Select Committee on Treasury Minutes of Evidence

Treasury Committee Questionnaire ahead of appointment hearing for Professor David Blanchflower


1.   Do you have any business or financial connections or other commitments which might give rise to a conflict of interest in carrying out your duties as a member of the MPC? Are there any relevant personal or other factors of which the Treasury Committee should be aware in considering your appointment?

  No. I will continue to keep an office at Dartmouth College but will have no teaching duties and will be on "leave on own charges". I will also have a part-time visiting appointment at the University of Stirling and will give a few classes a year to graduate students in the Scottish Graduate Programme in Economics. I will continue with my consulting practice in the United States which involves work as an expert witness in public sector wage setting and as a consulting expert for a variety of public entities on the operation of programs for Disadvantaged Business Enterprises in the construction industry.

2.   Do you intend to serve out the full term for which you are appointed?


3.   Please explain how your experience to date has equipped you to fulfil your responsibilities as a member of the MPC?

  My PhD at Queen Mary College, University of London was funded by an ESRC Collaborative Award in the Social Sciences (CASS) and co-sponsored by the Department of Employment who provided me with invaluable access to data and expertise. That provided me with "hands-on" training in the collection of data, including survey data, at both the level of the individual and the workplace as well as useful insights into the workings of the UK labour market and public policy. Since that time I have worked as an applied empirical economist interested in the workings of international labour markets with emphasis on the UK. My particular expertise involves the analysis of macroeconomic problems from their microeconomic foundations with special concerns for aggregation and missing variable biases. My knowledge of the workings of the US economy is likely to be particularly helpful and different.

  I have chaired the Economics Department and acted as Associate Dean of the Social Sciences at Dartmouth. I have consulted for many public and private organisations around the world. I have acted as an expert witness in many legal cases in the US which has included significant amounts of trial testimony. I have been involved in wage setting for groups of public sector workers in the US, including economists, bankers, judges, police and teachers as well as private sector firms in both the UK and the US. Further, I have advised a number of UK public sector organisations on the operation of the Area Cost Adjustment (ACA) and the Market Forces Factor (MFF), which sets budgets for local authorities and health authorities respectively. In the mid 1990s I acted as advisor to the Elliott Commission which examined the operation of the ACA.[1]

4.   To what extent will membership of the MPC require a different approach from that required in academic research, with regard to the discharge of the duties and responsibilities involved?

  I don't believe my membership of the MPC will require a very different approach than that required from my academic research, which is applied rather than theoretical in nature. At the simplest level the focus of the work on the MPC is on a single issue, how to set interest rates to keep inflation in a narrow band. My academic research, on the other hand, has been wide ranging across a host of different economic and social questions. However, a considerable part of my work has focussed on understanding one single issue—how wage dynamics and unemployment are related, which is clearly central to the work of the MPC.

  My work is highly practical and related to questions of the day—the role of profit sharing; the impact of unions; the causes and consequences of growing wage inequality; the causes of unemployment, how to set public sector wages and so on. I have a broad range of experience outside academia. My consulting work has involved applying much of my academic work to the real world. For example, a large part of this work has involved examining wage setting in the public sector, especially for police, including the NYPD. Further, I have consulted for the Board of Governors of the Federal Reserve and the Farm Credit Administration on the setting of pay of economists and other executives. I have also advised approximately twenty state and local governments in the US on the adoption of policies toward small businesses, another area of focus of my academic work.

5.   Which of your publications or papers are of most relevance to your future work on the MPC?

  The publications of most relevance to my future work on the MPC relate to the workings of the UK labour market in general and wage inequality, wage setting, wage dynamics and wage inflation in particular. The work on the wage curve—the relation between wages and unemployment—is of special interest. The wage curve work emphasises the importance of using microeconomic data in macroeconomics in contrast to aggregated time series methods. The wage curve has now been documented as existing in similar form in over forty countries. I have recently been doing further work on the relation between wages, unemployment and the housing market.

  Of relevance also is the work I have done on youth unemployment, trade unions, job creation, employment growth, the housing market, self-employment and small businesses plus the role of capital and liquidity constraints. In recent years I have published several papers on well being and happiness with the aim of understanding why, despite rising GDP, time series measures of wellbeing are remarkably flat in both the UK and the US.


6.   How important do you think it is for MPC members to be subject to ex post parliamentary accountability? What are the strongest and weakest parts of the current procedures in the UK? How favourably do you believe the UK system compares with the US system?

  I believe it is vital that members of the MPC are accountable to Parliament for their actions. The MPC does this in a number of ways including issuing minutes of each meeting; publishing a quarterly Inflation Report; writing an open letter to the Chancellor if inflation deviates by more than one percentage point from target; giving speeches and interviews; writing academic articles and technical papers plus appearances before the Select Committee.

  The greatest strength of the current procedures, I believe is (a) its transparency (b) the fact that there is a single symmetric target (c) that there is majority voting rather than the need for a consensus. The procedures in the UK seem to me favourable to the US system where there is no single target and the lack of majority voting sometimes makes it difficult for the Fed to convey a clear message. The current procedures appear to have worked very well.

7.   If you were to make yourself available for reappointment to the MPC at the end of your term, what criteria should be used to assess your individual record as an MPC member?

  The main criteria must surely be how well the MPC had been able to hit its inflation targets. I would hope to be judged on my voting record, my ability to communicate my decisions as well as my ability to work with other members of the MPC and my contribution to internal discussions.


8.   What other professional activities do you expect to undertake in addition to your position on the MPC and how do you intend reconciling these activities with your position as a MPC member?

  I will give a few lectures to graduate students in the Scottish Economics Graduate Program. I will continue to do some consulting work in areas I have traditionally worked in, including wage setting of public sector workers, goal setting for programmes in public sector purchasing, primarily in construction and desegregation of Chicago public schools. I intend to keep this work entirely separate from my work on the MPC. I will also continue as a research associate at (a) the National Bureau of Economic Research, (b) CESifo and (c) IZA. I have been associated with these research organisations for a number of years.

9.   Outside of MPC meetings, what activities do you intend undertaking in order to add to the public's understanding of the role and decisions of the MPC?

  I intend to undertake regional visits, speak with businesses, academics and the media and make speeches regarding my interest rate decisions and other matters. I plan to continue to write technical papers on a variety of economic issues as well as attending and presenting papers at academic conferences and seminars.


10.   How might the system of control over monetary policy in the UK, in place since 1998 be improved? Is the framework of an explicit symmetrical inflation target the best within which to conduct policy?

  It is early days for me as I have not yet been involved in any vote and have not seen the process working in its full complexity, but it appears that the current system is working well and is contributing to economic stability. The existence of an inflationary target appears to be particularly helpful in impacting inflationary expectations. I support the existence of a symmetric target because it means that risk of an excessively tight policy is treated by the MPC in the same way as the risk of too loose a policy. Majority voting also appears to have had a calming impact on inflationary expectations. The current framework seems to have worked well. I hope the MPC is as successful during my term as it has been over the last few years in reaching its inflation target with steady growth and low unemployment.

11.   How great is the risk to UK growth and inflation posed by high nominal oil prices? How should monetary policy react to higher inflation caused by increased oil prices?

  The current episode of high oil prices has, so far, only had modest effects on UK growth and inflation. Why has this been the case? The general view seems to be that the economy is now less reliant on oil relative to the 70s, and that in the current episode oil prices have increased more gradually. In addition the current monetary regime has helped to anchor medium-term inflation expectations. In some ways this has been surprising to me as I had expected to see somewhat larger effects on both prices and unemployment.

  On monetary policy, I think that the current received wisdom is that lags in the transmission mechanism mean that monetary policy is unable to affect the direct impact (or first round effects) of oil prices on consumer prices. So central banks have to tolerate these. But central banks need to carefully monitor the potential second round effects. For example, it is possible that increased consumer price inflation resulting from the higher price of oil can dislodge inflation expectations. My worry would be that increased oil prices might feed through to unemployment; although the very recent downward movement in oil prices below $70 is encouraging. The concern would be if there were to be a significant further increase in oil prices which drove up inflation and inflationary expectations and had major effects on employment and unemployment. The February 2006 Bank of England Survey of Inflation Attitudes suggests that inflationary expectations are on the rise. The MPC will clearly have to monitor the future impact of oil prices very carefully.

12.   What consideration should be given to the exchange rate and to asset prices, including house prices, within the framework for inflation targeting? In particular, how should monetary policy react to asset price bubbles?

  The role of asset prices in the conduct of monetary policy remains a controversial issue. The majority view is that monetary policy makers should only react to asset price movements in so far as they affect forecasts of inflationary pressures. The alternative view suggests that monetary policy makers can do more. Namely, by reacting to asset price bubbles, over and above considerations of their impact on inflation, monetary authorities can improve macroeconomic performance.

  It doesn't seem to me that monetary policy can act to minimize the likelihood of macroeconomic instability arising from large movements in asset prices, including house prices. This is because it is nearly impossible to identify an asset price "bubble". How does one know if the rise in asset prices has occurred because of fundamental factors, non-fundamental factors, or both? In addition, there are a number of practical concerns that have been raised. For example, the appropriate timing of a proactive monetary policy response is difficult to determine, the size of the interest rate rise needed could lead to a significant downturn and there is the historically relevant risk that a bubble once "pricked" could degenerate into a panic. Exchange rate movements can feed into inflation, but then the inflation-targeting policy would need to kick in.

13.   How would you describe the state of the UK labour market at present? In particular, how has net migration impacted on growth and inflation in the UK?

  The UK labour market remains historically tight. Employment levels have been rising and unemployment has remained at low levels for several years at or slightly above the natural rate. Recently the participation rate has started to increase. Wage settlements have held steady between three and four percent although there has been a recent spike due to bonuses. There is, however, some evidence of softening since the middle of 2005 with small increases in the claimant count and in ILO unemployment. There have also been declines in the number of vacancies although most recently there has been a levelling off. The cause of this recent softening and whether it is a start of a new trend remains uncertain.

  The overall impact of higher net migration on inflation and growth in the medium term are not clear-cut. This is because there are two offsetting effects. On the one hand, a rise in net migration will raise the potential supply of the economy. But on the other hand, migrants are consumers too, and their spending will raise aggregate demand. These two effects may cancel each other out, but even if they do not the impact is likely to be modest at the level of the economy. At a disaggregated level such effects may be more discernible. For example, if immigrants help to ease skills shortages in particular areas, it is likely that the wages and prices of that sector will grow less quickly that they would have otherwise done. The trouble is, of course, that one will never observe that counterfactual, so it is very hard to measure the effect. The bulk of the academic literature in the US and UK has focussed on the labour market effects of immigration. Economic models suggest that net migration is likely to temper wage growth. But most economists have struggled to find any significant empirical evidence to support these models.

14.   Do you believe that the natural rate of unemployment is a useful concept? On your assessment, where is unemployment currently relative to the natural rate?

  I believe the natural rate of unemployment is a useful theoretical way to think about equilibrium in the labour market. A good way to think of it is the normal rate of unemployment around which the unemployment rate fluctuates. It is difficult to measure empirically, and there are a number of procedures one might use. It seems that the natural rate in the UK fell during the 1990s, likely because of improvements in productivity but has remained relatively flat since then. I calculate that the natural rate is slightly less than 5% which is just below prevailing unemployment levels.

15.   How would you describe, and account for, the recent performance of business investment growth in the UK and the USA?

  Investment growth is generally pro-cyclical and more volatile than GDP and, like profits, very difficult to model. The investment recoveries in the UK and the euro area appear weak relative to previous cycles. US business investment appears to have been a little stronger than that observed in the UK most recently. There is no single, clear explanation for this observation; rather it is likely to be a combination of several, quite complicated inter-relationships. First, there may not actually be a puzzle, since investment, particularly recent investment is subject to a significant degree of measurement error. It is perfectly feasible that the recent path of business investment will eventually be revised upwards. Second, if there is a divergence, it seems likely that cyclical factors can explain some of the difference, such as greater corporate debt in the UK, or less clearly, because of stronger business confidence in the US. But it may also be the result of structural differences, with US producers having potentially anticipated an increase in productivity not expected in the UK. Recent concerns about rising oil prices and worries about pension fund deficits may also have impacted business investment in the UK.

16.   To what extent should fiscal policy play a demand management role alongside monetary policy in the short run?

  I don't believe that fiscal policy can successfully play a short run demand management role. I believe that demand management should be left to monetary policy. In my view government spending and borrowing is about having a good health service, schools and public services generally, not principally about trying to "fine tune" the economic cycle itself.

May 2006

1   Elliott, R F, McDonald, D, R MacIver. July 1996. Review of the Area Cost Adjustment, Waverley Press, University of Aberdeen and the Department of Environment. Back

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