Select Committee on Treasury Minutes of Evidence

Examination of Witnesses (Questions 1-19)

20 NOVEMBER 2003  


  Q1  Chairman: Good morning, everyone. Thank you for coming along to this session. Can I ask you to introduce yourselves formally, for the shorthand-writer, please?

  Ms Rosewell: Bridget Rosewell, Chairman of Volterra Consulting

  Professor Pissarides: Christopher Pissarides, Professor of Economics at the London School of Economics.

  Professor Dow: Sheila Dow, Professor of Economics, University of Stirling.

  Mr Bootle: Roger Bootle, of Capital Economics.

  Q2  Chairman: Thank you. I will start with the well-publicised comments of Mervyn King, I think in his Leicester speech, when he said that the economic success of the past decade is unlikely to be continued over the next decade as the economy has used up most of its spare capacity. Do you agree with that general assessment? Who is going to start: Sheila?

  Professor Dow: The one qualification I would raise for this assessment is due to the change in the GDP estimates, which suggest that investment growth has been higher than we expected, so there may be more capacity in that sense. In general, it is a rather worrying assessment.

  Professor Pissarides: Although he did not have the information we have now, I agree, but I think there is a good deal of uncertainty attached to that assessment.

  Ms Rosewell: I think that there is the potential for more capacity growth than necessarily is included in the estimates. For one thing, the increase in output that apparently we have now in the estimates, compared with what we did have, suggests that, in effect, we were able to run at higher capacity utilisation rates in the past than was previously thought. It depends a lot on how much difference you think that makes to the trend rate of growth, and it does not need to make very much difference for there to be increasing scope for capacity growth in the future. I think you have to be slightly careful about what the dynamics are of this, particularly when growth which is largely service sector oriented requires much less in the way of physical capacity and physical investment than does, say, manufacturing growth. I am moderately optimistic.

  Mr Bootle: I would agree broadly with the Governor's assessment, although I think there is a second issue, the first one being, of course, how much spare capacity there is. The second issue is about management, that is to say, is the economy going to be as lucky and as well managed as it has been, the combination being important, in order to be able to realise the trend rate of growth and the way that the economy has been both lucky and well managed over the last few years.

  Q3  Chairman: Looking back to the July rate cut, with hindsight, was that a mistake?

  Professor Pissarides: No, I do not think it was a mistake, given the information that we had at the time. The economy was not growing up to trend at the time, there was still recession in the main trading partners of the United Kingdom, there were no inflationary pressures in the economy to speak of. The only worrying market at that time was housing debt, consumer debt associated with housing, which had been present for a while, so I think the decision to lower interest rates at that time was the correct one, given the information we had at that time.

  Ms Rosewell: To say that we would have made a different decision had we had different information is not very helpful I think, because the point is that you can make a decision based only on the information that you have. I agree with Christopher, based on that information, that was the right call.

  Mr Bootle: I agree.

  Q4  Chairman: Now on to the November rate rise. First of all, was that appropriate, and was there a case for increasing the interest rates by a Ö% rather than a quarter?

  Ms Rosewell: I think that had you increased interest rates by half you would have run the risk of generating a very sharp correction in markets across the piece, not just the housing market but also stock markets, and you would have signalled a very sharp increase in interest rates by doing that. A half on top of where we were is a big rise, it would not have been a big rise 10 years ago but certainly it is a big rise now. I think that would have been completely out of scale. What they are trying to do is nudge the situation. It is not the case, after all, that we are in boom across all markets.

  Professor Pissarides: We have to be careful about two things concerning the rise in the interest rate in November. The first one is, where do we think interest rates would go next, given the new information we had; the second one concerned timing. On the first one, I think the MPC was absolutely right in saying that the next move for interest rates was on the up, that interest rates would be increased. On the timing, I have some doubts, without being absolutely certain, when the correct timing would be because that is a difficult decision that is facing monetary policy-makers. The November meeting and the time that the rise took place I think was the earliest we could have had a rise and argue reasonably that we needed it, given the information that was coming through. We could have waited another month and I do not think there would have been any damage done to the economy. On the question of how much should the rise be and should half have been better, in my view the answer is that it may have been worse if we increased by a half instead of a quarter. Given what I have just said, I think it was more of a pre-emptive rise, given the information we had, and raising by a quarter of 1% is more cautious and wiser in the circumstances than raising by half of 1%.

  Professor Dow: Yes, I agree that it was wise to stick to the quarter point rise. The situation was very finely balanced and the rate continues to be finely balanced between the different considerations of holding back inflationary potential, on the one hand, and, on the other hand, not promoting greater fragility in the financial structure. The move by the MPC is very much a signal not only about their analysis of the situation but also about their intentions, and the minutes of the meeting that have come out since have been quite influential in calming expectations about further rises, which I think is quite appropriate.

  Mr Bootle: I think it depends what exactly the Bank is trying to achieve, because I think there is a fair amount of mystery and difficult issues to be prodded on this particular rate rise. In particular, in the Inflation Report, the Bank makes next to nothing of the impending transition to HICP. On that HICP measure I would not have thought most assessments, if the target is going to be set at 2%, would come to the conclusion that there was an inflationary danger, and the Bank's response to that is simply to ignore the issue. Similarly, even on the RPIX, personally I think the Bank's assessment is rather too bullish of the economy next year and rather too worrying about the inflation prospect. The reason why I say that there are some issues to be discussed here is that possibly you could have been aiming to set monetary policy at this stage according to a rather different principle. Namely, you might well be extremely worried, within the broad context of inflation targeting, about the housing market and the surge in personal borrowing. If you were then I think there would be a reasonable case for increasing interest rates by Ö%, because a Ô% has not actually shocked people enough, I think, and at some point the Bank may have to consider seriously increasing rates by a half.

  Q5  Chairman: The MPC's strategy in recent years has been to increase domestic demand to offset the weak external demand. With household debt and the trade deficit both hitting new records this autumn, is that strategy now hitting its natural limits?

  Ms Rosewell: Clearly, the MPC is concerned that further increases, particularly in unsecured borrowing, run the risk of destabilising the situation. If we look at secured borrowing, for example, certainly it is not the case that looks particularly vulnerable and we are running at very low levels of repossessions and levels of arrears. The ability of households to finance their borrowing is still not, I think, at a dangerous level, nor is it obvious that equity withdrawal is being used to finance consumption. This is an area which is quite difficult to get a handle on, but if you look at the discussion in the Inflation Report certainly it would suggest, on the best evidence that we have got, that we do not need to panic about that. On the other hand, certainly you would not want to see continued increases at these sorts of rates in that borrowing level, but that means you want to nudge it down. To that extent, I think I would disagree with Roger, because I think there is a significant risk that if you make too abrupt a termination then everything just goes into reverse. Then you are quickly at a point where you have to start cutting interest rates again because consumers have stopped spending as well as borrowing, because they feel very uncertain and because they think that if there is a half-point rise there must be only further increases on the way. I think that balancing act, which the MPC clearly is trying to make, remains a difficult one. In other words, without consumer spending growth the economy goes nowhere. At the end of the day, that drives the economy. Therefore, it is not the case that there is no more room for consumer spending, there must be room for consumer spending, but it is a question of trying to manage expectations gently rather than abruptly.

  Professor Dow: Could I disagree with the suggestion that we have enough information in the Inflation Report to make a judgment about financial fragility. The information on household financial structure in the Inflation Report is all aggregative. In fact, what we need to be concerned about is how close some sub-groups are within that aggregate to financial difficulties, because once a significant group face financial difficulties and are faced with falling house prices that could trigger a reaction which would lead to house sales and much more generalised financial distress. I was disappointed not to see more in the Inflation Report disaggregating the information on household debt.

  Q6  Chairman: I think the Governor mentioned that in a recent speech when he said there is insufficient information on household debt, and I think he is commissioning a study on that in a little while?

  Professor Dow: I believe that is the case, but the Financial Stability Review in June did provide some information on disaggregated data, and certainly I am looking forward to seeing the report to which the Governor refers.

  Mr Bootle: I think the policy of forcing domestic demand clearly has been the right policy in the circumstances, but the longer it goes on the greater the subsequent dangers become. If it is the case that world demand and the rest of UK domestic demand is set to revive then I think it is imperative for the Bank to make sure that consumer demand glides down, albeit gently but to a sustainable picture reasonably quickly and that we do not get a dangerous bubble inflating in the housing market. I agree very much with Bridget's comments about nevertheless you do not want to bring people up so you cause worse than a slowdown and have to cut interest rates, that would not be advisable. Clearly, the Bank has got a very delicate balancing act to perform here. At the same time, you do not want to be increasing rates so gently, I suggest, that borrowers and people in the housing market take no notice whatsoever. If rates are increased very gently every so often by a Ô%, I think that could be dangerous.

  Professor Pissarides: There are two factors in the MPC's thinking that have been important here, I think. One of them is that the prospects for aggregate demand are good, because the United States economy is recovering well and there are positive signs in Europe, although they have not appeared yet in the official statistics, they have appeared in confidence indicators, both from businesses and consumers. The second positive factor is that investment demand in the United Kingdom was better than known earlier, that came up in the revision to the official statistics that the ONS has made. In those circumstances, I think the MPC's thinking was probably it was the right time to try to contain consumer demand. What was said about consumer demand by Roger, in particular, I agree with but, I do not think consumer demand will need to glide down for the debt to come under control, I think it can rise more slowly and wait for the rest of the economy to catch up, as it were. I do not think we are quite at such dangerous levels that we would need to reduce it.

  Mr Bootle: It is filling up, not gliding down.

  Professor Pissarides: I am sorry. Where I see the downside risks would be in the international economy not recovering as anticipated, especially Europe, because the United States hopefully is showing more confident signs that demand will continue at this high level.

  Chairman: Before I hand over to Angela, can I thank all of you for the papers that you produced for us before the meeting, and for the effort you have put into them and the quality of the papers, they are very, very helpful to us.

  Q7  Angela Eagle: I want to ask a question about the sensitivity of rate rises, because, as both Bridget and Roger have pointed out today, we are now in ¼% rises. Roger said maybe we need a half, Bridget said well a half might be catastrophic, and, exaggerating only slightly, it might shock people. Are we getting to the stage where our adjustments now are so minor that they are not giving really very many signals at all outside, especially to consumers, when we are worried about indebtedness? Are the tweaks so tiny that nobody notices?

  Ms Rosewell: No, I think that is wrong actually, because if interest rates were back at the sort of levels that we had a decade ago, and you were talking about quarter points, then that is right, it would not be noticed. It is a question of how much money that translates into relative to the money you are paying already, if you like, so if it is a personal loan, or whatever, and in that context a quarter point is much more significant than it would be if the rates were much higher. Do people take any notice? Given the proportion of mortgages on a fixed rate, for example, the sort of amount of money that a quarter point change might make to an average mortgage across the book, if you like, the answer is about £5 a month. You might say, that is not enough that it will make a significant difference. Of course, that is more for the people who are on a variable rate, but if there is a good proportion on a fixed rate then across the piece it makes less difference. I think it is a question not just of the amount of money but the perception that it gives.

  Q8  Angela Eagle: Up or down?

  Ms Rosewell: Up or down, exactly. It is not just about the amount of money and the size of the rise, also it is about a perception, "Have these things now turned round and we are going to see increases in interest rates?" Rather than "We are not going to see any changes," or indeed "We're on a downward path." I think it is perceptions that matter to consumers as much as any given amount of money, and those perceptions can be very important particularly at the margin, as Sheila was pointing out. Also it is a question of the distribution, and that can make a big difference.

  Q9  Angela Eagle: Do you think that we need more information about percentages of people on those kinds of mortgages, more disaggregated information, in other words, so that we can assess more how that would work? Presumably, there would be a switch into fixed-rate if people thought that interest rates were going to rise for a significant level of time. Do we not need to track that more effectively than we do?

  Ms Rosewell: It moves very quickly. People do respond. One of the things certainly that you see is—as you know, probably, I am a director of a building society—we notice how quickly people respond to interest rate incentives, one way or the other, so they will move from fixed to variable and vice versa, depending on their calculations of what things are worth doing and what things are not worth doing. It is quite a hard thing to track because it does change quite quickly. I agree that in principle it will be nice to understand it better, but you do get an awful lot of movement.

  Q10  John Mann: I would like to ask a couple of questions on the labour market. There seems to be a bit of a trend building up to suggest that wage-led inflation is going to be a bigger problem in the next year, and yet, at the time, productivity would appear to continue to be increasing rather healthily. Is this concern on wage-led inflation a real concern, is it an evidence-based concern, or is it probably speculative, in your view?

  Professor Pissarides: At the moment I think it is rather speculative. Private sector pay has not been rising at alarming rates. Public sector pay has been rising but it has been catching up on losses that it made in the past. The danger with public sector pay, if it is rising too fast, arises when the private sector tries to copy what has been happening in the public sector, but this has not happened yet and there is no indication that it would happen, although there is always uncertainty attached to what private sector wage negotiators might do. For the moment I am not concerned about what we see in the earnings statistics. Having said that, I think we have to be very watchful because I think, if there are inflationary pressures that will come in the future, they will come from the labour market. Let me put that a little bit differently. If the labour market starts showing signs of bottle-necks and earnings rising faster than productivity then that would lead to inflationary pressures and the Monetary Policy Committee would have to act quickly. To repeat what I just said, I do not see that happening yet. On that issue, maybe I should add that I attach a lot of importance to the new work of the Bank of England on calculating indices of labour market tightness that go beyond unemployment. I think that is very important work.

  Q11  John Mann: Perhaps I could explore that issue, because that is new and important. To take a quote from the current Inflation Report, it talks of taking into account the size and composition of the entire non-employed adult population. Is not that rather dated thinking and should we not be looking also at the flexibility of the labour market and, for example, the propensity of part-time workers to increase the number of jobs they are taking as well as the number of hours they might be working? Additionally, what about the role of the grey labour market in this?

  Ms Rosewell: I think that you are right. Obviously, there are quite a number of changes that are going on. I think though to say that this sort of analysis does not go far enough is perhaps a little mean, given that at least they are trying to look at what is happening not just in the context of unemployment. In particular, one of the interesting things is flows from inactivity, and looking at flows from inactivity into the labour market is one of the things which seems to be different, and understanding that a bit better. My guess would be that is more important than changes in hours for part-time work, or indeed taking more jobs as part-time work. We know that there is flexibility in hours anyway, and that is quite well tracked and has been over quite a long period. It is the tendency to continue working for longer, in other words not to retire early, which is going to be an important element in the labour market going forward, and in part that is not flowing into inactivity in a way that might have been the case earlier. Clearly that is a phenomenon which has become more important and is going to continue to be more important, as people are worried about their pensions they will stay working.

  Professor Pissarides: I agree with that. I think it is a question of how much do you put in the Inflation Report on the labour market. I agree with you. I wish there were a little bit more. I try to read between the lines and I see that there is concern with flexibility, there should be concern. I think the underlying assumption is that probably we have done enough, or done a lot, on flexibility that we could rely on a flexible response from employers if the additional labour supply were to come through. It is a rather optimistic scenario, but the experience of the 1990s sort of encourages us to look more optimistically at how flexible the employers' side in the labour market can be. Given that flexibility that we have on the employers' side then the right population group to look at, when we are looking at labour supply, is the working-age population group, from, say, 25 to 65, but we might go to even younger ages and look at 16, 17 year olds to 25 year olds, as a potential supply. Not only that, I think also we should look at the potential supply of labour from abroad, especially from the new members of the European Union, where they will have the freedom to come in and work in the United Kingdom. Given the wage differentials that we have, there might be an increase in the supply of labour there. Then post retirement people staying in the labour force beyond the age of retirement, as Bridget has just pointed out, to enhance pensions.

  Q12  John Mann: It seems to me that there is a fundamental assumption built into inflationary forecasting, and the title, section 3.4 in the Inflation Report is "Labour market tightness", that there is going to be a problem there. Is it not the case, in fact, that, looking back historically over the last 10 years, there has not been that problem and commentators have been surprised that it has not emerged as a problem? Is not the real issue that we need to be looking at the propensity to flexibility, which will incorporate regional flexibility as well as a sectoral flexibility, in terms of the potential for the labour market to create, or not create, inflationary pressures?

  Professor Pissarides: As I said, I agree with that entirely. Behind the supply of labour that is discussed, behind the labour market tightness that is being discussed in the Inflation Report, there is an underlying thinking of flexibility. The reason why the economy surprised people in the 1990s is that there was a very flexible response from the labour market, and we should continue looking at that and hopefully keep it at that level.

  Q13  Mr Cousins: Just to follow on from the point my colleague has made, and what I think is a very interesting line of argument, almost the whole of the net growth of employment in the last year is accounted for by the growth of self-employment. Do you not think we may be looking at quite a considerable change in the structure of the labour market that perhaps analysts are not yet picking up?

  Ms Rosewell: I have not looked at self-employment numbers, but certainly what we have had is changes in the structure of employment too, so that we have had big increases in the number of people employed in the public sector, for example. It is not the case that employment is static and there are changes just in self-employment, there are big changes in employment. The numbers in self-employment are relatively small, so you can get big percentage swings with not that many changes in the actual number of people. I think self-employment tends to be still a residual, in other words, that is what you do if you cannot get a job, generally speaking. There is a proportion of people who like to be self-employed, or run their own small businesses, like myself and Roger, but, generally speaking, most people want to have jobs, and if they become self-employed then that is because there is an issue in a particular sector or at a particular point in time. I think what is most interesting in the labour market at the moment is that changing structure of employment, and one of the things I think is missing in the Inflation Report is enough consideration of what is happening on the public sector side of things. There are some estimates out of the ONS, for example, about inflation in the public sector and productivity, or lack of productivity, if you like, in the public sector, and it is quite hard to get your head round how good those numbers are. I would say it is that changing structure that one ought to be looking at, at the margin in the labour market, rather than at self-employment. I think that would be much more interesting.

  Professor Pissarides: I am a little more positive about self-employment actually. I think we have to go back and ask where is the employment growth coming from, where is the job creation in the labour market? The job creation is in the service sectors, and particularly in new service sectors, like business services, and in those service sectors there is a higher fraction of self-employed people. In the United States, for example, where they had this growth some years ago, there is a lot more self-employment in those sectors where the UK economy now is creating jobs. It is part of the changing structure of the labour market. I think we will see more highly qualified, professional, self-employed people, like my two colleagues here. I think it is part of the normal development of the economy.

  Ms Rosewell: It is still quite small numbers, in absolute terms. It is never going to be a dominant force in the labour market, do you think?

  Professor Pissarides: It is quite dominant on the margin when you look at the increase in employment, because the increase in other employment in the last two years has been quite small as well, and one small number, which is self-employment, is quite a big fraction of the other small number, which is the increase in other employment. There is an increase also in part-time jobs, and more women, and especially more students, coming into the labour force to get part-time jobs, which again I think is a healthy development. It shows more flexibility in the labour market, it shows that people are getting more into this enterprise mentality, which characterised the United States for many years, of doing not just the one thing and not looking beyond what you are doing. You might be a full-time student but at the same time you have five months of the year when you do not have to study ten hours a day and, those five months, you might go out and look for a part-time job and help in the overall productive process.

  Professor Dow: I would say it is applying increasingly to students during the time that they are studying that they are taking on jobs, just to reinforce that. If I could add, there is a further distinction to add to the one that you have raised between self-employed and employed labour. There is a table in the Report which shows the breakdown between manufacturing employment in small firms and large firms, and it shows that the growth is coming in the small firm sector. The Bank does publish a lot of detail on small firms in other reports. Again, it would have been nice to see more detail on that, because it would give us a better picture of the composition of employment.

  Q14  Mr Plaskitt: There is perceptible growing optimism about the state of the world economy, and the encouraging figures in the United States are part of that. To what extent do you think we should worry about signs of growing US protectionism? Does that have the potential to derail the recovery of the global economy?

  Mr Bootle: I think it is a serious danger, yes, and, of course, we have seen just recently the reaction of China to the latest US move. It is part of a general concern which stems from I think the unbalanced nature of the world, the fact that it has been too dependent upon American demand for so long. Therefore, with these massive imbalances, Europe is still not pulling its weight, as it were, in the generation of demand. Japan is still pretty sluggish. From the point of view of the state of development, you would think that countries like China ought to be running a significant current account deficit, not a significant current account surplus. The dangers overhanging the world are several. As you point out rightly, there could easily be a protectionist backlash. We have seen already the breakdown of the trade talks at Cancun. This is just another stage in all of that. Meanwhile, the dollar is looking extremely overvalued, in my judgment, so it is quite possible that there could be a combination of these protectionist measures and a fall of the dollar, which could be quite damaging, I think.

  Q15  Mr Plaskitt: Enough to stop in its tracks the signs of recovery we have seen so far, would you say?

  Mr Bootle: I think so, yes.

  Q16  Mr Plaskitt: Do the rest of you agree with that?

  Professor Dow: I think it is a danger, and, just to put it in an historical context, the imbalance of the role of the States stems actually from the design of the international monetary system whereby the dollar is the key currency. That is a market choice now rather than a design choice, but it follows from the fact that there were such large capital inflows into the States that they can run such a large current account deficit. In a sense, that is part of the problem, which is not of their making but it is inherent in the international monetary system.

  Ms Rosewell: The scale of the deficits must be a risk. There are global imbalances. It is possible to envisage an unwinding of those that would not cause severe disruption. Equally, because they exist, it must always be a risk that something very nasty could happen, that markets lose confidence, that the dollar falls, that could be a reaction to a particular institutional event, like an increase in protectionism, or a particular set of limits being put on. That is the kind of risk that one has to live with and monitor and try to be aware of. I am not sure it is anything that we can do anything about.

  Q17  Mr Plaskitt: Has the level of that risk risen noticeably recently, or are you saying that it is just a constant background risk?

  Ms Rosewell: I think it is a constant background risk. I am not sure I would say that it has increased. Obviously, the failure of the trade talks is not good news, but that is also part of a continuing pattern. I am not sure I would say that it has risen dramatically. Maybe it has picked up a bit as a risk, but I am not sure I would say it has increased dramatically.

  Mr Bootle: I think it has increased quite a lot because of the sheer growth of China and the sensitivity within America to that growth, the number of manufacturing jobs going. I think the underlying issue has been there for some considerable time, but people are waking up now to the sheer size of the competitive threat that China poses, and equally not offsetting that against the opportunity that the development of the Chinese market causes. American politics works in such a way that I can be quite clear, I think, that worry about the competitive threat is going to dominate.

  Ms Rosewell: That is absolutely right, but, on the other hand, we have been here before, some 15 years ago, or so, maybe a bit longer, on the Japanese threat, when there was exactly the same debate, if you like, about the Japanese coming in and taking our jobs sort of thing, and American politics responded to that. Nonetheless, we managed through that risk, the deficits increased, the imbalances went on, but actually it did not end in tears, on occasion it looked as thought it might but it never did.

  Q18  Mr Beard: The November Inflation Report shows some slippage in the Bank's expectations of growth in the eurozone, and yet last week there was more upbeat economic data coming out of both France and Germany. Is it possible that things are recovering finally for all the eurozone and is it the case that it is essential there should be a better economic performance in the eurozone before the United Kingdom export performance can pick up?

  Professor Pissarides: I have to say, I was a little bit surprised by the pessimism that was expressed in the Inflation Report, especially in view of the discussion that went on before. It was pointing out to positive signals and then, at the end, that imbalance, we are pessimistic about that. I was a little bit surprised by that. I think we can afford to be a little bit more optimistic, because there have been a few quarters since when the confidence indicators from both businesses and consumers have been rising, quarter in, quarter out, and usually when that happens you would expect a pick-up of investment and consumption spending to follow. True, we have not seen it yet in the official statistics, but usually these things take time, so I am a little bit more optimistic than the Inflation Report. On the question of whether we shall expect to see first export demand from Europe rising and then tighten here, my answer is, not necessarily, but it would be good to have more robust statistics about an international recovery before we tighten. This goes back to the comment I made right at the beginning. I think it is clear that the move in monetary policy was going to be towards more tightening. Given that we are relying on the United States economy, which is expanding mainly on the back of fiscal deficits, we are relying a little bit on the forecasts for the European economy, I think if we had waited a little longer and actually seen these things happening, I would underline, especially in Europe, we would have got the balance better.

  Mr Bootle: I would agree with Chris and sympathise with the Inflation Report's worry about the eurozone. It is true that the confidence surveys have picked up but they are far from being reliable indicators, they have disappointed on a number of occasions in the past. I think particularly it is worth recognising that not just Governments' forecasts but the outside consensus forecast has a prolonged record of seriously overestimating eurozone growth over the last few years. The notable factor that I would put between a number of other factors, first of all, with the end of the war in Iraq and the fall-back in worry about terrorism, and all sorts of ghastly things which dominated opinion earlier in the year, I think it is natural you should expect there to be some sort of up-tick in confidence over the last few months, without necessarily, I think, meaning very much about the underlying economic situation. The second point is the rise of the euro, where now it has surpassed its previous peak against the dollar, and if I am right in thinking the dollar is going to move a fair bit weaker, the euro is almost bound to move stronger and that I think is going to be a serious worry for the eurozone economy. Also I think there is a question about the stand-off between the policy authorities over the stability and growth pact, where I had hoped that there was scope for reductions in interest rates. Certainly if the euro does strengthen a fair bit more then in my view there ought to be further reductions in eurozone interest rates. There is a very difficult and dangerous game being played between the ECB and eurozone governments. Effectively, the pact is a dead duck, we have not got anything to put in its place, but it looks to me as though the ECB is trying to keep some semblance of it alive, or at least have in the background a nasty threat to hold over governments, in case they relax the fiscal stance rather too much, and I think that is all really rather dangerous. In reply to the second question, which I think was about, was it not, the case that the revival of the European economy is vital for the growth of UK exports I think that is right. As we know, the figures are subject to some dispute and discussion, but broadly speaking roughly half of our exports go to the European Union, more than that as far as goods are concerned and less than that as far as services are concerned. The evidence seems to be that the overall level of demand is way, way more important than the exchange rate or narrow competitiveness factors that might change on a year-by-year basis. Unless we get a revival of European demand, I think, even if the pound falls overall, it is difficult to see UK exports doing extremely well.

  Ms Rosewell: I would like to support, in particular, what Roger said about this policy stand-off. That would be why I would say, although the indicators look positive, nonetheless, I would be very nervous, because it is entirely unclear to me how this is going to be resolved, both in terms of the stability and growth pact and indeed in terms of ECB policy. Therefore, it is extremely hard to see where interest rates will be going, or indeed the fiscal positions will be going, and that must be creating uncertainty right across the piece for investors and businesses in the eurozone. All of that is where it is dodgy.

  Q19  Mr Beard: The October minutes of the MPC noted that, even after a 25 base points rise in interest rates, the rate still would be below the plausible estimate of the neutral rate. Where do you see that plausible estimate of the neutral rate being? Given that the Bank's central projection for GDP foresees growth just a little faster than the trend level, when do you see them having to correct the rate back to the neutral setting?

  Ms Rosewell: I do not believe in neutral interest rate concepts, so I am not really qualified to answer this. In other words, you are always moving in some direction or another.

  Professor Pissarides: There is a lot of uncertainty. If you were to put your finger on an interest rate you would add the rate of growth of GDP to the rate of inflation, but I agree there is a lot of uncertainty. Say, we have an inflation target of 2%, and there is another 2 to 2.5% real growth in the economy then I would think that 4% to 4.5 is the more true rate than the one we have now, with a lot of uncertainty attached to it.

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