Examination of Witnesses (Questions 80
THURSDAY 13 JUNE 2002
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
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
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
(Mr Nickell) No, but it is very interesting, nevertheless,
that real returns over the centuries have not moved that far away
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
(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
(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
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
(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
(Sir Edward George) Yes. We are anticipating a reduction
in the extent of the current imbalance.
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.