Select Committee on Treasury Minutes of Evidence

Treasury Committee Questionnaire completed by Ms Kate Barker


  1.   Do you have any business or financial connections or other commitments which might give rise to a conflict of interest in carrying out your duties as a member of the MPC?

  I will have no such connections or commitments when I join the MPC on June 1, 2001.

  2.   Are there any relevant personal or other factors of which the Treasury Committee should be aware in considering your nomination?


  3.   Do you intend to serve out the full term for which you are appointed?


  4.   Please explain how your experience to date has equipped you to fulfil your responsibilities as a member of the MPC.

  Since 1981 when I moved to the National Institute of Economic and Social Research (NIESR), I have been fortunate to have a wide range of experience as a practical economist, both analysing economic developments and developing expertise on policy issues. However, there are three particularly relevant aspects of this experience:

    —  In all three jobs, at NIESR, at Ford of Europe and at the CBI, a significant part of my responsibility involved taking forecasting judgements. To perform successfully in these jobs it was necessary to understand forecasting models, and also to acquire the ability to take judgements going beyond what the model would project.

    —  At both Ford of Europe and at the CBI I have been in close contact with business, enabling me to acquire a good understanding of how the business world is changing in the UK and beyond, and of how firms respond to pressures and opportunities. The CBI has also given me a good understanding of the interpretation of business survey data, and of its strengths and weaknesses.

    —  One of my strengths is the ability to communicate clearly to non-specialist audiences about the economy. Ensuring that business and other audiences understand and support the work of the MPC has rightly been recognised by the Court of the Bank, the Treasury Committee and the MPC itself.


  5.   How important do you think it is for MPC members to be subject to ex post parliamentary accountability? Could the current procedures be improved?

  The operational independence of the Bank of England has proved a success so far. It has also won a good measure of support. The requirement for members of the MPC to explain their decisions to this Committee, rightly ensuring as it does accountability to democratic institutions, is a major reason for this widespread support, even from some who initially were cautious about a more independent central bank.

  This role will be even more vital during the inevitable times when the MPC's decisions are less popular. I believe that the present system works well and is sufficiently robust. It ensures that the MPC's decisions are not only taken after a very thorough debate, but also that this is seen to be so.

  6.   If you were to stand for reappointment to the MPC at the end of your term, what criteria do you believe should be used to assess your individual record as an MPC member?

  The most obvious criterion is that the MPC has continued to be successful in meeting its policy objective as set out in the Bank of England Act 1998. (This familiar goal is to ensure that the Government's specified objective for price stability is met, and, subject to this primary objective, to support the Government's economic policy objectives, including those for growth and employment). In assessing the personal performance of any MPC member, their own voting record and the lags in the operation of monetary policy would need to be taken into account.

  In addition, there are three further objectives which I would set for myself:

    —  A consistent willingness and ability to give a clear and cogent account of my personal decisions, and of the decisions of the whole MPC, to a variety of audiences including the Treasury Committee.

    —  Evidence that time and effort has been spent in looking at the full range of regional and sectoral information, and in ensuring that the flows of this information into the MPC as a whole are as robust as possible.

    —  Substantive contributions to the analysis of the flow of data which is regularly reviewed by the MPC, and to the debate about how interpretation of this data is changing.

  7.   What resources do you think you will need to perform adequately as a member of the MPC?

  It is rather a tall order to be definitive in advance of starting a job about exactly what resources will be required. In answering this question I have therefore drawn on the views of Dr Julius, who considers the present team of researchers available to external MPC members to be sufficient at present. It is something I would keep under review.


  8.   Is the framework of an explicit inflation target the best within which to conduct monetary policy? Given that an explicit target has been set, is RPI(X) the best index to use; should it also include asset prices?

  In considering the right target for monetary policy, as in other economic rule-setting activities, it is important to start off with the realisation that the perfect policy solution almost certainly does not exist. The question clearly is what is best for the UK over the next few years, given the goals which other central banks have adopted, and given the UK's own monetary policy history.

  When the Government first gave operational independence to the Bank of England, it was widely argued that an explicit inflation target was important to establish confidence in the new policy framework. This referred both to confidence in the financial markets, and to confidence among wage and price setters in the UK. Although the new framework with the MPC now seems terribly familiar, it is important to remember that the UK has only operated in this way for four years, and it would seem far too soon to change so fundamental a feature as focusing on an inflation target. In the past, frequent changes in monetary targets were a major factor in creating a lack of confidence in the UK's commitment to low inflation.

  In selecting the precise inflation target, which is of course a matter for the Chancellor rather than for the MPC, the points about consistency and confidence are also relevant. For the MPC to retain credibility in the wider UK community, it is important that the inflation target should be one which businesses and individuals are familiar with, and recognise as relating to their own experience of inflation. For this reason, RPI(X) still seems the best measure. (However, it was sensible to move away from headline RPI as it is so heavily influenced by interest rates directly.)

  There are certainly theoretical arguments in favour of including asset prices in the MPC's target. These include the view that stability in financial markets (stability of sterling, or of equity prices) is an important goal in its own right, as it affects the stability of economic growth. However, the arguments against including asset prices in the target seem to outweigh this advantage:

    —  The construction of such an index would in practical terms be a difficult matter—how should all the elements be weighted, for example? Disputes around this question would quite likely prove damaging to policy credibility, in addition to worries about loss of credibility from yet another major change to the UK's policy framework.

    —  The transparency of policy to the wider public, and public understanding of the MPC's role, would be hindered by this change.

    —  The practical operation of policy would be made even more difficult, as interest rates do not have a predictable relationship with asset prices (of course, this is also true of RPI(X), but to a much lesser extent).

    —  The argument that asset prices should be included also falls foul of the criticism that it is in effect asking the MPC to achieve stability of economic growth as well as monetary stability—the impossible task of hitting two targets with one policy instrument.

  However, I would agree strongly with the proposition that asset price overshooting (if it is judged to exist) and the consequences for the expected path of RPI(X) of this overshooting either continuing, or being unwound abruptly, should be taken into account in the MPC's debates and decisions. Where this has had a major effect on the final decision, this would require particular explanation in the minutes. And of course monitoring asset prices at all times should be an important part of the MPC process.

  9.   Why do you think the MPC has undershot the target so consistently? Should undershooting the target be viewed as seriously as overshooting it?

  I would not agree with the bald statement that the MPC has undershot the target consistently—which seems to imply that the MPC has failed to achieve its key objective. RPI(X) has been below 2.5 per cent for the 23 months up to February 2001, but in only 8 of these months has it been away from the 2.5 per cent target by 0.5 points or more. The average inflation rate in that period has been 2.1 per cent. From January 1998 (taking the period prior to January 1998 as clearly too early in the MPC's tenure to be included) to March 2000, however, RPI(X) was frequently above 2.5 per cent, and averaged 2.6 per cent.

  While it is tempting to describe the past 23 months as a period of undershooting, that would risk placing an unreasonable requirement on the MPC to keep inflation at an average of 2.5 per cent over very short time periods. For most of this period, inflation has been stable and has not looked like moving down to the 1.5 per cent level which would trigger a letter to the Chancellor with the accompanying explanation. It is right that undershooting should be regarded as seriously as overshooting, but equally it should not be regarded more seriously. If inflation had averaged 2.9 per cent over 2 years, but been stable, that would equally not strike me as a clear policy failure.

  However, it is clear that the MPC did not aim in advance for an inflation rate averaging 2.1 per cent over such a period. The exact reasons that inflation has been lower than expected are difficult to glean from the information about the Bank's forecast given in the Inflation Report. However, they are likely to include a better labour market performance than expected, with whole economy unit labour costs surprisingly subdued in 2000 in particular. In addition, sterling clearly has been stronger than the MPC expected—for example in the February 1999 Inflation Report the 2 year ahead forecast for the sterling effective rate was 97.6, whereas the actual February 2001 average was 104.1 (although this has not, surprisingly, resulted in growth being slower than forecast). But of course there are a whole range of other factors which will have affected the inflation rate, upwards as well as downwards, compared with the MPC's projections of two years ago.

  10.   Should the inflation target be lower? If not now, when might be an appropriate time to change the inflation target?

  As commented above, the inflation target is a matter for the Chancellor, rather than for the MPC. It should be noted, however, that it would be as wrong to conclude simply from the fact that inflation has been around 2 per cent for some time that the target should be cut, as it would be draw the opposite conclusion following a period in which inflation averaged 3 per cent. Setting these targets should be seen as a long-term game, once the inflation rate has been reduced below the level at which it would be regarded as excessively costly to a country's economic well-being.

  I would argue that 2.5 per cent, given that in the UK we use an arithmetic mean which tends to overstate the impact of price rises slightly, and given the well-known concerns about capturing quality changes adequately, is a sufficiently demanding target to avoid the UK facing significant inflation costs. A lower target for RPI(X) might raise concern about the dangers of deflation.

  11.   How should the MPC act if some sectors of the economy are booming (eg the service sector) while others are in a slump (eg manufacturing)? Is there any sense in which the MPC should be especially concerned about manufacturing?

  Interest rates cannot of course be set at different levels for different sectors of the economy. In the circumstances as outlined above the MPC's job is to assess the inflation outlook, taking full account of the effects in both the short and the longer-term of the different sectoral experiences.

  This means, for example, considering why the difference between the fortunes of the manufacturing and services has occurred.

  The UK economy has now been broadly in this situation for some time (although it would be more accurate to say that it is sectors exposed to international price-sensitive competition which have been suffering, including agriculture and tourism as well as major parts of manufacturing).

  The root cause is mainly the surprising strength of sterling, which has also proved unexpectedly persistent. This situation could result in longer-term upward inflation pressures. These would arise if the result of the prolonged period of high sterling caused a cutback in investment in the traded sectors and an inadequate supply base to respond to the opportunity to raise output if and when sterling depreciates. In the extreme, this implies a policy dilemma in which interest rates might need to be higher in the short-term to dampen inflation pressure from the domestic sector, but an (uncertain) risk of future price pressures in the traded sector. (It should be clear that this is not a question of departing from the MPC's remit, but of how best to meet that remit.)

  Manufacturing should not therefore regarded with any particular preference per se, but raises particular concerns because of the sector's exposure to international competition. In addition, new investment tends to take longer to install than in most parts of the service sector, so that if capacity gets out of line with demand it takes longer to correct.

  12.   Do you believe that there is any trade-off between inflation and unemployment (or output) in the short run or in the long run?

  I do not believe there is any trade-off between inflation and unemployment in the long-run, beyond the rather modest negative effects on growth (estimated by for example Barro) of high inflation rates (above 10 per cent).

  In the short-run, however, I do believe that a trade-off can exist, and there are many examples. A good reason to bear this trade-off in mind is that if inflation were undershooting significantly (by more than 1 point and falling) then an attempt to bring inflation back up to target quickly by dramatic interest rate cuts could result in undesirable volatility of output. A preferable policy course would be to aim to bring inflation back up over a period.

  13.   Do you believe that the natural rate of unemployment is a useful concept? On your assessment where is unemployment currently relative to the natural rate? How would an increase in productivity affect the sustainable rate of unemployment?

  It is pretty difficult to imagine how to manage monetary policy without the use of a concept such as the natural rate of unemployment. However, personally I would prefer to refer to the "non-accelerating inflation rate" (NAIRU) as the expression "natural rate" sounds too much as though the rate were permanently fixed by some law of nature.

  I would also prefer to talk about the output gap rather than imply it is only labour market conditions which can lead to accelerating inflation. Neither of these broad concepts make policy judgements easier, unfortunately. While looking at past data it is reasonably clear how big the output gap was, or how far unemployment was above or below the rate consistent with stable inflation. However, even this is far from an exact science. The discussion about the position of the economy at the present time, relative to these concepts, is always highly uncertain.

  The labour market is certainly as difficult as ever to read at present. A look at unemployment and vacancy data would suggest, based on past relationships, that unemployment was already likely to have fallen below the NAIRU. Employer surveys also suggest that skill shortages are increasing (looking at the data from both the CBI and the BCC) although the indications are that this is still much less of a problem than in the late 1980s.

  Despite these trends, and despite considerable anecdotal evidence of particular pay pressures, pay settlements and average earnings (excluding bonuses) have so far remained surprisingly subdued. I would judge it likely that unemployment could not fall significantly further in the short-term without putting upward pressure on wages, and therefore that the UK is very close to the NAIRU at present. A more interesting question perhaps is how much scope there is to raise employment levels in the UK over the next five years as the efforts to lift skill levels should start to bear fruit.

  The impact of an increase in productivity on the NAIRU is a complex one. My view would be that it is possible for the economy to move to a lower NAIRU as a result of an adjustment process following a rise in productivity. But this will depend on labour supply conditions—essentially, what happens to real wages. It is a difficult proposition to discuss in the abstract.

  Higher levels of productivity certainly do not automatically mean lower unemployment—as the examples of France and Germany demonstrate.

  14.   What effects do you think the information and communications revolution is having on the economy? How should it affect the current conduct of monetary policy? How well do you think such effects are being recorded in the data?

  The ICT developments are obviously having very considerable microeconomic effects throughout the economy—affecting everything from business supply chains to personal banking transactions. However, while this alters how many transactions are conducted, the overall economic effects remain a matter of dispute.

  Evidence in the US is generally looked to for an indication of what impact will eventually emerge in the UK. Some recent studies (for example Oliner and Sichel; The Resurgence of Growth in the 1990s: Is Information Technology the story? Federal Reserve Board Paper, 2000) seem to indicate that there is now evidence that ICT has had an effect on productivity beyond the ICT producing sectors. However, there are still those who would challenge this view, and argue that the rise in productivity in the US can be attributed entirely to labour force growth, capital investment and the long cyclical upturn. A final judgement on this issue will only be possible at the end of the present cycle. My own view would be that the balance of the evidence, with productivity strengthening especially in the sectors that make intensive use of ICT such as financial services, now suggests that ICT has had a significant positive effect on productivity in the US during the present cycle.

  In the UK, however, the impact on productivity is not yet clearly apparent. Indeed, although productivity growth in manufacturing has increased sharply since mid-1999, there is less evidence of improvement across the whole economy. Of course, this does not necessarily mean that ICT has not had any effect on productivity. Other influences are also at play, most notably that as more people are drawn into employment due to labour supply changes, the productivity of the most recent entrants may be lower than the average as these are likely to be lower-skilled.

  The UK is also still some way behind the US in adopting ICT, so it may be that the most significant productivity gains are yet to come.

  The most relevant question for monetary policy is the effect of the ICT revolution on inflation. In sectors where the adoption of ICT is strong (in the supply chain, or in dealing with the customer) then the market for products is becoming more competitive, lowering prices and squeezing profit margins at least in the short term.

  This in the short run may tend to raise real wages, which in the absence of any supply response could actually push up inflation. However, in the UK so far as this effect has been felt, the response of supply seems to have kept pace. In the longer-run firms will need to cut costs, including wage costs, to restore adequate profit margins.

  Turning to the measurement of the effects of the ICT revolution—in terms of the micro impacts on the supply chain—these are clearly difficult, if not impossible, to measure directly. In terms of the measurement of retail prices, it is clearly important to ensure that transactions conducted over the internet are reflected in price indices as these become more significant. But of course part of the impact will in any case be reflected as internet transactions compete with conventional ones.

  15.   To what extent should fiscal policy play a demand management role alongside monetary policy? If you think greater fiscal action is desirable, what instruments would you recommend?

  It is generally argued that monetary policy, which is easier to change and has fewer undesirable effects in terms of economic distortions, should be used as the sole instrument of demand management. The year to year setting of fiscal policy is then focused on achieving long-term fiscal goals—such as the Chancellor's fiscal rules, or the constraints of the eurozone's Stability and Growth Pact.

  This approach to policy has much to recommend it. Indeed, one reason for believing that the UK is well-placed to weather the current global slowdown is that the success of both fiscal and monetary policy management over the past few years has left the UK with room to manoeuvre. However, this approach does not provide a sufficient guide to policy in all circumstances. At present, for example, fiscal policy is over-achieving on the Chancellor's rules, and how fast the surplus should be reduced requires a view to be taken on how different fiscal adjustments would affect economic growth and inflation.

  I would also agree with the proposition that at a time when the economy is unbalanced by a strong exchange rate (see Question 11) the sectoral balance may be better served by a tighter fiscal policy with more scope for lower interest rates. But this is by no means a certain solution to these policy difficulties. Indeed, it is probably as important to look at the micro aspects of fiscal policy, for example, which sector, in the short term, will feel the impact of any added burden or benefit from tax changes. However, these questions are properly for the Chancellor to decide, rather than the MPC.

  16.   What role should econometric (and other) models play in the formulation of interest rate policy?

  Econometric models are best thought of as useful tools to aid the understanding of the interrelationships in the economy. The nature of the economy is too complex for one model to capture it all—which is why a number of models are used by the Bank to answer the range of issues which the MPC is likely to be concerned with. Use of models is however not going to yield easy answers about interest rate decisions. Uncertainty about if and how past relationships between economic variables are changing, about the reliability of recent data, and the future course of factors not determined in the model, are all issues which require the exercise of forecasting judgement.

  17.   What factors have caused Sterling to be so strong over the past three years? Could a temporarily over-valued currency have permanent effects on economic growth, and inflation, in an open economy?

  If a currency moves to a level which many economists and commentators are prepared to describe as "over" or "under" valued, this tends to imply that economists are going to find it difficult to explain. I do believe that sterling has been overvalued over the past three years, mainly by comparison with the euro. By "overvalued" I mean at a level where many firms find it difficult to compete either in export markets or against importers into the UK. The decline in profitability in manufacturing firms, and the fall in investment in 1999, are both evidence of this competitive difficulty. Nevertheless, it is also true that manufacturing has performed better than many commentators (myself included) would have expected, had we known just how strong sterling was going to be. In that sense the currency has perhaps been less overvalued than earlier estimates suggested.

  To the extent that this situation is explicable in terms of economic fundamentals, the two key factors are:

    —  Stronger growth in the UK, leading to the economy being closer to, and possibly at times above, its long-term growth potential, therefore requiring higher real interest rates to keep inflation on target. In the eurozone, however, the economies on average have remained below trend and real interest rates have been lower.

    —  A perception that the UK economy has better growth prospects, due to greater flexibility, especially in the labour marker, and to earlier adoption of the "new economy".

  A temporarily overvalued currency can have long-lasting (though not permanent) effects on growth (ie a change in the level, rather than the long-run rate). These would probably be expected only if the overvaluation is significant (over about 10 per cent) and "temporary" implies at least 18 months to two years. The main channel through which this occurs is the run-down of capacity in the exporting sectors. The UK has recently been experiencing this particularly in sectors such as metal manufacturing, where the product is sold very much on price. When the overvaluation is corrected there is a shortage of supply, leading either to higher inflation needing to be checked by higher interest rates, or directly to a lower level of output, than would otherwise have occurred. (This point should not be taken as implying that this effect is necessarily very large.)

  18.   How important a role should the exchange rate play in influencing the MPC's decisions?

  In the short-term, the effect of exchange rate volatility on prices and the lag before the effect is felt clearly needs to be taken into account in setting interest rates, just as any other short-term influence on the inflation rate is. The MPC therefore has to take account of the present level of the exchange rate, and consider the possible impact of their decisions on the rate. However, it is of course impossible for the MPC to have an exchange rate target as well as an inflation target. The answers to Questions 11, 15 and 17 discuss worries about the effects of exchange rate volatility on economic prospects in the longer-term which would also need to be borne in mind, although the policy implications of these concerns are highly uncertain.


Katharine Mary Barker

Born: 29 November 1957

Nationality: British


  1974-76 Stoke-on-Trent Sixth Form College

  1976-79 St Hilda's College, Oxford (BA First Class Honours, Philosophy, Politics and Economics)

Career (with relevant job content briefly indicated):

  1979-81 Investment Analyst, Post Office Pension Fund (now HERMES)

  Analyst of, and dealer in, UK equities—primarily in consumer non-durable sectors.

  1981-85 Research Officer, National Institute of Economic and Social Research

  Forecasts for European economies and world trade as model inputs.

  Major project leading to co-authored articles in National Institute Review on comparative European macro-economic policy.

  1985-94 Chief Economist, Ford of Europe

  Analysis and forecasting automotive markets across Europe, and related corporate strategy.

  Forecasts of exchange rates and interest rates—advice on company's hedging strategy.

  Management information and presentations on economic issues.

  1994-2001 Chief Economic Adviser, Confederation of British Industry

  Developing CBI policy, in discussion with member firms, on major economic topics (chiefly UK monetary and fiscal policy; European Economic and Monetary Union). Heading up work on major issues (for example, the UK's productivity performance).

  Articulating and representing CBI policy in public (including press and broadcast media) and private lobbying activities, in Whitehall and in Brussels.

  Regular communication on policy and economic trends with member companies.

  Responsibility for all CBI business surveys, economic forecasts, and detailed work on business taxation issues.

Other appointments:

  Member of Royal Economic Society Council 1994-99

  Member of Chancellor Clarke's Panel of Independent Economic Advisers 1996-97

  Member of Institute for Public Policy Research (IPPR) Commission on Public Private Partnerships 1999-2001

  Member of Board of Governors—Anglia Polytechnic University (since 1999)

  Non-executive Director, Yorkshire Building Society (1999-April 2001).

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