Examination of Witnesses (Questions 80-99)|
TUESDAY 27 NOVEMBER 2001
80. Given your background, what do you consider
when you come to vote in decisions?
(Ms Barker) We all consider the same evidence. As
you all know, we are given on the previous Friday very long and
detailed discussion of all the different aspects of the economy
and we all look at all of them. What I think we all as individuals
bring to the Committee is perhaps different knowledge about some
of them in the way that Professor Nickell is a labour market economist,
so he would be expected to comment on that data within the committee
meetings and I will often comment on business surveys, what I
think is going on in the business community, but we have to weigh
all the evidence together. We do not all just vote because we
know about the labour market or the business community.
81. Mr Plenderleith, in the MPC minutes for
November, paragraph 32 says,"Various possible arguments .
. . were identified which might favour an immediate cut of only
25 basis points. First, the assessment of deteriorating outlook
placed considerable weight on surveys. But surveys tended to be
volatile and might be influenced by temporary factors . . . Second,
a 50 basis point cut might incorrectly signal that conditions
in the United Kingdom were as difficult as in the euro area, and
as in the United States . . . Third, a sequence of small cuts
might have a more potent effect on confidence than a larger cut
if the fact of cutting, and the attendant media coverage, were
important." Which of those arguments were you considering
when you voted for a cut of only 25 basis points?
(Mr Plenderleith) All of those, Chairman. That paragraph
reflects very much the considerations that were in my mind. They
are partly related to the situation, as best I could judge it,
in the economy, so to speak fundamental factors; whilst there
was clear evidence of the world environment slowing and of the
damaging impact of the terrorist attacks on confidence and whilst
I shared the general view of the Committee that we should be cutting
rates, it did seem to me that the evidence for the impact in the
UK over and beyond the cuts that we had already made in previous
months was much more in terms of anecdotal evidence, surveys and
expectations than in the actual data we could see. That is not
conclusive of course; actual data is always in degree backwards
looking and the surveys give you hopefully a more forward looking
view. Nonetheless I was nervous on those grounds of moving as
much as 50 basis points in one step and felt it would be more
sensible to move perhaps that month 25 basis points and then see
how things went. But my view was also partly based on grounds
of timing which is really the second, third and fourth factors
indicated there, that there seemed to be some benefit in moving
in a series of graduated steps rather than necessarily moving
sharply. Therefore, on balance, I favoured moving in 25 basis
points. As always, it is a very fine judgment but basically based
on all four of those factors.
82. Do you feel any of them have been justified
by events since then?
(Mr Plenderleith) I think it is too early to tell.
The implication of my view was that, if the situation continued
to look weak, particularly in relation to the world environment,
that there would be a good case for considering a 0.25 per cent
cut in December. That was done in November with the 50 basis point
cut. I think the evidence we have seen since then is still very
hard to interpret because there is clearly a slowing in the world
situation broadly in line with the view in our inflation report
which I subscribe to. There is clearly deterioration in confidence
but not a huge deterioration, and it is hard to distinguish the
instant impact of the terrorist attacks and the damage that causes
to confidence from the more persistent effects once people have
got over the initial shock, and that is truly what I was waiting
to see in my vote earlier this month.
83. Mr Allsopp, the Bank's press release on
18 September said it was too early to make an informed judgment
about the scale of the impact of events in the United States,
but you went on nevertheless to vote for a 0.50 percentage point
increase on 18 September when the majority of the Committee voted
for 0.25. Why did you feel that there was sufficient indication
to justify that?
(Mr Allsopp) At the time, I think I was pretty impressed
by the uncertainties andindeedthe deteriorating
world prospect, if you like, before 11 September. I had been holding
off a little; I thought the world was pretty bad and some of the
things Sushil has said are things I would, so to speak, have agreed
with. I thought that the position domestically, in terms particularly
of consumer demand and so on, was a timing reason really for being
rather cautious about the timing of reducing interest rates. In
the face of what I thought of as very large shock, one that was
likely to affect expectations, confidence and so on, I could see
at that stage no reason for, if you like, half measures and I
thought that 0.50 per cent was fully justified and that I would
be unlikely to want to immediately reverse it soon afterwards
and therefore took the view that, since that was my view, I should
vote for 0.50 per cent.
84. Do you regret that the rest of the Committee
did not follow you down that road but waited until November to
(Mr Allsopp) To be honest, the question of whether
you cut within a couple of weeks by 0.25 and then another 0.25
or 0.50 all at once, in terms of the longer run effects on the
economy, is relatively small. It could possibly have an effect
on expectations and some of what has been called the psychological
aspects of it, but, in terms of the underlying economics, that
is not a very big change, so of course I do not think it would
have made a huge difference one way or the other, in the event,
given that we, a couple of weeks later, had cut further by 0.25
Chairman: On the issue of inflation and
growth forecasts, I will ask David Ruffley to ask questions.
85. Governor, could I return to the growth projections
at Table 6.A on page 56 following David Laws's point. We had evidence
from our specialist advisers last week expressing concern about
the rosy expectations contained in those growth projections. One
figure given to us was the 39 per cent probability that growth
will be more than 3 per cent in 2003 but only a 7 per cent probability
that growth will be less than 1 per cent and one specialist adviser
said to us that he thought that was daftthose were his
words, not mine. Another witness, Roger Bootle, said it was pretty
striking. There was a consensus that these growth projections
were on the rosy side. Can you explain to the Committee why you
appear to have a more optimistic view of growth in the next two
years than outside forecasters.
(Sir Edward George) I would just draw your attention
to Table 6.D where the numbers you refer to, which are 39 and
7, the exactly comparable numbers in Table 6.D, which was 24 outside
forecasters' average assessment, is 28 and 13. Frankly, I do not
see that as being significantly different, so that I think what
you are telling me is that the people you interviewed had a particularly
strong view in one part or another of the probability distribution.
86. Could I ask about recession because the
Deputy Governor said at the press conference that the odds of
recession over the next year were much lower than 1998-99 and
yet the economic environment was slightly more benign at least
in the sense that the US was 2.5 per cent analysed growth rate,
it is nothing like that now. What is the basis for saying that
the odds of recession are less than in 1998-99?
(Sir Edward George) I think this is simply a description
of the forecast that we have made. If you ask, "What are
the grounds for it?" we have to go through every dimension
of the forecast. We think that the global environment, as I have
explained to you, is negative now. I agree with Sushil that we
have three major currency areas probably all in recession at the
same time and we expect that to persist in the next year but we
do see a pick-up from the middle of next year onwards. At the
same time, we have a domestic demand in the UK driven by consumer
spending supported by government spending which is kind of offsetting
that negative effect and that is where we come out.
87. Could I ask Dr Wadhwani what his views are
on the probabilities for growth in the next two years because
I think you said in response to Mr Laws that it was a less than
50 per cent chance of recession.
(Dr Wadhwani) I think one wants to avoid spurious
precision here but, in broad terms, I still think that the probability
of a recession in the UK is significantly less than 50 per cent
but it is significantly higher than the projections here.
88. Could you explain why you take that view.
Your view is that recession is more likely than the projections
on page 56.
(Dr Wadhwani) Yes. I think that view is primarily
driven by a greater concern about the global economy. Rightly
and wrongly, my best guessand these things can only be
a guessis that the global economy will recover perhaps
a little later and more weakly than we have in our projection
and that I think will inevitably feed into the UK economy.
89. Could I just ask why the house view or consensus
is that the global economy will perform better than your judgment
(Dr Wadhwani) I think that, as the Governor said,
so many different factors go into a forecast, so it would be churlish
to just identify one, but I guess that my personal sense is that
the investment overhang will last for longer and that therefore
the risks to consumption in places like the US are greater coming
through the labour market. The profit squeeze that we have in
the US will mean that you have more lay-offs than we have in our
projection. Added to all that, I think there are significant downside
risks from the global equity markets where I think that long term
profit expectations are still too high. These are all judgments
and it is reasonable for people to disagree on these judgments.
In my previous job, I know what it is like to have been wrong
several times, so I know to be humble about these sorts of projections.
Chairman: I think we are getting a feel
for Table 6.A to D on page 56.
90. If uncertainty has increased since 11 September,
why has the spread of possible outcomes for growth remained virtually
unchanged since the August report?
(Mr King) Because two things have happened, really.
One is that the outlook for the world economy, and hence therefore
to some extent the UK, has changed. I do think that we should
not lose sight of the fact that the outlook for the UK does not
depend solely on the outlook for the rest of the world. Also,
because we have seen significant revisions to the data and we
have seen a much faster than expected growth rate in the third
quarter, the 12 month growth rate to the end of Q3 this year was
no less than 0.6 percentage points higher than we had expected
in August, so there has been a significant revision upwards in
the growth that we have seen over the past year. So what the fan
chart for growth shows you is the outcome of a picture in which,
over the past year, growth has been much faster than we had expected
only in August. We do expect quite a slowing of growth in the
next two to three quarters, so we do have quite a weak picture
over the next two to three quarters but then we see some recovery.
The result is that, if you are looking at what happens to the
growth rate over each 12 month period as it moves along, that
growth rate does not actually change very much and it is that
which gives you the relatively low figure for the probability
of a fall in output over any 12 month period. We do expect weak
growth over the next few quarters. So, I think it is a combination
of clearly the big news on 11 September and we have also learned
since 11 September that the world economy, not only in the US
but also in Europe and Japan, was weaker than we thought, but
we have also seen that the UK economy was actually quite a lot
stronger than we thought despite that fact.
91. If you have learned a lot since 11 September,
can you tell us why it was necessary to have a special meeting
of the Committee on 18 September when you had a normal meeting
scheduled a couple of weeks later.
(Sir Edward George) Clearly, the fact that other central
banks had moved again at special meetings was something we needed
to consider. I think our instinct was that really we would be
better to wait until we had our normal regular overview of the
monthly data and we actually would see more what had happened
in the financial markets. Given that the United States moved,
which we had anticipated, before the opening of the US financial
markets and given particularly that the ECB which had not moved
on the Thursday before the US moved but did decide to move on
the Monday, we thought it was sensible to actually consider whether
we should respond to that new factor in the situation and we decided
then to have a special meeting and we moved by 0.25 because we
actually felt that that was appropriate to our situation.
92. You describe the 0.25 in the minutes as
signalling the Committee's responsiveness to the change in economic
conditions, which is presumably what you are supposed to signal
anyway at regular meetings.
(Sir Edward George) One of the changed economic conditions
was what had happened elsewhere.
93. The other banks' decisions?
(Sir Edward George) Yes.
94. Dr Wadhwani, in your speech in Edinburgh
which we have already picked over today, you said that your personal
inflation projection was lower than the best collective projection
published in the inflation report. Why do you think it would be
up to 0.5 per cent lower in two years' time?
(Dr Wadhwani) Essentially, there are three reasons
for that. The first is that, as I said a little earlier, my central
projection for the global economy is somewhat weaker. The second
is that I think that the global dis-inflation that we are likely
to see has a more important effect on the UK inflation than is
reflected in the best collective projection. The third is that,
in my personal judgmentand I should add that, in everything
I have just said, these things are all necessarily uncertain and
we all somehow have to come up with our own personal judgmentsthe
third source of disagreement is about the supply potential of
the economy. That is the degree to which I think the economy can
grow without triggering inflation. Those are the three principal
reasons why my best guess for inflation two years out is about
0.50 per cent lower than the best collective projection.
95. Would that analysis have justified you voting
for more than 0.50 per cent?
(Dr Wadhwani) If there were a mechanical link between
one's projection and the decision, the answer is surely "yes",
but there is no mechanical link and I think, as I said in an earlier
answer, I did contemplate 75 basis points but, for reasons of
psychology, did not think that was a prudent course.
96. Governor, I think you would confirm that,
as a result of 11 September events, the Committee has cut interest
rates more quickly than they might otherwise have done because
of the perceived impact on confidence. If it turns out, as some
of the answers have suggested might be the case, that confidence
recovers relatively quickly perhaps as result of a successful
operation in Afghanistan and perceived diminution of terrorism,
could we expect a fairly rapid rebound in interest rates?
(Sir Edward George) I think the point we have tried
to make publicly is that we do have to be extremely vigilant on
the upside as well as on the downside and certainly whether it
was simply a consequence of stronger confidence, whatever the
reason, if we actually see the economy performing and likely to
continue to perform more strongly than we have in the forecast,
particularly if we see a recovery in external demand, a dying
down of some of the dampening external influences, then we will
have to be alert to the possibility of actually having to move
promptly in order to slow down the growth of consumer demand which
we have been seeking to encourage because we are, as I said at
the outset, seeking to offset these negative influences from abroad
by sustaining domestic demand. The price of that is that we have
a very big imbalance within the economy between the internationally
exposed sectors and the domestic sectors and it is uncomfortable,
acting as we are, to sustain it, but it is actually not ideal
though it is better than simply accepting that the economy should
experience an unnecessary loss of output and an unnecessary rise
in unemployment. So, yes, you are absolutely right but whether
it was simply the confidence factor or developments in the economy
relative to our present expectation, we certainly do have to be
just as sensitive to changes which point to upside risks as we
have been to downside risks.
97. The impact on psychology of an interest
rate change is obviously immediate and the impact on longer term
investment decisions is much more of a lagging effect and I wonder
whether you are concerned that this possible zigzag approach will
in fact have a delayed impact on the economy at the wrong moment,
that the decision to cut will have led to an inflationary impact
perhaps 12-18 months down the line and the decision to increase
would perhaps also come at the wrong time.
(Sir Edward George) As I say, yes, we are conscious
about that and we are conscious particularlyand there have
been lots of discussions reflected in our minutesof the
imbalance within the economy. Of course there is a concern; we
could fall off on either side. If we do not cut, then we could
have a weakening of domestic demand which would mean that the
economy would be overall weaker than we anticipate. If we over-stimulate
and are not sufficiently reactive in the sense of reacting to
a change in that perception, then we could get an upside risk
which would actually carry with it the danger that we got a sharper
correction and unsustainable consumer spending growth sometime
in the future. So you are absolutely right that there are risks
on either side. What we did reflects the judgment that the risks
in the short-run anyway are on the down-side or would have been
if we had not responded.
98 . Governor, are you entirely confident there
is no risk of Britain experiencing deflation?
(Sir Edward George) It is not our expectation.
99. How are we going to avoid the Japanese scenario?
(Sir Edward George) I think we are a very long way
away from the Japanese, but I am never confident about anything.