Select Committee on Treasury Minutes of Evidence

Examination of witnesses (Questions 420-430)



  420. I am going to ask Mr Charles Bean because I can remember when he was our adviser that there were times when he thought that maybe you had not got it entirely right.
  (Mr Bean) Of course, I do not take any responsibility for the errors! I think with hindsight you can take the view given that inflation now is turning out a little bit below target and say that indicates maybe at some earlier stage it would have been desirable if interest rates had been a bit lower. But that, of course, is with hindsight. The key, as I emphasised to you in my earlier incarnation, is that it is not judging just the outturns vis a" vis the target, but the question is were they reasonable decisions at the time. I think by and large the decisions the Committee has taken since it was formed in 1997 were pretty much the right decisions given the information that was available at the time. One can quibble maybe about a quarter of a point here or there, about maybe a rate change that might have happened a month earlier or a month later or something like that, but they were really very—

  421. Or maybe there was a particular rate change. Was it in 1998 on the basis of the earnings figures which may possibly have been—
  (Mr Bean) That is a good example of the importance of taking into account the information that was available. Clearly on the information that was available to the Committee at the time, which included what turned out to be a somewhat erroneous signal from the average earnings index, it was perfectly understandable why that decision was taken. I do remember as an adviser at the time saying to you that maybe there was a case for not responding to that, because it was not clear that it fitted with all of the other bits of information. But it was not clearly an erroneous decision given the information that the Committee had available.

  422. Dr Julius, could I ask you the same question. Do you think you have done well and have you made any mistakes?
  (Dr Julius) I think we have done pretty well judging by the economic history of this country.

  423. You are worth your salaries then?
  (Dr Julius) That is for others to say. I think we have stayed remarkably close to target. I think that we have had some shocks during this period. The Asian crisis was not something that we anticipated and I think the oil price rise was not something that we anticipated, so I think we have been stress tested to some degree during this period and inflation has been fairly close to target. If one was to think about the period of the Committee when the outturn on inflation is actually something that can be attributed to our own decisions, and that really means the last couple of years because initially the outturn on inflation was probably the implications of previous decisions before we were set up, there is certainly evidence that we have been consistently below the target and that is something I think we are all aware of but we need to really understand the reasons for that, to make sure that we are not building in any persistent undershooting of the target.

  424. Any other views?
  (Mr King) If you look at the broad movements in interest rates, what the Committee has done in its history is first to raise interest rates from six per cent to 7.5 per cent and then following the problems in the world economy, following the Russian default and devaluation and the collapse of LTCM, we cut rates from 7.5 per cent to five per cent, and then as the world economy recovered raised them from five per cent to six per cent and left them unchanged for a year until the last meeting. Every member who served on the Committee during that period was in favour of that broad pattern of movements. There were only four occasions out of 45 meetings when the differences of view were bigger than 25 basis points. I think the outturns show that that broad pattern of first of all raising rates and then cutting them sharply in response to events following Russia and LTCM and then pre-emptively raising them and then holding them constant has all turned out pretty well. The most important thing to say is the differences on the Committee around that have been absolutely tiny. The average differences between members can be measured in small numbers of basis points. They are much less than a quarter per cent. There was broad unanimity on the Committee of everyone who served on it during that period and these patterns of interest rates I think have served the economy well.
  (Professor Nickell) Since I have only been on the Committee since June perhaps I could talk a little bit more about the broad history. Since late 1992 when the inflation target started there seems to have been absolutely no question that the British economy has been relatively stable and has performed relatively well. One might want to argue that "oh, well, the world has been a much nicer place", but the fact is even if one intends to control for that by looking at how well the British economy has done relative to the rest of the G7, say, over that period, the fact is that the British economy has done better relative to the G7 on the inflation and unemployment fronts than was the case for the previous 15 years. There seems to be no question that the general structure of monetary policy based on inflation targeting, of which the MPC is a refinement, is a good structure. I think that the idea that you have a bunch of people who spend a lot of their time just focusing on what is going on in the world and what they think is going to happen and then making judgments on the basis of that, which while one can argue at a quarter point here and there seem to be broadly sensible, is something which enables the actors in the economy to have some trust in what is going on, which is expressed in what they feel is going to happen to inflation in the longer term. That is a huge benefit to the economy. The fact that the actors in the economy think that whatever happens in the short-term, inflation in the longer term is going to settle down to around 2.5 is an extremely valuable thing which helps the British economy no end.

  Chairman: Thank you very much.

Mr Davey

  425. This really follows on from that. I think the Governor explained that in December there was an undershoot of the target and you largely explained that by the unexpected strength in sterling. Is that not the case?
  (Sir Edward George) That has certainly been a factor. I think the question is did we make mistakes? There were certainly things we did not foresee and that was one of them.

  426. There has been some speculation in the press that particularly if the Chancellor decides not to index various indirect taxes that we could see inflation going below the 1.5 per cent mark and we have already heard today about you being relatively happy and relaxed about writing letters. Do you think there is a problem in this area with having a symmetric target, that it creates some difficulties for you, or are you quite relaxed about that framework?
  (Sir Edward George) I am very happy with the framework. I think the fact that we have been as close as we have to the target for this period does generate an expectation that that will always be the case and it will not. I think that will create difficulties because I think it will create a good deal of excitement when we are hit by some kind of shock which drives us further away. I think we just have to live with that and try to explain to people that the only way you can really judge, it seems to me, is on average and over time. The kind of precise monthly number in relation to the target I just think is not an appropriate criterion, but we will face that problem when we come to it.

  427. You are not worried then that with that framework and with the fact that you have been undershooting that there are going to be people out there looking at you and saying "this is typical of central bankers, they are always far too cautious and keeping the lid far too tightly on inflation, they could give us a bit more leeway"? Are you not worried about that potential criticism being heard more and more over the next few months?
  (Sir Edward George) I have no doubt that people will say that and I will explain, as I have done very often already, precisely how we do actually take account of the exchange rate. That is really the complaint, people say that because you have kept the monetary policy too tight the exchange rate has been stronger than it needed to have been and, therefore, that has had a very aggressive impact upon some parts of manufacturing in particular and in some other sectors and that has had regional concentration effects. As you know, I am very conscious of the imbalance and I have spent a lot of time trying to explain to people why the imbalance is like that, including how we actually do take account of things like the exchange rate in the prospect for inflation and, therefore, policy. We have to spend a lot more time explaining that. The letter that we would write would obviously be a part of that process.

Mr Kidney

  428. Finally, Governor, and it is on the same point, you are now on to your third way of assessing what you think will happen with the exchange rate and most recently there has been a slight fall in the exchange rate, which is roughly what you expected. I know this is tempting fate but do you think you have now got a handle on the exchange rate or is it just good fortune?
  (Sir Edward George) No, absolutely not. We are in the middle way, if I can use that expression, because we still do have the random walk, which is flat, and we have the uncovered interest parity approach and we basically draw a line through the middle because we do not know of a better way to do it than that. I would not be at all confident. In the long run I believe in uncovered interest parity because I think that the rationale for that is more persuasive than the others. I think as a forecasting technique people can show that the record has been that it has been worse than some of the others. No, I do not believe that it is something that we are ever going to be very confident about being able to forecast.


  429. Thank you all very much indeed.
  (Sir Edward George) Chairman, I believe that this may be the last occasion on which you chair this Committee.

  430. When you are here, yes, that is indeed true.
  (Sir Edward George) I would just like to acknowledge that and to thank you for your Chairmanship over the last few years that we have attended. Thank you very much indeed.

  Chairman: Thank you for your kind words.

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