Select Committee on Treasury Minutes of Evidence

Examination of Witnesses (Questions 20-39)


6 JUNE 2006

  Q20  Ms Keeble: The point is are we open to inflationary pressures here as a result of the instability possibly of some of our investment abroad or some of the investment that comes into the UK?

  Mr Butler: I think to a degree with the oil issue a lot of instability is pushing up oil prices and boosting their profits. That has been something that has been stable and it is unclear whether that will remain so. If you look at the UK's net external assets, then the UK has been investing on a net basis abroad in companies. They are pretty illiquid assets to have. Foreign investors have been investing a bit of equities, bit of bonds, but predominantly bank deposits. They are pretty liquid, and I think a lot of that has probably been on the back of UK offering you much higher interest rates than other economies. It is questionable whether that can be sustained in any environment where the Eurozone is now raising rates, Japan might be on its way to hiking, and the US has rates now above the UK. You are talking about, on a stock basis, assets that are equivalent to 40% of GDP. Those positions could be liquidated pretty sharply and pose a potential danger to sterling. If they were liquidated fast and sterling fell very sharply, then you create the inflation you are talking about and it becomes the number one topic for the Bank of England.

  Professor Muscatelli: I would agree with that. In addition, coming back to your earlier point about whether these flows are a problem, I think we have to be a bit careful. International capital flows create smooth adjustment in the world economy. If the oil exporters diverted some of these funds into the G-7 economies in terms of capital flows, we would have had real short-term adjustment problems with big movements in currencies needed in order to try to adjust to our trade deficits, instead these things smooth the situation. In terms of long-term development goals, the only way to address these is to make it more attractive to invest in developing countries like securing property rights and political stability. You do not manipulate it by controlling capital flows. That is at the end of the stream and you need to work upstream.

  Mr Saunders: The UK stands out as being one of the most globalised economies with a relatively high level of inward and outward investment. There has been a theme everywhere of increased mobility of trade, investment in people, and the UK generally has been towards the forefront of that. What we were talking about here of high FDI in and out is a part of that story but by no means the only part. I would say by and large the UK economy has gained enormously from that. Overall it has improved the inflation trade-off and has helped to encourage greater innovation and productivity in the sectors which have high inward investment. There is no way you can stop UK firms investing overseas, but if you do not keep the UK attractive to overseas investment then you lose the money coming into the UK and clearly that would leave us at a disadvantage. The other point I wanted to make is in terms of poor countries sending us our money. Part of this is a self-interested policy on their side to pursue a model of export led growth and accumulating foreign exchange reserves in order to do, as Mervyn King talked about, self-insure against the risk of a future currency crisis. While you might view the returns on their foreign exchange reserves as relatively low compared to other alternatives, you have to admit it has produced a reasonably good period for many of these emerging markets in which they have achieved fairly good growth, low inflation, no rerun of the late 1990s Asian crisis. In that sense they have brought themselves relative stability. The price has been relatively low return on their reserves but it has achieved a genuine prize of a good period of economic performance.

  Professor Quah: This trade in capital, on one hand, and trade in goods and services undoubtedly benefits the UK economy. It is something that should be encouraged. We should not be worrying about whether this might have negative implications for inflation and then seek to control it in any way. Even if a foreign FDI pulled out all their foreign-owned capital stock from the UK economy, even if they were 40% of GDP, the capital stock in the UK is 50 times UK GDP so it is less than 100th of the total capital stock in the economy and we would not even notice.

  Q21  Angela Eagle: I was wondering, given that there is no World Trade Agreement at the moment, the chances of warning about protectionism. Do any of you see that possibility as a risk on the downside?

  Mr Butler: Yes, I think there would be a pessimistic scenario but it could be something on the table with the US. One way to deal with some of the things they are unhappy with, in terms of Chinese trade for instance, is to increase protectionism. If that happened as a last resort, then it would be a pretty negative thing for world growth.

  Professor Muscatelli: The tensions have alleviated slightly on that front. I agree there is always that risk and these things can always explode but things have improved slightly in terms of tensions between the US and China. I think it partly depends how the whole US deficit issue unwinds. If it unwinds gradually, then tensions will dissipate, but if it remains high then there is always a chance of a crisis.

  Q22  Angela Eagle: In the labour market area the May Inflation Report suggests there might be two alternative reasons for the recent pattern in labour productivity: one is labour hoarding and on the other is a lack of capital. What is your view on what is the reason?

  Mr Butler: My view is always I thought it was labour hoarding. I felt that companies faced with a slow down in growth when they are close to full employment were reluctant to lay workers off aggressively and that led to lower productivity growth. I do not think the evidence really supports that view at the moment. The UK economy has grown at trend for the last six months. It has been at trend or below for much of the last seven quarters. If you look at the labour market data, the UK is employing again. If it was purely a labour hoarding story, I would have expected companies were cautious in the upturn when they started recruiting but they do not seem to have. My view has been tested by some of the more recent data and then you have to look at other explanations, whether measurement issues or whether it is just a lack of capital given the low investment.

  Mr Saunders: I would put it just as a normal cyclical pattern. Employment or, more strictly, hours worked always lags GDP growth. What we saw early last year was the economy slowed and the hours worked did not slow initially and so productivity slowed. Now we have seen in the last couple of quarters hours worked is pretty weak and so productivity picks up again. The big rise in unemployment we have seen in the last couple of quarters is the unwinding of that temporary slow down in productivity. I would not even call it labour hoarding because that implies something unusual but it is just the normal one or two quarter lag between growth and jobs. Part of the productivity story is that on the ONS figures productivity within the public sector is flat or negative and private sector productivity growth is pretty good over the last few years. If you look in the Q1 figures, you can see that hours worked in the private sector are down year to year, and productivity therefore is pretty strong. In that sense, the overall productivity figures do not quite tell the story for the different parts of the economy.

  Q23  Angela Eagle: There is not an agreed reasonable definition of productivity in the public sector. Does anyone have a view how on earth we bottom that out? It always looks like the public sector never produces anything, and we all know that is ridiculous. I know the Treasury are doing some work on this but are any of you?

  Professor Muscatelli: No. There is not a solution because if you measure it with GDP then, by definition, you cannot easily increase productivity. If you start looking at quality of services, then there might be productivity gains in that sense but it is not something that is easily translatable to GDP productivity.

  Professor Quah: There is no agreement on how to do this for the public sector. I do not know that we will be able to resolve that any time soon.

  Q24  Angela Eagle: It fits the same story there is no productivity in the public sector and mass productivity in the private sector, and that does not say what is going on.

  Mr Saunders: The importance of this is in the policy debate. The argument of some on the MPC is that trend in productivity growth is slowed and therefore the economy's trend growth may be weaker so you have to hike rates as growth picks up a little bit. If that slow down in measured productivity is chiefly a public sector story, and over the last few years it has been, then you have to be cautious about concluding that the economy's trend growth in the private sector, the bit you are trying to affect with monetary policy, really has slowed. I do not think it has. I think you are allowing your mismeasurement of public sector productivity to feed through to probably an overly pessimistic view on the economy's trend growth.

  Q25  Angela Eagle: There is something you were saying earlier about the UK's main markets being in the most slothful bit of the world economy, i.e. the Eurozone, was almost a cry for some kind of re-adjustment or re-orientation of UK activity to the higher growth areas, be it China, India or some of the Asian economies. Do you think the government ought to be doing anything about that? Why are not the markets delivering that?

  Professor Quah: Part of it is information, part of it is uncertainty. We do not really know. We, as a whole, who do not have the special expertise in particular parts of the world, may not be used to doing business in other parts of the world. The kind of information misalignment that we see might well be interpreted as a market thing. It might well be interpreted as the government taking a more pro-active role in this regard like the education sector in trying to push its activities. We are trying to do the best we can and we are getting help from the government in this.

  Q26  Angela Eagle: Do you think there is an issue of market failure here, and for the interests of future prosperity perhaps the government ought to be looking strategically at what it might do to encourage our private sector to get more involved in the emerging economies?

  Professor Muscatelli: It is difficult to call it market failure. These trends are very slow. If you look at the way in which the UK re-orientated its trend when it entered the European Common Market, it takes a long time. It took six or seven years to adapt to new patterns. I agree with Danny that the way you address these issues is by developing global linkages, whether through education, or in the case of the private sector by making sure there are no barriers to that sort of trade. Ensuring good political relations is the best you can do in terms of developing trade links.

  Mr Butler: It is becoming harder and harder to differentiate trade with investment income. What I mean by that is the UK has a comparative advantage in some services like financial services. A lot of those services you have to be located in the local market rather than exporting from abroad. Germany, for example, is very good at exporting capital goods. For the UK we have been quite aggressive at investing in companies abroad and have you seen the benefits from that in repatriating profits rather than seeking it on the export flows.

  Q27  Mr Todd: The Inflation Report suggests that factor utilisation has returned to either normal levels or slightly below. Do you think that is accurate? What does it tell us about this nebulous concept of the output gap which we had a lot of discussion about last time?

  Professor Muscatelli: We were talking earlier about labour hoarding which is one dimension of factor utilisation, and it does appear as if some of that is now unwinding. The output gap issue, as we said earlier, I am still a bit concerned by how low investment over the last couple of years has impacted the trend rate of growth and this might give the Bank less flexibility towards the end of this interest rate cycle. That is the main risk. Coming back to the point I was making earlier about the Walton analysis to the extent to which the current increase in unemployment is structural, I do not buy that story. Essentially what we have seen here is an unwinding of the labour hoarding, and the factor utilisation measures seem to indicate we are beginning to see a return to normality.

  Professor Quah: On the factor utilisation issue, it is a good thing for policy makers in general, for analysts, and for the economy to figure out how far we are from full capacity utilisation. The number of considerations here have to do with our estimates of the capital stock, the state of technology, just how tight the labour market is. We are getting conflicting figures. On the one hand unemployment is high but employment is also high. Some of that is coming from an inflow of fresh labour from other sources previously unused. All of that is important for assessing the state of the economy. I wonder if perhaps at this stage in our understanding of central banking we might want to separate our thinking about inflation from these issues now. It used to be that we all thought that when you get closer to full capacity utilisation inflation was going to wrap-up and that was something to watch out for. We really have moved to an era of central banking worldwide where we try to disengage these two more and more now. Now may be a good time to start thinking about how we can separate them further.

  Mr Butler: We have had discussion in the past and we all know the problems with concepts about gaps and regional utilisation. I do not know what evidence we have had over the last three months that would have changed your view about the degree of spare capacity in the economy. The economy, if you believe the GDP numbers, grew in trend, so it would not have closed your view about how much spare capacity there is in the economy. If you look at the survey evidence, nothing has really changed in terms of companies' views of whether they have working at full capacity. To me the biggest surprise this year has been the labour market, and that has been the biggest surprise for the UK the last seven years. What we have seen over the last six months has been an acceleration in the pool of people looking for work. That has been a mix of immigration and also people who had left the labour market and retired and are now coming back to work. That has far outpaced the rise in employment so it has actually meant that the pressures in the labour market, one of the key gauges of the inflationary pressure in the UK, has actually eased over of the last three and six months and not gone the other way.

  Q28  Mr Todd: That would suggest a slight disagreement between you and Professor Muscatelli over the issue of whether this is structural or not. I think it is fair to say he dismissed that view?

  Mr Butler: I think you are seeing a pick up in unemployment structure. Where I differ from the Bank of England and David Walton is they have seen that as a negative structural shock. My view is that changes you have seen in the labour market in the last six months have been a positive structural shock and a reason to be more comfortable with the inflation outlook rather than more cautious.

  Mr Saunders: I agree the economy has a bit of spare capacity, and it is futile to debate whether your output gap estimate is ½% or 1%. That is a waste of time. To me the evidence of a bit of spare capacity is that the jobless rate has been rising quite quickly, pay growth is slowing and so is core inflation. I agree with John that the big thing that is going on is the acceleration of workforce growth from low cost migration and the pensioners going back to work. The question is whether you call it structural. You are going at cross purposes here. Walton's argument is that the rise in unemployment will not help to slow inflation. That is what he means by structural. What John is saying is it is persistent. In other words the acceleration in the workforce growth is something that is likely to be there for a while and will help to stop inflation. I am with John on this one. This helps to ensure that the growth-inflation trade-off going forward is better than the MPC believe. In other words, we get growth of close to their numbers and inflation comes through much lower chiefly because pay growth is low.

  Q29  Mr Todd: Can I just turn to an aspect of, again, rather traditional discussion, which is looking at labour costs and its implication on inflation. This time the Bank calls attention to the fact that, although wages have not shown any significant inflationary growth, there have been other labour costs which have shown growth and they predict our pensions. Does that indicate, again, an issue which we ought to be giving more attention to, the non-wage labour cost element which may fall through into inflation?

  Mr Butler: I think this has been going on for some time with the rise in national insurance on employers, the minimum wage, pension issues. What is interesting, and I think this is mirrored across the economy, is the way companies are coping with these shocks is almost like a relative price shock. They are not seeking to pass this on to the end user (the consumer), they are looking at other ways they can reduce other costs, and it may be one of the reasons why nominal wage growth has been slowing, and so workers, in some sense, are bearing the cost or the burden of these non-labour costs, like pension issues, and if that is the case, if it is a relative price shock and you are seeing this, energy prices are rising and non-energy inflation is falling, it is actually a declaration that the Bank of England has a lot of credibility and should, again, make you much less worried about a general headline inflation shock coming through.

  Q30  Mr Todd: I am of the generation that recalls a great deal of discussion of the relationship between wages and inflation. Do you think that there is sufficient transparency in the process so that people now understand the multiple contributions that can be made to labour costs other than simply seeking a pay increase that reflects or exceeds the CPI? I still think there is quite some way to go, amongst bargainers on both sides, as to quite the implications of pensions and other non-wage elements of the emoluments package.

  Professor Muscatelli: I agree with you. I think there are still some issues. Although John is right, I think it has been remarkable just how resilient the supply side has been to these very shocks. I am slightly concerned by one aspect of the analysis. It is the only point on which I probably agree with David Walton, which is that I am worried about the general public's expectations of inflation suddenly rising. That suggests that unless these are adjusted downwards very rapidly, there is an expectation that some of this will feed through into wages and prices. We will need to see whether that comes true or not, but that was the biggest concern for me in the current Report. We may not see it in the private sector initially. We may begin to see, for instance, an attempt to try and put some of these higher inflationary expectations into public wage settlements (a subject close to my heart at the moment for other reasons), and it is slightly worrying that we have seen this jump from 2.2 to 2.7%.

  Professor Quah: Can I pick up on some of the other points that I think you wanted to emphasise? I think, on the one hand, you are saying perhaps we should look at figures on payments and earnings in general, including bonuses and so on, that are disconnected from wages and in the way in which we manage the economy now, information wise, organisationally, et cetera, that disconnect is getting worse and worse, it is getting more and more pronounced. I think that there are two levels of communication here. The Bank of England very clearly understands, I think, that this disconnect is happening over there, and in looking at wage numbers or earnings numbers, it looks at the broad spectrum, it looks at, among other things, average earnings with bonuses, not just wage agreements, but you are also referring to how businesses and workers need to communicate better, and that translate into how the Bank has to conduct monetary policy. That communication and that understanding has to proceed consistently, that is absolutely right, but that is not something that the Bank or this Committee has control over, that is something that we need to communicate to the public at large.

  Q31  Mr Todd: I was more drawing out the fact that pensions, for example, 15 to 20 years ago would have been regarded as a dead issue within the bargaining process. It is now very much a live issue, but not necessarily one that operates in a fully informed environment and that the element that that fits into this total picture of cost inflation is now much larger, and particularly some of the corrections that have taken place. Let me ask one last question, because the two of you at the end, I think, drew out this issue of the growing labour force both from immigrants (and I think one of you said low-earning immigrants) and those returning from retirement. I think one of you said that this was something that you saw as an on-going trend into the future for quite some time. On what basis do you think that is the case?

  Mr Butler: The new issue is about the people who had retired coming back into the labour market, and I think part of that is associated with the pension issue, people retiring, realising that their pensions may not guarantee the lifestyle that they were assuming, coming back to work. It is also to do with people living longer, feeling healthier and feeling they can work. I do not expect that trend to be short-lived and you will see it over a two-year period, I think it is something that will persist, and I think it has been incredibly important in keeping the UK labour market flexible.

  Professor Quah: The supply is certainly there. All Western economies are ageing rapidly, and the fraction of the population that is aged 60 and above now in the UK is about 20%. It is going to be 30% in 40 years, 45 years. This is happening across all of Western Europe and across all of the United States, and so the supply of such labour is certainly available.

  Q32  Mr Todd: But there is a distinction between countries on whether that supply has been utilised, and this country is, I think, some way ahead of many others in that respect.

  Professor Quah: Absolutely.

  Chairman: Just the other morning I was out near one of the local primary schools and I saw the lollipop man taking the kids across the road. I said to him, "Oh, you have retired. I am surprised to see you back here." He said, "Oh this is great wee job. My wife and I can now get three holidays every year out of this, so I am happy with that."

  Mr Todd: Have we measured his productivity yet!

  Q33  Peter Viggers: My local vicar's wife is very proud of her job as a lollipop lady! I would like to ask some general questions about the sustainability of the inflation target itself, but I would like to lead through into that by putting some questions about the areas which are causing pressure on the inflation target. Oil and gas prices have remained high for some time, so who is absorbing the rise?

  Mr Saunders: The MPC has said many times that in the end the rise in oil and gas prices will be reflected in the squeeze on real pay, and their worry was that this would be chiefly through higher inflation rather than a slow down in nominal pay. I think, in practice, it is happening through a bit of both. In other words, headline inflation has been pushed up but firms, responding perhaps to weak consumer spending, perhaps to the rise in their costs, have been able to achieve a slow down in pay growth, and so that necessary slow down in real income growth, if you like, is coming through pretty quickly and I think less delayed, less painfully, than the MPC had feared.

  Q34  Peter Viggers: Is volatility, especially in gas prices, which have gone up and come down, as much a problem, because it causes uncertainty, as the actual price itself?

  Professor Quah: Yes, I do think that volatility is a problem. There is a direct impact on oil and gas prices which simply comes from the fact that they are a component part of the general price level and, therefore, act on inflation. That is one level of effect. The other level of effect that I think you are getting at is: does this have deeper structural implications on the rest of the economy? Here, despite all the news that we read, oil prices now nominally seem high but they are less than two-thirds inflation adjusted, they are less than two-thirds of the level they attained in the early 1980s. That is the first point. The second point is that energy spending, as a fraction of GDP, is now only about 3%, less than 4%, and it used to be 15% in the 1970s. Energy is much less important for economics right now, and so the arithmetic impact will be there, but the structural impact will probably be muted much more than most of us think.

  Q35  Peter Viggers: Do you, similarly, agree with the Bank which appears to play down the importance of non-oil commodity prices, suggesting they only make up a small part of the manufacturer's costs? Would you agree with that general assessment?

  Professor Muscatelli: I would generally agree with that assessment. I think the biggest concern there, as you mentioned earlier, is the volatility of it, and it is gas as opposed to oil. The hike we saw last year is now expected to be repeated this year, and it is that volatility that has caused quite a bit of uncertainty and it is that which is more likely to have an impact on both consumers and firms. That is where the concern lies, not in the long-term impact that these might have because of their determination to keep inflation under control.

  Mr Butler: I think in the past what was a very strong relationship going back over decades was that, if commodity prices rose in the earliest part of the supply chain, you saw quite a predictable lag before it fed through eventually to the consumer. What is interesting, and I think it started happening from about 1998, is when you have had cost shocks it has been more a shock to profits rather than to inflation, and I think that is an interesting development in the UK economics. It may relate to the introduction of inflation targeting and greater credibility, but costs shocks have not tended to feed through the price system in the way they have done in the seventies and eighties.

  Q36  Peter Viggers: The Bank has published in its report a chart showing the perceptions of past inflation and the expectations of future inflation, and it is quite clear that there are expectations of higher inflation. Should the Bank take pre-emptive action and raise rates to break the link between higher inflation expectations leading to higher wage settlements?

  Mr Saunders: I think, no, and I think it is because of these other things going on in the labour markets which we have talked about. You have got big disinflationary pressures on the labour market from high labour supply, the structural, persistent decline in demand for low-skilled labour and, going forward, a slow down in public sector job growth. To me these conditions, the likelihood that a rise in inflation expectation feeds through to pay deals, is pretty low, and so I think they can afford to wait.

  Professor Muscatelli: I would agree with that, and that is why I said in my written evidence that I would prefer rates to be held. It is an amber light essentially. It is showing that there is an increase in both general public expectations that inflation will be higher but also financial market expectations, but unless we see some evidence that this gets translated into higher earnings growth, I do not think there is any reason for the Bank to step in and try to improve its credibility. I think it has bought enough credibility to be able to afford to wait to see whether any of this feeds through to earnings growth.

  Mr Butler: I hate to agree, but I agree. I think the Bank of England had a chart on inflation expectations picking up. Clearly, the Bank of England or the central banks have to worry about inflation expectations. The problem is that you do not have many good measures or measures that capture what you want to see. For every survey that they have produced where the inflation expectation is high, there is another, like the GFK Consumer Confidence Survey, where inflation expectations are incredibly low. So, it is very hard to hang your hat or hang an interest rate hike on an inflationary expectations measure where there is so much uncertainty. Where I agree is, I think, looking at pay settlements here. The rising costs of energy prices is not a new phenomenon, it has been going on for some time. Yet look at what has happened to pay settlements: they have actually been falling rather than rising.

  Q37  Peter Viggers: Can I move on to the main point. It seems that inflation is stable, almost (to use the Governor's favourite word) boring, at a time when there are areas of high volatility in some areas which are, as Professor Quah says, a puzzle. I was caught by an article in the Financial Times yesterday by Wolfgang Munchau entitled "The beginning of the end for inflation targeting", and it looks at the example of the Swedish Riksbank where they missed their target. The inflation level was lower than expected and the Riksbank was left with the choice of either leaving inflation rates up or reducing them, which would be an inconsistent thing to do. Do you think that the world is moving and that the target which we have all been concentrating on may need to be revised?

  Professor Quah: Possibly. The United States' economy has gotten along very well without an explicit inflation target and they have done as well as any central bank anywhere else in the world. I think what really matters here is that there is a credibility and an authority and a reputation for how a central bank conducts its business. The mechanism by which we do that might in certain cases involve an explicit inflation target. In other cases it might not, it might involve personalities or expertise in other ways. If we focus too much on the explicit features of the mechanism rather than the underlying principle, then we will tend to get into the kinds of contortions about whether we should do this, change this mechanism or change that mechanism. The underlying principle that we have got working in all central banks in modern developing economies now, I think, is a sound one and I think we will stick to that regardless.

  Professor Muscatelli: I do not see us abandoning inflation targeting either in the UK or in other countries that have an explicit target. I think it has been a very helpful device that anchors expectations, and although I agree with Danny that it is not just that, there have to be actions, there cannot be just a device such as an inflation target, it has been very helpful. I think the only thing that might lead inflation targeting to be either abandoned or modified would be some major global crisis which then makes it very difficult for us either to adhere to targets, because it is a massive increase in commodity prices well beyond anything we have seen here which then feeds through and it is inevitable and it is a first-round increase in inflation and the central bank cannot really do anything about it, or if you see a massive recession along the lines of Japan, in which case the central bank has an issue on its hands as to how it deals with it, but I think in most normal circumstances it is a very effective device to anchor expectations.

  Mr Butler: I think the problem a lot of the time with inflation targeting is not the framework or the principle, it is more the conduct, how you deal with that inflation targeting. What I mean by that is that I think price stability is a good goal to have and, if that is what the inflation targets are trying to capture, that is great, but often, I think, the problem is in interpreting shocks. I think sometimes central banks in the past have dealt with a supply side shock, like China coming on stream with cheap goods, as if it is representative of the demand within the UK and responded by just purely cutting rates. I do not think that is a problem necessarily with inflation targeting, I think that is a problem with how difficult it is to identify the source of the shock.

  Mr Saunders: I would say that inflation targeting has been fantastically successful as a policy framework both here and in many other counties. The Swedish case is quite interesting, where they have had the massive external disinflationary shock over a big decline in import prices, and the question for the central bank was how far to cut rates to offset that, how much to pump up domestic inflation. I think they have done that quite well. They cut rates quite a long way and are raising them very slowly from level which is well below ours, accepting that they will get back to their inflation target at a distant horizon, trying to balance the error back to the inflation target quickly against the risk of stoking up an asset price boom. I think, if anything, we could do more to increase our commitment to the inflation target. To me the things which we could do which could be useful would be to have the inflation target committed to for more than just a year ahead. At the moment the inflation target is just set by the Chancellor in the Budget. There does not need to be a vote in Parliament; the target is reset each year. We have been talking about the importance of inflation expectations here. If you want to send a strong signal that we aim for low inflation on a persistent basis, I would have thought we should look to have the inflation target set for a more distant period and not open to revision by any one person.

  Chairman: We are actually reviewing the MPC 10 years on next year, so we look forward to a submission from you.

  Q38  John Thurso: Can I ask first about the minimum wage. At the May Inflation Report press conference, the Governor suggested that this is having a much more significant effect, especially for those slightly higher up the wage scale. Do you think that is accurate and that it will have more of an effect on wage pressures?

  Mr Butler: Again, I do not see the evidence. We have spoken at length already about pay settlements, about wage growth and the real users, how benign they have been rather than whether they have been picking up, but I think the real test will be in October when you get the big rise in the minimum wage, which is around 6%. I think that will be a real test for certain centres, like retailing, for instance, where you have a lot of low-paid workers and where people might want to maintain some differential: because retailing at the moment is under pressure through demand, it is under pressure from higher cost and in some degrees has lost a lot of pricing power, and so the way they reduce the margins is through reducing labour costs, and if you cap their ability to do that, you could see a lot of problems on those types of sectors.

  Mr Saunders: I think in practice the low-cost migrant labour will come through as a very powerful offset. However, for the workers coming to the UK under the Workers' Registration Scheme from Eastern Europe, roughly 80% earn less than £6.00 an hour, in other words, just above the minimum wage in the UK. Amongst the UK workers only 25% are in that kind of pay area, and so that acts to compress, if you like, the differentials which you are talking about. We have this potential upward pressure on pay from the minimum wage but offset by this big rise in the supply of low-cost labour, and nobody can be sure what is going to happen to migrant flows going forward, but what you can see is they have been massively greater than people would have expected a couple of years ago, and the incentives for people to move are still large, because of the disparity in the level of pay, and there is EU enlargement still going forward. So, I would make the assumption that the inflow of low-cost migrant labour will persist and then those worries about a knock-on effect from the minimum wage are unlikely to pass through into actual fact, and I stress that is these unusual conditions.

  Q39  John Thurso: If that holds true, interestingly, for the pensioners who are coming back in as well, as the Chairman was saying, they have the capacity, because they have got a pension, to take a lower paid job because it just pays for holidays, as it were.

  Mr Saunders: Sure. Also from the company's side, they may not need to contribute to their pension fund if the pension fund is closed. There has been quite a big rise in tax allowance for pensioners if you look back over the last 10 years, and in that sense you can view it as a policy which is succeeding.

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