Examination of witnesses (Questions 340-359)
TUESDAY 27 FEBRUARY 2001
THE RT
HON SIR
EDWARD GEORGE,
MR MERVYN
KING, MR
CHARLES BEAN,
DR DEANNE
JULIUS, PROFESSOR
STEPHEN NICKELL
AND MR
IAN PLENDERLEITH
340. For this meeting you were flying blind
then?
(Sir Edward George) We knew simply what you know about
what is going to happen.
341. Governor, the inflation target is nearly
four years old now. It has been re-affirmed in successive Budgets.
Do you think an inflation target has a natural kind of shelf life?
(Sir Edward George) No, I think it is something that
should be kept under review, both the precise measure of inflation
we should target and, also, the number of the target. However,
my own view is that I would not actually have made a change within
this period because I think it is terribly important that we actually
try to bed down inflationary expectations at the current level.
That already seemed to me to be a tremendous task, and we have
been making progress on that. I think if the rules are changed,
certainly if they were changed too often, that would actually
damage that process. So I do not think I would feel it had a sort
of natural shelf life, but I think there would come a time when
it would be sensible to review it seriously. I am not sure that
time is now.
342. Do I take it then that you or the Bank
have not been consulted on any possible changes to the target?
(Sir Edward George) We had not actually ourselves
suggested that there should be a change in the target.
343. I asked you whether you had been consulted
on any possible changes.
(Sir Edward George) In a general sense we are always
open to make suggestions of that kind if we feel we want to.
344. I asked you whether you had been consulted.
(Sir Edward George) I am not prepared to tell you
whether or not I have been consulted because I think that would
imply something about what is in the Chancellor's mind. I do not
think I feel I can actually answer that question.
345. There has been this general speculation
that the Bank could be influenced by the time of the Budget and
the election. How are you going to reassure the wider public that
the timing of the election will play no part at all in your decision
making on interest rates?
(Sir Edward George) I think it would become absolutely
apparent. The great advantage of the transparency that we have
is that if it were clear that we were being inhibited, that all
the discussion was about the need to change rates up or down and
we did not move, then people would begin to wonder why. I think
that is the securest prediction. In making it absolutely plain
that we do not feel inhibited, I think that is part of the process.
Mr Davey
346. Following on from Mr Fallon's point there,
Governor, at the last election the different bodies debated the
pros and cons of an independent central bank. Would you like them
at this election to be debating the pros and cons of different
inflation targets?
(Sir Edward George) No, I think that is kind of premature.
347. So you hope all the political parties will
go with the 2.5 per cent and, indeed, the current framework of
the MPC for that matter?
(Sir Edward George) Yes, I think, myself, that these
arrangements are still bedding down. I think it is best to leave
them bedding down, but not inhibiting politicians from doing what
they like.
348. That is very kind of you. Could you remind
the Committee how many meetings of the MPC there will be with
respect to decisions on interest rates before May 3, and when
exactly those meetings will be?
(Sir Edward George) There will be one on Budget day
and there will be one in April. There will not be one before May
3.
349. So two possible days when interest rates
could be changed.
(Sir Edward George) Yes. We can, in principle, change
interest rates between meetings, if we have a special meeting
to do so. So you could have very many changes in interest rates.
350. But it is unlikely. Reading your Inflation
Report for February, it does seem that the likelihood of any movement
of interest rates between now and May 3 is likely to be down.
Is that not how we should read the Inflation Report and the Minutes
of the MPC meetings?
(Sir Edward George) I think you would be ill-advised
to draw any conclusions about future movements in interest rates
because I have to tell you, speaking for myself, that I am driven
by what happens between now and then, and what happens implies
looking out over the next couple of years. So that I do not believe
that it is sensible to try to anticipate what we will decide at
our meetings either in March or in April—or indeed beyond.
351. If you look at table 6A which has been
referred to previously, page 67, there is a 92 per cent chance,
according to your Committee, that by the end of Q4 this year inflation
will be less than 2.5 per cent and a 63 per cent chance that it
will be less than 2.5 per cent by Q4 2002. That is a very clear
indicator that the risks are on the down side and that the next
move is likely to be down in interest rates.
(Sir Edward George) If the evidence suggests that
those risks are crystallising that would be a logical consequence
because you would then have the prospect of inflation on the down
side. I do not think that you should read too much into that.
The world is changing all the time.
352. Just to look on the flip side of this issue,
about whether there is a possibility of interest rates going up
between now and 3 May, one would have to see a concurrence of
quite a number of events for that to happen, a large give-away
in the Budget coupled with the US economy stabilising, presumably,
coupled with perhaps commodity markets improving or becoming tighter
with tensions in the Middle East, for example, food prices going
up. If that were to happen, if all these events were to come and
move the prospects in a completely different way from what we
see today, you are assuring the Committee that you would be prepared
to put up interest rates, that you personally would persuade colleagues
on the Committee that interest rates should go up, even if that
were to happen before 3 May?
(Sir Edward George) If I were persuaded that the risks
had shifted in relation to the inflation objective, looking out
across the next two years, such that we were unlikely to achieve
the inflation target of 2.5 per cent over that period, then certainly
I would vote for a rise in interest rates. I can think of lots
of other factors which would push me in that direction, like the
increase in the tightness of the labour market clearly reviving
and that being reflected in rising labour costs; something happening
in the oil market. There are lots of factors which could shift
the thing in that direction. They would have to be significant
factors because one does not pop about from one month to the next
typically. I think our behaviour has shown that. If they did point
in that direction we would be obliged by the statute as I understand
it to take the appropriate action.
353. I certainly welcome that. Given that your
Committee and the whole nature of the monetary framework now in
the United Kingdom is based on credibility and the perception
of the commitment of the MPC to hit the target, do you feel over
the next few months that you are in quite an unenviable, uncomfortable
position because of the way that commentators might choose to
read any decisions you take? Do you feel that this is quite a
testing period for you or are you completely relaxed and happy
to write letters, happy to put rates up and down?
(Sir Edward George) Completely relaxed. I write letters
all the time. If the data and the implications of that data from
the analysis point in one direction or another I am happy to reflect
that in my policy judgments on the day.
Mr Beard
354. My question is to those members of the
Committee who took the view that the slowdown in the US economy
is likely to be sharp but short-lived. On what basis is that view
held by those members? What is their estimate of the impact of
that on the outlook for inflation?
(Sir Edward George) Shall I speak because I am one
of those members of the Committee which took that view? I think
some of the reasons have already been explained by Charlie, that
there are reasons for being relatively optimistic. What you have
to recognise is that in the first half of last year the US economy
was growing at a totally unsustainable rate and that was absolutely
generally understood within the United States. We were looking
for a slowdown in the United States economy, as they were. I think
they were tightening policy in order to bring that about. Any
slowdown from five or six per cent a year, which was what was
happening in the first half of last year, to a sustainable number,
which may be between two and three per cent or may be a bit more
if you are very optimistic about the productivity improvement,
is going to feel like a pretty dramatic event, and clearly this
was exaggerated by the movements first of all in financial asset
prices in the US equity prices. I think that caused a lot of people
to say, "What is the worst thing that might happen?"
If you do that you can really scare the pants off yourself and
there was quite a lot of that happening. You have to keep it in
perspective. Given that we were looking for a slowdown, given
that there are reasons, both on the stock side and in terms of
the nature of investment in the United States, which would cause
that to be relatively short-lived, and given particularly (because
I think the Federal Reserve responded very promptly to what was
the real worry) that people really would say, "What is the
worst thing that is going to happen?", so you see a very
abrupt fall, not just in financial markets but in industrial confidence,
in consumer confidence, which in turn would drive a further fall
in financial markets so that you would get a downward spiral,
the very prompt action by the Federal Reserve I found reassuring.
They were signalling that they are looking for a slowdown, but
not anything worse than the V-shaped thing, but are prepared to
act. Given the capacity for fiscal action which I think is now
very broadly accepted in the United States, even to the point
of saying that it might actually be helpful if we could advance
some of that by making it retrospective, it is too soon to panic.
There is undoubtedly a risk that all these things will come to
pass, that you will get a much more extended period of relatively
slow growth. You may even get some period of negative growth in
the United States. That is a risk. The central expectation in
my view is that it will not be as bad as that. I think it would
have aggravated the position here if we had responded to a perception
of, "What is the worst thing that could happen?" If
we had moved rates early or sharply then I think we would have
been signalling to the United Kingdom economy which, as Mervyn
says, is in a quite different situation from the American economy,
that we feared something of the same kind happening here. I think
that would have been calculated to induce a sharper slowdown in
the United Kingdom than I think we are heading for.
355. Is there any one amongst those present
who takes the view that the slowdown could be more prolonged or
deeper and could explain why they take that view and how that
has influenced their position? Nobody?
(Dr Julius) I think it depends on what you mean. I
personally do subscribe as my central case to the view that the
Governor has just explained, that is, the soft landing in the
United States, but I think there is a very significant risk that
that is not the scenario that materialises. However, if I had
to put my money just on one view at the moment, I would put it
on that view, not the alternative.
356. Is it the case that the much talked about
productivity gain in the United States has probably been falsified
by the presidential election in America? Is there any indication
that it has not really materialised?
(Dr Julius) I think that is the $64,000 question,
as we used to say. Over the course of the next couple of quarters
we will have better evidence on that. It is almost certainly true
that, as the US goes into at least sharp cyclical slowdown, productivity
gains will also slow, but the underlying view, and it is my view
as well, and as I understand it the Fed's view, is that those
productivity gains are real; they are based on evidence that has
actually taken place, and they are widespread enough in the economy
already that they will support continued fairly strong growth
momentum once this cyclical slowdown has passed.
357. Does anyone take the alternative view,
that the much talked about productivity gains have effectively
been wasted as the whole situation deteriorated?
(Mr King) Again, I think you are trying to give extremes
to which people have to identify. What I would say is that much
of the productivity gains in the US has been associated with investment,
in particular in information technology. Whether the growth rate
of productivity will remain at the levels we have seen in the
last five years is hard to judge at this stage and that is, as
DeAnne said, what we will find out in the next six to 12 months,
and a slowdown in investment may lead to a fallback somewhat in
the rate of productivity growth, but it is not going to disappear.
(Professor Nickell) One of the driving forces behind
the improvement in US productivity growth has been the continuous
decline in the price of IT equipment. That continuous decline
looks like carrying on for some little time. While that continuous
decline goes on there is every chance that underlying productivity
growth in the United States will be higher than it has been historically.
(Sir Edward George) I thought one of the most significant
comments in the statement that the Federal Reserve put out when
it cut interest rates for the first time, between meetings, although
subsequently repeated, was its conviction that, leaving aside
the cyclical element in productivity, the underlying rate of growth
in productivity still had a long way to go in spreading through
the United States economy, which is their perception. It is not
just the introduction of technology. It is the application of
that technology through the whole of the economy. I have to say
that that weighs with me a great deal because I think they are
very much closer to it. They inevitably have done a great deal
more analysis of this thing. It is not as if it is a new thing
for them. They have been monitoring this process over a considerable
period of time. The reason why I see that as significant is that
the implication is that that would put them, in terms of the sustainable
rate of growth for some period ahead significantly above 3.5 per
cent, and that gives them the room to respond if in fact the US
economy looks as if it is going to go substantially below for
any length of time. I think that is a tremendously important aspect
of the perception about the situation in the United States.
Mr Ruffley
358. Governor, there was a report on 12 February
in the Financial Times which said that the Bank is "developing
techniques to assess economic convergence between the UK and the
euro zone". Is that true?
(Sir Edward George) You should not believe everything
you read in the Financial Times, is my answer. It is certainly
true that we are continuously monitoring the evolution of the
euro zone economy as well as our own. That is to put us into a
position where we can make judgments about some of these questions,
but we are certainly not launching special exercises to develop
special techniques to assess the five tests.
359. But there are techniques that you are using
to assess economic convergence between the United Kingdom and
the euro zone?
(Sir Edward George) In the sense that we are monitoring
what is happening to the euro zone economy and how that relates
to what is happening in our economy, of course. We are doing the
same thing with the United States.
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