over the years.

  (Mr Kohn) It is an honour to be here, Chairman. It is a long flight but a wonderful place to come in the end. I think the Bank and the MPC and the non executive directors are very much to be complimented for asking an outsider in to examine their processes. It is a very unusual thing to happen. I was very honoured and complimented that they had the confidence in me to ask me to do that.

  189. Would you like to say just a few words about your Report, your main areas of concern? We have, of course, all read it. Could you tell us about it in your own words?
  (Mr Kohn) The Report, I hope, speaks for itself.

  190. Indeed it does.
  (Mr Kohn) What I found was a system that was functioning very well but in need of some improvements in certain areas. The areas I addressed were the Inflation Report and the inflation forecast process, the work of monetary analysis which is the chief staff support for the Report and the inflation process and the MPC which I thought was very, very good but there were some issues there having to do with staff turnover and the relationship of the staff to the MPC and the input into the monetary policy process. In general I was quite impressed with what I saw. Any process can be improved and in particular this one is only basically about three years old and still evolving from one in which the Governor was advising the Chancellor to one in which the MPC is making the policy under the Chancellor's remit of an inflation target. So, yes, there was room for improvement, I think particularly in the preparation of the Inflation Report and the inflation forecast, but it was a very, very good process. I think one reason that I was glad to undertake the task, and I am glad to come back and consult with you again, is I think what the Bank is doing is very important. Increasingly countries are going to an inflation targeting regime in which the government gives the central bank an inflation target and the central bank is given independence to carry that out. People look to the Bank of England, to the MPC, to a considerable extent for guidance on how to do that best. The extent that I can be helpful to the MPC, and hopefully to yourself, I think that has favourable effects potentially on policy making in other countries as well. I am glad to be able to do that. I would like to finish perhaps by emphasising that I do speak for myself, not for the Federal Reserve or any of the Board Members. I am here as an expert in monetary policy whose expertise has been obtained by serving the Federal Reserve for 30 years now but I do not represent their views, I represent my own.

  Chairman: Thank you very much. James Plaskitt.

Mr Plaskitt

  191. You have just said that a lot of bodies around the world are looking to the MPC for guidance, that was the word you used, in terms of how they operate the system. In particular, can you just reflect for a moment, first of all, on the definition used of price stability and the process of setting the inflation target and in respect of other institutions, looking around the world, would you say that the European Central Bank had anything to learn from the MPC process?
  (Mr Kohn) I think I would rather not answer the latter because I do not consider myself an expert on their things. In terms of setting the target, I think in the context of the United Kingdom and your system and where you came from, the idea that the Government would set a target and empower an independent monetary authority to reach that target and be accountable for reaching that target, was a very good thing and something that brought you further along the line towards an independent monetary authority that would be insulated to a certain extent from short term political pressures but at the same time subject to the overall guidance that such an authority needs to have in a democratic society. I think it was a very good step for the United Kingdom, given what the United Kingdom was doing, and other countries have found it to be that way also. As for the exact target, if that was part of your question, the 2.5 whether that is the right one, I think that is something the Chancellor—I am not sure where the 2.5 came from, I think it is something that obviously will be reviewed over time but I also agree with the thrust of many comments that I have heard that it is not something that ought to change on a year by year basis.

  192. You seem to be saying the idea that Parliament defines a target and the Bank independently delivers that target is the sort of model to aim for?
  (Mr Kohn) It is a model to aim for. I do not want to say it is the model to aim for because, of course, we operate under a different model in the United States. I think different models work for different countries in different circumstances. Our model has worked very, very well for us, as you know, over the last 20 years, pretty much over our history since World War 2. It is a different model but I think each model needs to be adapted to the circumstances of the country depending on the experience of the country.

  193. Can I just move on briefly and ask a couple of questions about research available within the MPC which is something you had quite a number of interesting things to say about. There was, as you know, some public disagreement back in 1999 between the internal and external members in terms of their access to independent research and changes were made to the arrangements. Do you think the changes have overcome the problems?
  (Mr Kohn) From talking to people at the Bank, and I have not done a thorough update on this—I certainly talked to people while I was there quite extensively, obviously, and I have had a few conversations since then—I think they have gone a long way. There are two central elements. One is that the externals have their own resources now so they can be sure that if they have specific topics that they want to get covered they do get covered. The other aspect of it is that the externals participate with the whole MPC in setting the longer run research agenda. I think it is set at the beginning of the year, the end of the previous year, and then is reviewed part way through the year. The whole MPC also sits down after every Inflation Report round, I believe, and talks about short and intermediate term research over the next three and six months. There is a lot of interaction among the members on the MPC to set the research agenda now and, as I say, the externals have their own resources. My understanding is that helped to clarify the relationships between the staff and the MPC members to a considerable extent and things are much, much better than they were.

  194. Do you feel they make good choices about the subjects to research?
  (Mr Kohn) Yes, I do. I attended two what they call research away-days while I was there in which researchers presented maybe five or six topics to policy makers and senior staff in very rapid order. I was very impressed with the breadth of the research, the way it was focused on the policy problems at hand, with its use as near as I could tell of very up-to-date research techniques and topics to research and a clear understanding of the literature that it was building on. So I think that the research is well-focused, it is comprehensive and it is responsive to the needs of the MPC. Everybody at the MPC as well as the Federal Reserve are puzzling or are researching, let me say, into what is happening to the supply side of the economy. This is a major topic. As economists in university we are trained to think about demand management relative to given supply and one of the things that has happened in the United States over the last five or six years, and a big question for the United Kingdom, is whether something is happening to the supply side of the economy. And the monetary analysis, along with the independent researchers who work for the externals, were putting quite a bit of energy into this, and I think that is entirely appropriate. The other area that I identified was the model-building area. In the United States the Federal Reserve, the FOMC, starts its consideration of policy from a staff forecast that forms a benchmark for policy makers to talk about at the meeting. To a certain extent the models fulfil some of that function (because they do not have a staff forecast, they are building their own forecast) at the Bank of England, so I thought it was particularly important that they put some more resources into model building. The MPC would be well-served by making sure that their models were state-of-the-art, and that they could be used for policy-related research. Models are always going to be imperfect, they always need to be improved, but I think more resources (and as I understand it the Bank is doing that) would give them some fairly large benefits.

  195. Did you observe a relationship between the research and the month-to-month decision-making on interest rates?
  (Mr Kohn) I observed the research that went into the Inflation Report very closely because I sat in on all the meetings that led to the Inflation Report and there was quite a bit of research that went into that and quite a bit of reporting on the latest findings of the model and the latest analysis of the staff bearing on the inflation outlook. I also observed that the material the MPC were getting was from the staff. They were getting a lot of shorter-term research pieces. "Here is a puzzle in the data, here are two lines of data that seem to be telling us a little bit of a different story. Can we differentiate that there is something different happening now than might have been happening before? Can we bring some research to bear on that?" There was quite a bit of that that went into the rate-setting process and I thought it was good. It was certainly comparable to what happens at the Federal Reserve where a lot of that short-term research is given to the policy makers before a meeting to help them sort through the contradictory evidence.

Mr Beard

  196. Mr Kohn, the Federal Reserve's equivalent to the MPC, the Federal Open Market Committee, has got regional representatives on it whereas the MPC does not, it just has the report of the Bank's agents. How would you compare the two models in relation to the regional input?
  (Mr Kohn) I think there are quite a few similarities in the following sense. At each meeting of the FOMC the regional presidents do give a report on what is happening in their regions. Those reports are sometimes of a confidential nature. We publish about two weeks or ten days before a meeting something called a "beige book" which also has regional reports but the presidents come to that meeting and they update that material, they bring confidential material to the table. They were talking to the chairman of the XYZ Corporation and that chairman said that something had happened to sales at their stores very recently. They can bring confidential material to the table. They try to look at the material in the light of the national issues that are being raised, so, for example, if the Open Market Committee is worried about inflation pressures and labour cost pressures they would often tailor their material to answer the national questions that the Open Market Committee has. At the end of the day, however, although this regional material is presented, it always feeds into a national picture and the presidents do not vote their regions at all. They know they are voting on national monetary policy. The regional information is of interest because it illuminates the national picture. There have been occasions (they are rare) in which you hear of the various regional presidents giving their views of what is happening in the regions and you realise that something is going on in the economy that has not been captured by the data and that can influence the Committee's decision because they have some new information if there is a repeated pattern in a number of regions. But the presidents are very, very aware that they are making national monetary policy and many times I have heard presidents come into a meeting and say, for example, "My region is very depressed; the following bad things are happening to it—real estate markets are down and this, that and the other thing—but I think the national economy is in danger of overheating and I am in favour of taking action on those grounds." So I think to a considerable extent the data that the agents bring, the information that the agents bring is very similar to what our presidents bring. A lot of it is anecdotal. They do try to regularise it and try and compare it over time. It is perhaps a bit more systematic in some respects than the information our reserve banks bring to the Federal Open Market Committee but like the information the reserve banks bring it feeds into a national picture. And it is also key to special questions that the MPC has. I was particularly impressed with the agents' reports when the MPC had said to the agents, "Here is something we are puzzled about. Go out and ask your sources about that," and the MPC of course was very interested in the kind of answers it was getting, and I think that is particularly useful. In the end although the agents are not voting on decisions I think the regional input is comparable and is used in a comparable way.

  197. Do you think that the individual MPC members get enough of a feel for what is going on in the regions just by visiting from time to time?
  (Mr Kohn) I think that is an important part of what they do. They get a lot of input on the regions from the agents so at each pre-MPC meeting there is a lot of written material on the regions but also as the agents present their reports they bring anecdotes and stories about the regions to bear on their reports on how national conditions are developing. In addition, the MPC members themselves make a systematic effort to get out into the regions and talk to folks. I think this is a very important thing. I do not know how many visits they make but my understanding is it is quite a few. I think it is important for each MPC member to not only get out and tell the story of what the MPC is trying to accomplish but to get the feedback from the people on the battle lines of the economy, on the frontlines of the economy as to how their policies are affecting them and how these things are developing. Our reserve banks serve that purpose to a considerable extent in the Federal Reserve system, and I think it is a strength of the system, but the MPC members seem to be trying to fill that gap.

  198. Your Federal Reserve members from the regions actually live in the regions they are reporting on.
  (Mr Kohn) That is right.

  199. All MPC members are based in London.
  (Mr Kohn) That is right.

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