Select Committee on Treasury Minutes of Evidence

Treasury Committee Questionnaire completed by Mr Paul Tucker


1.  Do you have any business or financial connections or other commitments which might give rise to a conflict of interest in carrying out your duties as a member of the MPC?


2.  Are there any relevant personal or other factors of which the Treasury Committee should be aware in considering your nomination?

3.  Do you intend to serve out the full term for which you are appointed?


4.  Please explain how your experience to date has equipped you to fulfil your responsibilities as a member of the MPC.
  (1)  Much of my career has been spent working in financial markets. This has given me experience of the way in which monetary policy decisions are transmitted into market interest rates and other asset prices and via the banking system—important parts of the monetary transmission mechanism. It has also given me experience of the ways in which financial markets form expectations of monetary policy decisions. That is relevant to using financial market prices as indicators or diagnostics of expectations, which affect economic behaviour.

  (2)  I have been involved in various ways over the past 10 years or so in advising on the formulation and presentation of monetary policy. I ran one of the Bank's monetary analysis divisions, which focused principally on questions of monetary policy strategy/framework and on the monetary and credit aggregates. Over the past five years, I have been one of the small team preparing the minutes of MPC meetings, and in earlier roles I contributed to speeches on monetary policy—giving me some experience of explaining policy.

  (3)  In my current role, I have experience of synthesising macroeconomic, financial market and banking system information with market intelligence, as represented for example in the Bank's twice yearly Financial Stability Review. The information relevant to monetary policy overlaps considerably, and the objectives are closely related.


5.  How important do you think it is for MPC members to be subject to ex post parliamentary accountability? Could the current procedures be improved?
  (1)  Very important. MPC members are not democratically elected but take decisions which affect the people of the country individually and collectively. It is right that we should be accountable to the people through the people's elected representatives. For that accountability to work, the framework and objectives should be clear, which I believe they are.

  (2)  So far the current procedures seem to have worked well. The public debate on monetary policy has improved considerably compared with a decade ago.

6.  If you were to stand for reappointment to the MPC at the end of your term, what criteria do you believe should be used to assess your individual record as a MPC member?
  (1)  First and foremost, the outturns of inflation relative to the target set by the Government; and the explanations the Committee has given of its analysis and decisions. The lags in the effects of monetary policy changes need to be taken into account: there can be shocks to the economy before the full effect of earlier policy settings has worked through. So ex post assessment needs to be based on the information available to Committee members when making their policy choices.

  (2)  Secondly, my voting record, coupled with my record of explaining my analysis and policy choices. If/where I vote in a minority, the counterfactual path of rates I preferred would need to be taken into account, which of course is not straightforward.

  (3)  Third, my record in publicly explaining the Committee's work, and in listening to input from around the country.

  (4)  Fourth, my record as the Executive Director for the Markets area of the Bank, accountable to the Bank's Court of Directors; and so in particular the Bank's performance in (i) the implementation of monetary policy (through open market operations etc) and (ii) providing analytical and practical input on financial markets to the Committee's deliberations.


7.  Is the framework of an explicit inflation target the best within which to conduct monetary policy?

  It is by far the best framework the UK has had in recent decades. It has three distinct merits:

      (1)  It focuses monetary policy on the objective it can achieve: low and stable inflation, which is a pre-condition for a stable macroeconomic environment more generally. That is the contribution which monetary policy can make to the real economy.

      (2)  By focusing on the objective of monetary policy (low and stable inflation), it means that the monetary authority must (i) take into account the whole range of possible influences on inflation; (ii) be forward looking, given the lags with which monetary policy changes affect the economy. In particular, this means that the monetary regime does not rely on the stability of one particular economic relationship (as, eg, with monetary targeting).

      (3)  It is more straightforward to explain—to the public, business, and financial markets. This is important not only for effective accountability, but also to facilitating understanding of the Committee's "reaction function" and so to influencing private sector behaviour in a way consistent with achieving and maintaining low and stable inflation.

8.  What consideration should be given to asset prices, including house prices and the exchange rate, within the framework of inflation targeting?

  Asset prices are important in two (separable) respects:

      (1)  The value of many assets affects the path of aggregate demand. For example, consumption is affected by wealth— directly, and indirectly via the effect of collateral values (house prices) on credit availability; investment by the cost of capital, and by the value of "collateral" companies hold; net trade by the real exchange rate, etc. So asset prices are an important input to assessing the outlook for activity and inflation.

      (2)  Asset prices are forward-looking, and so are an important indicator of expectations of, for example, corporate earnings growth (eg equities), real interest rates (eg equities and bonds), credit risk (eg corporate bonds), inflation (nominal bonds). Given lags in the monetary transmission mechanism, policy has to be forward looking, making the availability of forward-looking asset prices potentially very helpful. The Bank has published a lot of work over the past decade or so on the extraction of information from asset prices.

  Although separable, these two perspectives on asset prices are related. The effect on the outlook for activity/inflation of a change in asset prices will depend on what was the underlying cause of the change. One diagnostic of the shock can be any changes in relative asset prices; for example, a shock to the inflation regime and so to inflation expectations would, in principle, increase the yields on nominal bonds but not yields on RPI-indexed bonds. In practice, such diagnosis is fraught with uncertainty, in particular because asset prices can be temporarily or even persistently affected by institutional influences on demand and/or supply and because of the difficulty of identifying changes in risk premia more generally.

  Should the Committee in any way target asset prices—in general or in particular? No. First, that would clearly be contrary to the Government's remit. Second, the Committee has one instrument, so there would be confusion if it were trying to hit more than one target. Third—even if the remit were changed, or the Committee were somehow given another instrument (neither of which I advocate or believe feasible)—the Committee could not know what level of asset prices to target. Fourth, even if it did know what level to target, I doubt it could influence asset prices sufficiently to bring them to the desired level.

9.  Is it appropriate to concentrate on the projection of RPI(X) at the two-years ahead point?

  The significance of the two year forecast horizon is that, on average in the past, it is roughly where a change in the official interest rate has had its maximum effect on inflation, while of course there is some effect on inflation sooner than that. There are, though, a series of riders to this:

      (1)  The point about "two years" is empirical. The Bank needs to keep under review whether the average alters at all over time, with an understanding (and so explanation) of why.

      (2)  Whether inflation is increasing or decreasing at the two-year horizon obviously also matters.

      (3)  The appropriate horizon may vary according to the nature of the shock to the economy. Related to that, in the event of shocks taking inflation away from the target, the Committee needs, in line with the remit, to take account of the possible effect on the volatility of output in deciding how quickly to bring inflation back to target.

      (4)  It is not just the central (modal) projection which matters, but the distribution of risks and the weight different kinds of risk can sensibly be given in policy settings.

10.  Do you believe that there is any trade-off between inflation and unemployment (or output) in the short-run or in the long-run?

    (1)  There is a generally recognised trade-off in the short-run.

    (2)  In the long-run, I believe there is no such trade off. A monetary expansion finds it way into the price level, with output and employment determined by real economy/supply side factors. It is plausible, in fact, that the opposite of the short-run trade off holds, with low and stable inflation enhancing the long-run performance of the real economy. First, in an environment of high and unstable inflation, longer-maturity nominal debt contracts would plausibly carry not only a premium to compensate holders for expected inflation but also a risk premium given the uncertainty about future inflation outturns. To the extent that investment is financed by longer-maturity nominal debt, such a risk premium would add to the real cost of capital. In a stable monetary environment, that risk premium might therefore be saved, helping to support investment. Secondly, in a stable monetary environment, households, firms and entrepreneurs should find it easier to disentangle changes in the general price level from changes in relative prices, potentially aiding an efficient allocation of resources - including to investment projects.

11.  What are the consequences of the current imbalances within the economy for future inflation and growth? What can monetary policy do to address these imbalances?

  Imbalances have for a while characterised the economy in three ways which, although closely related, it is helpful to separate:

      (i)  in terms of the components of aggregate demand: weak external demand relative to strong final domestic demand, especially consumption;

      (ii)  in balance sheet terms: an associated accumulation of debt by the household sector, and of external debt in the national balance sheet reflecting a persistent current account deficit;

      (iii)  in terms of the breakdown of output: strong services sector output and profitability relative to weaker output and profitability in the sectors of the economy—notably manufacturing—with a large export or import-competing component.

  These imbalances have been rooted in a series of shocks to external demand combined with the strength of sterling against the euro (and for a while in the mid-late 90s, against the dollar too). Monetary policy has responded to the weak (in fact, persistently negative) contribution of net trade to output growth by stimulating consumption growth in order to keep the path of aggregate demand in line with the economy's supply potential.

  Looking ahead, this poses risks through a number of potential sources. For example, the accumulating debt will, other things being equal, leave the household sector more vulnerable than otherwise to "bad luck" with the possibility of abrupt adjustment; or the euro may rise against sterling. It is very difficult to judge whether the unwinding of the imbalances would put upward or downward pressure on inflation. That would depend on the circumstances in the economy at the time. But the greater the imbalances become, the greater the risk of abrupt adjustment, and so the greater the possibility of undesirable volatility in inflation (and activity) in future.

  What can monetary policy do about this? Little if anything to affect the external environment, and so little to reduce the imbalances directly. It can, perhaps, by consistently achieving the inflation target and so accumulating credibility, help to anchor inflation expectations in the medium term, which may help to stabilise inflation if/when the imbalances unwind.

12.  What is your assessment of the outlook for UK productivity growth?

  The most likely outlook is probably that productivity growth remains in line with its long-term average of around 2 per cent. A central estimate is needed but there is inevitably considerable uncertainty about it. This issue is perhaps especially difficult to judge at present. On the one hand, if the US economy has enjoyed a material improvement in underlying trend productivity growth over the past half decade or so, stemming from technological change and the organisational efficiencies it permits, that could reasonably be expected to spread to other economies over time. In principle, flexibility in the UK economy should help it over time to share in those gains. On the other hand, the extent and persistence of the US improvement is still difficult to judge; and it is not so far obviously apparent in the UK data. It is an issue where I hope to learn from talking to business managers around the country.

13.  What weight do you place on (a) the monetary aggregates and (b) the output gap in your assessment of inflation prospects?

      (a)  The monetary aggregates

  Inflation is a nominal (or monetary) phenomenon. The price of goods and services is expressed in terms of money; and inflation is a rise (or fall) in the general level of prices. Thus while—as part of keeping inflation pressures in balance (see (b) below)—the MPC has to aim to keep real aggregate demand in line with aggregate supply, that is strictly consistent with any rate of inflation. It is therefore vital to track nominal indicators. The monetary aggregates are, by definition, nominal and therefore warrant monitoring. Interpreting both narrow and broad money has, however, for a long time been complicated by changes in the pattern of demand for money (so-called velocity changes) reflecting, for example, changes in the characteristics of the saving and instant-access deposit facilities provided by banks. Nevertheless, in order to help avoid big mistakes, the monetary aggregates can potentially provide a useful source of questions: the relationship between persistent rapid monetary growth and rising inflation is well established internationally.

  Even if the relationship between the monetary aggregates and GDP/inflation was so unstable as to make them useless as an indicator, that does nothing to alter the importance of monitoring nominal variables. In the UK set up, various measures of inflation expectations—from surveys, derived from bond markets, etc - are very important in this respect. Keeping medium-long inflation expectations in line with the target is necessary to achieve inflation in line with the target over time.

  Separately, the sectoral money and credit data can provide useful insights on developments in the household and business sectors.

      (b)  The output gap

  From a position of balance, a reduction in interest rates (monetary expansion) will tend to lead to a positive output gap and thus to inflationary pressure, and vice versa for an increase in interest rates.

  The output gap is a real economy concept. In terms of thinking about monetary policy choices, it is important in focusing on levels rather than growth rates. Keeping inflation stable requires the level of output to be in line with the economy's potential supply capacity rather than just the growth rate of output to be in line with trend growth. Thus, for example, in the face of a negative shock to demand taking the level of GDP below potential, output may need grow at above its trend growth rate for a while in order to bring inflation back to target.

  In practice, things are somewhat less straightforward, as the supply capacity of the economy is not directly observable, and estimating it is hard, subject to uncertainty and error. A range of tools should be helpful: econometric estimates, indicators of cost and price pressures, survey and other indicators of spare capacity, anecdotal information, etc.

14.  To what extent should fiscal policy play a demand management role alongside monetary policy in the short-run?
  (1)  The most important contribution that fiscal policy can make to monetary stability is to maintain a prudent level of government debt, so that there is no question of the country needing to inflate away its debts to remain solvent. The UK is most certainly in that position at present, and has been for some years.

  (2)  Fiscal choices—the size of government spending, and the extent of deficit or tax financing—are matters for the Government. The job of the MPC is to understand any fiscal policy changes so that they can be taken into account in its projections of output and inflation.

15.  What role should econometric models play in the formulation of interest rate policy?

  Not only econometric models, but economic models more generally are essential to policy formation—alongside more anecdotally-based assessments of prospects. Since policy has to be forward-looking, a forecast is an essential ingredient of the policy process. Econometric models bring the benefit of ensuring that analysis is framed in a consistent way, so that wider effects of assumptions/judgments about one part of the economy are traced through. But econometric models are based on estimates of relationships prevailing on average in the past. This calls for alertness to whether key relationships change; and for a focus on identifying the particular pattern of shocks affecting the economy at any time, since the coefficients in the model will reflect the average of all past shocks. More structural models, attempting to get at underlying behaviour, can sometimes contribute to that and so to the judgments which have to inform the forecasting and policy process.

16 May 2002

Curriculum Vitae

P M W Tucker (Paul)
Date of Birth:24.3.58
Education:Trinity College, Cambridge (Maths Parts I and II, and Philosophy Part II)
September 1980—1982Joined the Bank of England. Banking Supervision Division, supervising small banks.
1983-84Banking Supervision Division; Policy and Legal Section.
1985-86Secondment to Baring Brothers & Co., Ltd; Corporate Finance Department.
January-October 1987Banking Supervision Division; Policy (Basle International Capital Convergence Agreement).
November 1987-June 1988Secondment to Hong Kong Government as Adviser to the Securities Review Committee on the reform of the Hong Kong securities markets and regulatory system, under the Chairmanship of Ian Hay Division.
July 1988-April 1989Money Markets Operations Division; review of payment system risk and development of proposals for Real Time Gross Settlement wholesale payments system.
April 1989-October 1992Principal Private Secretary to Governor Leigh-Pemberton (now Lord Kingsdown).
November 1992-June 1994Gilt-Edged and Money Markets Division.
July 1994-December 1996Head of Gilt-Edged and Money Markets Division. Led teams which analysed and implemented reforms of the Bank's money market operations and the structure of the money and gilt markets.
January 1997-December 1998Head of Monetary Assessment & Strategy Division, including from May 1997 secretariat to Monetary Policy Committee.
From January 1999Deputy Director, Financial Stability, including membership of the Bank's Management Committee. Also secretariat to Monetary Policy Committee.

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