Select Committee on Treasury Minutes of Evidence

Examination of Witnesses (Questions 80 - 99)



  80. You are happy to see inflation undershooting?
  (Mr King) No. I did not say that.

  81. But it has been undershooting for two years. Are you concluding anything?
  (Sir Edward George) You would say exactly the same thing if we had been overshooting for two years. You would say we should have been a quarter or half a per cent higher. If over a prolonged period that was what you said, both Mervyn and I would be very happy.
  (Mr King) A point we have made before to this Committee, and I think it is important, is that if there is an inflationary shock, which could come through an unexpectedly strong exchange rate, for example, or something that pushes up inflation unexpectedly for a period, that is going to be in the data for some considerable time, and therefore an overshoot or an undershoot relative to target is not something that one month you are above, then you are below for two months, then you are above for a month again. You do not oscillate around the target like that; you tend to move above it and stay there for a couple of years or so. When you see periods in which inflation deviates from target, you should expect it to deviate in the same direction for a period, because we are taking action to bring inflation back to the target over a horizon of approximately two years or so, and that would depend on the circumstances. That is what we are trying to do. We are not trying to zig-zag around 2½ per cent.

  82. Do you think that for the UK economy there is such a thing as a neutral interest rate?
  (Sir Edward George) Conceptually, I think there probably is, but I think as a practical matter, using it as a kind of guide to policy, I am very doubtful of that. We have done that often in the past and we have been totally misled. So I think the process that we have is superior to making an assumption about a neutral interest rate.

  83. People talk about a neutral rate. Some members of the MPC talk about a neutral rate, and when they do, they talk about 5.5 per cent. It is interesting to see that in your own Inflation Report you publish market expectations in table 6C and they tell us that the market expects interest rates to be back at 5.5 per cent by 2004. Is there something magical about this 5.5 per cent?
  (Sir Edward George) Certainly not in my mind. What you have to do is take account of the circumstances that you have, your expectations about the future, and set interest rates on that basis. Over time you can establish an average which was consistent with inflation staying around the target rate, and then you can say that is the neutral rate if you want to, but I think it is a concept rather than a guiding policy.

  84. Do you think it is a helpful concept or an unhelpful one?
  (Sir Edward George) It is like so many of the other concepts, like the output gap or the natural rate of unemployment. It is very helpful to think in those sorts of terms, to recognise that during a period of weakness we are probably below the average rate that would apply for the future. In that sense, it is helpful. It is helpful as a way of thinking about the thing, which I do not find particularly helpful in the case of the neutral rate, I must say, but I do not think it is more than that.

  85. Would you have a different view about where this neutral rate might be for the UK economy if our inflation target was an asymmetrical one as opposed to a symmetrical one?
  (Sir Edward George) I think the neutral rate has to be calculated in relation to the rate of inflation you are seeking to achieve or the rate of inflation that you have achieved over the past, so that if you change the target, whether it was a matter of symmetry or a matter of level, it is true that the neutral rate, the concept, would produce a different number.
  (Mr Nickell) Surely the key point about any conception of a neutral rate has to apply to a real interest rate. There could not conceivably be such a thing as a neutral nominal rate. It would be a neutral real rate, in which case, as the Governor has just said, of course, the nominal rate associated with any given rate would change when you change the target. I suppose 5.5 comes about because people make the calculation: target 2.5, some neutral level of the real rate might be around 3, answer 5.5.

  86. How do they arrive at 3?
  (Mr Nickell) They arrive at 3 because over the centuries the real rate of interest in the UK has been around 3, but it has fluctuated over different eras. So I would not like to say where the neutral real rate was today, but it is probably not that far away from 3.

  87. Why is there any magic about this? It is not the same economy as it was centuries ago, or even a decade ago.
  (Mr Nickell) No, but it is very interesting, nevertheless, that real returns over the centuries have not moved that far away from 3.

Dr Palmer

  88. In February you said that the fourth quarter figure for UK GDP growth was probably at a low point. A couple of months later the statistics showed continued zero growth. Does this surprise you?
  (Sir Edward George) Yes, it did surprise us, I must confess. We thought we would see positive growth, and indeed, in the initial estimate from the ONS growth was marginally positive, and now it has been revised downward to zero. We still feel that there are some puzzles about that. I think the counterpart of it is that the GDP deflator rose quite sharply in the first quarter on these numbers, and of course, they are connected, because it is the volumes times deflator which you can look at. If you have a higher deflator then you have lower volumes, and this zero growth. There are some puzzles about elements of that, particularly the trade deflators and the government expenditure deflator. I think we can see inconsistency between the actual statistics and the survey evidence, including evidence from our own agents around the country about what was happening. I do not think one should at all disregard the ONS number. You ask whether it surprises us, and the answer is yes, it has surprised us, and of course, these numbers are subject to revision and it is possible that they will be revised, and we would expect if that happens that it would be in the positive direction, probably not hugely.

  89. So you are saying you do not quite believe the figures; at least, you are suspicious about the figures because your agents around the country are giving you a somewhat different picture.
  (Sir Edward George) It is not just the agents around the country; it is all the trade association surveys which suggested it would be rather stronger. Services growth at 0.2 is consistent with the impression that we had from those things. All of these things are impressions. The estimates at any particular time made by the ONS can change. That is really all I am saying. You ask us what we expected; we expected the number to be mildly stronger. If you ask us do we expect them to be revised, we think it is quite possible because they often are, and if they were revised, then we would expect them to be revised in a positive direction.

  90. Is it not worrying that you are basing your policy on a mixture of a supposedly objective model and what one might almost call the old mass observation techniques of lots of individuals writing in? Does that not suggest that there is a need to revise the model so that you have more confidence in it?
  (Sir Edward George) Others may want to comment on that, but I am not sure of the implications for the model arising out of the uncertainty of the data. The uncertainty of the data is something that we live with all the time because there is no way of achieving early perfect data that is why we have to look at absolutely everything, not only the official data, but also the more survey-type data, market data, financial market data, all the different statistical series which go into the data. So you ask whether it worries us; I suppose it would be wonderful if we could have perfect data, just as it would be wonderful if we could have perfect hindsight, but that is not the world in which we live.

  91. The quality of my memory varies over time as well, but I do not recall an earlier occasion when the Bank expressed such explicit reservations about the official statistics. Do you feel that the divergence from the real world has perhaps grown a little larger?
  (Sir Edward George) No, I do not think so. I was simply responding to your question about whether we were surprised, and I was giving you the honest answer, yes, we were, and trying to explain why.

  92. In February your central projection of GDP growth in the first quarter of next year was 2.6 per cent, but it has now shot up to 3.28 per cent. That is quite a dramatic difference, and I wonder whether that too reflects your belief that the actual level of GDP is perhaps a little higher than we believe, or are there other reasons for this substantial adjustment?
  (Sir Edward George) In our current forecast we did start with a mildly positive number for GDP, so I think the downward revision had not come through at the time we were making the forecast. So if it is revised up a little bit, that is already in the forecast.

  93. If it is not revised up a little bit, you think 3.28 might be a little too high?
  (Sir Edward George) The starting point would be lower, and that would feed through to the forecast, unless other things in the forecast change.

  94. Would you like to suggest what the forecast ought to be if there was no upward revision of the current figure?
  (Sir Edward George) No, I would not. The reason I would not is that you have two things: the starting point, which is the first quarter of this year, and the rate of growth, and the fact that you start with a lower level is not inconsistent with a faster rate of growth in the period looking forward. In fact, if there are particular reasons for thinking that the starting point was lower because things had been pushed forward in time, that would be compensated.
  (Mr King) The starting point would be different by 0.1 percentage point, a tiny amount. What is more relevant here, as the Governor said, is that this has led to some of the puzzle about Q1. We expect quite a significant difference between Q1 and Q2, and that does not necessarily mean the data are wrong; just that you do get quite significant differences in growth rates sometimes between one quarter and the next. We have seen already the official data: manufacturing data and construction data. There is some reason to think there might be a modest upward revision of Q1, but certainly more compelling, as the Governor says, is the survey evidence that Q2 is likely to be higher. I do not think any of us suggest a significant change to the output projection two years ahead.

  95. So you are standing by the 3.28 per cent projection?
  (Mr King) I do not think we stand by anything to a second decimal place!

  96. That statistical reservation aside, you see no reason to change the broad view.
  (Sir Edward George) No, I do not think we do.

  97. Do you feel this relatively rapid acceleration could lead to inflationary bottlenecks? Do you feel the economy has enough spare capacity?
  (Sir Edward George) Part of it is because of the change in the external environment, and I think some of the internationally exposed sectors do have the capacity to respond to that. I think there are other areas. Everybody is talking about the housing market, for example. I would be very surprised if we did not get on to that later. That is, in the broad, aggregate way in which we have to do these things, incorporated into the forecast, so that the forecast for the path of inflation that we have is our best collective judgement given the path of output growth that we have. The short answer is that we are not anticipating bottlenecks which would generate an acceleration in general inflation until quite late in the forecast period at the end of two years.

  98. Finally, does that last answer imply that in that 3.2 or 3.3 growth in a year's time you anticipate a certain unwinding or re-balancing as you have mentioned, and that you might see a slowing of housing price growth but an increase in export growth?
  (Sir Edward George) Yes. We are anticipating a reduction in the extent of the current imbalance.

Mr Fallon

  99. Kate Barker, in the May minutes the Committee has said the question was how soon this house price inflation would begin to slow. What is the answer?
  (Ms Barker) Like all of us, I very much wish I knew the answer to the question of whether house price inflation will begin to slow. Implicit in your question is the fact that of course since the May minutes we know that house price inflation has, if anything, continued to accelerate and from the fact that we were talking about the prospect of it slowing, as with other commentators, we have been a little bit surprised by the strength of the housing market. The difficulties of the housing market are trying to disentangle exactly what is going on. Clearly, over the last year the fact that interest rates have been lower has to some extent fuelled house price growth, but there are other issues in the housing market: we know that we have had quite low housing starts over the last year, so there is a question about demand and supply, which in itself would have tended to push prices up even if interest rates had not been changed at all. It is possible that we have under-rated the influence of some of those factors together with the influence of buy-to-let buyers coming into the market. Very clearly, if you look at the rate of house price growth that we have at the moment, it is not a rate that we would expect to be sustainable over the long term. It clearly is a rate that will slow down. We continue, as we monitor everything, to monitor the housing market very closely and to try to assess the effects of the current level of house prices on consumer demand.

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