Select Committee on Treasury Minutes of Evidence

Examination of Witnesses (Questions 20 - 39)




  20. On the wider economy and imbalances in the economy, what has this Budget done to correct imbalances? Or would you agree with some commentators who have said that the Chancellor has ducked that, the consumer boom is going to continue and it will be up to the MPC to correct any imbalances?
  (Mr Barr) You can argue it is not up to the Chancellor to address it at all, that is why there is an independent central bank and it is their job to address these imbalances and overall meeting the inflation target and making sure the whole economy is growing close to its productive potential. That is the first point. I think to use the word "duck", even though it is tempting, I may have done it myself immediately after the Budget speech, is a little bit harsh. It is certainly fair to say that he did not do anything to slow the consumer really. About the tax increases that we are seeing directly on the consumer sector, we should note (a) they are not happening for a year and (b) most of it is being given back in the form of tax credits. There are also many people making the argument, as has been said earlier, that it is a redistributive Budget so, if anything, it might lead to an expansion in consumer demand. I think the burden is completely on the MPC to address this issue and to say whether it is a problem and whether some issue needs to be taken. I think what is interesting though, and I think this is a point Tim mentioned earlier, is you now have both sides of policy making, both the monetary side and fiscal side, saying to us that consumption is going to slow very aggressively next year, and most of the policy projections we see have it returning back towards trend without really saying how that is going to happen. If you look at the Chancellor's trend growth forecast he is telling us there are going to be further rises in employment, further rises in population, and that does not suggest to me an environment in which the consumer slows on its own. Of course what we do not know is what level of interest rates the Treasury is using in their growth projections, but I do think it still remains out there. Should we be slowing the consumer and, if so, is it going to have to be monetary policy and when should that process begin? Of course, we heard the Governor at the weekend telling us he is not overly concerned about it at this stage.
  (Mr Weale) If you look at the employers' national insurance contribution in the medium term I think it makes very little difference whether you collect taxes like that from employers or employees, in the end they are taxes on labour income and where you take it out of the pay packet does not matter enormously. I think in the short-term, in effect, it is rather likely to be paid out of saving, consumers will carry on, it will either be paid for out of profit or despite the tax advantages on pension contributions, that you do not pay national insurance on those, I do think that for employers who are looking at ways of saving money it will give added impetus to reducing employers' contributions and that again means that the tax will be paid out of saving. This will continue a trend that really we have seen since 1997 that as the Budget has moved into surplus so household saving has fallen and fallen, and I am not sure that that is the appropriate thrust that policy should have taken.
  (Professor Congdon) Could I make a point here. The big imbalance in the economy in the last six years now, getting on for seven years, has been domestic demand rising faster than output with growth in consumption being the most conspicuous feature of growth in domestic demand and, associated with that, imports rising faster than exports. I think it is a fair comment that this Budget does not really do very much to address those imbalances. It is true, nevertheless, that it does increase taxes in line with increase in spending and in that case that is responsible, but it does not actually attack the imbalances in terms of excess consumer spending. There is an aspect of the forecast which I think one might raise eyebrows about and that is the volume of exports. It is expected to fall by about one and a half to two per cent this year and then to rise by seven and three-quarters to eight and a quarter per cent next year. It is true that there have been swings of that sort between years of poor export growth and then extremely fast export growth in the past, but typically these have been after a big exchange rate movement and I cannot believe this Government really wants the pound to fall heavily in the next six months to a year. I think that some questions might be raised about these forecasts for exports and they need to be seen in the broader context of the Budget not really dealing with the imbalances in the economy with excess consumer demand.

Mr Tyrie

  21. What table are you on?
  (Professor Congdon) Page 200. I think it is in one of the other places in the Budget documents as well.

Mr Plaskitt

  22. Can I throw in a supplementary there? The Chancellor said in his statement that he expected world trade to grow by 8½ per cent in 2003, is that not an important underlying assumption on export volumes?
  (Professor Congdon) Yes, that is a fair comment. It seems a very high figure to me. There have been figures like that in the past but it seems a very high figure. I would not get too alarmed about all this but just review it critically.

  23. But you seemed to say that you thought he was working on an assumption of a devaluation in the exchange rate, but there is also an assumption about the growth in world trade.
  (Professor Congdon) Do not forget, it is not just the growth in world trade, it is the growth of world trade going from a minus figure in 2002 to plus 7¾ to 8 in 2003.
  (Mr Weale) The picture I have is that these figures are broadly in line with the squeeze in world trade. The difficulty arises, or at least the complication, because of the difference between the annual profile and the monthly profile. World trade fell sharply between January and December of last year, but the average figure in 2001 was quite a lot above the average in 2000. Because of the fall from January to December, even if we have a modest pick-up during the year, the average in 2002 will be below the average in 2001. I think that is built into the projection. A greater worry perhaps is that the most recent data do give a hint that Britain has started to lose its share of world trade again. It has been stable for about two years and there is a hint in the latest figures that maybe we are losing export share again.

  24. Can I move on to the European question? The Chancellor said in his statement that he feels he is well within the Maastricht criteria for the euro. Does anyone dissent from that statement? You all think it is right? No dissent from that statement? He also told us, and I would like your comments on this, he had written to the Governor of the Bank of England reasserting the symmetrical inflation target of 2½ per cent. He then went on to describe it as "a target which is not only pro-stability but also pro-growth". Would anyone like to interpret that statement and suggest why he said it and whom he might be addressing?
  (Mr Barr) He is obviously reflecting the symmetrical nature vis-a-vis some other targets. The Government has made it very clear for a long time that is why they have this range and prefer that to the ECB target of 2 per cent or less, which is an asymmetrical target. That is something which Gordon Brown has been promoting as a policy issue and benefit, if you like.

  25. Do you read much significance into the fact he has said that?
  (Mr Barr) Personally not, no. My own belief is that in years to come we will see significant reform of the ECB anyway ahead of enlargement, so I would not be surprised if the ECB changed its target to a more symmetrical one.

  26. But does it not suggest to you that the Chancellor might be minded against sterling entry into the euro on the current stance of the ECB, and that a change in that stance which you are forecasting would be a pre-condition in his mind to ticking the box for entry? Is that what you are saying?
  (Mr Barr) No, it is not what I am saying. I am saying why I think he has said that. He is reaffirming his inflation target, reaffirming the confidence that the financial system has in that target and reaffirming the success, to be fair, we have seen in meeting the inflation target. I think to look deeper for hidden EMU messages is a mistake. I am not sure that is the signal he is trying to give.

  27. What leads you to think the ECB will reform?
  (Mr Barr) I think we will have to see ECB reform ahead of things like enlargement. The ECB for its first three years of operation I think was reasonably insecure, reasonably uncertain, needed to bed down, needed to be seen to be trusted by the financial markets, and I think after a rather shaky start in terms of perceptions, in terms of transparency, it has actually come on a long way in recent years. I think as we go forward we will see—and I am not talking about next year or the year afterwards but five or ten years ahead—the ECB, as it expands, as it takes on more countries, potentially the UK, it will be much more open to reform in the way it conducts monetary policy, whether that involves changing the target, whether or not it involves publishing minutes or whatever. I am very optimistic we will see that gradual evolution of the European Central Bank.

  28. Does anybody else have a comment on that? Does anyone violently disagree?
  (Professor Congdon) I am not sure what the basis for these statements is, forgive me. I do not see any signs of any radical change in the way the ECB currently manages its policy framework.
  (Mr Barr) We have seen already some significant changes, for example, the movement away from having a meeting every two weeks to having a meeting only once a month, and having a press conference following rate moves. We have seen an increase in transparency in the ECB. Sitting in the markets, as we both do, I personally feel we have seen an easier-to-understand Central Bank than we did, say, in 2000. Whether that continues or not and whether we see further evolution is of course important.

  29. But Professor Congdon does not see any of this.
  (Professor Congdon) It is not very obvious to me. As they get more members there will be problems about the composition of the governing council. For example, on the question of the minutes and the publication of the voting, they have explained very well why they will not do this, because there are different nations involved and it is affecting the amour propre of the different nations. It is not a matter of giving some experts a technical task, as we have in Britain, and you can publish the debate and publish the discussion and have the voting records. The problem with the ECB is that each national governor of the Central Bank could be taken as representing his constituency and they do not want the political debate out in the open. They are very clear, it is understandable, and I do not see any sign of this changing.

  30. What about the symmetrical versus the asymmetrical—
  (Professor Congdon) It is pretty clear that the ECB with 2 per cent or less do not mean a minus figure, so in that sense it is zero to 2, so 1 per cent is in the middle. This is very semantic.

  31. No, it is not, because that is much more deflationary than having 2½ per cent as the central target.
  (Professor Congdon) It is not, not really. There is no long-run trade-off between employment and inflation in this policy area. In this country we had 27 per cent inflation in 1975 and we got it down to 2½ and unemployment is actually lower now Saying that going from 2½ to 1 is deflationary is nonsense.
  (Mr Barr) Can I make two quick points? As regards the changing of the ECB, to all intents and purposes they have disregarded their monetary pillar as a policy issue. They may pay lip service to it but it is very much a targeting inflation issue. They talk about distortions in the monetary figures. I think most people in the markets now disregard the monetary pillar to all intents and purposes. The other issue in terms of changing the target, whether it makes a difference or not, it is worth bearing in mind that our 2½ per cent RPIX inflation target does equate, give or take, to the 2 per cent on the harmonised target. It is a small point but it does narrow the gap between the two, if you like.
  (Mr Weale) Could I make two points? First of all, to agree with Professor Congdon, that if the European Central Bank had a target of 1 with a 1 per cent band either way, we would then say it was a symmetrical target. If the Chancellor believes a 2½ per cent target is pro-growth whereas a 1 per cent target is not, then that raises the obvious question, would a 3½ per cent target be more pro-growth than a 4 per cent. In other words, where do you stop. I think if he does take the view there is a trade-off between the inflation target and the growth rate, he should be able to explain how he has calculated that 2½ is the optimal target. If he does not think that there is, it is difficult to see why we should be worse off moving to a 1 per cent target, or an arrangement of having inflation between 0 and 2 per cent.

  32. You assume that is what he means when he says he is pro stability and pro growth?
  (Mr Weale) Then there is the question would 3½ per cent be more pro growth.

  33. Yes, but it is less pro stability.
  (Mr Weale) Not necessarily with a 1 per cent band either way—

  Chairman: This is all fascinating but—

  Mr Plaskitt: I sense you have had enough!

Mr Tyrie

  34. One question while we are on the ECB which will relate to Bank of England policy. Most people argue that the long-run survivability of the ECB structure will depend on the extent to which there is growing flexibility for countries to make labour markets more flexible in the euro area—whether or not one agrees with that view, that is a commonly-held view—so that the area can adjust more easily should there be an asymmetrical shock. Do you think the ECB should engage more actively in the debate about the kind of structural reforms which are required to the economies of the participating countries?
  (Mr Weale) I suppose looking at the strikes in Italy recently over the reform of labour markets and all the changes in the labour market law—whether "reform" is the right word, I am not sure—if I were an Italian politician, either for reforms or against them, I suppose I am not sure my job would be helped if there were noises from Frankfurt saying how the Italian labour law ought to be changed. I think you could apply the same argument to pronouncements from Brussels, but at least pronouncements from Brussels are from people who have connections with elected governments, whereas the ECB once appointed does not, so I should have thought a prudent governor would keep quiet on this issue.
  (Professor Congdon) I really do not see it as the Central Bank's job to comment on things like relations between governments and trade unions or on trade union law. These are very political subjects, very much subjects for the time being for national preferences and national legal systems and cultures, and it is not the job of the European Central Bank to make comments on these things. It does in fact make quite a lot of comment on supply side issues in very broad terms in its Monthly Bulletin.

  35. I only ask that question because the Bundesbank did comment very actively at the time of the unification of Germany on a whole range of structural reform questions and Alan Greenspan, unlike his predecessor, also has engaged heavily in this type of debate. Neither the ECB nor the Bank of England feel they should participate. Of course the point which has been made against it is a highly political one, but is it not the case that what we want perhaps from independent banks is an ability to express a more pure economic view on these issues?
  (Professor Congdon) Let me put it like this, if you are the Governor of the Bank of England who has just had independence, and that has obviously given the Bank a bigger respect, would you then start to criticise the way in which the British Government relates to the TUC? It does not seem to me this is the job of a Central Bank Governor. Sure, a Central Bank might be involved in things like banking supervision, pension arrangements, all these have structural implications, but there are limits to what a Central Bank should be commenting on.

  Mr Tyrie: You have taken it to an extreme by talking about the Government and the trade unions. You have provided a set of examples where the Bank is extremely cautious about commenting at the moment and I am asking about where it might have a role.


  36. We are actually engaged in a separate investigation into Europe and we are seeing Mr Duisenberg amongst others and I think we will ask him those questions and report back to you. Looking at it politically, can I ask you a political question, does this Budget make it easier to have euro entry or not? Could you give us your economist views on that in very simple terms? Does it make it easier or harder?
  (Mr Weale) I think it probably makes it slightly harder. In the short-term I agree with the view that on its own it is not doing very much to restore it, to give a better balance to the economy. In the long-term, the Budget is undoubtedly expansionary. Both of these issues make it harder for the exchange rate to move to a level that many people would feel more comfortable with for euro membership.
  (Mr Emmerson) I have no view whether it makes it easier to join the euro, though if we wanted to strictly adhere to a balanced budget rule, because the Chancellor is increasing borrowing and has reduced the proportion of the finances slightly, it makes strict adherence to the balanced budget rule rather than the golden rule harder.
  (Mr Barr) If we are or are not going to join EMU in the foreseeable future, the 2002 Budget will not be seen as any contributing factor for or against. If anything, if you want to be politically clever you could argue, by not raising household taxes it might make it slightly easier to win a referendum next year.
  (Professor Congdon) It is difficult to criticise the fiscal rules that the Government has got in the European context, because they are plainly consistent with the Maastricht criteria—the budget deficit is less than 3 per cent of GDP and the debt is less than 60 per cent of GDP. Just a couple of points. One is the imbalances have not really been dealt with. I have been saying this for years but one would expect sooner or later the pound will have to fall against the euro, maybe it will happen very quickly, and to some extent the fact that the consumer boom has not been restrained makes that sterling adjustment more likely. So there is that question. I am also a little bit worried about this on the excise duty front. I think it is fair comment for two years now he has been holding back excise duty increases with a view to helping the inflation numbers. This is a little bit artificial and it does raise questions about whether in the medium term inflation will be in line with the European average as it needs to be in line.

Mr Tyrie

  37. Can I move on somewhat to something else which you raised in your opening remarks, Professor Congdon, where you talked about whether it was possible for the housing market to sustain these low interest rates. Do you think that unless some action is taken, and I note from your briefing notes you have often been on the hawkish side, we could be on the edge of another housing boom and bust?
  (Professor Congdon) The normal behaviour of house prices is that they rise in line with earnings, they rise about two per cent faster than retail prices. So the increase in house prices that is consistent with the two and a half per cent inflation target is four to five per cent a year roughly. In the last year, the Nationwide House Price Index has gone up by about 14 per cent and Halifax by about 16 per cent, so effectively house price is rising by about one per cent a month and, by the way, that continues, there is no sign it is coming to an end. There are two ways that the adjustment can take place. One is that the house price inflation comes back towards the four or five per cent figure, maybe even house prices may fall for a bit. The other way is that the growth of earnings and, indeed, inflation generally takes off. One or the other of these things must happen because we know what the long run behaviour is. I am worried that the consumer boom is too strong and that part of the adjustment may be through inflation increasing towards three or four per cent, not immediately but perhaps in the next two or three years. I think that is something to worry about, yes.

  38. Have any of the others got comments they want to make?
  (Mr Barr) One thing I will say about house prices is whether what we are seeing is a reaction to permanently lower expectations of interest rates whereby because people, if you like, price in more affordability in terms of a repayment mortgage in coming years, the level of house prices rises. At some point that should, as Tim mentioned, level off, the question is where is that point, have we reached it yet? On some calculations you can argue prices have another 20 to 30 per cent to go before we would reach that higher level, if you believe in that kind of analysis, personally I do. There has to be a risk that things do overshoot in the short term because consumers are unlikely to retrench of their own accord. There are all sorts of strange things going on beneath the surface. For example, it is very well known and it is very much highlighted in the press that people are just borrowing and borrowing and borrowing and things like house lendings are at very, very high levels but what is sometimes not reported is the fact that on the asset side of the household accounts they are putting a lot in their bank accounts also. We are seeing the fastest rise in bank deposits since 1997 when they had the demutualisation. Perhaps that does represent delayed consumption, that is going to come down the line, or there could be many other reasons why we are seeing these portfolio adjustments. Last year, for example, the household sector was not a net borrower, it was in an overall balance sheet context a very, very small net lender. There are also some strange beneath the surface actions going on, it is not just about one side of the balance sheet that is rallying significantly, I think there are more complicated issues going on. My own personal belief is that the consumer will not slow of its own accord. We felt it would slow because of rising unemployment but I am not now a believer that is going to be the case.


  39. I think for the last ten minutes or so we will concentrate on the health issue and the aggregate taxation and expenditure. The Chancellor, as we know, announced plans to raise health spending by 7.4 per cent per annum to 2007-08, but the Treasury have made tax projections to 2006-07. Assuming other spending plans remain unchanged, do you expect that taxes will have to increase in the future to meet the NHS commitment in 2007-08?
  (Mr Weale) I think the answer is yes, that the situation generated in the Budget to 2006-07 is, as I said at the beginning, one which I think will lead to a less satisfactory budgetary situation and therefore I think probably requires higher taxes. Any faster growth in spending or growth in spending ahead of national income beyond that is bound to require further increases in taxes.
  (Mr Emmerson) The Chancellor's annual published Spending Plan is really up to 2005-06. Between there and 2007-08 he wants to increase NHS spending by 0.7 per cent of GDP. If we want to spend more on any one thing out of financial income that means we have to spend less elsewhere. That means either he will have to spend less on other public services or he will have to increase borrowing or he will have to increase taxes. That does not mean he will have to stand up and announce more increases in national insurance contributions, for example, it might be that other errors of public spending can grow less quickly or that the tax system might deliver him the money, the areas that far out are very big, but I would add that the spending plans for, say, 2006-07 and 2007-08 are yet to be set and will depend on how far the Government wants to continue progress in delivering world class public services and doing things like reducing child poverty, which we know are likely to require real increases in benefits for families with children.

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