Select Committee on Treasury Minutes of Evidence

Examination of Witnesses (Questions 100-119)



  100. Does any member of your committee think there is any likelihood in the near future of inflation going below 1.5 per cent and you being forced to lick the stamp on a letter to the Chancellor?
  (Sir Edward George) We had a discussion earlier about that and that is, really, reflected in Table 6A and Table 6D.

  101. I do not really want to go back to that.
  (Sir Edward George) As I say, it is possible some people may think that is more likely than others, but the centre of gravity of the committee is that it is pretty unlikely.

  102. If any of the possible candidates here think it is slightly more likely, would they speak up?
  (Mr King) Please do not get too obsessed by this "below 1.5 per cent inflation". The most remarkable thing about the past five years is that inflation has been within an extraordinarily narrow range and the most likely thing that would lead to inflation falling below 1.5 per cent over the next year is not, in any sense, a failure of policy, it is just a sharp movement in oil prices or seasonal food prices, which can be reversed. What matters most is not whether or not inflation falls below 1.5 per cent but the reason for it. If it is one of those temporary factors then we will explain it.

  103. You actually say, and there are only a couple of paragraphs in the entire report about it, that oil prices are falling very steeply. Are you considering what impact on the economy that is going to have? What are the expectations about oil?
  (Sir Edward George) I do not think we can second-guess the oil market, so basically what we do is to take the starting point, which is an average of the oil price over a period, and we take the forward price for oil as reflected in the markets.

  104. Do you disregard, therefore, the commentators out there who are talking about a $15 barrel or even a $10 barrel in the not-too-distant future?
  (Sir Edward George) People are actually trading in oil at higher prices than that or had at the time of the Inflation Report, and we frankly think that the people who put their money where their mouth is are probably more reliable than commentators, but, of course, there are risks always around these things.

  105. What would the impact on the UK economy be of a $10 a barrel price?
  (Sir Edward George) It is actually rather helpful. Eighteen months ago, or whenever it was, it was down to $10 a barrel. It would provide room for policy stimulus not just in this country but elsewhere too. So that in the short-run it is not an unhelpful development. Of course, the problem is the volatility of the oil price, and if it fell to that level then we would get less production in the future and you would see it rise more sharply in the future. I am, personally, very supportive of the objective of the OPEC countries who are trying to stabilise the oil price within that kind of $20 plus range. I think managing any kind of market price is extremely difficult, but I think it would actually be very desirable if that were the outcome.

  Chairman: We are going to move on to recent economic developments.

Mr Beard

  106. Sir Edward, you have already mentioned the imbalances in the United Kingdom economy which have several different manifestations, such as the manufacturing sector looking rather depressed compared with the bubbling in the retail sector; there is the corporate sector reducing investment while the private sector has increasing debt, and we have got the old division of North and South with the North East and, say, the South East of England. A lot of that is expressed in the fact we are getting poor exports against a bubbling growth in consumer expenditure and a rising balance of payments. How concerned is the MPC about these imbalances and, in particular, how long can the United Kingdom economy go on stoking up domestic demand with a rising balance of payments deficit?
  (Sir Edward George) Well, as I said, we are concerned abut these imbalances. It is extremely uncomfortable, but the question is what can we do about them. Since the origins of the imbalances are mostly external in origin we cannot directly ourselves affect the rate of growth in the United States or the euro zone. Some people think we could affect the exchange rate but that is more difficult than people assume. I have pointed out very often before that the United States has reduced its interest rates hugely relative to those of the euro zone but the dollar is stronger than it was before they started, and the same is true to a lesser degree of what has happened in terms of sterling interest rates against euro interest rates. So we cannot directly influence the exchange rate either. Given that we cannot do anything about those things, we have a straightforward choice. Are we going to pursue our mandate, which is stable inflation, by encouraging, in compensation for those negative influences, the growth in domestic demand—uncomfortable though that is—or are we simply going to not do that, in which case the economy would be very much weaker and unemployment higher than if we did do it. That does not seem sensible but in any case it would be inconsistent with trying to achieve 2.5 per cent inflation, which is a symmetrical objective. So it is not ideal but it is the best available course to us.

  107. These are quite substantial qualifications on the general projections in the inflation report, yet this question of the mounting balance of payments deepening in exports and the increasing problems there for you hardly get a mention in the report.
  (Sir Edward George) They are certainly referred to. I think that concern is part of the concern that underlies the sense that we could see a kind of rapid, sudden exchange rate adjustment. That is the point really reflecting this growing imbalance on the trade side. All I can say is that it has actually persisted for some time and it has not happened. It has persisted in the United States where the trade deficit is substantially larger as a percentage of GDP than it is here, and so anticipating when that kind of form of correction is triggered is extremely difficult. In the meantime, as I say, I think we are better off living with it than simply trying to not respond by sustaining domestic demand and accepting lower output and also, therefore, lower inflation.

  108. Would these black clouds not lift rather more if the circumstances were right for us joining the European Monetary Union and avoiding some of the external problems?
  (Sir Edward George) I am not sure which is the chicken or the egg. Part of our problem is the weak euro and the strong sterling exchange rate against the euro. So the consideration is the rate at which we were to go in. This has cropped up a number of times. If the suggestion were that we should give up on our inflation objective and try to drive the exchange rate down in order to make that feasible, then I think that would have disadvantages, too. Somebody would have to change our instructions if we were to do that. That is quite apart from the five tests which are very much the Chancellor's province.

  Mr Beard: Are there any members with varying views from those that the Governor has expressed?

Mr Ruffley

  109. Just very quickly, Governor, on the very poor balance payment performance relying on strong domestic demand. Could you take the Committee very quickly through what assumptions you are making in the next two years about what is going to happen to this balance of payments deficit and how persistent you see it being? Do you see it deteriorating? Secondly, what assumptions are you making about demand domestically holding up as it appears to be holding up? What are those two sets of assumptions?
  (Sir Edward George) I cannot remember the precise number (maybe, Mervyn, you can) but we have got a balance of payments current account deficit of something like 2 per cent of GDP right now and we expect that to deteriorate fairly gradually over the next two years. As I say, it is not enormous, it is half the size of the equivalent position in the United States. The indication of when it becomes of concern will actually be in the exchange market, and so long as it is financable without great difficulty that is fine; it is the problem of if the capacity to finance it erodes that it becomes a concern. The second imbalance?

  110. Strong domestic demand in the context of poor balance of payments.
  (Sir Edward George) We do anticipate that investment, basically, will be pretty weak through the forecast, picking up in the second year; that consumer demand will gradually moderate (I have to say we have been looking for that for some time, too, and it has held up rather better than we anticipated) and that government spending will grow in line with the Chancellor's objectives.

Kali Mountford

  111. Does not that rather smooth response cover huge disparities in regional growth, particularly in industry? Do you not think that for the manufacturing sector, especially in textiles which is significant in my own area, with the 30 per cent reduction in production and output, the policy of waiting to see what happens in the rest of the world, in the Euro zone and in America does nothing for the people in those jobs?
  (Sir Edward George) I absolutely understand that and, of course, we are constantly visiting the regions and in touch with those people, and we have all that fed to us month-by-month through the regional agents. So we are perfectly well aware of that situation. What I think you have to try and hold on to—which is what I try and hold on to—is that overall macro-economic stability that we have seen for nigh on the best part of eight or nine years has been a tremendous thing for the British economy as a whole. It has been a particularly good thing for the labour market, as employment has increased pretty well continuously until very recently over that period; and unemployment has come down on both measures until, again, very recently. What you have to hold on to is that that is true not just for the United Kingdom as a whole but it is true for every region in the United Kingdom, notwithstanding the imbalances that have emerged. The question is, if you try to do something in order to protect particular sectors of industry then you would put that at risk. What could we do to try to offset these influences? I repeat, they originate abroad. What could we do to try to offset them? The only thing we could do would be to really try to pump up, to compensate for, that demand on those sectors which are internationally exposed. I am not actually sure how we can possibly attempt to do it, but if we did attempt to do it what is very clear is that we will generate instability for the whole of the macro-economy. I think all past experience would say that that would not do much for the adversely affected sectors except, conceivably, in the short-run if we could succeed.

  112. Is there not a long-term problem if one sector goes into what looks like a permanent decline?
  (Sir Edward George) You deal with that, of course, all the time. The expansion in the Far East is having that kind of effect in a structural sense. Then there is the emergence of Eastern Europe. There is a lot of business activity being relocated, not just from this country but from elsewhere in Europe, to Eastern Europe and into Asia. So, to some extent, that is how the economy works. The important thing is that, if that is going to happen, you actually get a change in the activity in this country which replaces the activity that is in decline. I think that the exchange rate has taken us beyond that. The exchange rate can be constructive if it is putting pressure on industry to improve its performance. However, we have gone beyond that and I do not know what I can do about it.

  113. I wonder if Ms Barker, with her particular macro-economic background, has anything to add to that?
  (Ms Barker) I think the distinction I would draw, in terms of what one would be concerned about, would be the distinction between the sectors and the regions. The Governor has just said, and it is absolutely right, that in the long sweep of history sectors rise and fall and the difficulties of the textile sector—which we all understand are very great—are very much driven by a set of global factors even beyond the exchange rate, which may mean that production for that sector in this country is becoming less economic. Where it is then a problem is if in a particular region you do not find you have other opportunities coming along and you have the position where you have regional imbalances. These are difficult because they lead to people being out of jobs for a long time and a draining of skills, and that is the kind of thing that we would, at least, have concerns about because it may affect the whole economy. However, in terms of what the Monetary Policy Committee can do, we simply cannot do anything to affect and help particular situations. I agree that regional imbalances are things we need to look at, and as people we are concerned about it, but as policy-makers—to the extent that there is a role for policy there—it is a role for fiscal policy and the way in which the Government manages the country. Sadly, we are not all powerful.

  114. Do you think that regional imbalances are, in the main, due to sectoral differences?
  (Ms Barker) They can be due to sectoral differences. Certainly, at the moment, the regional imbalances that we see are very much driven by the imbalances that have been extensively referred to, between the tradable and non-tradable sectors, and that, at the moment, does lie at the root of most of the regional imbalances in the UK.

  115. There is a huge difference between the South East and the North East (which I think perhaps is the biggest difference) and you are painting a pretty gloomy picture that we cannot bridge that gap.
  (Ms Barker) No, I certainly would not paint a gloomy picture that over the long-term you cannot bridge the gap, but I am saying that we cannot—in terms of actual monetary policy—do anything to help address that gap. The best thing we can do for the country in the long-term, as the Governor has already said, is to encourage macro-economic stability. To the extent it is clearly an issue for policy it needs to be dealt with by considerations from fiscal policy and from regional policy, such as actions by the RDA. It is not something the Monetary Policy Committee itself can address.

  116. Do you feel you know enough about what is going on in the regions?
  (Kate Barker) I certainly think the RDAs themselves know a great deal about what is going on in their regions, but you are asking whether we, as a committee, know enough about what is going on in the region, and the answer to that is that given both the amount of time we individually spend going out into the regions and talking to businesses and the amount of time we spend listening to the very good reports we get back from regional agents, yes, we absolutely do, and it is a vital part of the macro picture we have to build up to enable us to take our judgments.

Mr Mudie

  117. I wonder how you think it comforts somebody on a Liverpool council estate or somebody in machine tools, textiles, optical products, electrical engineering—all sectors—who are experiencing great difficulties to be told that "macro-economic stability will deal with your problems?" Can you tell us how macro-economic stability will deal with their problems?
  (Ms Barker) I do not think it is in the least comforting for anybody who is in a sector in difficulties who has a particular skill set they have invested in to realise those difficulties are very great. I do not intend to bring them any direct comfort. The point about macro-economic stability is that over the long-term it affords the best prospect of growth in the economy as a whole, and that means the best prospects for growth in other sectors, and that should mean the best prospect of job opportunities in those sectors. Now, clearly, if you have a particular skill set, that is going to make it very difficult for you and there may be a period of adjustment. I certainly do not wish to imply—and I do not think I have implied—in any of my answers that as people we do not find those situations difficult and distressing. I am simply saying that as policy-makers it does not lie in our power to address it.

  118. I am sorry I picked on you but you were the last speaker. The Governor worries me more because the Governor actually said at one stage "I do not know what to do". The macro-economic theory that is propounded sounds like the "redistribution of wealth with a trickle down" theory. If we have growth eventually it will reach Liverpool, Newcastle, Bradford and Halifax. That is very comforting but the people in those cities will tell you it has not reached them for 100 years. How soon is it going to come? You shake your head.
  (Mr King) I was in Newcastle last week and I did not get the message that people say they have not had growth for 100 years. The gap in unemployment rates between the North East and the South East has narrowed over the past two years. There are problems in the industrial sector but it does not help to exaggerate them. The fact is that the gap in unemployment has narrowed. That is a fact.

  119. Am I exaggerating when I read from your minutes that: "The Bank's regional agents had reported that business confidence was weak, with further declines in manufacturing orders and slowing activity in business services"? Am I imagining that the regional differences we are speaking about are not growing, and secondly, manufacturing is continuing to decline?
  (Mr King) Let us take them separately. It is true that manufacturing output has fallen over the past year. There is no doubt about that. A major contributory factor to that, over and above the slowdown in the world economy, is the exchange rate, as the Governor said. I think we have been honest on our side of the table in saying that we do not think that there is any magical or simple answer to the problem of the exchange rate.

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