Examination of Witnesses (Questions 40-59)
MR MERVYN
KING, MR
PAUL TUCKER,
MS MARIAN
BELL, PROFESSOR
STEVE NICKELL
AND MR
RICHARD LAMBERT
24 MARCH 2005
Q40 Angela Eagle: There has been a significant
downward shift in inflation expectation?
Mr King: There has been a significant
downward shift in inflation expectations and it is very closely
linked to the target. There was a small upward shift in the last
few months that we would watch very carefully—it is one
of the factors that would lead us to be concerned on the upside—but
by and large that has helped all those involved in wage bargaining
focus on the medium term, confident that the inflation target
will be met. And I think that helps wage bargaining then focus
on the issues about the demand and supply for particular types
of labour in particular areas rather than be concerned about some
national movement in inflation: if inflation were to move away
we had better get the wage demand in now. That has all helped
and I think the reforms to the labour market over 20-25 years
now, the cumulative effect of all that has given us a much more
flexible labour market and that has helped to ensure that patterns
of remuneration have been more flexible. All these things probably
add up and it is very hard to know what the impact of any one
of them is. I think, to go back to the starting point of your
question, if you had said to me three years ago that unemployment
would be where it is now, and it is lower where there the MPC
thought it was going to be three years ago, so unemployment has
fallen more than we thought and wage inflation has not picked
up as we had expected, that is a real development. I think it
is an accumulation of factors that explain it, but since we cannot
be entirely certain we have to watch very carefully what happens
in the labour market, and we will do so, right through the coming
wage round and onwards. As I said earlier, it is not just settlements
that would concern us, it is pay drift and the growth of average
earnings, and regular pay drift has started to pick up. We will
have to watch it very carefully, but it is a very striking development,
and one that has been helpful to us in meeting the inflation target.
Q41 Angela Eagle: Marian Bell, you seemed
to indicate earlier that you thought there was more supply in
the economy than perhaps other people thought. Does that apply
to your view of the labour market as well?
Ms Bell: I think one of the striking
things for me over the last few years has been this combination
of strong growth and lower inflation, both in general and in wages,
than we might have expected. I think the most obvious explanation
for that is that supply is greater. But I am not a labour market
expert and I have no greater wisdom in any of this than the Governor,
so I would not like to claim that I have the answer. I think it
is certainly the case when you speak to businesses that there
is greater flexibility. Quite often they are meeting shortages
by allowing more flexible working practices, allowing women with
children to work, perhaps people to enter the labour market who
may not have been very active in it in the past. We have seen
an increase in older workers. I think there are lots of potential
explanations and I do not know that we will ever have the right
one, but I think it is important that we allow for the possibility
that some of what we have seen might be sustained.
Q42 Angela Eagle: The Red Book talked
about the highest level of employment ever for people of working
age—I think 71.9%—and had an aspiration to increase
that to 80%. Again that would imply that there is slack in the
labour market rather than it being tight, or at least the potential
for shifting the space in which the labour market exists. Do you
have worries about that?
Mr King: Let us ask the country's
expert on this, Professor Nickell.
Q43 Angela Eagle: Mr Nickell?
Professor Nickell: Thanks very
much. The 80% is obviously an aspiration. However, if you look
at some of the countries in Europe, such as Denmark, then it is
clear that such an aspiration can be achieved. The issue about
what that means for labour market slack, however, is a bit different.
If you introduce policies to try and get people who are currently
inactive into work, those policies are usually uncertain in their
outcomes and take quite a long time. The impact that would have
on labour market slack in the short run is probably not going
to be very great.
Q44 Angela Eagle: I suppose I am asking
about long-term structural shifts here rather than short-term
dealing with a certain tightness, when clearly migrant labour
is a more obvious way of dealing with it?
Professor Nickell: I think in
the long term we can certainly look forward to higher participation
rates among people aged between 60 and 70. I think it is absolutely
undoubted that that will happen, and it is happening already,
and that will obviously increase the potential labour force. I
think it is likely that participation rates among single parents
will probably go up further. They have gone up somewhat up until
now, but I think that they will probably move up further. I think
that those are the two main areas. Aside from the whole issue
of disability, I think it is highly—
Q45 Angela Eagle: There is a big potential
pool there?
Professor Nickell: Yes. I think
it is highly likely that some progress will be made in allowing
people currently on disability benefit to get work. As I understand
it, the pilot schemes, Pathways to Work schemes, are looking quite
hopeful in that regard, and, of course, as you rightly say, there
is an enormous pool of people there and that in the long-term
could also make some difference.
Q46 Angela Eagle: In the minutes in paragraph
20, when you were discussing wage inflation, quite surprisingly
you said the Bank has received information on only about 15% of
the January wage settlements, so you were left to make your judgment
with quite a small sample of information. Is there any way that
you can increase your access to this information more quickly
so you could make a more accurate assessment of what is going
on in the labour market than relying on 15% of the wage settlement?
Mr King: Perhaps the wording here
is not as clear as it might be. The phrase "January wage
settlements" refers to settlements which are normally made
in January, and some of those settlements may have been delayed
or come in later. It does take time for information about those
settlements to trickle through the very sources to reach the Bank's
database, which is pretty comprehensive, so that number will go
up towards 100% as time goes by.
Q47 Angela Eagle: So it is the slowness
in the negotiators coming to an agreement rather than the slowness
in you getting the data?
Mr King: That is partly it. It
is both. It is not easy for us. We cannot tell people, "Let's
hope you reach a wage settlement. Ring the Bank of England tomorrow,
the first thing you do, and let us know." You have to go
through the usual channels for receiving this information, but
it can also be the case, and this is a very interesting reason
for making sure that you keep tracking back to the settlements
that may normally be reached in a month where the information
comes in later. If it is the case that those settlements have
taken much longer to reach, it may be because it has been a more
difficult settlement to reach and, hence, perhaps a higher settlement,
so we do have to keep track of that and we look at the revisions
each month when we meet and are briefed by the staff.
Q48 Chairman: Governor, in recommending
a rise in the minimum wage to £5.05 per hour the Low Pay
Commission argued that wage growth is low, clearly not threatening
the Bank of England's inflation target. Do you agree with that?
Mr King: I am not sure if that
was a terribly good argument to give for setting the national
minimum wage at a particular level.
Q49 Chairman: That is down to you here?
Mr King: When they started setting
the minimum wage they were pretty cautious in setting it below
the level where they thought it might settle eventually because
they did not know how many people will be affected by it, and,
as time went on, I think they have found that fewer people have
been affected by the minimum wage than they had expected or feared
and therefore it was possible to move it up to a level they thought
was appropriate, and that is for them to make a judgment about
how far they want to move up the wage distribution in setting
the minimum wage. I think it is fair to say that over the last
year I have heard more comments about the impact of the minimum
wage on labour costs from employers, markedly more than I had
heard before, so I think it has got to the level now where it
is having an impact and where employers are beginning to say,
"This is affecting the wage settlements we have to reach
for those above the minimum wage level", as people attempt
to restore differentials. In the Inflation Report we did point
to the fact that in the hotel and restaurant sector wages had
risen at 6.8% a year in the three months to November, up on the
previous rate of increase, so it is starting to have an impact
now. A balance has to be made and the objectives of the minimum
wage are partly to do with interaction with tax credits and partly
a social argument about how far you can move up people's relative
incomes—there has to be a balance there—but I would
say that we are beginning to get to the point now where employers
start to mention this as a factor that is relevant to their overall
labour costs.
Q50 Chairman: The Inflation Report suggests
that pay settlements tend to reflect trends in RPI inflation and
not CPI inflation. Does that create problems for a central bank
given an inflation target set in terms of CPI inflation?
Mr King: I am not sure if we really
know what index truly affects people's bargaining behaviour. I
am confident if you are in a bargaining situation you tend to
adduce evidence from whichever index seems to favour the claim
you are making, and at present, since RPI is higher than CPI,
it is not surprising that people turn to RPI and use that to justify
a higher claim—it is an irresistible temptation—and
that has always been the case. If you remember a long time ago,
I think Nigel Lawson introduced RPI X in a way to get away from
RPI and wage bargains, so I think it is bound to be the case that
there are these different measures of inflation. Indeed, I think
it would be a mistake for us to pretend that there is only one
measure of inflation that represents the truth and that any other
measure of inflation was misleading. That cannot be right. Everybody
has a different basket of goods and services on which they spend
their income, and for each basket there is a different measure
of inflation. What we are trying to do is to target 2% CPI inflation,
a broad based measure of consumer price inflation. I think that
is broadly understood, but it is our job to try and make sure
that the target is clearly understood.
Q51 Mr Walter: I wonder if we could now
look at some costs pressure in the economy and perhaps focus immediately
on oil prices. On 7 March the Department of Energy in the United
States reported in its March Outlook Report that they estimated
that the 2005 average price of West Texas Intermediate (their
bench mark) would be $48.95 a barrel, which was up 7.5% on the
previous month's report and, in fact, this time last year they
were forecasting only $29.40 for 2005. In the minutes of your
last meeting, which were released today, at paragraph seven you
comment that oil prices have risen by more than 20% since the
Committee's February meeting in both dollar and sterling terms,
with oil prices expected to be over $40 a barrel over the next
three years, well above the level assumed at the time of the February
Inflation Report. Last autumn, when oil prices went above $50
a barrel, you noted that the implications for the world economy
depended on the extent to which the increase turned out to be
permanent. That sort of evidence that I have given would seem
to indicate that that is very much the case that it is going to
be permanent, certainly for the next couple of years. Should we
be getting more concerned about energy costs?
Mr King: Clearly energy costs
have risen, and, as you point out, they rose very sharply last
month up to our recent meeting, but I think that the current spot
price is still well above the price that the market expects to
persist over the next two years. I think you are quite right to
say that the path of oil prices that the futures market implies
and that people expect to hold over the next two years has moved
up significantly since last autumn and it does not show much sign
of falling back. It is also the case that the information that
we have from oil suppliers—from those in the industry—suggests
that this is something which represents, if you like, a risk premium
that they believe that there is adequate supply and that prices
at this level will call forth supply more than enough to meet
the demand. I do not think there is any reason to panic about
this at all. Oil prices do move up and down, and the price can
be very sensitive to quite small changes in the balance between
demand and available stock, so the stock position is also quite
important. I think we will see volatility in the price. It is
very sensitive to political developments too. Although demand
remains strong, and is likely to grow, there are plenty of signs
that in the medium term supply is there to meet that demand at
prices certainly not above the current price and I think the market
would suggest at below the current spot price. China is investing
in new capacity. There are reserves available. I do not think
one should get too worried about it, but it is a factor. It has
led to higher input costs and probably output prices of manufacturers.
It has fed through and, clearly, it feeds through to petrol prices,
so it is something we have to take into account. I think what
we can all draw some comfort from is that central banks around
the world have taken note of this. They look at the effects on
inflation, but inflation expectations—to go back to the
answer I gave before—seem to be sufficiently well anchored
to the inflation target, whether explicit or implicit in different
countries, that it is not leading to a rapid change in inflation
expectations, which itself calls forth a need for a policy response.
I think the greater climate of stability in which it works makes
it easier to handle these short run fluctuations in the oil price.
Certainly, I do not want to sound complacent. There is no doubt
that the finance ministers of the G7, for example, have spent
a good deal of time talking about how they can ensure there are
adequate supplies.
Q52 Mr Walter: Looking specifically at
the domestic inflation situation, would you favour the Treasury
not increasing the duty on petroleum products?
Mr King: That has to be a matter
for the Treasury to comment on and not us.
Q53 Mr Walter: Can I look at non-oil
commodity prices. In your February Inflation Report you say, in
dollar terms, non-oil commodity prices have increased by around
5% since the November Report. Is that a worrying factor?
Mr King: I think it reflects the
strength of the world economy. If you like a strong world economy,
that is a natural consequence of it. Again, they can be fairly
volatile and move up and down, often in anticipation of movements
in world economic demand. In itself, I do not think it is a great
matter of concern. I think it highlights the fact that the world
economy has moved from a position in which there was widespread
discussion—including around this table at some time—of
deflation, to a situation where people are more concerned about
ensuring that policy is adequate to head off inflationary pressures.
Q54 Mr Walter: Perhaps I can shift slightly
now. Your Inflation Report highlights a fairly dramatic switch
in UK imports from developed to developing countries, such as
China, and the role this has had on holding down import prices.
If we net off the upward pressure from countries such as China
on energy and commodity prices—which we have just been talking
about—against their downward pressure on prices for manufactured
goods, has the UK inflation rate, in overall terms, been higher
or lower than we might otherwise have expected?
Mr King: I think this development
has lowered consumer price inflation. Indeed, one of the quite
marked factors of the last two to three years has been that consumer
price inflation has been lower relative to domestic producer price
inflation than we might have expected. That is true of the United
States as well, though, interestingly, not of the euro area. I
think this has been a development which has been significant for
consumer price inflation and has affected the course of policy.
How long it will persist is hard to judge. Professor Nickell has
done a lot of research on this question, perhaps he would care
to comment on it.
Professor Nickell: Certainly,
it is true that import prices and the switching from more expensive
to cheaper countries has undoubtedly contributed fairly substantially
to the very low level of import price inflation, indeed falling
import prices, over the last few years. As far as the switching
to cheaper supplies is concerned, I think that will go on for
some time. Of course there are other factors governing import
prices, including the general buoyancy of the world economy, which
could start moving import prices in the other direction in the
near future. Overall, going back to oil, in one respect we are
quite lucky in this country in that we are less oil intensive
than nearly all the other major industrial countries. I do not
know why that is, but I assume that is because of our relatively
high level of service sector relative to manufacturing. Of course,
the other thing is oil prices do not feed through into retail
prices in quite the same way in this country as they do in most
other countries because of the extremely high levels of tax on
petrol. The direct impact of oil prices is less in this country.
Q55 Mr Walter: Professor Nickell, I wonder
if I can direct a question at you on some work you have done.
You have done some research on the role of improved efficiency
and squeezed margins in the distribution sector. You concluded
that without a further squeeze on distribution margins, we will
see a rising trend in the CPI goods price inflation. Distribution
sector margins are already near a ten year low, is there much
scope for them to fall further?
Professor Nickell: I would not
have thought so. Retail margins were squeezed quite a lot about
three or four years ago, there has been less of a squeeze since.
Going forward, I think the key issue is distribution sector productivity
growth. If distribution sector productivity growth reverts to
the average level of productivity growth in the private sector,
then looking forward, with the benefits of negative import prices
coming to an end, a slow rise in CPI inflation is a plausible
outcome. Of course, if it turns out to be the case that the distribution
sector productivity growth remains at its current relatively high
level, then that would, of course, exert downward pressure on
inflation going forward.
Q56 Mr Walter: Going on from there, if
we look at the Inflation Report, page 28, chart A, distribution
sector profits, what we see there is retail margins have been
on a rising trend while those distribution sector margins have
been falling. Is this consistent with the view that a highly concentrated
retail sector, particularly in areas such as food retailing, has
been squeezing both the supply and the distribution chains and,
therefore, keeping a large part of the gains for itself? I have
to say, certainly, that is the view of dairy farmers in my constituency
who see the retail price of milk going up whilst the farm gate
price is static or falling. I think we have seen Sainsbury's reporting
a 6% jump in profits this morning.
Professor Nickell: I do not want
to get too bogged down in the issue of supermarkets versus supermarket
suppliers. Certainly, I think it is true that in the distribution
sector, as a whole, the retail part of the distribution sector
has, in some sense, squeezed the wholesale part of the distribution
sector, there is no question about that. Of course, to some extent
it has taken over part of the job of the wholesale sector so that
major supermarkets, in some sense, now do their own wholesaling
and have their own distribution sector dealing directly with the
agricultural suppliers and other suppliers. I think that picture
you see there is representative of this trend, which I guess will
go on.
Q57 Mr Beard: When you referred earlier
to the botched reform of the Stability and Growth Pact, you spoke
of the lack of fiscal discipline which it will leave and, also,
the dismay of central bankers. What are the likely economic consequences
of this for the euro zone?
Mr King: Only time will tell.
The point I was referring to was the need for very careful institutional
design. I think one of the successes of our framework is we have
very careful institutional design and that is one reason why it
has been successful. There is no doubt that those who planned
monetary union thought, also, that they needed very careful institutional
design. They succeeded with the European Central Bank, with the
Stability and Growth Pact they have not and the consequences will
be seen in the future. In terms of implications for long-term
interest rates, primarily, it may take some time to come through.
In the long run, it is difficult to imagine a monetary union being
successful without genuine collective fiscal discipline.
Q58 Mr Beard: Long-term interest rates
around the world have fallen to levels which we last saw when
there were widely voiced fears of deflation a couple of years
ago, which you mentioned already. Do you share Alan Greenspan's
view that the recent strength in bond markets could turn out to
be—in his words—"short-term aberration"?
Mr King: I do. I think it is quite
possible to understand, in the present circumstances, why with
a great deal of saving in the world economy coming from the developing
countries which one might otherwise expect to be borrowing to
finance investment, in fact, they are saving more than enough
to finance their own investment. This may be a relatively short-lived
phenomenon. I think it is plausible to imagine—with weak
domestic demand in much of the euro area and still in Japan—that
real short-term interest rates might be very low, leading to low
interest rates at the short end. This level of rates, at the very
long end, does raise questions and you have got to be pretty confident,
over a very long period, of the determination to keep inflation
down and close to price stability. You have to be very confident
of that over a very long time period in order to justify this
level of rates. I suspect at some point there will be an adjustment,
it need not be very large but the rates do seem to be extraordinarily
low.
Q59 Mr Beard: The search for yield by
investors has translated into an appetite for higher risk in both
bond and equity markets. The latest Financial Stability Review
noted an underlying concern about this trend, and Mr Tucker has
warned that the price of risk was "possibly too low".
Are we getting into the "irrational exuberance" which
Alan Greenspan warned about in 1996 when the capital market bubble
first began?
Mr King: Let us ask Mr Tucker.
Mr Tucker: Chairman Greenspan
has described both the low long-term rates, the government yields,
which you were talking to the Governor about a moment ago, and
the low credit risk rates as a conundrum. I completely agree it
is a puzzle; it is a puzzle which has to be a worry too. It has
been going on for some time. Long-term yields—long government
bond risk free yields—have been on a downward path for quite
some time. And accompanied with that there has been this search
for yield—which we have talked about in the Financial Stability
Review—probably for about 18 months now. I think it is fair
to say that those of us who have contact with the market on these
issues have continued to be surprised that it has continued to
the extent which it has. Are there risks in that? Yes, there are.
I think the risks take two quite distinct forms. One is the price
of credit is just too low, and on a slow fuse that will lead to
the corporate sector internationally borrowing too much to re-leverage
their balance sheets. The other kind of risk is quite different:
there will be a short, sharp and uncomfortable adjustment at some
point. One cannot be certain that either of those risks will crystallise.
In fact, over the past month or so, perhaps a little bit less
than that, there started to be some correction. Chairman Greenspan
has talked about this a number of times. Since the last time he
talked about it the rising inflationary pressures in the United
States have caused long-term bond yields to edge up quite a bit
really, approaching 50 basis points. That still leaves intact
the conundrum and puzzle which the Governor talked about. More
recently—in part, perhaps, triggered by the news from General
Motors a week or so ago—credit spreads, in particular in
the lower quality high yield industries, have continued to edge
up. A gradual adjustment of that kind, if it were to persist,
on balance would be a good thing probably, but I do not think
we are out of the woods yet in terms of these risks.
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