Select Committee on Treasury Minutes of Evidence

Examination of Witnesses (Questions 70 - 79)




  70. Good morning, Governor. Welcome to you and your colleagues. Following your recent meeting on the Inflation Report, can I ask you what you see as the likely challenges that the MPC will be facing in the coming months?
  (Sir Edward George) The issue which has been with us for some considerable time is trying to balance the external pressures which have been, of course, weakening the British economy over the past year or more but are now beginning to turn round, with the domestic demand pressures in the economy. What we have been doing, of course, has been to try to sustain domestic demand, because if we had not done that, the overall economy would have gone into recession. We have been very conscious that at some point, as the external situation improves—and that has been principally a function of demand internationally but also a function of the exchange rate—domestic demand growth would have to slow, or moderate anyway. The question is precisely how you balance those two forces. If that does not happen, if domestic demand does not slow down and the external demand picks up, that is when we will generate inflationary pressure.

  71. In your report you stated that the MPC "stands ready to act to contain any developing inflationary pressures further ahead." One of our witnesses recently, Roger Bootle, focussed on that particular comment and said that, "taken together with the central target projections, the shift in emphasis is probably as close as the MPC gets to adopting a US Fed-style tightening bias without officially stating it." Are you softening us up for an increase in interest rates very soon?
  (Sir Edward George) Not at all, Chairman. I think it is entirely consistent with what I have just said that at some point we will have to moderate the rate of growth of domestic demand, which has been growing now for some considerable time well above the trend rate that would be consistent with a stronger global economy. We have been indicating that at some point we would have to moderate that. We have pointed out that there are reasons for supposing that it could moderate of its own accord, but if that does not happen, we would have to tighten policy in order to bring that moderation about. So I think it is consistent with the perception that we are saying—and indeed, this was the implication of the forecast that we made in the Inflation Report—if things turned out in the way the forecast has it, with inflation picking up quite sharply at the very end of the two-year period, we would have to tighten policy. It is not a bias statement; it is simply a logical consequence of the analysis.

  72. If you had to make a judgment as to whether it was going to moderate of its own accord, as you said, or if you would have to take action, which side would you come down on?
  (Sir Edward George) If we found that it was not moderating of its own accord, we would have no option; we would have to tighten policy in order to bring that moderation about, assuming that the external situation improved.

  73. Are you confident at the moment that it will moderate of its own accord?
  (Sir Edward George) We do expect there to be some moderation. We feel that there were factors in the past which meant that disposable incomes were growing more strongly than they are likely to looking forward, and that in itself would tend to moderate the rate of growth of domestic demand, and certainly we have a moderation in our forecast. I am saying that if that does not come about, we will have to act to bring it about.

  Chairman: Dr Wadhwani was a distinguished member of your panel, and he has written a number of articles in the past couple of months. One of them we would like to take up with you.

Mr Plaskitt

  74. Dr Wadhwani has said a lot of interesting things reflecting on his time on the MPC, but one of the things he points out is that the average two-year-ahead inflation error has been 50 basis points since you took over operation on the independent model. Do you accept that finding of his?
  (Sir Edward George) That degree of precision is always a challenge, and in writing that article Sushil Wadhwani made it very plain that this was based upon a particular econometric model of the economy. He is entitled to his view; indeed, we have always encouraged him to express his view, but I do not think I would necessarily say that this is established wisdom.

  75. But he is statistically right, is he not? Going back over the history of it he is saying that the average forecast has been 50 basis points too high. That is a factual statement, is it not?
  (Sir Edward George) This is based upon 100 per cent hindsight, and unfortunately we did not have that at the times we were making these judgements.

  76. Nevertheless, the statement is accurate, is it not, as a description?
  (Sir Edward George) If we had been able to anticipate the strength of the exchange rate, if we had been able to anticipate the weakness of the external economy to the degree that we could now, we might have been able to get away with a somewhat lower interest rate. That is possible, but certainly not in terms of the policy making process itself.

  77. You are sounding reluctant even to admit that factually he is right. That is true, is it not?
  (Sir Edward George) In the sense that inflation has been marginally below 2½ per cent over most of the last couple of years, it is a matter of arithmetic, but I do not actually think that is relevant to anything much.
  (Mr King) Can I just make two points on this? We published last August the same calculation in the Inflation Report, and then the overshoot, if you like, was 0.7 percentage points. So we have been publishing these numbers for three years now. This is not terribly new. The number of observations went up from 6 to 10 in this latest calculation, and we will have another box in the Inflation Report in August. These numbers we have brought before you each August for the last three years. This is not new. Secondly, this is not the result of a model; this is a judgement. The forecast that is published is the judgement of the Committee.

  78. All he is saying is, looking back over the period of independence so far, fundamentally he is making a case for saying he thinks you have been running policy too tight, and it would have been possible—all right, with hindsight—to have been running slightly looser policy, you would still have hit the inflation target, not overshot it, but the economy would have delivered marginally higher growth.
  (Sir Edward George) If we had had 100 per cent hindsight.

  79. Is there anything in his argument?
  (Mr King) I would make two points about this. Right through this period unemployment was falling, and output was growing, if anything, above trend. I do not see why you would want a period in which output would have been growing even more above trend, which would have to be compensated in the future by output growing more slowly, because there is no suggestion here that we would have improved the trend rate of growth by having a marginally lower interest rate. Secondly, if the day I leave the Bank you can tell me that, with the benefit of 100 per cent hindsight, interest rates should have been a quarter of a per cent either lower or higher, I will take that now.

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