Select Committee on Treasury Minutes of Evidence

Examination of Witnesses (Questions 140 - 159)



Mr Ruffley

  140. A question for Mr King on the euro. Are any of the five economic tests being met at the moment?
  (Mr King) I do not know. We are not carrying out an assessment.

  141. So the Bank is not doing any monitoring of the five economic tests of any kind at all?
  (Mr King) It clearly monitors the European economy because that is relevant to our remit, but our remit does not include an assessment of the tests.

  142. Does not the possibility of the tests being met within the next 12 months have any influence on the setting of monetary policy, informing the thoughts and judgements, albeit indirectly, of MPC members?
  (Mr King) Not in itself. Where it is relevant, of course, is in affecting market expectations, and that may affect the yield curve, asset prices, the exchange rate. Those things obviously are highly relevant to us and we take them into account, and indeed, when we think about why the exchange rate may have changed, it is important to us to try to understand why. Trying to understand market reactions to this is important to us but it is not in terms of carrying out an appraisal ourselves.

  143. You do not even do an informal assessment internally when you are looking at all the things you have just described, yield curves and the rest of it? You do not come to any preliminary view as to whether or not the meeting of the tests is unlikely or very unlikely or quite likely. You do not make any of those judgements. You are saying it is not part of the Bank's working at all.
  (Mr King) That is correct.

  144. So I can take it from that that you do not have any discussions with HM Treasury about the five economic tests in any way at all.
  (Mr King) No.

Mr Tyrie

  145. If and when the tests are published, if you fundamentally disagreed with the conclusions, is it something on which the Bank is also going to remain silent?
  (Sir Edward George) I have said publicly that if we were summoned by a proper body to give our opinion, we would do that to the best of our ability.

  Mr Tyrie: I am sure that is something for the Chairman to discuss with the rest of us, but for my part I think we would like to see you.

Mr Cousins

  146. I want to come back to something which you said which I want to be clear about. You said that if there were to be a change in the pattern of the exchange rates so that the pound sterling fell against the euro but rose against the dollar, you would regard that as being a neutral position, if those numbers worked out, that would not necessarily trigger any fears of an exchange rate effect on inflation.
  (Sir Edward George) What feeds into the prospect for inflation is essentially the effective exchange rate, which is a measure, a weighted measure, against all currencies. So yes, you can envisage a circumstance in which it weakened against the euro but strengthened against the dollar, and that was absolutely offsetting allowing for the weights, so the effective exchange rate would not change at all. That is not what has been happening in the recent period. In the recent period the euro has strengthened and we have tended to stay more closely with the dollar, so that our effective exchange rate has fallen by more than we factored into the Inflation Report, and that as a matter of arithmetic will imply an upward pressure on the inflation forecast from where we were. Of course, that could change, but it does depend upon the pattern that this thing takes, not the movement of sterling against any bilateral currency.

  147. Just to be clear, you are operating with a concept of an effective exchange rate against the dollar zone as well as the euro zone, and other currencies, and therefore a straight read-off of the pound falling against the euro meaning an increase in interest rates does not necessarily apply if the effective exchange rate, as you put it, remains reasonably stable.
  (Sir Edward George) That is right, but you have to bear in mind that the euro zone is a big weight in the effective rate index, so that is why the rate against the euro zone is relatively important, but it is the effective rate index which matters.

Mr Laws

  148. I wanted to touch on the speech Mr King made in April about the monetary policy challenges in the UK. The whole thrust of that speech seems to be that you are expecting a significant re-balancing of economic policy in the UK in the next few years, which would be a lower exchange rate and a less buoyant domestic sector. You talk about the need to restore domestic demand growth to sustainable levels. Given that we have had a very buoyant consumer sector in the housing market over the last few years, how much do you think we are going to have to reduce the growth of domestic demand and consumer demand over the next few years in order that that will play its part in the re-balancing that you anticipate?
  (Mr King) As a question of where the growth rates might go over the medium term and how rapidly that adjustment takes place, broadly speaking, final domestic demand has been growing at more than twice the growth rate of output of the economy. Net trade has been making a substantial continuing negative contribution to output growth, so that overall the economy has been growing reasonably close to trend, slightly above it, so that unemployment has come down. It is hard to see how in the future it is possible for that negative contribution from net trade to unwind and to make room for the provision of better public services without the growth of private sector final demand coming down to a little bit less than the growth rate of output. It looks as if, broadly speaking, the growth rate of private sector final demand over a number of years will have to halve compared with the average over the past four or five years. The issue for policy of course is whether that is likely to come about of its own accord, and to a significant extent it may; we have already seen that in investment; where business investment had been very strong for four or five years, business investment has now been extremely weak for the last year. So in that sector the adjustment has already occurred. The big picture is that those growth rates of private sector final demand that we saw in the past five years will not be able to continue at that level, but that unfortunately does not answer the question of over what time horizon this adjustment will occur, and that, of course, is the tricky one which is relevant to policy.

  149. Do you think that means that, compared with the last few years, in which we have had very buoyant consumer demand, as you say, we are likely to see consumer demand for a period of years growing under the trend rate of growth of the economy?
  (Mr King) I think certainly much less buoyant, and much closer to the growth rate of output, and possibly even a bit below it on average over a number of years, but that is generally just the arithmetic of trying to square the circle between a reduction in the contribution from net trade, which has been negative, and the need to make room for more resources to go into the public sector. How that comes about and over what timescale is very hard to judge, but over a number of years, yes, I think one would expect to see a much lower growth rate of private consumption than we have seen in recent years.

  150. So we are going to get a better environment for industry and a less good market for the consumer and housing sector over the next few years.
  (Mr King) I think it depends on which part of industry you look at. Obviously that part of industry that has been producing to meet domestic consumption may find that the growth of their markets will be slower, and those people producing for the overseas sector may find it easier—it has certainly been extremely difficult in recent years—and that is, of course, part of the re-balancing that we would hope to see occur.

Dr Palmer

  151. Returning to some earlier questions in this section, Mr King said that at the moment you do not see assessment of the five economic tests as part of your remit, but my colleague Mr Tyrie has encouraged you into saying that you would be willing to make such an assessment if you were asked by an established body, such as the Treasury Select Committee. Is that a correct interpretation? Are you offering yourself as a sort of brains trust for any question that we might ask?
  (Sir Edward George) No. You can ask us for our opinion on things, which we come and give you as freely as we can, and if you thought it would be useful for us to give you our opinion on the Chancellor's assessment, I think I could be thrown into the Tower of London if we refused!

  152. But you would agree that you would not want to give an off-the-cuff opinion; you would have to make an independent assessment yourself of the state of the tests in order to give a qualified opinion.
  (Sir Edward George) I would have to review the assessment as published by the Treasury.


  153. Governor, the impact of the Budget. You said in your Inflation Report, page 43, that the cumulative growth over the next two years is likely to be somewhat faster than assumed three months ago, principally reflecting the overall stimulus from the Budget changes and a slightly stronger picture for global demand, but the Budget itself in paragraph 261 indicated that there would be a small tightening in the fiscal stance in 2002-03 and in the year 2003-04. Why therefore do you cite the Budget as being a principal reason for higher growth than you expected in February over the two-year projection period?
  (Sir Edward George) It is the pattern. Basically, if the government is spending more and it is recouping the cost of that expenditure from the private sector, the private sector will fund some of that from savings, or it will not fund it all out of reduced spending. That will tend to add to total demand and growth to that extent. The other factor is that the propensity to import from government spending is lower than the propensity to import from the private sector, and therefore the impact of demand on the UK economy will be somewhat larger, and those factors together, we think, means that there will be a net expansionary effect even from the broadly balanced Budget.

  154. On National Insurance contributions, one of our witnesses this week, David Walton, said that he personally thought that the MPC made a little too much of the increases in National Insurance contributions given that they do not kick in for another year, and a lot can happen over the course of the next year. How much of the effect of the higher National Insurance contributions on inflation is included in the central projection of RPIX?
  (Sir Edward George) We agree that the National Insurance contribution issue does not kick in until next year and what I think we discussed at great length was what is going to be the process. In the long run, we assume that the impact will actually fall on a rather slower rate of growth over time in nominal earnings, and indeed real earnings, so that it will fall on to the employees, both the employee increase and the employer increase, but that could come about in a number of different ways. The employees might demand higher wages to compensate certainly for their increased National Insurance contribution, and that would mean that earnings grow faster than before the change in the National Insurance contributions. On the other hand, you could have resistance on the part of employers to that process. Employers, if they were adversely impacted either by the wage demands or simply by the contribution that they have to make to increased National Insurance charges, they could try to recoup it through higher prices. We really do not have much of a read on how that process is likely to occur. Depending on how it occurred, it could obviously have a larger or smaller impact on inflation, so we had to make assumptions about that which we built into the forecast and they come through next year. Obviously we will be doing as much analysis and research as we can to try and harden up those assumptions.

  155. What feedback are you getting privately from your agents in the different regions on the matter?
  (Sir Edward George) Well, I think on the whole, it does vary of course, the view I think we are getting from employers generally, though it is not consistent across the piece, is that competition is so tough that they could not possibly hope to recover this from raising prices which means that they will either have to accept it as a reduction in profits or they will have to be tougher in recouping it from employees, either in the form of a slower rate of wage increases than they would have otherwise or in the form of reduced employment. I think on the whole that is the sense that we are getting from a lot of contacts, and indeed I think the reaction from some of the trade associations has been in that direction.

Mr Fallon

  156. Just on this point. You say in the Minutes that "Households might reduce consumption in anticipation of the additional tax burden, before the tax changes took effect". Is that speculation or is that measurable where previous increases of this kind have been in the pipeline a year ahead or is there evidence already of that?
  (Sir Edward George) I do not think we have got any kind of hard evidence of that sort of effect. It is unusual to have this increase announced early and this far ahead. We really do not have much indication. It would be a rational response if employees—leaving aside the impact it could have on pay negotiations—either felt that they were going to have pay this higher tax themselves, therefore, their income would be reduced or feared that the effect would be to impact employers in the direction of reducing labour.

  157. When would you expect to see that response start to appear?
  (Sir Edward George) In 2003 after it happens.

  158. Not before?
  (Sir Edward George) We will be monitoring the expenditure numbers. Our assessment of what is happening to consumption, we will be looking to see if there is any evidence of this happening.

  159. What I meant was if people did reduce household consumption in anticipation of that, when would they start doing that, now?
  (Sir Edward George) I suppose if they know that it is going to happen now, if it is definitely going to happen then any time from now on. You could see it reflected in the pay bargaining process in anticipation too so we will be looking for that. Honestly, we are not in a position where we can say any of these things are definitely going to happen. We just have to think about what is the nature of the process and monitor the incoming data which we will be doing from now on to see if we can detect any directions.

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