Examination of Witnesses (Questions 43-59)
20 NOVEMBER 2003
MR MERVYN
KING, SIR
ANDREW LARGE,
MR RICHARD
LAMBERT, PROFESSOR
STEPHEN NICKELL
AND MR
PAUL TUCKER
Q43 Chairman: Can I open the meeting,
Governor, by welcoming you and your colleagues to this session.
Starting with Professor Nickell, could you identify yourselves
formally, please, for the shorthand-writer?
Professor Nickell: Stephen Nickell.
Sir Andrew Large: I am Andrew
Large.
Mr King: Mervyn King.
Mr Tucker: Paul Tucker.
Mr Lambert: Richard Lambert.
Q44 Chairman: All members of the
MPC. Thank you. Governor, I think you want to make a quick opening
statement?
Mr King: A short opening statement,
if I may, Chairman. I am very grateful for this opportunity to
explain the reasons for the Monetary Policy Committee's decisions
on interest rates since we last appeared before you in September,
and, of course, in particular, the reasons for the rise in interest
rates at our November meeting. In most of the industrialised world,
demand and output, as expected, are responding to the exceptional
supportive stance of monetary and fiscal policy in recent years.
In the UK, estimates of demand and output have been revised up,
and some of the statistical fog has dissipated. Following a weak
first quarter, output has grown at around its historical average
and inflation has been above the 2.5% target for almost a year.
Consumer spending has decelerated markedly to growth rates averaging
just over Ö% a quarter for the past year, from around 1%
a quarter over the previous five years, but neither consumer spending
nor the housing market have slowed as much as the Committee expected,
and the growth of secured and unsecured credit continues at high
rates. Last week, in its November Inflation Report, the MPC published
projections for output growth and inflation conditional on official
interest rates remaining at their current level of 3.75% throughout
the two-year forecast period. The central projection is one of
growth around or a little above its historical average throughout
the forecast period. Overall, this outlook is somewhat stronger
than in August. Although some of the temporary factors pushing
up RPIX inflation are expected to unwind in the coming months,
the central projection for inflation is that it remains around
the target through the forecast period, picking up at the two-year
horizon as underlying inflationary pressures build. The Committee
sees moderate growth of consumer spending and slowing in house
price inflation as the most likely outcome, but obviously there
are enormous uncertainties surrounding that outlook. In particular,
the Committee is mindful of the risks to domestic demand and inflation
resulting from the high level to which household debt has risen.
Its best assessment is that the position of households in aggregate
is not as fragile as some have suggested, but the Committee is
aware of the need to understand better how that debt is distributed
among households and hence the scale of those risks. In the Committee's
view, the risks to the central projection for inflation are broadly
balanced. Inflation is expected to remain close to the target,
but continuing, steady growth—at home and abroad—and
diminishing spare capacity are likely to mean that underlying
inflationary pressures will build gradually. As a result, the
Monetary Policy Committee judged that the first interest rate
rise for almost four years was necessary to keep inflation on
track to meet the target. Chairman, those are the remarks that
I would like to make this morning, and I and the other members
of the Committee stand ready to answer your questions.
Q45 Chairman: Thank you very much,
Governor, for that opening statement. Could I start by focusing
on your broad, strategic assessment, the one you made in your
Leicester speech, which highlighted that the strong economic performance
of the 1990s had eroded most of the spare capacity of the economy.
You highlighted also the dangers posed to inflationary pressures
by diminishing spare capacity, in your opening comments at the
Inflation Report press conference. Therefore, is the MPC operating
now against a basic background which requires it to act quickly
to constrain UK growth if at any point growth looks like rebounding
back above trend?
Mr King: I do not think it is
a question of trying to target growth, but it is a question of
the Committee, I think, as before, always looking forward and
being ready to take action on interest rates when it is felt to
be necessary. The message I was trying to give in the Leicester
speech was that we have been through a decade in which gradually
we managed to use up the spare capacity and in which supply side
reforms brought down the normal level of unemployment. That was
a period in which living standards were able to rise faster probably
than they would be able to normally, because of the sharp increase
in the terms of trade of around 10% since sterling started to
rise in the mid 1990s, and it is very unlikely that there will
be a repetition of that increase in the terms of trade. I am not
suggesting that the terms of trade will unwind necessarily. I
think, a repetition of that sharp increase in the terms of trade—which
enabled real wages and household consumer spending to rise at
above trend rates, without any substantial financial imbalance
in the economy and without undue upward pressure on employers'
costs, and hence inflation—is not likely to repeat itself.
It is a slightly more normal, if you like, but slightly more difficult
position than the one in which the Committee operated over the
past five years or so.
Q46 Chairman: What does the Bank
estimate the trend growth rate to be currently, in the UK?
Mr King: It is hard to judge,
and I think the recent revisions to national accounts data make
it more difficult to judge still. For some time we have felt that
around 2Ö% is not a bad estimate, that is close to the historical
average. Of course, there are arguments to suggest that perhaps
changes in investment and IT might lead to there being some increase
in that, but it is not easy to detect that in the data. The upward
revisions to the National Accounts really raised the estimate
of growth in 1999 and 2000. I think it is a good question to ask,
how should one react to the upward revision of growth in those
two years? I do not think it is obvious that one would infer,
from an increase in the estimated growth rate in just those two
years, that there has been a rise in the trend growth rate. I
think this is a question, obviously, to which the Committee will
wish to pay a good deal of attention in the future.
Q47 Chairman: On the issue of spare
capacity, it has been suggested that the euro economies and Japan
have spare capacity, and when their economies rebound that could
be used up. What implications will that have for US growth over
the next few years? Do you think, as a result of that, if these
economies rebound, that the US growth will be weaker by international
standards than we have become used to?
Mr King: I do not think the question
of whether the European or Japanese economies will grow faster
in the next few years has any direct implications as such for
the US. Indeed, I think that faster growth in those economies
would help the position of the imbalances in the US economy, particularly
the large current account deficit, and it would help the US economy
see those deficits unwind somewhat, as one would expect they would
do, within the medium term. I do not think it would have any negative
signal for US growth, indeed, I think actually it would ease the
position for the US.
Q48 Chairman: Could it have any negative
effect on UK growth?
Mr King: No. Again, I think it
would lead to a somewhat better world climate. To a much lesser
extent than the United States, we have also suffered from a position
in which we have managed to grow at around trend growth rates
for quite a long time, during a period in which the world economy
has been slowing quite rapidly. It is now starting to pick up
from that. I think a recovery to historically more normal growth
rates in the euro area and Japan can be good for not only the
world economy and the US but also for the UK.
Q49 Chairman: Could I ask what factors
have led household consumption to be stronger than you expected
at the time of the August Inflation Report?
Mr King: I do not think it is
easy to give a definitive answer on that, at this stage. Clearly,
it is a conjunction of factors and you could point to the housing
market as one explanation for why mortgage equity was withdrawn
and spending has continued to be buoyant. Equally, one can argue
that, in fact, the key question is what is driving both of them,
and that both consumption and the housing market simultaneously
have been stronger than we thought. There has been a slowing in
the growth of real wages. This is the first time for some considerable
period in which the average growth of take-home pay in real terms
actually has been negative. That is, real take-home pay has fallen
in the last few months compared with the year before, and I think
we had expected that the growth rate of consumer spending would
slow. Of course, it has slowed quite significantly compared with
the growth rates of the past five years, but perhaps not quite
as much as we had expected. That may be because households have
responded to the low level of interest rates, it may be because
they can detect, looking ahead, that perhaps the climate is more
optimistic. Certainly, consensus views about the world economy
have become more optimistic in the last three months. There are
many factors and it is hard to pin down what is the factor that
has driven it. Whatever it is, it has been a little stronger than
we expected, though I think we should not lose sight of the fact
that the growth rate of household consumer spending is a good
deal lower than it was over the past five years.
Q50 Chairman: I know that you have
expressed concern about the number of highly indebted households
with little or no liquid assets, and you have expressed the need
to have more information on that, and I believe you are commissioning
an independent study on that. What implications could that have
for the economy with these individual households, ex post,
as it will be?
Mr King: It is not easy to judge,
but I think if you look back to the early 1990s it is not easy
to understand why consumption was so depressed without looking
at the distributional effects. That is that, where over a million
households suffered from negative equity, they cut back their
spending more sharply than they might have done had the fall in
average incomes and real pay been spread evenly over that population.
If so I think the total fall in consumer spending would have been
less than we saw in the early 1990s. If there are significant
balance-sheets effects focused on a small group in the population,
that can have a disproportionate effect on total consumer spending,
which will be of relevance to the Committee. We do not think we
are in that position now. Even if house prices were to fall, we
do not think we would go back to the number of households facing
negative equity. It would require a very dramatic fall in house
prices for that to be the case, so the negative equity situation
looks considerably better than it was in the early 1990s. On the
other hand, because the debt burden has increased, there is a
minority of households facing fairly high income gearing, and
they are more vulnerable, and so we decided we would like to know
more about it. I remember, when we came to you in September, you
asked whether we would repeat our survey on mortgage equity withdrawal,
and the impact of that on household spending. We did go away and
consider that, and we decided that we would not carry out our
own survey on that because there is a survey being conducted by
the Office of the Deputy Prime Minister, the Survey of English
Housing. They will be publishing some results at the beginning
of next year which will contain answers to the same kinds of questions
that we asked about mortgage equity withdrawal: what it was financing,
and so on. So we did not feel there was a need for us to replicate
our earlier survey on that, and the British Household Panel Survey
is producing data also. What we did decide to do, however, was
look at the unsecured debt position, and the British Household
Panel Survey produces information on secured debt and the distribution
of that across households. The latest data that we have from the
British Household Panel Survey concerned the year 2000. There
had not been any trend increase in the number of households reporting
themselves that they felt they had serious debt problems. We commissioned
a small survey earlier this year, in the spring of this year,
which we hope to be able to publish by the end of the year, which
updates the numbers to 2003. The broad conclusion is that, again,
there does not seem to have been any trend increase in the number
of households reporting that they face serious debt problems.
This is only a survey, it is not a large survey, and, of course,
the problem can be very severe for a minority of households, and
it is one that we wish to keep on top of because of its implications
for total spending. That is our particular concern. Obviously,
for the families themselves, there are potentially very serious
repercussions if they get into debt difficulties. Our remit that
we have been given is to worry about the macro implications of
that, and there could be such implications if it affected their
spending significantly.
Q51 Mr Beard: The November Inflation
Report shows your estimate of further slippage in the euro growth
rate, but last week there were more upbeat economic data coming
out from France and Germany. Do you think that this presages the
light but long-awaited recovery in the eurozone, and do you expect
UK export performance to improve before there is a substantial
improvement in economic performance in Europe?
Mr King: There is no doubt that
the position in the euro area economy is of absolutely crucial
importance because it accounts for more than half of our trade
in goods and services, so it is very significant from that point
of view. I think it is too early to judge whether the figures
we have seen, the first estimates for output growth in the third
quarter, really will be the sign of the upturn. It is part of
our central projection. Our central projection is that during
the course of next year the euro area economy will return to around
trend growth rates, and I think the survey evidence suggests that
is a reasonable, central view. The survey estimates are becoming
more and more optimistic over the last few months. The figures
to which you referred are the first sign in the official data.
One needs to be cautious still because, as we know here, the first
estimates can be revised easily, in either direction, and it will
be too much to put a lot of weight on that one latest number,
but it is supportive of the view that is embodied in our central
projection that we would expect to see an upturn in the euro area.
Q52 Mr Beard: Sir Andrew, in a speech
you gave on Monday at the National Liberal Club, you referred
to the Financial Services Action Plan and gave a warning about
the concerns that are arising about the pace at which this is
being introduced. I know this reflects many comments in the financial
services industry. You went on to say: "We need to achieve
so much so quickly and warn against people taking their eye off
the ball in the process of instituting these changes." Is
this likely to have an impact on the economic performance of the
eurozone?
Sir Andrew Large: When I said
people should not take their eye off the ball, really I was thinking
particularly of the UK. I think that the concerns about the Financial
Services Action Plan and the speed with which it is being introduced
are more to do with potential financial stability than they are
for the immediate prognosis for demand and output within the eurozone
or, for that matter, the UK. That was really what I had in mind.
Q53 Mr Beard: Thank you. The Bank
has voiced doubts about the sustainability of the United States
recovery. Do you think the financial markets are becoming complacent
about the world growth prospects: whoever wishes to answer?
Mr King: Let us share it around
then. How about Professor Nickell? Always a considered view.
Professor Nickell: I do not think
the financial markets are particularly complacent on this matter.
It is always hard for me to detect whether they are complacent
or not, however, I should say. My view is that the US recovery
benefited greatly from the tax cut, of course, in the immediate
past, so it seems very unlikely that US growth in subsequent quarters,
after the tremendous burst in the third quarter, is going to continue
at an extremely high rate. However, I think that there are certain
factors going on in the United States, notably the very high level
of productivity growth, rising profitability, rising investment,
which suggest that a relatively high growth rate will be sustained
in the United States for some time. My guess is that these real
forces will tend to dominate. They could be disturbed by some
financial crisis generated by the huge current account deficit,
but my guess would be that the most likely outcome is that the
United States will grow quite strongly for some time.
Q54 Mr Beard: How confident are you
in general that the external demand will recover enough to maintain
the momentum of the United Kingdom's economy and also allow some
rebalancing in the economy?
Professor Nickell: I have to admit
that the picture one is beginning to get, namely the strength
in the United States, the recent, one has to say, welcome news
from the eurozone, that the eurozone economy is starting to get
back at least towards trend, the patchy but by and large relatively
optimistic news from Japan, and certainly from non-Japan Asia,
all these things to me add up to a recovery in the world economy
being more likely than not, and that will be a tremendous help
to the rebalancing of the UK economy. I think the most likely
outcome is reasonably positive on that score. Of course, there
are always risks, but that is the most likely outcome.
Q55 Mr Beard: Does the Monetary Policy
Committee generally share that view?
Mr Tucker: I think that the two
key pieces of data that have come out of the States over the last
two months have been on the labour market and on business investment.
If you go back a few months, the big question there was would
households restrain their spending, which had been strong for
a while, before business recommenced investment? The reason there
was that concern was that unemployment was continuing to go up
quite markedly. From August, the data from the labour market have
been encouraging. In particular employment has risen, while they
have revised up some of the employment data too. Going back to
an earlier question about financial markets, I think that had
quite a big effect on financial markets' perception of the risks
in the States. Separately, for both Q2 and Q3, business investment
came in quite strongly and, I think, again, financial markets
took encouragement from that, as did I. The reason is that, although
you cannot rely on it absolutely, it is the first strong sense
we have that the atmosphere of nervousness and risk aversion that
has been fairly pervasive in the US business community over the
past few years has started to pass. You asked, Mr Beard, whether
that meant that financial markets are now overoptimistic about
US recovery, and I guess there is a risk of that. I think the
one thing that would suggest perhaps there is still a kind of
tempering thing there is that—really the point that Steve
made—with the current account deficit continuing to be pretty
big, the dollar has gradually glided down and had there been strong
bullishness in financial markets about the US, a kind of "no
risk" scenario, I am not sure that would have happened.
Q56 Mr Beard: With this relatively
fragile, global economic recovery, how important do you think
it is to avoid tension over trade tariffs between major blocks,
such as is emerging now over steel?
Mr King: Extremely important,
but it is not just a cyclical problem, it is not just that it
is now. One of the sources of greater prosperity through the whole
post-second world war period has been the growth of trade, involving
many countries around the world. I think the concern that all
of us must share is not just the signs of tension about trade
among developed countries but also the breakdown of the trade
talks in Cancun. If you put those two things together, I think
that is a concern, and clearly the people involved are working
extremely hard to make progress, and I think we would only encourage
them, they have a very difficult task. The big picture here is
that one of the sources of our prosperity has been the growth
of trade, and anything that would endanger that, whether that
be tensions about trade between our closest trading partners in
the industrialised world or, indeed, failure to make progress
in the trade talks with the developing world, either of those
would cast question-marks about the longer-term growth and prosperity,
and it is very, very important that we make progress on that.
Q57 Mr Fallon: Governor, when you
appeared last, we discussed the switch to HICP inflation, and
you accepted the importance of the presentational side of this
and said you needed to do some explaining. You said, I quote:
"This morning is part of that process." It seems also
to have been the end of that process. Why have you been silent
since then, why has the Bank been silent on this?
Mr King: I do not think we have
been silent. I think the position is one in which we know now
exactly the date on which the Chancellor will announce his decision,
and I think until he announces his decision it is very hard for
us to explain something It would be wrong for us to explain his
decision. The first part of the process is that the Treasury must
explain what the decision is, and we do not know what that is,
and why that decision has been made. And once that has been done—that
part of the process is out of the way—then certainly we
will go to great lengths to explain the consequences of that decision
for our work and the prospects for inflation. Until we know what
that decision is, and if and when there will be a change in the
inflation target, it is very hard for us to know what to say.
Q58 Mr Fallon: There could have been
some more technical explanation of how it is going to be modelled,
whether your forecasting techniques will be the same for HICP
as RPIX. On the website, I think, there have been only two MPC
speeches since 18 September and neither of them touches on HICP?
Mr King: I think it is important
to give explanations which are clear when there is something to
explain. The world is not short of speeches and I do not wish
to add to a world of unnecessary speeches. When we know the target
then I promise you that we will explain frequently and often what
there is to explain, but I think to try to explain clearly and
simply to people what a change in the target might mean when we
do not know what that change in the target is, or even whether
it will take place, would be slightly presumptuous on our part
and actually would not aid the clarity of the process. I think
it is sensible to wait now. It is a matter of only days really
until 10 December when we will know the decision and the outcome
and then we will know what it is we will have to explain.
Q59 Mr Fallon: That rather implies
that you think it is possible the switch itself could be deferred?
Mr King: I have no idea. The Chancellor
will announce his decision. I simply do not want to anticipate
his decision. It is right and proper that it is his decision,
but I do not know what that decision is.
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