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
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
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
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
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
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
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
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
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
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
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
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
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