Select Committee on Treasury Minutes of Evidence

Memorandum submitted by Ms Bridget Rosewell, Volterra Consulting

Rates are on the rise again . . .

  On 6th November the Monetary Policy Committee raised bank base rate for the first time in four years. Their worries about indebtedness of consumers and continued house price inflation have outweighed considerations of whether recovery is fragile and the state of manufacturing. Are they right? And how many more rises are we likely to get?

  We can start by looking at what kind of recovery we have. The downturn started in the wake of the dot com crash and deepened further post 9/11. However, it has not been a very serious dip, as the chart of US growth shows. On a quarterly basis, it was only just a recession, with only two quarters of falling output on a year on year basis. For the last 7 quarters output has been growing again, with a bit of setback during the war with Iraq. As far as the US is concerned, this is now a well developed recovery.

  What of the UK, however? So far, it is the only country to raise rates of interest and indeed they never fell so far here as in the US or even the Eurozone. Admittedly, the Eurozone remains in the doldrums, with little economic growth either occurring or in prospect.


  In the UK, we have not actually experienced a recession. A comparison with the US shows a downturn emerging at the same time as in the US, but is did not go as deep, bottoming out one quarter later than in the US, but with growth never much below 1.5% year on year. Since then, it has been pretty stable at 2%. Moreover, the overall position of the economy is stronger than was previously thought—all because of the introduction of a new technique.

  The chart below compares the old and new measures for the main indicator of output—GDP. The statisticians have introduced a new method of calculation which makes more rapid adjustment to the weights applied to those parts of the economy which are growing. The chart shows how this has made the boom up to 2000 stronger, while the downturn is about the same as before. As a result, the Monetary Policy Committee are almost certainly worried that there is less room for expansion in the economy than they thought and that their last rate cut was misconceived. (Incidentally they also unwound the effects of an import VAT scam which had been so successful that it had significantly increased the apparent value of imports. This correction has also improved the growth rate!)

  At present therefore the economy appears to be pretty stable at slightly below the underlying growth rate. The rate rise we have had (probably) corrects what now looks like a mistake. There seems little reason on the basis of the real economy to do more. The new figures show that growth has been somewhat faster and that therefore capacity utilisation is at a rather higher level than previously thought. However, the Bank's analysis suggests that they are not too concerned and still think that utilisation is below normal, giving room for growth. In addition, their look at the labour market also provides some evidence that further increases in participation are possible (p 27). This would be worth probing. I agree that the capacity utilisation figures as generally presented may not be worth very much. But they are used quite widely in Treasury.


  The fear is about personal indebtedness. Directly this is not the Bank's concern. But over extension leading to a house price crash and a reduction in spending would be. They are trying to use interest rates to curb our desire to borrow without scaring us. Doing this will help moderate house prices and borrowing without bringing it to a halt. It is noteworthy that the Inflation report is quite agnostic on Mortgage Equity Withdrawal and whether this is being used to finance consumption. Indeed on balance I would conclude that it may well not be. Moreover, the report points out that arrears and repossessions are at extremely low levels, suggesting that households are managing their debt successfully. Though personal bankruptcies are at a high level, the numbers involved are very small.

  The other main issue which is not addressed in sufficient detail is that of the contribution of the public sector. Public sector wage inflation is running well ahead of the private sector. The real consumption wage is falling as a result of tax increases (p 31). Both of these features put upward pressure on inflation.

  In both the demand and output sections, the Report is coy about what is happening to government consumption in real terms. It points to the difficulty of measuring productivity in government services, but do not address the issue in enough detail. This should be challenged. A recent report in "Economic Trends" from the ONS suggests that prices are rising faster in public services than elsewhere and productivity is falling. This has implications for the government's fiscal policy and for the MPC too. What view is the MPC taking of public sector inflation and what assumptions is it making about the future of fiscal policy?

19 November 2003

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