Examination of witnesses (Questions 240-259)|
MONDAY 26 FEBRUARY 2001
240. And you say in your paper that "one
is left with the suspicion that the central forecast is being
driven by hard-line members of the Committee and that it does
not fairly reflect the balance of views on the Committee as a
whole". This is tough stuff.
(Mr Bootle) That is right. I am saying that because
the report does not reveal that there is any camp on the other
side of the so-called central view.
241. David, you wanted to add something.
(Mr Miles) I think an interesting question to ask
the MPC is whether they consider the costs of deviating from the
central target of 2.5 per cent are entirely symmetric. In other
words, do they consider inflation turning out at one per cent
to be as bad as inflation turning out to be four per cent. I think
that the official remit the MPC is given does not actually answer
the question as to whether the costs are symmetric. It does say
that if one is above or beneath the central rate by a certain
(equal) distance then a letter has to be written justifying this
but that does not imply that the costs of being above or beneath
by the same amount are equal. I think it would be interesting
to hear what MPC membersand they may well disagreesay
about how they view the costs of deviating.
242. You mean the cost to the economy, not to
(Mr Miles) That is a very interesting distinction
to draw. It will be interesting to see whether they come up with
different answers depending on how they see the costs.
243. Professor, before I move on to another
question, do you want to add anything?
(Professor Scott) Just to pick up a little bit more
on what Roger was saying. You do not want the fan chart to be
an average forecast and when you have a close vote 5:4 there are
two camps and naturally the fan chart probably reflects the dominant
group. The question here about how you deal with these two different
camps is crucial to what you are trying to achieve. Do you say
"Well let us not worry about the uncertainty around our forecast,
let us just go with our central forecast. How do you factor in
uncertainty?" The two downside risks, absolutely right, are
the US and the other one slips my mind right at the moment. So
there is downside risk in inflation which is dominating. There
is another camp which can make a caseit is made in the
Inflation Reportabout strong domestic demands, strong wage
market and also strength in Bank lending. What seems to be the
case is that there is a very low weight on the downside risks.
They know there is this downside risk but there is a low weight
on it in that original 5:4 vote. It is a central forecast, it
is the dominant one but there are two different camps and you
have to work out how to deal with those different ones.
(Mr Bootle) Chairman, can I follow up on that? I think
the word "central" is critical really. To say it is
the majority view with dissenters seems to me to be fair, if that
indeed is what it is. To say that it is central when in fact it
is simply a 5:4 vote with nothing the other side seems to me to
be misleading. What is happening here, I think, increasingly,
is it is becoming clear how difficult it is to present a single
view of the future in this way. This has been an issue which has
cropped up, of course, repeatedly over the last few years. There
is an awful lot to be said, as this particular Inflation Report
is emphasising, for the idea of having a forecast of the future
from the Bank staff and it being quite open and clear that this
is not necessarily, as it were, the central view of the Committee
as a whole.
244. Donald Kohn has just rejected that rather
firmly in front of us a few minutes ago. He does not think that
would be a good idea.
(Mr Miles) There is a hint in table 6B on page 67.
I do not think we have seen a table like this before. It is a
measure of the disagreements within the Committee on what the
impact of things like changes in the UK supply side potential
are. That is quite a big factor. Somebody on the Committee believes
the central forecast is a quarter of a per cent less than the
middle of the range due to what they think is happening in the
labour market and somebody else thinks it is about the same the
other way. Maybe the MPC are moving in the direction of giving
more of an indication of the range of opinion and why there is
a range of opinion.
(Mrs Rosewell) It is, however, quite surprising. I
thought what was interesting here was that this range was actually
(Mr Miles) It is narrow.
(Mrs Rosewell) The impact of supply side and labour
market performance would only be a quarter point either way. Whatever
the risk is surely it is a lot bigger than that or, indeed, the
world slow down and impact on the United Kingdom, the maximum
is about a quarter point lower and that is only on inflation and
it is only 0.15 on GDP. It is a consensus of what the possible
effects are of these risks. I found that surprisingly unilluminating.
I agree that is the first time we have seen this sort of table.
The real difficulty is that we hear from members outside the Committee
process, they make speeches and so on and it is clear that there
is this alternative view emerging but it does not emerge in the
pages of the Inflation Report. I think that is our real difficulty,
that we get potentially one specification, we get this obscure
statement Roger referred to about certain Committee members who
prefer to make different judgments but we are not actually told
what these different judgments are.
245. If I can move on, perhaps to David Miles,
David Walter has written to us saying "There seems little
reason not to expect another cut in interest rates soon"
and that is right, is it not?
(Mr Miles) I am not sure for two reasons. Firstly,
it seems to me that what has been happening with the building
society and bank sector on mortgages has eased monetary policy
quite significantly. Typical mortgage interest rates might be
lower by half a percentage point as a result of what the Halifax
has announced and the reactions to that. That is quite a substantial
reduction in the cost of mortgage finance and it is an easing
in monetary policy in some sense. That may have done some of the
job that people were expecting the MPC to do. The other thing
comes back to the uncertainty in the US. I think had there not
been those dramatic falls in the confidence indicators, I doubt
very much whether there would have been such a reaction from the
US Fed. Those confidence indicators, I would imagine, are extremely
volatile. One might find in a month's time or two months' time
that they have shot right back up and we are not hearing talk
about the US going into recession at all. I suspect the MPC is
going to wait and see what happens on the US economy. It strikes
me as far from clear cut that there are more interest rate cuts
to come in the UK.
246. Who is with this David and who is with
the other David who is not here today? Will rates stay or will
there be further cuts?
(Professor Scott) I am not expecting an increase in
interest rates. I think we will get another one. I do not think
there will be a rush.
247. Another cut?
(Professor Scott) Another cut, that is right. It may
be we will get one next meeting, I doubt it, but I think undoubtedly
interest rates will fall. I do not think there is any evidence
yet for a dramatic downward reduction in interest rates. We have
to realise the US boom has been very different from the UK growth
experience and on previous evidence the US slow down does not
have a disastrous effect on the UK economy. I do not think we
should over exaggerate and draw too strong a parallel with US
monetary policy in the UK but the economy does seem to be slowing
down. It is probably going to nudge below trend growth so one
would expect reductions in interest rates but not dramatically
and not large unless something materialises which is unexpectedly
(Mr Bootle) I take a rather different view; I do not
know if you would call it optimistic or pessimistic. I suspect
that interest rates are on course to hit something like about
five per cent by the end of the year. I believe that not because
I think the UK is going to suffer massively as a result of the
US slow down but rather because of the inflation picture which
is after all the objective with which the Bank is primarily charged.
I think the status of the Governor's impending letter is worthy
of some discussion. I reckon he is going to have to write a letter
at some point or another this summer. I sent you some charts,
which I hope you have got, which showed that if you took out petrol
prices, he would have to have written a letter already. It is
not that one needs petrol prices or oil prices to fall off from
where they are, it is simply the falling out of an upward distortion
from before. My judgment is that it is going to be increasingly
difficult for the Bank to argue as we go forward that in two years'
time inflation is going to pick up nicely to hit the 2.5 per
cent target point as the starting level gets lower and lower.
248. David, you want to argue for wait and see:
do you think the Governor is about to send this letter later this
(Mr Miles) I think what triggers the inflation letter
is one per cent beneath the central target, so that would be 1.5
per cent. It is clearly something that may well happen. I would
guess that it is less than a 50 per cent chance that it will happen.
Just looking at the fan chart again, if that is a representation
of the MPC's own views on the probabilities then it looks pretty
small to me.
(Professor Scott) There is a table on page 67.
(Mr Miles) Okay.
(Professor Scott) Which has also been pointed out
to me which gives an exact number, it is 25 per cent.
(Mr Miles) The MPC's own view is revealed here, there
is a 25 per cent chance they are going to have to write a letter.
It seems it is far from clear that they are going to have to write
249. Do you think they are wrong, Roger, with
25 per cent?
(Mr Bootle) Yes, I reckon the chances are much greater
250. Bridget, are you "wait and see"
or do you expect more cuts?
(Mrs Rosewell) I am glad everybody else answered the
question first because I am trying to make up my mind what I think
they will do as distinct from what they ought to do. I suspect
that they will wait and see. They have, after all, been waiting
and seeing now for a very considerable time. They have made one
very small cut. The relationship between interest rates and inflation,
I suspect, is getting stickier and inflation is moving downwards
generally, so I would agree with Roger that the probability he
would have to write a letter is higher than 25 per centI
put it more like 50/50, possibly 60/40and that this downward
pressure on inflation which is being generated elsewhere will
continue. I think the loosening of policy by the cuts in mortgage
rates is not going to be big enough to counteract that. It does
not apply to new mortgages which are all on special deals anyway.
It will help some people but it is not going to make much difference
to people's spending patterns and anyway it is not going to last
unless interest rates come down to bring down the rates on savings,
because otherwise they go bankrupt at these sorts of rates across
the piece. I think combined with that there will through this
year be developing a cumulative slowdown in the economy itself
which will put further downward pressure on inflation. So all
of that adds up to wait and see on the part of the Committee because
they do not seem to care about high real rates in any fundamental
sense and at the same time inflation is falling, so that raises
the odds on having to write the letter. I am more pessimistic
than Roger that we will hit five per cent by the end of the year.
251. Andrew, when you said there might be another
quarter per cent cut at the next meeting, the next meeting is
the last one before the General Election if it is May 3, as lots
of people think it is going to be; does that influence the thing
one way or the other? Either, "Let us help the Government
be re-elected," or, "Let's show we are absolutely independent
by not changing the rates"?
(Professor Scott) I can only speak for myself. Given
the speed they normally move it is unlikely that they will do
two cuts. Given they are normally very cautious in change, I do
not think there will be another cut. The risk of appearing political
in some way would be something that they would wish to avoid but
you will have to ask them. Roger is talking about five per cent
by the end of the year. We have got a lot of meetings and we can
proceed at quite a cautious pace. I do not think we need to do
anything dramatic like the Fed has been doing in the last few
months, so it really is a question of a number of small cuts,
two or three, spaced out over six months or a year. I do not think
it is too different from what Roger was suggesting.
252. Is there evidence in the data so far of
the slowdown in the USA affecting the UK economy?
(Mr Bootle) The first direct evidence came the other
day, namely the CBI Survey, which showed a real weakness on export
orders. Before then I think it is fair to say that there was next
to no direct evidence. There were some signs of UK slowdown, the
figures for Q4 GDP for instance, but you cannot pin those down
directly on anything to do with America. So the evidence at the
moment is very, very slender and I think I would point to the
CBI Survey as the only bit so far.
(Mr Miles) I do not know if you have got a copy, but
Sushil Wadhwani gave a talk in Newcastle last Thursday specifically
about the US slowdown and all the rest of it and he has got some
information there about new indicators that have come out since
it became clear about the slowdown. Some of them show optimism
falling off, some of them show consumer confidence looking a little
bit stronger. His interpretation of this is that as yet there
is not any clear knock-on effect in the United Kingdom. I have
got a copy if you want.
253. How long do you think it will be before
there are positive signs, if there are going to be positive signs,
reliable signs, of the US slowdown affecting us?
(Mr Miles) The direct channel is that if the US economy
slows down a lot, demand for UK exports to the US falls off. If
that is the channel one is looking at, it is probably not a terribly
powerful one because so much more of the UK's exports go to Europe
than to the US If that is the channel you are looking at it probably
takes quite a long time and the size of the impact may not be
very dramatic. I think if there is going to be a big knock-on
effect it is more likely to come through something like the stock
market selling off very dramatically in the US and that having
a very big impact on stock prices in the UK, and that really could
hit. That is the way it is going to happen, if it is going to
happen significantly, rather than via trade.
(Mrs Rosewell) There are two other things. One is
not so much a direct effect through trade but an indirect one
through the exchange rate. The collapse in the US economy and
the dollar strengthening is a problem across many markets where
there is dollar pricing. That is one additional thing. The other
is a general confidence effect. People do read the newspapers
and if they see stories about difficulties in the world economy
or stock market, or whatever, that does have an impact on people's
willingness to invest, in particular, and that is one of the areas
where you could look for the evidence on the confidence front.
(Professor Scott) Not much to add there. The biggest
threat is a serious US recession which creates a lot of financial
sector/banking sector weaknesses. It can spread very quickly and
have a big effect here. It would manifest itself in the stock
market with a banking sector weakness. I do not think that is
going to happen. That would be a quicker and more substantial
route. Exchange rate, small effect, six months, nine months, that
sort of timescale. On confidence I am less concerned about the
confidence measures. What you do see is very much what Bridget
is saying, short-term weakness. The Chairman of the Fed talking
up recession, confidence levels plummet. You hear that and the
UK consumer/producer confidence falls but unless the economy actually
weakens and unless unemployment rises or wages fall a lot, it
does not have a long-running effect on confidence and so does
not affect it.
254. Do you all agree with the MPC central projections
based on the assumption that the US should see a return to moderate
growth in the latter part of this year, or are you more pessimistic
(Mrs Rosewell) I think the difficulty is what happens
between now and the end part of this year. It is clear if there
are signs of further weakness that there will be further strong
policy reactions, judging by what we have seen already, so I suspect
that by the time we get to the end of this year then there would
be a return to some low/moderate growth. I think, however, there
is a possibility of quite severe weakness in between those two
points and quite a lot of turbulence in the markets as a result
of that. It is the bit in the middle that I am most worried about
particularly over the summer. By the time we are sitting here
in a year's time it will all look a bit more comfortable.
255. You expect it to be that quick?
(Mrs Rosewell) It is a very flexible economy. It grew
very fast but it can also go back down very fast too. It is the
downside of the upside.
(Professor Scott) Most economies react with a year/18
month lag with interest rates. Given the big reductions at the
end of last year that should be feeding through. The concern is
what is happening in between whiles. I would have thought low
positive and rising growth is the most likely scenario in the
US. I am not sure about moderate, I am not sure what that means.
(Mr Bootle) I take a different view on that. No-one
knows the answer on this. In my view we are dealing with a mass
psychological phenomenon so it is extremely difficult to be remotely
confident about it, but my view is that the outturn of the US
is likely to be rather worse than the one the Bank is assuming.
I think that partly because of the underlying conditions in the
American economy. It is not as though weakness in the demand indicators
you have seen over the last month or two months come out of clear
blue sky. On the contrary, the Bank itself has been warning about
the underlying imbalances in the United States' economy for some
years and worrying about the risks that they pose to the world.
It may well be that the whole shemozzle can continue for even
a matter of years yet and that therefore there will be this bounce
back later on, but my suspicion is that this is the long-awaited
adjustment which will eventually deal with the imbalances referred
to so often and the danger for the rest of the world, of course,
is that although that adjustment is necessary it is not very helpful
with regard to the adjustment in the world demand.
256. Mr Miles, do you have a different view?
(Mr Miles) I think it is enormously uncertain what
is happening in the US. As I said before, I think the confidence
indicators have had a big impact on the Fed but I suspect those
confidence indicators are extremely volatile. It would not surprise
me if they shot right back up within the next few months; we might
not be talking about recessions by the summer.
257. Looking at the US on its own, would you
say the MPC was right to lower interest rates pre-emptively last
(Mrs Rosewell) They have described it as pre-emptive.
It is not quite clear to me what it is supposed to be pre-emptive
of, given that there is already in progress a slow down in the
UK economy and this just seems to me to be making an excuse for
something which is actually justified on other grounds, if that
is what they really think is happening. As I said before, I think
that interest rates in the UK are getting increasingly out of
line with both what is happening in other countries and also the
state of the economy. We could easily be at five per cent now
and it would be an appropriate rate for the state of the economy
that we are at and the underlying inflation that we have.
(Mr Bootle) I think you have to consider it in terms
of risks. If you ask yourself the question what risk the Bank
was running by cutting rates by a quarter when it did, I think
it is difficult to come up with a convincing answer. Now that
would not have been the caseto get back to my hobby horseif
inflation had been running well above the target and if there
had been clear dangers in the near term that it could go a lot
higher. It seems to me that there was not any risk of that nature.
There was however a risk, there is a risk, that the US slow down
will be serious and the knock on effects on Britain will be serious
and therefore I think it is right to think of it as a sort of
insurance premium really. The direct effect of the quarter per
cent I do not think will be very great, I have to say, in staving
off a recession. It is not so much that, I think it is more akin
to what the Bank did in 1998, which it did very successfully I
think, which was to say to people "Look, you may be worried
about the state of the world, and you are right to be, but be
confident that we are going to make adjustments quickly and firmly".
It is only a quarter of a per cent but I think it has demonstrated
that, again, it has said they are prepared to cut, I think in
principle, as far as is necessary.
258. Would it be fair to say your unanimous
opinion is that interest rates should fall and will fall almost
irrespective of what happens in the United States?
(Mrs Rosewell) Yes, that would be my view.
259. David Miles takes a different view.
(Mr Miles) Yes, I do slightly take a different view.
It is partly because of looking at the structure of the real economy
where unemployment is the lowest level it has been for probably
25 years and various indicators of skill shortages suggest great
tightness in parts of the labour market. Inflation clearly is
underneath the 2.5 per cent limit but it is not enough simply
to say, "well inflation is beneath the target, it probably
will not go back to the target or above it over the next year
or so and therefore we should cut rates". I think you have
to ask what is the wider economic environment we are in, and we
are in an environment where GDP growth has been pretty strong.
Over the next year or so it may be running at around, or very
marginally beneath, the trend rate. Unemployment is extremely
low. It does not seem to me an environment where you would say
well clearly monetary policy should be significantly looser so
I think I do take a slightly different view from some of my colleagues
(Professor Scott) I think to understand what is happening
here you have to draw a distinction between a forward looking
inflation target where all the time the Bank is saying what is
going to happen to inflation 18 months, two years down the road,
and then what the level of inflation is today. Inflation is really
quite a sluggish variable, it does not suddenly roar up in a month
or two. That I think is causing a bit of a problem here because,
as Bridget says, we could have five per cent interest rates without
probably breaching the inflation target in 2003. I think that
is right but I think you then breach it beyond that. I think what
the Bank is wrestling with is saying "Why is inflation currently
low, why is it below target? Is there a mistake that we have made
over the last couple of years which will make us review or change
the models we are using to think `Oh, what is going to happen
over the next two years'". If you do not want to change your
models then all the factors David is talking aboutlow unemployment,
high consumption growthwill lead you to worry about reducing
interest rates very sharply. If you think there is a reason why
you have inflation low at the moment, because the world has changed
and there is a structural change in the economy, you would probably
want to be more aggressive about changing interest rates. That
is the tension you have. What weight do you put on the current
inflation models? I think the Bank always says, "Today's
inflation reflects what happened a year, a year and a half ago",
and that is the key forecast issue.
(Mr Bootle) I agree with my colleagues in principle
but I am afraid I disagree, as it were, in fact about where the
argument leads, in the sense I think the current and immediately
prospective inflation rate is worth more than some of my colleagues
suggest. It is true to say it does not matter or mean a great
deal if you know the correct model for the way the economy works
and all the parameters and so on but, of course, we do not. One
of the things in particular we do not know is the sustainable
rate of growth of this economy, and the sustainable rate of productivity
growth is a part of that. It is possible that the sustainable
rate of growth is higher than it has been in the past and higher
than we are giving it credit for. One of the ways in which that
would be revealed I think is to see this downward pressure on
inflation for no apparent good reason. Given that we do not knowand
this is the great imponderablethis sustainable rate of
growth, I think there is a lot to be said for looking at the thing
which you are actually measuring there in front of you month by
month, a price, a little imperfect but a price of sorts. I think
that is telling you something. If this were just to occur on the
odd month, it would not mean very much, but I go back to my point
that it has been happening for getting on for two years. If the
Bank could explain that by virtue of all sorts of favourable shocks
which are responsible for that development, that might be one
thing, but I do not think it can. It has got the exchange rate
up to a point but there have been an awful lot of unfavourable
shocks as well, in particular oil prices and petrol taxes. So
the fact inflation is so low and looks likely to be so low for
the foreseeable future I do not think can just be dismissed.
(Mrs Rosewell) I think there is another way of putting
what Roger just said, which is that it may not be so much that
the sustainable rate of output growth has increased, or has only
increased a little in terms of capacity increases and so on, but
if you like the sustainable rate of inflation which goes alongside
that has fallen as a result of changing expectations, the way
that wages are set, the inflation expectations which are embedded
in the system. I think the extraordinary thing is that we have
got low unemployment and we have got strong demand and yet we
have got wage increases of only 4 to 4.5 per cent and we have
inflation at around 2 per cent. That is why I think you have to
put a strong weight on the current numbers because they seem to
me to tell us something about where the trend is in these numbers
going forward, and why I find this rise to 2.5 per cent at
the end of the forecast period so completely incredible, frankly.
I just do not think that is really what is happening in the economic
system that we currently have, and that is why I think you could
reduce interest rates and it will not make a tremendous difference
to anything, and it will give you a lower base to start from if
the economy, after going through the current downturn, is then
in its upturn period by the time you get to 2003. If you started
from a base of 4.5 now, it would be easier because when you
are going to increase them you would not have to go quite so high
and it would not make a tremendous amount of difference to the
situation now. That is the real situation. Of course it is entirely
possible, I guess, that the Chancellor may get Eddie George out
of the need to write a letter in a month or two's time by changing
the target level in the Budget and bringing it down to 2 per cent,
and that would get everybody off the hook.