Examination of Witnesses (Questions 20-39)
20 NOVEMBER 2003
MR ROGER
BOOTLE, PROFESSOR
SHEILA DOW,
PROFESSOR CHRISTOPHER
PISSARIDES AND
MS BRIDGET
ROSEWELL
Q20 Mr Beard: Are you all of the
view that the concept of the neutral rate is baloney? That is
more or less the answer, is it?
Professor Dow: Apart from anything
else, it is conditional upon which rate of inflation you are talking
about, for a starter. It is statistical.
Q21 Mr Beard: We are talking about
the RPIX here?
Professor Dow: Yes, which clearly
is going to be very important for future decisions.
Q22 Mr Beard: Most outside commentators
in the market see the November rate rise as the start of a sustained
upswing in the interest rate cycle. Do you think the markets are
right to price in a 5% rate, 18 months out, and how do you think
that the consumer and housing market will do, if we see 5% base
rates by the end of 2004?
Professor Dow: It may be that,
because these expectations have been given a lot of publicity
in the media, that in itself is impacting on the perception of
households about their financial position, and that in itself
might help to curb excessive borrowing and keep things stable.
Having said that, given the uncertainties surrounding the forecasts,
which I think are larger than are implied by even some sort of
fan chart, I would be loathe to make such a prediction that that
kind of rate would be appropriate over that time frame also.
Mr Bootle: I think that the market
probably is overestimating the level of interest rates. It does
have a record, over many, many years, of doing that, by the way,
that is to say, of not adjusting fully to the change of inflationary
conditions and overestimating the level of interest rates that
is going to be necessary. It does all depend in my view on the
reaction of the housing market and consumer borrowers. If modest
rises do not bring a significant reigning back in the rate of
growth of borrowing and the increase in house prices then, even
within the inflation targeting framework, and after a switch to
HICP, if that is going to happen, I think the Bank will have to
consider pushing up interest rates until they do get a reaction.
Q23 Mr Fallon: Could we turn to the
paragraphs on bond yields in the Inflation Report. Roger Bootle,
if inflation expectations have risen quite sharply, as they appear
to have done since the summer, does not that mean the MPC's credibility,
in fact, is a little more damaged now than it was perhaps a year
or two years ago?
Mr Bootle: I do not think so,
not to a notable degree. The increase in inflationary expectation,
such as it is, is pretty small. If you compare the movements in
bond yields over the last several months with what we have been
used to over the last 10 or 15 years, this is just a totally different
kettle of fish. Indeed, comparing the movements in bond yields
in Britain with the movements in bond yields in the United States,
for instance, ours have been comparatively minor. I would not
say that the credibility of the MPC is at risk.
Q24 Mr Fallon: The Bank itself attributes
some of the rise to expectations of the changeover from RPI to
HICP. Do any of you think the debate there has undermined some
of the MPC's anti-inflation credentials?
Ms Rosewell: Not at present, no.
It will depend entirely upon what actually happens to that target,
when and how and at what it is set, after all, which we do not
know, and then how they respond to that.
Q25 Mr Fallon: Were you surprised
that this Report itself did not discuss the changeover and some
of the more technical aspects that needed to be aired before the
changeover itself?
Ms Rosewell: I would have been
more surprised if it had discussed those. I am sure that discussion
is going on, but I am not surprised that it is not published in
this Report.
Q26 Mr Fallon: You do not think it
would have been useful if the Bank had published HICP projections
alongside its RPIX projections, given we are going to move?
Ms Rosewell: I think, if they
had tried to do that, that is the kind of thing which would have
confused markets and had the potential to undermine credibility.
The time to do that is when you know what that target is going
to be. I think it would be useful if there were separate research
reports being published on the relationship between these measures
over history and how they have been moving together and that was
published by the Bank.
Q27 Mr Fallon: It means, if there
has been no airing of this in the November Report, if the target
is switched in the next couple of weeks, everybody then has to
wait until the February Report to see the Bank's HICP projections.
Is there not some disadvantage in that?
Professor Pissarides: Hopefully,
the ad hoc projections will come out. I think it is important
to know what the Bank thinks about HICP when it has made it the
official target, but I agree entirely that it would not have been
appropriate to have it in the Report now, because it is going
to be the Treasury's decision as well. I hope and expect that
there is a lot of background discussion, technical discussion,
between the Treasury and the Bank as to exactly what the targets
should be and the advantages of switching over to HICP. Until
the switch is actually made, I agree with Bridget, it would be
better for the Bank not to have them both running side by side.
Q28 Mr Fallon: The Governor said
himself, did he not, back in September, they had a lot of explaining
to do about this change, there was an awful lot of presentational
work to do? Would you not have expected them to start debating
this, if you did not want to see it in the Report, would you not
have expected to see more speeches by MPC members on it, more
technical papers published, and so on?
Professor Pissarides: We would
expect them probably to have had discussion and be having this
discussion now at the Bank, but make it public when we know more
about the timing of the switch and the new target. Inevitably,
questions are going to arise about the target and should it be
0.8, or should it be 1.5, and what are the implications, and then
you get into speculation about policy before that policy has been
agreed.
Ms Rosewell: Certainly I would
expect to have a lot of publications and presentations when such
a switch is made and around that switch.
Mr Bootle: I will dissent on this.
I would have expected some sort of treatment of the HICP issue
in this Report, or at least an acknowledgement of the change and
a broad discussion of how it might affect policy. The Inflation
Report was written as though the change was not going to take
place, and that I find absolutely extraordinary, I have to say.
We have just had an interest rate rise predicated on the idea
that inflation is going to be above the target, or in danger of
being above the target, on one particular definition, and all
of that may be changed radically if the target is set at a particular
level. Not to have treated that at all does seem to me to be absolutely
bizarre.
Q29 Mr Fallon: Could that mean, in
fact, that the switch might be delayed or deferred?
Mr Bootle: There is a strong rumour
in the markets exactly to that effect, that Gordon Brown is going
to make a statement announcing that we are going to move to the
HICP definition but it is not going to be enacted now. Given that
the markets are speculating about that, I think the argument that
there would have been speculation if the Bank had treated this
head on is quite weak, frankly, and already there is considerable
uncertainty about exactly what is happening.
Professor Dow: I think it would
have been particularly helpful, in fact, if they had updated the
table they had in the May Report, which showed the breakdown of
the difference between the two measures. At least people would
have up-to-date information on which to base their expectations
about the relationship between the two and what that would imply
for monetary policy.
Q30 Mr Fallon: Two of you would have
expected some treatment of this issue in the November Report?
Professor Dow: Yes.
Mr Bootle: Yes.
Q31 Mr Ruffley: Can I ask Roger Bootle
about asset levels and house prices. The remit that the MPC has
got obviously is in relation to the price level but also to securing
high and stable levels of growth in employment. I just wonder
what you thought about the second bit, whether or not the MPC
was paying sufficient attention to that, given that it seems to
downplay the bursting or deflating of asset bubbles?
Mr Bootle: I think, sotto voce,
the MPC has been paying more attention to that gradually as the
years have gone by, although the presentation of what it is doing
obviously is still very much in terms of hitting the inflation
target. Indeed, with regard to asset price bubbles, I think you
could readily express a policy of trying to avoid the worst of
a bubble, in terms of hitting the inflation target over a longer
period. As I said in my note to you, I do think this is becoming
a serious issue now. As long as the Bank, of course, thinks that
inflation, whatever definition, is threatening to move above the
target in the foreseeable future, and it is worried about the
house price boom, then policy is not subject to any sort of dilemma,
both factors are pointing in the same direction. I think the really
interesting issue is what would happen, let us say, if they adopted
HICP and a certain inflation target, and on the basis of that
target there was not really any reasonable prospect in the foreseeable
future of inflation exceeding the target, and yet house prices
were continuing to rise and rise and rise at unsustainable rates,
what would policy be then? This seems to me to be the gathering
issue around monetary policy.
Q32 Mr Ruffley: Do you think the
MPC should be talking down asset levels in any way, sort of ex-cathedra
statements? Are they doing enough, do you think?
Mr Bootle: As things stand, it
is not part of their brief, and I think this is the interesting
question, how they interpret their brief in relation to asset
levels, and how they think they ought to behave, as and when there
is a conflict, which at the moment there is not, according to
their forecasts, between what a narrow interpretation of inflation
targeting would have them do and what an attempt to control the
bubble would have them do.
Q33 Mr Ruffley: There could be a
divergence, there could be a need for a change in their emphasis?
Mr Bootle: Yes, I think that is
right.
Q34 Mr Ruffley: Do the markets share
that view, do you think?
Mr Bootle: I do not think the
markets, dare I say it, think very much about that issue. I think,
for the time being, they are locked into the inflation targeting
approach, they do not see necessarily there is a problem.
Q35 Mr Ruffley: In the minutes for
the MPC for July there is an argument that the sum of the 25 base
point cap was unlikely to cause house prices to re-accelerate.
Is it the case that a Ô% base rate rise equally will have
no effect on house prices, Roger?
Mr Bootle: I think that is the
danger. We are dealing here very much in the realms of psychology.
I agree with Bridget's point that a quarter point matters an awful
lot more now than it did, given its lower levels of interest rates
and from these much higher levels of debt. Clearly, the Bank does
not want to overdo it, but we always argue that monetary policy,
to be fully effective, must carry people's hearts and minds. A
quarter point which leads on to the expectation of more quarter
points, by the way, could end up being more effective than a Ö%
increase, to which I referred before, which causes people to conclude
that is the end of the rate rises. The Bank has to play the psychological
and expectations game.
Q36 Mr Ruffley: In the Bank of England
model, what do you think the effect on the housing market and
housing prices would be of a rise in base rates by next September
to 5%, which is what the money markets are kind of pricing in?
Five per cent in a year's time, what does that do to house prices,
do you think?
Mr Bootle: The Bank has already
got the forecast, I think, still that house price increases come
down to zero within two years.
Q37 Mr Ruffley: I just wondered what
your take on it is?
Mr Bootle: That would be on unchanged
interest rates, I imagine, conventionally. Therefore, on the basis
of an increase of interest rates to 5%, you would have to imagine
that the Bank's model would give you house price falls.
Q38 Norman Lamb: Really just following
up on that last point. If it went up to 5%, that would be something
like a 40% increase in interest rates from the 3.5 level. What
is the extent of your concern about the potential impact on the
housing market and consumer behaviour if it gets to that level?
Will it be a smooth levelling-out, or could it be a more dramatic
reaction?
Mr Bootle: Although there are
serious grounds for concern, I think the point to emphasise is
that conditions are nothing like what they were at the end of
the eighties or the beginning of the nineties, either in general
macroeconomic terms or indeed in relation to the housing market.
Loan to value ratios, the absolute level of interest rates, the
putative level of repossessions, all these things are very, very
different levels. I think there could be an increase in interest
rates which prompted a consumer response without prompting, as
it were, mass distress. People would be able to pay their mortgages
still, by and large, and in today's labour market conditions I
do not think you would find the mass repossessions and the negative
equity stopping many people from moving, and all that stuff, that
we had in the early nineties, I think it would be radically different
from then.
Q39 Norman Lamb: Roger Bootle, you
said earlier that you thought there was a case for a Ö% rise
in order to shock people, that was the word you used, into a change
of behaviour, and you did not think that the Ô% had any
real impact on behaviour. Bridget Rosewell, you indicated that
you were concerned a shock could have disastrous consequences,
essentially. Those are two very different interpretations of the
situation we face and it rather indicates that we are walking
a tightrope. Do you have any further thoughts on the dilemma facing
the Monetary Policy Committee, given that you are painting two
very different pictures of what could happen?
Ms Rosewell: I think there are
more things than just the housing market. It is not just a tightrope
in the context of how fast the rate of increase in house prices
is appropriate and levels of debt for consumers, it is also a
tightrope in the context of the rest of the economy. We are talking
about it as if we are trying to set interest rates just in order
to manage the housing market, but that is not the case. Actually
what we are trying to do is set interest rates to maintain a high
level of employment and keep inflation within the target range.
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