Examination of Witnesses (Questions 60-79)
20 NOVEMBER 2003
MR MERVYN
KING, SIR
ANDREW LARGE,
MR RICHARD
LAMBERT, PROFESSOR
STEPHEN NICKELL
AND MR
PAUL TUCKER
Q60 Mr Fallon: It just puzzles me
why you said that on 18 September, "We've got to start explaining
this"?
Mr King: I am sorry, maybe I misspoke,
in terms of starting a process which was not yet appropriate.
We will start explaining it once that decision is announced, and
we know now that indeed it will be announced on 10 December.
Q61 Mr Fallon: Yes, I understand
that, but the difficulty surely for commentators and those who
say these things is that you yourself, in the Inflation Report,
note that the approaching switch, if it does take place, may well
have raised inflation expectations already, and that is an undesirable
development, is it not?
Mr King: I do not think it will
have raised inflation expectations. The broad picture remains
as we have said before when asked about this issue at several
points during the year, which is that, looking ahead two years,
we think the basic picture is that the likely difference between
the two measures of inflation, RPIX and HICP, is around half a
percentage point, and nothing really has changed our view about
that. I do not think we can get in the position of giving a precise
view of how we are going to model something until we know exactly
what it is that we have to model, and then we can explain to people
what the change in the target means, what its consequences are
for monetary policy. As I said, the big picture, I think, in terms
of explaining, is less to the commentators—I think the commentators
know full well as much about the difference between the two measures
as we do. It is going to be explaining to people at large why
it is that inflation is presently above target and then suddenly
it will appear below target, and yet from our point of view we
do not see that as having any major significance for monetary
policy. That is going to be the challenge to us, to explain why
it is that, despite the fact that you move just like that from
being above target to below target. Nevertheless, it does not
have any implications for monetary policy, because looking ahead
the difference between the two measures, which is at present very
large, at 1.3 percentage points, will come down to something around
half a percentage point. That is the challenge which is for us
to explain, what this means for monetary policy if that change
is introduced in due course. I think it is not a sensible background
to start the effort to explain, as you are trying to explain something
that at this stage is only hypothetical. I do assure you that
if and when it is not hypothetical but a real announcement, then
we will start to explain, and between the announcement and our
February Inflation Report there will be a number of opportunities
that all members of the Committee will have to explain the issue
and what it means for policy.
Q62 Mr Fallon: Does that mean, between
10 December and the February Inflation Report, there will be speeches,
or, in fact, now you know the date, will you be ready to publish
projections of HICP immediately after 10 December?
Mr King: No, I do not think we
shall be in a position to publish projections, because that would
be a projection of what we believe will be the outlook for inflation
and we make those projections only once every three months. I
do not think it makes sense for us to go through another entire
forecasting round, because what matters here is the big picture,
and the big picture is what is the outlook for inflation relative
to the target and that is something that sensibly we update only
every three months. That projection will be available in February.
I repeat what I have said before and what other members of the
Committee have said throughout this year that, as far as we can
see, in present circumstances, the likely difference, the central
view, of the gap between RPIX and HICP inflation looking two years
ahead is around half a percentage point. Beyond that it may well
be bigger, because the long-term, historical difference between
them is between 0.7 and 0.8 percentage points and that will depend
very much on how the technical differences between the two indices
evolve. I think a very important factor in this, what I would
like to see myself when the decision is made, is that the body
which should explain the technical difference between the two
measures is the Office of National Statistics. I think it would
be appropriate to hear from them about how the two measures are
constructed, because they construct the measures, they are the
guardians of these two measures of inflation and I think the appropriate
body to speak first on what is the difference between the two
measures and whether that difference will be likely to change
over time, in fact, is the ONS.
Q63 Mr Fallon: Have you been in discussion
with them about that? Will they lead the debate?
Mr King: They are not going to
lead the policy debate, clearly, but I do think that they will
explain clearly to us all what the difference is between their
calculations of these different measures, yes.
Q64 Mr Fallon: The other important
point in December, of course, is your own Monetary Policy Committee
meeting. That is very close to this potential announcement. Would
you expect, or prefer, to be told privately what the announcement
is a week before the rest of the world?
Mr King: No, I would not. I do
not like being in the position of having confidential information
that the rest of the world does not have. I think that is not
a good position to be in, and I think it would not be helpful
to us to be told privately that we were going to be given a change
in the target, unless we were told at the same time to ignore
that for the purpose of the meeting. The best way to do that is
not to tell us.
Q65 Mr Fallon: You could be voting
blind?
Mr King: That is fine. As I said,
I think looking ahead two years it does not make very much difference
to monetary policy. We do not know what that announcement is and
I think this is not a major consideration for policy. What I think
would be wrong would be for us to be making a decision on a basis
which people did not themselves know about. It is important that
the basis on which we make decisions is understood clearly by
you and the outside world when we make them. I think it would
not be helpful for us to be briefed on that before 10 December.
Q66 Angela Eagle: If possible, I
want to take you back to what seems to be a pretty optimistic
scenario of gradually increasing trends of growth and recovery
in some of the economies worldwide, which even Stephen Nickell
had to admit, he said, was out there. It was almost as if he was
disappointed that it was out there, but it is out there. Perhaps
there is a little cloud that might cheer Stephen up. I wonder
what your view is of the current institutional stand-off that
is going on in the eurozone with respect to the Stability and
Growth Pact, which is creating uncertainties as the stand-off
between France and Germany and the Commission is going ahead,
and it is creating uncertainties as to targets and the institutional
arrangements for the euro? How do you see this impacting on the
potential for growth in what is, after all, our largest market?
Mr King: I am delighted to hear
that Steve has become a true central banker and he knows that
to every silver lining is attached a cloud. You point to the uncertainties
about the operation of the Stability and Growth Pact, and I think
clearly there are great uncertainties as to how it affects the
medium term. I think it is fair to say that it is not easy to
know how it is operating at present. I think, in the short run,
it is very easy to see how it is operating, which is that it is
not stopping countries allowing their budget deficits to rise
when the cycle means there is a downturn in the economy, and that
can be only supportive of growth in the short run. They will need
a stability and growth pact in the medium term to make a success
of the monetary union, and no doubt there are many discussions
going on, in some of which we participate, as to how best to construct
a medium-term picture for a stability and growth pact. I do not
think there is any reason to suppose that at this stage it is
being operated in a way which is forcing down growth of the European
economy.
Q67 Angela Eagle: That is interesting;
so you are fairly optimistic that there is time to get the institutional
structure into a more sensible place without disrupting the natural
growth of the economies that is beginning to be indicated by the
signals? You seem fairly optimistic?
Mr King: There is certainly time
to do it. That is not the same thing as saying that it will be
done.
Q68 John Mann: I have two questions
on labour market issues. I note in your Inflation Report, in the
section on "Labour market tightness", you refer to indicators
of employment and unemployment. Do you not think that your approach
is rather outdated and that really what you need to be looking
at is some kind of indicator of the propensity to flexibility?
Mr King: I do not think it is
outdated in the sense of trying to get a feel for the balance
between demand and supply. Certainly I accept that, in order to
form judgments about the labour market as a whole and the likely
evolution of trends in wage costs and total unit labour costs,
you have to form a judgment about the degree of flexibility and
what that means for movements in unemployment, and so on. I think
that is a clear part of our judgment. I do not think that it is
outdated—or that to think about the balance between demand
and supply in the labour market is the wrong way of thinking about
it. We have seen in the last two years or so that we have had
a picture in which employment has still continued to grow, hours
worked may have fallen back a bit, but unemployment has been really
rock solid for two years with no change at all in the rate of
unemployment. Earnings growth also has been very steady. That
looks a position in which in the last two years or so there has
been a reasonable balance between demand and supply, and I do
not think that is a silly way to think about it. As I say, I do
accept that flexibility and understanding how the labour market
behaves and the fact that it may change over time is a key part
of our work.
Q69 John Mann: Certainly they have
come down, in real terms, have they not, I think quite significantly,
in terms of rather pessimistic anticipations of what would happen
with employment?
Mr King: Anybody who pretends
to have perfect foresight and to know what will happen is foolish.
There have been developments in the labour market, I think. In
terms of the measures taken to improve flexibility, they have
been taken over the last 20 years or so and the effects have become
evident in the last ten years in which the rate of unemployment
which is possible to run the economy without seeing inflationary
pressures has come down, and that is something to be welcomed.
It was very hard to know at the beginning of that process. I think
it was possible to argue that it would lower the rate of unemployment
at which the economy could be run, but it was very difficult to
know by how much and what the quantitative effect would be.
Q70 John Mann: With respect, my question
is should you not be looking to see whether some kind of indicator
of the propensity to flexibility can be created, in order to make
future predictions more accurate?
Mr King: I am not sure if I understand
really propensity to flexibility. I think a measure of the degree
of flexibility and how far wages respond to changes in the balance
of demand and supply, that is something that we try to look at,
and Steve is the expert not me. We do try to look at those things.
The propensity to flexibility suggests almost there is something
that you can observe and measure which predicts how future reforms
will operate or how labour markets will evolve, and that is difficult
to judge. I do not think, even if you could find it, it would
supersede the need to form a judgment now about today's balance
between demand and supply in the labour market.
Professor Nickell: I think that
is very fair. At the moment, the situation we are at is that if
you talk to most business people they will tell you that there
are quite large areas of the labour market where they find it
hard to get people. That suggests, in some sense, the labour market
is quite tight. On the other hand, they will say also they do
not expect serious upward pressure on wages, and therefore one
might think perhaps the labour market is not quite as tight as
they are telling us it is, but getting further than that is quite
difficult. We are in a situation where we have to look at these
things all the time, because if the labour market got tighter,
as measured by, say, the level of unemployment, and so on, we
are not quite sure at the moment the extent to which that would
impact on pay. That is yet another reason for operating cautiously,
which I think we do in a variety of ways. I think otherwise what
the Governor said is completely fair.
Mr Lambert: I take your point.
Personally, I have been surprised by how subdued earnings growth
has been over the last months, given what has happened to take-home
pay and given the position in the labour market. That is something
that has been a matter of interest. As we go round the country
talking to people, which we do a lot, you hear very different
stories from different sectors and different regions about what
that all adds up to. As Steve says, I think all we can do, at
the moment anyway, is look on a monthly basis and try to form
judgments about whether the trends are changing, and that is what
we are doing.
Q71 John Mann: My second question
was, considering the high levels of employment that we have got
in the UK at the moment, is the UK overrigid in impairing the
supply of labour through inward migration? If it is, is this going
to start to create underlying inflationary pressures?
Mr King: Whether there are inflationary
pressures is a matter of the balance between the supply in the
economy and our policy, we can react to any changes in supply.
The question of immigration policy is a national policy which
may have economic aspects to it, which goes way beyond it, and
that is not for us to comment on whether immigration policy is
or is not too rigid, that is for you.
Q72 Chairman: You are strictly non-political,
Governor?
Mr King: Sorry, I did not mean
to answer the question, I was just posing it.
Chairman: It is an issue we have raised
before.
Q73 Mr Cousins: I suppose, inevitably,
I have got to put these questions to you, Governor, because you
referred to some of the statistical fog having been dissipated.
I wonder if you could tell us which bits of the statistical fog
you consider have not been dissipated?
Mr King: Can I start by saying
which bits have been dissipated, which I hope will make it a bit
clearer what is left.
Q74 Mr Cousins: Let us have the boring
bits first and the entertaining bits later then, it will give
us something to look forward to?
Mr King: Clearly, what we were
faced with when we came to you last was that we felt, on the very
latest estimates for growth in the first half of this year, there
was a real inconsistency between the official data on GDP growth
and what we saw from the surveys and the anecdotes. One of the
things which has been clarified is that the data for the first
half of this year have been revised up. What we were concerned
with also was the implications of the problems in measuring trade
data accurately and what that meant for the growth of demand and
output in the past. We have seen a series of revisions. They are
more definitive estimates of demand and output growth over the
past five years, and the ONS has been able to take on board much
of the information it has got now on the pattern of trade, so
now we have a consistent series on the growth rates of demand
and output. There are still uncertainties, I think, about some
aspects of the trade data. The export data for certain quarters
are not entirely easy to understand. It is not yet obvious whether
the problems in the recording of exports have been fully clarified,
and, of course, for the very recent quarters, it is still possible
that there may be significant revisions. I do think the ONS deserves
credit for one important change that has not attracted very much
attention, for the good reason that it is boring, in your word,
which is that it has not had any really significant impact on
our view of the outlook, which is that we have now switched in
the UK to chain-linking of the National Accounts. Which means
that in the way in which different components of demand are added
together and are weighted together—using more up-to-date
weights than they were—we have moved to international best
practice. This is quite a major change. We were unsure whether
that would lead to quite significant changes in the picture for
demand and output, and it did not. I think this has been the dog
that did not bark and I think the ONS does deserve real credit
for introducing this change, in the way it went very smoothly,
has brought us up to best practice and has been very successful.
There do remain uncertainties still, inevitably, I think, about
what the picture for demand and output means, for whether the
underlying growth rate in the economy has altered or not. As I
said earlier, we do not see any evidence for that, but equally
it would be extremely difficult to deny that there has been such
a pick-up. I think it is very hard to detect these sorts of changes.
Maybe it is to borrow a phrase which I think Charlie Bean used
in an earlier session. Some of the statistical fog has lifted
and what is left is a certain amount of analytical fog, which
is, how do we interpret some of these revisions to demand and
output, what does it mean for our views about growth in the UK
economy and the rate at which it can expand sustainably? That
is something which will take even longer to sort out, I think,
and there never will be a point or a date when we know the answer
to that, it is part of the ongoing process. In that sense, I think
some of the fog indeed has lifted.
Q75 Mr Cousins: Taking up a point
you made earlier, which is that you consider the first preparatory
work for the translation of the present inflation target into
the European harmonised form would lie with ONS, you said that
here this morning. I think we would both accept, and I want to
be careful about what I say myself, I do not want to imply any
denigration of the work of ONS at all, I recognise the difficulties
that they have had, but they have been through a very rocky period
in terms of public presentation. Do you have some anxieties about
that, because, fairly or unfairly, their public credibility has
been damaged?
Mr King: If it has been damaged
unfairly then I think I would like to take the opportunity to
repeat what I have just said, which is, there are many stories
which have not attracted publicity for which they deserve great
credit. I am not going to comment on the other stories, that you
and others in this Committee rightly have asked questions about,
what happened to the data, and it is right that you should do
so. There are stories, and I think the switch to chain-linking
of the national accounts was one, that, within the Bank, the economic
staff in the Bank were saying to us, "This is a very big
change, it's an important and very valuable change. It's good
that the UK is making it, it could have significant implications
for how we see the economy." That change went extremely well,
sufficiently well that no-one outside really noticed it, and I
think they deserve credit for that, and I think it is worth putting
that on the record. In terms of inflation measures, I think there
are three steps in this. First, the decision clearly is one for
the Treasury and they will need to explain what the decision is
and why they have taken that decision. Secondly, I think at some
point it is appropriate for the ONS, because they are the guardians,
they collect and publish these data, it would be sensible for
all of us to hear from the ONS about precisely how they calculate
these measures and what in their view the differences are between
the two measures. Thirdly, and an ongoing process, is one in which
the Monetary Policy Committee, all nine members of the MPC, will
need to explain, particularly as we go around the UK, what the
change in the measure means, whether it is significant for monetary
policy and how policy is being set now in terms of the new target.
Q76 Mr Cousins: I am grateful to
you for that. The one area that you have referred to already where
the recent revisions in data have produced a dramatic impact is
in the area of trade, and it is so dramatic that you have drawn
attention to it in the Inflation Report, quite properly, in which
the lines are completely divergent as a result of the revision.
Do you think that indicates simply a data preparation problem,
or does it give to us an indication that there is an underlying
problem about the size of the trade deficit and how to finance
it?
Mr King: I think the particular
data problems that have given rise to this difficulty, that certainly
have exacerbated it, are the discovery of VAT-related fraud and
the problems Customs and Excise had in recording export figures
correctly. I think it is always difficult to know how to calculate
the trade figures in the absence of an even greater burden of
regulation on businesses. In the old days you could perhaps stand
at the docks and look at the exports, sort of measure them, but
now so many exports are in the form where you can only try to
record the values. I think it is extremely difficult and we try
to get better information. For example, we know we have very poor
information on capital account flows between countries, and they
are the counterpart to current account flows and would provide
a very useful check. But without imposing foreign exchange control,
which I have not heard many people argue for, it is very difficult
to know how you would ever estimate these flows accurately. There
are difficulties in retaining data which will always be there,
and they will be particularly important at times when you get
large and growing current account deficits. I do not think that
this has been a major problem in setting policy, because the big
picture story for us has been that the rise in the exchange rate
led to a position in which quite deliberately we allowed this
imbalance in the economy to grow, in order to make sure that the
economy could continue to grow and that inflation would stay close
to the target. The imbalances in the UK, whatever they are, are
significantly less, markedly less, than in the United States,
so I do not think it has been a major problem for policy. There
is no doubt that, in trying to gauge the development of the economy
during the course of a year, one of the lessons from this is that
since we cannot expect—and it is no good blaming the ONS,
they are the messenger not the source of the problem here—to
get terribly accurate quarterly data on movements in the trade
account, so we should not put too much weight on the latest number
for the growth of GDP. I think, those people who feel that "Oh,
the GDP number has changed from 0.2 to 0.3, this is a really important
change," that is very, very foolish. It is important not
to put too much weight on the latest number, and that is a responsibility
not of the ONS, not of anyone else but us. We are the people who
make judgments about how much weight to put on these numbers and
it is very important that we do not put too much weight on the
latest number.
Q77 Mr Ruffley: Governor, could I
ask about house prices and the house price bubble. I was just
looking at the revised remit that the Chancellor gave you in April
2003 for your Committee: "(a) to maintain price stability,
and (b) subject to that, to support the economic policy of Her
Majesty's Government, including its objectives for growth and
employment . . . The Government's central economic policy objective
is to achieve high and stable levels of growth and employment
. . ." Is not the house price bubble threatening the second
part of that remit, and can you be doing more to tackle the house
price bubble?
Mr King: I think there is no doubt
that one of the major challenges to monetary policy in many countries
in the last five to ten years has been how to deal with asset
price movements. I think I would say two things. I do not think
this is an easy problem and I do not think there is any magic
solution to it, but I do think that the inflation target framework
is still the right one to examine that problem. I think it is
the case that there may be circumstances in which the Committee
could say to itself, because of the movement in asset prices that
threatens future adjustments to demand, and hence inflation, that
maybe we would err on the side of thinking carefully about the
risks to inflation beyond the normal two-year forecast horizon,
and if we felt those risks were sufficiently large that might
affect policy today. The remit does not tell us to hit the inflation
target two years ahead but says that we should be looking at the
inflation target at all horizons. If we felt that the movement
of asset prices was likely to threaten large movements in inflation
away from target further ahead, that is something we could sensibly
take into account, and we have been very conscious of that in
the last few years. The second thing I think is that house prices
are not the only asset that we have had to think carefully about
in this context. If we had thought only about house prices then
it is true that we might have said to ourselves, "Well, should
we raise interest rates sooner and by more, in order to slow down
the rate of increase in house prices?" Instead we could have
looked at share prices, and there would have been a period in
which we might have been thinking of raising interest rates a
bit sooner, but then lowering them a bit faster and a bit more
than we did, in fact, because of movements in share prices. If
we had looked at the exchange rate then, in fact, we had the opposite
message from house prices. We might have been looking for quite
a long period at whether we should have held interest rates even
lower. I do not pretend that the movements in asset prices do
not create difficulties for monetary policy, I think it has been
the big conceptual problem facing monetary policy, but I do not
think it has been a problem because we had an inflation target.
I think whatever monetary policy framework we had, that problem
will have been there. I think that it is the inflation target
framework I still find the most helpful framework in which to
think about that problem and to deal with it. I think that in
the UK context it is not just one asset that we have had to think
about, it is several assets, and the messages from each of these
asset markets are very different. I know that is not a simple
answer, but I do not think it is a simple problem to which there
is a simple answer. I do think that this is something we have
thought about a great deal and I am sure that we will carry on
thinking about if asset prices behave in a way that, to us, raises
the prospect or the possibility of a significant correction further
ahead.
Q78 Mr Ruffley: I want to pay specific
attention to house price inflation, because that would seem to
have more of a pass-through effect than equity prices or an equity
bubble. In the immediate circumstances, that would appear to be
the case, so let us stick on house prices. Am I right in saying
that, from the first part of your answer, it is conceivable you
will be paying more attention in the next few months to house
price inflation when you are setting interest rates?
Mr King: No, that is not the case.
Just as a footnote, let me say I am not sure if I accept the premise
that house prices have more of a pass-through, and I think the
exchange rate is particularly important, and even equity prices,
if you look at the debates that were occurring when share prices
were going up about the impact of the equity market on consumption.
Q79 Mr Ruffley: I mean at the moment?
Mr King: I thought you were making
a general point, I am sorry. At the moment, in terms of house
prices, what we are thinking carefully about is what that means
for consumer spending, but we are not giving independent weight
for house prices, we are looking at what all of this means for
the outlook for inflation in the future, for the short run, the
medium term and indeed further ahead. One of the things that we
will be asking ourselves is whether we think it is house prices
or the growth of debt, or indeed the prospective growth of incomes,
that means there is a possibility that there could be sharp movements
in consumer spending or demand, and hence impacting on inflation.
That is the prism through which we will examine it. It will not
be an independent view, but when we form our judgment about inflation,
we also have to look at house prices. House prices are relevant
not just because of the immediate impact on spending but because
of the risks to the inflation target further ahead as well, but
it is through the inflation rate that we look at this.
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