Examination of Witnesses (Questions 60-74)
MR MERVYN
KING, MR
PAUL TUCKER,
MS MARIAN
BELL, PROFESSOR
STEVE NICKELL
AND MR
RICHARD LAMBERT
24 MARCH 2005
Q60 Mr Beard: When do you think we will
be?
Mr Tucker: I do not think that
is something that I can judge, I am afraid.
Q61 Mr Beard: The Treasury told us that
the US trade deficit has reached the point at which received wisdom
is that it has to correct, namely it is 5.7% of American GDP.
The February MPC Minutes note the view of some economists that
a sustained real dollar depreciation will be needed to secure
such a correction. Would such a dollar fall threaten the economic
outlook of the eurozone and the United Kingdom?
Mr King: Of course, on the latest
numbers the deficit is even larger, just over 6% of GDP. I think
it is fair to say that one can conclude that this cannot go on
indefinitely. Unfortunately, that does not help very much in knowing
when it will come to an end. I do not think anyone can be at all
confident about the time horizon over which this will adjust,
hence it makes it extremely difficult to know when and by how
much there will be a change in the dollar. If there were to be
a sharp change—I am not saying that will happen at all but
just take as a hypothesis if there were to be a sharp fall in
the dollar—what will matter clearly will be against which
other currencies that fall comes. That has been very much a bone
of contention in discussions about exchange rates internationally
over the past year. Those in the euro area are clearly concerned
that if countries in Asia try, by one means or another, to link
their exchange rates to the dollar, try to retain competitiveness
against the US, then in so doing they will (a) not only frustrate
the correction of the US deficit, but (b) it will mean that any
correction that does take place will be taking place largely against
the euro area and that would mean a bigger rise in the euro relative
to other currencies and, more importantly, a bigger adjustment
in current accounts with changes in movements of resources from
one sector to another, from the tradeable sector to the non-tradeable
sector. The adjustments are a matter of concern to everyone but
the important thing here is not to try to pin blame on anyone
because these deficits that we see around the world are not the
result of any one country's policy, they are the result of what
everyone is doing. I think it will be a matter of collective discussion
at the various international fora as to how we are best going
to cope with this adjustment as and when it seems to be starting
to take place.
Q62 Mr Beard: If there is a widespread
appreciation of what you have just said, is that not in itself
going to affect the economic expectations?
Mr King: Yes. I think it is clearly
part of the Federal Reserve's reasoning that they anticipate this
adjustment at some point will come about and, if they are not
careful, that could add to inflationary pressures in the United
States, so they are watching that extremely carefully. I think
it is part of the concern that those in the euro have that, if
nothing else happened, that might mean some depression in terms
of demand in the euro area. It is in everyone's interest to try
to ensure that when this adjustment takes place, it takes place
at a time at which all of us at least clearly understand the assumptions
on which other countries' economic policies are being based so
that we are not making mutually inconsistent judgments about what
is likely to happen. That is the value of the international fora
that we have for discussing international economic policy.
Q63 Mr Beard: When the change takes place,
is it likely to be controlled?
Mr King: It will not be controlled
because it will be a change in the exchange rate in a free market
and that can sometimes move quickly and then stop and take place
again. What should be controlled here is policy response and I
think that will be controlled. It is something that we do need
to discuss among several countries in the world. You cannot just
leave this to the United States and say that it is up to them
to deal with it and solve everyone else's problem.
Q64 Mr Beard: Are those discussions happening?
Mr King: There has been a lot
of discussion. You will notice at the last two G7 meetings, China
was invited to attend those meetings with the G7 precisely so
that we could have a private discussion about exactly those questions.
Q65 Mr Beard: Governor, you recently
wondered aloud if there was any fundamental reason why the world's
central banks should continue using one main currency as a source
of liquidity. In February, however, the first hint that South
Korea was considering diversifying its foreign exchange reserves
out of the dollar was enough to produce another burst of volatility
in world markets. Are you confident that any move by central banks
to a wider basket of reserve currencies can be managed without
provoking further turmoil in the markets?
Mr King: If it is managed and
explained very clearly then I think it could be managed, yes.
The main thing is to make absolutely clear in advance in a transparent
way what changes will take place and why. I think the volatility
that you referred to occurred precisely because there was a misunderstanding
about what the change actually meant. The message from all this
is that things have to be discussed and explained very clearly
to people before these changes in patterns of reserves take place.
Q66 Mr Beard: Is there a wider international
appreciation similar to your own that we do not really need this
reserve currency concept?
Mr King: To be honest, I do not
think the phrase "reserve currency" has been used very
much in discussion for quite a long time. Indeed, the phrase "international
monetary system" is a phrase that you can look back to in
the textbooks 20 or 30 years ago but has not really been part
of the recent debate. There has been a lot of discussion at the
IMF, G7 and elsewhere about "international financial architecture",
but that has all been about financial flows, the question of lending
to sovereign borrowers who may find it difficult to repay, the
issues surrounding Argentina, the policy of the IMF towards the
countries to whom they lend, those sorts of questions, not questions
about the international monetary system which is much more to
do with the relationship between the IMF and the major industrialised
countries. I do think it is time for more active debate about
what we mean by the international monetary system and the basis
upon which it works.
Q67 Mr Beard: Where should that debate
take place?
Mr King: The obvious place is
the IMF because that is a forum where every country is represented
around the table and there is plenty of scope for discussing how
that representation might be reformed and the way in which the
IMF works. As I said in the remarks I made at the end of January,
I would encourage the IMF to be bold when it is thinking about
a review of its own strategy. I would urge them to be as bold
as they dare be, but I cannot say that bold is a word that comes
to mind when thinking about recent changes.
Mr Beard: Thank you very much.
Q68 Mr Walter: Just following on from
that point very briefly, Governor. It begs the questions in terms
of reserves: if not the dollar, what? There has been some debate
recently about smaller central banks diversifying into corporate
bonds, equities and so on, but when we are talking about the Asian
central banks which have literally hundreds of billions of dollars
held in reserves, if they were to diversify out of the dollar,
where would they go? One can only speculate that the eurozone
is an alternative but is there sufficient liquidity in eurozone
assets in order for them to be able to do that?
Mr King: I think it goes to the
heart of the question of why countries hold reserves. The most
striking feature of the past 10-15 years is that foreign currency
reserves by and large are now held in Asia and not held to the
same extent anywhere else. In a world in which the major currencies
are floating freely it is not clear that there is a need for significant
foreign exchange reserves. What happened after the Asian crisis,
for reasons unconnected with the international monetary system,
was many of the countries in Asia realised that their banking
systems were quite heavily involved in dollar transactions and
that if there were to be a run on their banking systems then rather
than have to go to the IMF, which they perceived at the time was
lending money on terms which were not on the same basis as they
had lent to Latin American countries, conditionality was imposed
to a much harsher extent on the Asian countries, the lesson they
drew from it was the need to build up very significant dollar
foreign exchange reserves, not to do with supporting the currency
as such or the monetary system but in order that they could act
as an effective lender of last resort to their own banking system
in dollars because their banking system was borrowing in foreign
currency terms. I do not think that is going to go away quickly
and that suggests to me the demand for diversification will not
be such as to lead them to make a wholesale switch out of dollars
at all. The role of reserves in the international monetary system
is a rather different feature. These aspects need to be separated
and need to be thought through. I think one of the things to which
insufficient attention has been paid has been why these reserves
have been built up, the scale to which they have been built up
and the implications that has for the potential volatility of
the currency of the big country in the world that has been supporting
demand in the world economy and has, as a result, built up a large
current account deficit which in the long run is unsustainable.
There are certainly fragilities there.
Q69 Chairman: Ms Bell, your term of appointment
to the MPC will expire in May this year. What observations do
you have after your three years' experience on the way the MPC
works?
Ms Bell: I think the main impression
has been about the strength of the system, the design of the system,
the potentially huge importance in practice of individual accountability
and the terrific respect on the Committee and in the Bank for
individual accountability. What that means is the process benefits
from having nine individual views, independent views, not just
the externals but also the internal members who are prepared to
question and challenge each other's views and also the views of
the staff so that we do not get an approach to monetary policy
that is built up from the bureaucracy of the Bank of England.
I think that is probably the single most important thing I have
learned. The process, the strength of that, is laid out quite
nicely in Richard's article.
Q70 Chairman: If you were to stand for
reappointment to the MPC, what criteria do you believe should
be used to assess your individual record as a member of the MPC?
Ms Bell: I think we have discussed
this before.
Q71 Chairman: We did, and I will give
you the date: 22 May 2002.
Ms Bell: I think I argued then
that you would assess people's records on the wisdom, both at
the time given all the information available, and also perhaps
with hindsight, of the judgments that they have made. That is
quite a challenge and it is something for other people to do,
I think.
Q72 Angela Eagle: On the international
financial architecture, Governor, you did make some remarks at
the Advancing Enterprise 2005 Conference about your vision of
the future of the IMF. I suspect that particularly because we
have a stable situation there are less crises, and hopefully that
will continue in the future. Could you lay out in a bit more detail
for us how you see the IMF evolving if your vision were to be
adopted?
Mr King: I would rather not set
out a fully fledged vision because the IMF is going through its
own internal discussions and the UK will contribute to that. Rather
than pre-empt any of that discussion, the IMF itself, in the form
of the managing director, will be presenting to us at the end
of April his views as to where the IMF will go. I will do no more
than just flag two or three areas. One of the things the IMF feels
very strongly from the staff end, and I understand why, is it
wants to be seen to behave symmetrically towards all its members.
That is one reason why it has felt that it should always be involved
in dealing with low income countries, even though the issues that
are involved in low income countries are really about development
and not the areas in which the IMF has great expertise. Another
area where I think we do need to think in terms of what was meant
by symmetry is the relationship between the IMF and the industrialised
countries. A lot of resources go into regular monitoring of the
economy and sometimes I think they stray into areas that cannot
really be of any great interest or relevance to the overall macroeconomic
position. What I would like to see the IMF do is to talk much
more about the implications of the main macroeconomic policy settings
of each industrialised country for the rest of the world economy.
It is the interactions between countries where they have their
comparative expertise. That is one area. Another is to get back
to the question of the policy that is going to be adopted towards
lending to countries in serious financial difficulty that want
to borrow large sums of money. Exceptional access, as it is being
called. These are not poor countries, these are middle income
countries. A very large proportion of the IMF's balance sheet
is now tied up in loans to a small number of those countries.
We still need to proceed to make sure that the framework for exceptional
access is really robust and is not just left to making it up on
the hoof as we go along. That is a way in which discretionary
decisions are often influenced by political factors rather than
economic factors that enter into the decisions. Clearly we have
not seen the end of the debate on the consequences of the Argentine
default and that will have repercussions for the international
financial system for many years. Those are just two areas where
I think the idea that we have got a settled system and it is just
business as usual is not right. It is the international monetary
system, it is the role of the IMF in the monitoring and surveillance
of the industrialised countries and making a more effective contribution
to ensuring, almost of making, the G7 and other countries face
up to the fact that their policies have implications for each
other. The second aspect is that there is still more work to be
done in ensuring that we have a robust exceptional access framework
to ensure that sensible decisions are made about lending such
vast amounts of money to middle income countries in financial
difficulty.
Q73 Angela Eagle: There was an aftermath
of the Asian financial crisis, which we touched on earlier, and
you touched particularly on the effect it has had on the behaviour
of central banks in Asia since. Do you think that there are other
aspects of the international financial architecture, which was
created originally in 1945 and renewed in the 1970s and 1980s,
which really lag in terms of not only the political situation
that we now find ourselves in in the 21st century but also the
economic development that has gone on since which has seen countries
emerging, such as China and India, which can have a big effect
on the world economic system but are not properly represented
at an appropriate weight in the international systems? How do
you see this reform process developing? Clearly there is a lag
between the institutions we have now and what we may wish to see
in the future.
Mr King: I agree that the institutions
and the arrangements for meetings that we have now are not the
ones that we would set up today if we were starting again and
there is a big gap between those two. How we get from one to the
other is a matter of politics and experience and does not lead
me to be entirely optimistic about how much progress we will make.
At G7 level, and the UK Presidency played a big part in this,
we have encouraged China to attend the meetings and to play a
big part in explaining to us what their views are and we could
have a private discussion with them about how we saw the situation.
I hope that interaction with the Chinese is a permanent feature
of our discussions. I think it needs to be if we are to have any
serious discussion of the world economy. As you say, there are
other countries that have grown in size and importance, and India
is the most obvious example but there are others, where they probably
do not have the weight of representation that they should. The
obvious place to deal with this is at the IMF because all 184
countries are represented around the table of the IMF Committee
through constituencies. I do not think there is an enormous logic
to the pattern of constituencies. If it is to be effective I think
it is most important that the share of each constituency, the
person at the table, really is the big country that matters. I
do not think we can expect to make much progress if we do not
have a group where the countries that really matter are there.
That was the origin of G20 which came out of a G22, a G33, a G18.
All of these Gs were tried and we finally converged on the G20.
It is a slightly cumbersome body but it has got the right countries
around the table. It has not yet become an effective body, there
are still some countries which are nervous about raising sensitive
issues at that forum. We need to work hard on that. It may come
out of a process of informal development and, of course, the representation
of the euro area in the G7 or, indeed, the G20 is an issue that
some countries feel is holding up progress in rationalising membership.
There are a lot of difficulties ahead but it is so important and
without being willing to take on board the issue of membership
voting rights and who sits round which table, I do not think we
are going to persuade the rest of the world to take seriously
the other questions of substance which it is important that the
fund deal with, if it is to be as important now as it was when
it was set up in 1944.
Angela Eagle: Thank you. It is clearly
an important agenda.
Q74 Chairman: Governor, can I thank you
and your colleagues. There has been an heretical suggestion by
Mr Mann this morning that we extend Lent to Whitsun. Could I say
on behalf of this Committee that 40 days is enough and in the
next few days it will finish. Can I wish you and your colleagues
a happy Easter.
Mr King: Thank you. Happy Easter
to you, Chairman, and to Members of the Committee.
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