Select Committee on Treasury Minutes of Evidence

Examination of Witnesses (Questions 140-159)



  140. Let us go back to the questions you were being asked earlier about the balance of probabilities for numerical value. You said that the chance of recession was less than 50 per cent but you felt that it was certainly more than 1 per cent.
  (Dr Wadhwani) Yes.

  141. Can you give us some feel about where this lies—some sense of the range?
  (Mr Wadhwani) I was personally reluctant to be pinned down to a number, so what I said in my earlier answer was that it was significantly greater than the 1 to 5 per cent that was in the report. However, I also thought it would be below 50 per cent.

  142. Somewhere between 5 and 50 leaves quite a large range. There is a wider public out there quite interested to know.
  (Mr Wadhwani) One in four.

  Mr Tyrie: Twenty-five per cent.


  143. I think we are in familiar territory again.
  (Sir Edward George) Chairman, could I just make a point which has not really been made and which may be helpful to the Committee? That concerns the role of the forecast. We do this forecast every quarter. The forecast is really a kind of benchmark against which we can monitor the incoming data. If the incoming data proves to be inconsistent with the projections that have been made then we will change our judgment. So that, I think, what seems to be concerning Mr Tyrie is that we may be taking a huge risk that we are going to suddenly go into recession. It may be that that would happen, but if we see evidence which is actually affecting our judgment of the likelihood of that then we will respond to it. It may mean that we are a bit late but the alternative is to say "Well, this is the worst thing that might happen" and to direct policy to avoiding the worst thing that might happen. That carries the risk that you can actually create problems on the other side. That has been, necessarily, a constraint, particularly in this context of imbalance where we do have a concern that we could over-stimulate domestic demand, we could then see an abrupt contraction as an over-indebted household sector began to readjust. We could then see an abrupt adjustment because the current account of the balance of payments became so large that we found it difficult to finance. It is not as if we can ignore the risks, but what the forecast does is to say "Well, taking account of the risks on both sides, this is where we think we probably are" and it is a benchmark against which we will be monitoring the evolution of the global economy and our own economy as we move forward.

Mr Tyrie

  144. One quick question on the forecast. In drawing up the forecast, do you take account of the psychological impact publication of the forecast may have on expectations of non-activity? In other words, is one of the concerns that you take into account when you draw up the forecast that this itself may affect outcomes, or do you ignore that totally? Is there an element of aspiration sometimes in the drawing-up of a forecast?
  (Sir Edward George) No, because that would put our credibility totally at risk. If we try to do the old soft soap and say "Don't worry—

  145. Or vice versa.
  (Sir Edward George) Or vice versa, absolutely. That really would be terribly dangerous for the committee to do.

  146. Why do you think it is right that you should take that view for the MPC but, as we know, Gus O'Donnell and others have made clear that on fiscal policy a deliberately cautious assessment—not the central assessment—is made public?
  (Sir Edward George) That has to do with cautious assumption about the trend rate of growth and what is sustainable, and I think that is because they are eventually setting fiscal policy for the kind of medium-term.

  147. You are setting monetary policy for the medium-term.
  (Sir Edward George) No, we are setting it until next month.

Mr Cousins

  148. Coming back to the question of the exchange rate, the last set of minutes that we have, in paragraphs 16 and 17 of the Minutes of the Monetary Policy Committee, records there being two groups with two quite different views. In paragraph 16: "Some members placed considerable emphasis . . . on the . . . upside risks to inflation from the possibility of a sterling depreciation". In paragraph 17: "Some other members were doubtful whether downside risks to sterling implied upside risks for the inflation outlook . . ." I just wondered if the panel here today could identify which group they were in.
  (Mr Allsopp) I was in paragraph 17.
  (Kate Barker) I was in paragraph 17. I also made a speech in Edinburgh in which I think I very clearly indicated that I took that view.

  149. Governor, it is unfair to ask you. You are Mr Consensus.
  (Sir Edward George) Absolutely.

  150. Deputy Governor?
  (Mr King) I was in paragraph 16 where you will see it says " . . .not easy to see how the external/internal imbalance could be resolved at the current real exchange rate." I do think that if the exchange rate were to fall significantly then one would see an impact of that on the inflation rate, other things being equal. We have seen that in the past, too. What that would mean for monetary policy would depend entirely upon the circumstances at the time. So I draw no conclusion at all about what that would imply. I think it would be very odd to ignore the consequences of a fall in the exchange rate for the outlook for inflation when what we have seen in the past few years is the impact of the rise in the exchange rate which has put downward pressure on inflation.

  151. Mr Plenderleith, you are a paragraph 16 man?
  (Mr Plenderleith) I, too, am in paragraph 16. I have been uncomfortable at the impact of the strong exchange rate for several years past. I can see that one could explain some of that by the high regard that the UK has come to have in financial markets around the world for stable and successful policies. Nonetheless, as the economy slowed I would have expected sterling to have depreciated, and I am puzzled that it has not. I feel there is a risk that it will at some stage. I can see benefits to that in relieving some of the pressures that have caused the imbalances we were talking about earlier, but I can see inflationary risks as well. I would absolutely want to understand why it is depreciating and what effect it was having before I thought about the policy response, but it seems to me that it is much more likely to fall than to rise, looking forward. That is why I was keen to have that risk in the forecast.
  (Mr Wadhwani) I am a paragraph 17 man in the sense that I think that what we would do in response to a fall in the exchange rate would depend on the circumstances under which the fall had occurred. I can think of a wide range of circumstances under which an exchange rate fall would not be accompanied by significant inflationary pressure. For those reasons I think it is unhelpful to be talking about an upside risk to inflation from that source at this point, because other things being equal that actually risks pushing the exchange rate up now. Therefore, I am firmly in paragraph 17.
  (Mr Allsopp) Can I make a further remark about exchange rates because I too have made a speech about just this issue. I think the difference between members of the committee should not be exaggerated. Everybody knows the exchange rate might go down, which contributes to inflation; everybody knows if the exchange goes down, it is positive for demand and output, and if you have already very high employment and inflationary pressure, that would be bad. I think where we differ is the likely circumstances under which it might happen. Just to balance it out, a favourable circumstance, which I do not regard as unlikely, would be that, somewhere out there, there is a fall in demand, perhaps as consumers lose confidence, and at that point possibly markets are anticipating there might be a monetary response and that might then feed through to a downward movement on the exchange rate. The result of that would be the classic text book way of trying to get out of the joint imbalances in the British economy, namely a fall in domestic demand balanced by some pick-up coming through a lower exchange rate. No one would think those things would happen exactly in that kind of way but it does seem to me, somewhere out there, there is a situation which might not be all that bad, and in fact would not be particularly bad for inflation.


  152. Ms Barker, do you wish to claim a paragraph before we move on?
  (Ms Barker) I think I covered that in my previous remark, Chairman.

Mr Fallon

  153. We have heard you are uncomfortable with the exchange rate, and the Governor said he was consistently puzzled by the exchange rate, and you also said, Governor, earlier today that you did not know what to do about it. I did not know there was anything you could do about it. Presumably the one thing you could do about it to improve convergence with the euro would be to raise interest rates, which is the one thing you cannot do because it is not in your target.
  (Sir Edward George) Usually people suggest that we could weaken the exchange rate by lowering interest rates. Most theory would suggest that was the likely outcome and people in a rather simplistic way say, "You know, if you just got interest rates a bit lower, the exchange rate would be lower." What I point out is that presumption is actually not very reliable because you can see for quite long periods of time it just does not produce that effect, and the reductions in interest rates in the United States which have been pretty dramatic have not weakened the dollar at all, in fact the dollar is stronger than it was to start with. The same is true to a lesser degree of the reductions in interest rates here relative to Europe, where sterling is still stronger than it was at the beginning of the year.

  154. Does that not lead you to the conclusion that you can, if you wanted to improve the exchange rate, raise it rather than lower it?
  (Sir Edward George) Frankly, yes, we have discussed that possibility, and the way that could happen is if the exchange rate is reflecting perceptions of the strength of the economy and the prospective rate of growth of the economy and the returns that would generate. That is really consistent with Christopher's scenario, where if we hammered the economy and dampened down consumer spending we might very well make people think we were pathetic and that would reduce the value of sterling. But I am not sure many people are advising us to do that.

  155. But to get the value of sterling down to the kind of level that manufacturing would want if we were ever to join the euro, that would imply in fact not convergence of interest rates but eventually more divergence of interest rates, would it not?
  (Sir Edward George) If you were pushing the interest rate up in order to bring the exchange rate down, that would be true, yes. If the overall effective exchange rate were to fall very sharply and put up the pressure on inflation, then if at that stage consumer demand was not moderating of its own accord, yes, indeed, we would need to raise interest rates in order to restrain consumer demand and control inflation. If, on the other hand, the euro were to recover against the dollar, which is the puzzle really—it is that weakness—and we stayed somewhere in between, so although we weakened against the euro we actually strengthened against the dollar, the inflationary effects and therefore the implications for monetary policy could be quite different.
  (Mr Plenderleith) Could I add to that that I think the Governor's last remark illustrates an angle one has to keep in mind, that in thinking about the strength of sterling and the problems that is causing us, we have to recognise that looking back over the last couple of years sterling has in fact come down against the dollar. We were around $1.60, for the last year we have been in the range of about $1.40 to $1.45. It is against the euro we have looked extremely strong and at least some of the cause of that must lie in relation to the euro itself. So one is asking questions about what we could do about the strength of sterling, but actually one has to be talking in terms of what is causing the weakness of the euro which is giving such discomfort, and it does not lie in our hands to do anything about that directly.

Mr Beard

  156. Can I go back to the international scene. We have Japan which has got to the point where monetary policy is having no impact on stimulating the economy at all. America has had a 4.5 percentage point drop in its interest rates from the beginning of this year, it now has interest rates at 2 per cent. How much leeway has America got before it comes to the same position as Japan and cannot stimulate the economy by way of its monetary policy? If that happens, what are the likely consequences?
  (Sir Edward George) The glib answer to that, Chairman, is 2 per cent. If the import of the question is, is monetary policy in the United States going the same way as it has in Japan and is it losing its effectiveness, I think that is myself a very unlikely proposition. Monetary policy always takes time to work, and you will see the monetary policy in the United States working. To the extent they feel they need to do more, they have a little more they can do. I think it is significant that in the United States there is also talk of fiscal stimulus.

  157. Is there a risk of this happening, that you could get to a point where further reductions by the Fed will mean you are very nearly at zero and nothing is happening because the recession is well entrenched?
  (Sir Edward George) I have no reason at all for supposing that, and I think the contrast between the situation in Japan and the United States is great, so I do not have that kind of presumption.

  158. But 2 per cent is not very far.
  (Sir Edward George) Another 1 per cent cut is half the level of interest rates; 4 from 6 is only two-thirds.

Mr Laws

  159. I have one quick question and one clarification. The question is, on this issue of the exchange rate, it is largely, is it not, as Mr Plenderleith suggested, that the over-valuation of the pound is against the euro rather than against other currencies?
  (Sir Edward George) Absolutely.

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