Examination of Witnesses (Questions 140-159)|
TUESDAY 27 NOVEMBER 2001
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
liessome 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
142. Somewhere between 5 and 50 leaves quite
a large range. There is a wider public out there quite interested
(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.
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
assessmentnot the central assessmentis 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
(Sir Edward George) No, we are setting it until next
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
(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
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 reallyit is that weaknessand 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
(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.
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
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.
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.