Examination of Witnesses (Questions 20-39)
MR MERVYN
KING, MR
PAUL TUCKER,
MS MARIAN
BELL, PROFESSOR
STEVE NICKELL
AND MR
RICHARD LAMBERT
24 MARCH 2005
Q20 Mr Fallon: Could we turn to the fiscal
position, Governor. Last June you spoke about the famous golden
scales tipping increasingly towards the spending side, but that
you had been assured that they would swing back, you said, to
a sustainable fiscal position. Did the Budget last week reassure
you?
Mr King: I do not think the Budget
last week made any difference to the underlying fiscal position.
It was, in economic terms, pretty well neutral.
Q21 Mr Fallon: Are you more or less assured
than you were last June?
Mr King: Just the same. I think
what we have seen since then, if you look at the projections in
the Red Book—. I think what is important now is not to look
backwards but to look forwards. The really important thing is
whether the fiscal rules will be met over the next five years,
and that, I think, is the key issue in terms of economics. The
calculations published in the Red Book show that the fiscal rules
will indeed be met, because the ratio of tax revenues to GDP will
rise by two percentage points over the next three years. If that
happens, I have no reason at all to doubt the calculations that
show that the fiscal rules will be met.
Q22 Mr Fallon: You said it is a key issue
that they are met. We were struck by the evidence we took on Monday
from some of our advisers. David Walton from Goldman Sachs told
us that missing the rules by two or three billion makes absolutely
no difference economically, but that is not what you have been
telling us. You have said it is not an optional extra, it is an
integral part of the whole process.
Mr King: To meet the fiscal rule
as it is, but I think this is where looking backwards is not entirely
helpful. It is clear that the surpluses in the early stage of
the cycle, which the Treasury believe will end in about a year's
time, will be broadly offset but not entirely offset by the deficits
in the later years in that cycle, so that it looks very much as
if in a year's time the Golden Rule will be met. I think it is
fair to say that whether it is plus a billion or minus a billion
is not in itself economically very significant. What I think is
significant is the need to look forward, and that is to look at
the rules in terms of whether it is plausible in a forward looking
sense that the rules will be met. That is, I think, where, if
you look at the numbers in the Red Book, the Red Book states that
the ratio of tax revenues to GDP will rise by two percentage points
over the next three years, and given that and the current spending
plans, the fiscal rules will indeed be met. I have no reason to
doubt those numbers.
Q23 Mr Fallon: Do you think there is
a case for revisiting the Golden Rule? You have often spoken of
the need for the nation to save more. The Red Book shows the savings
ratio pretty constant over the next few years. If the country
is not saving enough, should not the Chancellor be running a surplus
rather than aiming at balance?
Mr King: I think it is difficult
to look at this solely in terms of the fiscal rules. I think this
is a matter of policy on a wide range of areas, including pensions
and how we provide pensions and how much we save collectively
and whether we choose to save through the public sector or the
private sector. All of those go into determining the national
savings ratio. I think that it is important to look at the private
sector savings ratio as well. It is not just the household savings
ratio; it is the whole private sector. I do not think I would
equate the fiscal rules with the national savings ratio, though
there is no doubt that if you look at movements over time and
differences between countries that one of the major determinants
of the overall national saving rate is, indeed, whether fiscal
policy is sustainable or not.
Q24 Mr Fallon: There still seem to be
significant differences between the Treasury's view, which is
that there is still some useful spare capacity to be drawn, and
others like you and the IMF, who think the economy is now operating
pretty close to full capacity. What practical issues flow from
that difference?
Mr King: I think that the Treasury
have a different concept of spare capacity than the bank and the
IMF. Because of the difference in concepts, it is not obvious
to me that it is easy to draw out whether there are direct implications.
Clearly, broadly speaking, we cannot see any signs of any significant
spare capacity. If you look at what has happened in the labour
market and the product market there is no obvious sign of spare
capacity, but the Treasury look at it in a rather different way.
In terms of implications for the forecast, I think it does mean
that they have and are able to have a forecast of faster growth
in the near term than either the Bank or the IMF, their central
view is the base for growth to be about half a percentage point
higher in 2005 over 2004 than in our central projection, but,
of course, a difference as well within the margin of error, but
we have a faster growth rate looking two or three years ahead
than in the Treasury's central view. Over the medium term there
is not a great deal of difference, because our view about the
underlying trend in the growth rate of the economy is very similar,
so I doubt that there are many major implications there.
Q25 John Mann: Kevin Hawkins of the British
Retail Consortium has talked of trade and is set to take in a
downturn. To quote him precisely, he says, "Consumer confidence
is weak and concern over interest rates and the housing market
continues to impact on retail sales." Do you think he is
right when he says that?
Mr King: It depends how much weight
you put on the various adjectives. I do not think consumer confidence
is particularly weak, no. I think there are some signs that the
housing market is stabilising. It is true that retail sales have
weakened and they have weakened over the Christmas period and
in February, but retail sales are less than 40% of total consumer
spending, so I think it would be premature to draw conclusions
about how weak consumer spending is likely to be, and we have
seen in the past quite marked divergences between the pace of
retail sales and consumer spending as a whole. I think one ought
to be a little bit cautious before drawing very strong conclusions,
but there is no doubt that over the last three months with the
growth of retail sales, the reports from our own agents around
the country and the direct information that I receive from some
of the large retailers suggests that the position has been weaker
than they might have expected three months ago.
Q26 John Mann: In terms of the Monetary
Policy Committee March minutes, in paragraph 17, you seem to be
hedging your bets a little bit in terms of consumer spending.
You state that the slow down in consumer spending growth might
prove temporary, but at the end there was little clear evidence
to support any of the hypotheses at this stage?
Mr King: I think the reason for
hedging one's bets—and all bets ought to be hedged if you
are sensible about it—on consumer spending is that there
is a clear difference between some of the short run indicators
of what has been happening and the underlying determinants of
consumer spending. Income growth is still strong, so we have not
seen the signs of the factors that determine the growth of consumer
spending in the medium term weakening, and that, I think, is a
good reason for hedging one's bets on this. We do not know. The
central view still is that the scale of the slow down that we
have seen in retail sales is likely to prove temporary and, given
what we know about the underlying determinants of consumer spending,
that is still a sensible central view.
Q27 John Mann: The question is not whether
bets should be hedged but how you in your introductory statement,
Governor, pointed to the fact that Lent is not yet over. The retail
sector seems to be putting an enormous weight of expectation on
the phenomenon of high Easter sales and the phenomenon of Easter
sales. Can we expect Whitsun to become the new Lent?
Mr King: That is your phrase,
not mine. If you want to put that forward, by all means do so.
What we have said is very clear, which is that there are in the
short-term some signs of weakness in retail sales, but two caveats
to that: (a) no signs of weakening of the underlying determinants
of consumer spending, and (b) retail sales are less than 40% of
total consumer spending. If you ask, "How have we hedged
our bets?", the answer is fairly clear that interest rates
have been kept on hold. That is the response that we made. The
one that we identified, this near term risk to consumer spending,
was one of the risks that clearly influenced our policy decision.
Q28 John Mann: If you think in terms
of the way that retail spending is going, we have seen an increase
in the phenomenon of larger surges and dips with these seasonal
holiday timed booms in terms of how consumers see spending, and,
if so, does that lend weight to you giving less consideration
to any short-term changes in retail sales?
Mr King: Yes, I do think that
the month to month changes can be very heavily influenced by quite
small changes in weather patterns, how many week-ends there are
in a month, and although the ONS try to adjust for all that, there
is no doubt that those adjustments are very difficult. The classic
case is December where typically retail sales rise 20% over November;
so when you see a seasonally adjusted change in December of minus
1.2 or plus 0.8, whatever the number is, it is dwarfed by the
seasonal adjustment, so it would not be sensible to attach too
much weight to one month's number. What we have seen over the
last three months is a bit more than that. We have seen it continue
and we also have anecdotes from our agents' reports and from retailers
themselves. Nevertheless, you are quite right to emphasise the
difficulty, and it is not just in consumer spending, it is in
output growth too where the number of working days in a month
can change, but this can make quite a big difference to the numbers,
and even quarterly numbers can be misleading in that respect.
It is a continual temptation to put far too much weight on the
latest number and it must be resisted.
Q29 John Mann: In terms of the cautious
approach to short-term changes in paragraph 18 of your minutes,
you seem to do the same thing in relation to housing and "indicators
of activity in the housing market were mixed". How serious
a risk to economic stability do you think the housing market imposes?
Mr King: Any asset price at any
point can always move markedly up or down, so there are bound
to be risks, but I do not think we feel the risks are stronger
now. If anything, they are slightly less. There was clearly a
concern when we moved from a position in which house price inflation
was around 20% a year to a position in which it was zero, house
prices were flat—there is a very big change—and there
was a risk that that might have had some impact and it was not
clear where house prices would go from then on. What we have seen
in last three months is that, although the different measures
give slightly different answers, if you average them all out over
the past three months, you end up with a view in which house prices
have broadly been flat over the past three months. Some of the
indicators of activity in the housing market have also stopped
falling as rapidly as they were; so that there are mixed signals
there. I think it is reasonable to say that the last three months
could be described as showing some signs of the housing market
stabilising in a position where prices are broadly flat, but I
am not going to predict where they will go because it is extremely
difficult to do that.
Q30 John Mann: What will the impact be
of the Budget changes in relation to housing—obviously they
are not short-term—the stamp duty changes?
Mr King: I would be surprised
if they would be particularly noticeable in the big picture.
Q31 John Mann: Do any colleagues have
any different views in relation to the housing market?
Mr Tucker: It is essentially the
same point. I think in the late autumn of last year there was
a feeling, as house prices decelerated, that there was a perceived
risk that they would go further, and that was talked about greatly
in the media, and it was understandably talked about, which itself
created the risk. I think where we are now, compared with the
end of last year, as the Governor said, is probably a situation
of rather smaller risks. But the risks have not gone away.
Q32 John Mann: I see no-one indicating
any difference. Let me change to another subject if I could. You
seem to be having strong company results coming through in recent
times, but profits seem to be paying dividends rather than retaining
cash for future investments. What do you think is happening in
relation to the corporate sector?
Mr King: To whom is the question
addressed?
Q33 John Mann: Start with yourself, Governor.
Mr King: Again, I do not think
I would want to draw strong conclusions from short movements in
the data. You might be tempted to conclude that firms were not
retaining and investing, but in fact investment has been relatively
buoyant, and one of the encouraging features is that the level
of business investment, the level of business investment relative
to GDP, has been much more buoyant in the last five to ten years
than we have seen for much of the previous period since the Second
World War, and I think this is encouraging. It has meant, I think,
inevitably, that the growth rate of investment may not have been
quite as rapid in the recovery period in the last two years as
we saw before, but that is because it was starting from a higher
level relative to GDP. I think the investment picture is still
reasonably encouraging. When we talked in the last two to three
years about the need for a switch of the proportion of total spending
in the economy going on consumer spending towards business investment
and net exports, we have seen some that switch come about in favour
of investment. It is much harder to know what has happened to
exports. That is something that may be seen over the next couple
of years. What has been happening in terms of the corporate picture
is that the pattern of financing has changed rather than the decisions
on investment.
Mr Tucker: Can I add a couple
of things to that? If one goes back a year or so, quite a few
companies were cutting their dividends as part of a broader process
of rebuilding their balance sheets after a period of excess in
the late nineties and the early zeros, and to the extent that
the corporate sector is now increasing its dividend payments,
it might be a signal of optimism that they are approaching the
completion of the process of rebuilding their balance sheets.
The other point that I make, which is quite different and indeed
speculative, is that if some companies pay out more in dividends
because they do not see fantastic investment opportunities, those
funds could well be recycled through financial markets to companies,
newer companies that see buoyant investment prospects. There are
a number of reasons for thinking that the more one observes in
recent months could be a positive signal.
Q34 John Mann: What about pension fund
deficits? Does that continue to have a negative impact on business
investment? That is what you were predicting as a Committee two
years ago?
Mr King: I do not know. I think
it is very hard to judge. The estimates of deficits are very sensitive
to changes in assumptions about interest rates, long-term interest
rates, and in particular about longevity, and these can move all
over the place and very often they are constrained by assumptions
imposed by actuaries. I think there is still an underlying concern,
and, of course, what we also do not know, which is perhaps even
more important for the economy as whole, is whether the impact
of prospective problems in funding pensions is weighing down on
consumer spending as people feel that they need to save more in
order to provide for their own pension rather than rely on promises.
These, I think, are very important questions, but I do not think
it is easy to give a definitive answer.
Q35 John Mann: In terms of what you as
a Committee were worried about in April 2003 that this might result
in further cuts in planned investment, to quote you, that has
not really come to fruition?
Mr King: That is true. I think
investment has not appeared weak. Of course, it is very hard to
know the counterfactual. If there had not been those concerns
maybe investment would have been even stronger, but is has not
led to anything serious on the part of investment.
Professor Nickell: I think it
would be true to say that the key factor determining business
investment is demand prospects, and that the issues of financing,
and so on, while of some importance, are not the overriding factor.
If demand looks really good looking forward, then companies will
invest.
Q36 Chairman: Paul Tucker, in your speech
on 1 March you highlighted the much wider range of financing options
available to companies over the past decade. You mentioned that
the largest firms have access to the international commercial
paper, bond and asset-backed markets and to derivative markets
for managing the financial risks. For smaller firms, compared
with a decade or so ago, there seems to have been an expansion
in asset-based financing options enabling them to utilise collateral
more effectively. Alongside the relatively lacklustre picture
of fixed investment trends, does that suggest that whatever is
holding back UK corporate investment it is not structural problems
such as the financing gap in the UK financial system?
Mr Tucker: I think that is broadly
right. The other thing I would say, as the Governor said, is that
investment has been reasonably robust over the past year, it has
picked up, and the level of investment now looks okay. I think
the most important consequence of what I was describing was that,
if I am right, it will mean that the economy will be more robust
to adverse shocks than otherwise because companies of various
different sizes would have more financing options. And the proposition
that you put that there is not a financing gap, I would agree
with.
Q37 Chairman: What about other members
in terms of housing retail business investment, other aspects
of demand? What are your views on it?
Ms Bell: I would only add to the
discussion on investment and pension funds and the observation
that we do not have the counterfactual. I think it is true to
say that the recovery we have seen in investment has probably
fallen short of other significant upturns. So investment is strong,
the prospects are good, I think corporate finance is looking in
a healthy position, but probably the pace of increase has fallen
a little short, which might be consistent with those earlier comments
on pension fund deficits.
Professor Nickell: I do not have
much to add on aggregate demand prospects. I would revert to the
issue of consumption. Consumption growth is the biggest bit of
aggregate demand and that is in a state of no little uncertainty
at the moment, and I think that is probably the key factor in
a lot of our short-term decisions.
Mr Lambert: I think business investment
is not growing quite as fast as I would have expected at this
stage of the cycle, but then corporate balance sheets started
off quite highly geared and are now improving. To echo an earlier
point that Paul made to a question about returning cash in the
form of dividends or share buy-backs, I think that is an entirely
healthy side of the market working, and there is a good chance
that money is being recycled from mature industries into new industries
and we should welcome that.
Q38 Angela Eagle: Governor, you said
in your statement to us, quite rightly, that unemployment is at
its lowest level for a generation and then you highlighted the
strange absence of wage inflation, which is what the theory would
predict in this kind of situation. What does that lead you to
think about what is happening in the labour market, because it
is clearly something different to what we would have expected
in the past?
Mr King: That is a very good question
to which I wish I had a good answer, but I am afraid I do not.
I think there are a number of explanations that one could adduce
for the combination of subdued wage pressure and low unemployment
and clear signs of a tight labour market. One might be that perhaps
the labour market is not quite as tight as we think and that the
reforms to the labour market that have taken place over a long
time increase the availability of labour, the employment rate
that more people in inactivity are willing to work. I think the
argument against that would be that everywhere I go certainly
employers talk about how tight the labour market is.
Q39 Angela Eagle: Are they talking about
skill shortages?
Mr King: They will refer to it
most frequently in terms of skill shortages, but not entirely
so. In most cases there is a very tight labour market, so the
question is why is this not showing up in higher wage pressure,
to which I would come back to the issue of migrant labour. I do
think, and one sees this increasingly in comments made by employers
around the country that at least that I visit, that, although
the numbers are not enormous, they are not insignificant, and
in particular the inflows of migrant labour from Eastern Europe
have helped employers deal with particular skill shortage—,
construction is an obvious example but not the only one—that
might otherwise have put up the pressure on wages, and I think
if you look at the figures on the number of applicants to the
Government scheme for workers coming from Eastern Europe, that
was 130,000 in the last eight months of last year at an annual
rate of almost 200,000, these are not trivial numbers, and it
may be enough to at least temporarily ease some of the wage pressure.
Looking forward, it is hard to judge where wage pressure will
go. One of the things that has made a real difference, I think—at
least I hope it has—is the credibility of inflation target,
that people know that if there are temporary deviations in the
headline RPI or CPI measure that people engaged in wage bargaining
now put that to one side and say, "No, we are fairly confident
that in the medium term inflation will be held at 2%."
| 
