Select Committee on Treasury Minutes of Evidence

Examination of Witnesses (Questions 48-59)


29 JUNE 2006

  Q48 Chairman: Governor, good morning and welcome, to you and your colleagues; can you introduce them for the shorthand writer, please?

  Mr King: Yes. On my right is Paul Tucker, Executive Director for Markets. On his right is Kate Barker, external member of the Monetary Policy Committee; and on my left is Charlie Bean, who is Chief Economist and Executive Director for Monetary Policy.

  Q49 Chairman: Governor, before we begin, I would like to take the opportunity to say, on behalf of the whole Committee, how deeply saddened we were to hear of the death of David Walton. He was scheduled to appear before us today with you and I have no doubt that he would have brought his customary economic insight and intellectual rigour to our discussion. Many of you will be aware that prior to his appointment to the MPC, a well-deserved appointment, David acted as a special adviser to this Committee and he gave us very wise advice over the years. I would like to place on public record how much we appreciated the quality of his advice to us and the extent to which I feel we all benefited from his wisdom and expertise as an adviser. We have lost a very valued member. He was a warm and generous man, he was a trusted adviser, and I have written to his wife, Nicola, with our condolences. I know you have an opening statement, Governor, you wish to make?

Mr King: Thank you very much, Chairman. I know your words will be much appreciated by the Bank and indeed David's family. He always enjoyed appearing before you because of his former association with your Committee. As you said, he was due to appear before the Committee today and his loss is felt greatly by everyone who knew him, particularly by his colleagues on the MPC and in the Bank. He had a wonderfully clear mind, an independence of thought and, as you say, Chairman, he was a warm and generous colleague. He will be deeply missed. The British economy has continued to experience steady growth with low inflation. CPI inflation was 2.2% in May and has remained within 0.2 percentage points of the target since November last year. Recently-announced increases in gas and electricity prices have started now to pass through to household bills. Despite rising energy costs, wage pressures so far have been muted. It is likely that firms facing higher input costs have been able to offer only moderate increases in pay, so higher energy prices and weaker wage growth are not independent. Output growth returned to close to its historical average in the final quarter of 2005 and the first quarter of this year. Consumer spending was weak in the first few months of the year but more recent indicators, including reports from the Bank's Agents, point to some recovery since then. Surveys of investment intentions have picked up and, in line with the continued expansion of activity overseas, export orders are significantly higher than a year ago. In its May Inflation Report, the MPC published a central projection in which inflation remained close to the target and output grew at a steady rate. But there are many risks to that outlook. Just as they did last year, energy prices will cause fluctuations in inflation from month to month and, as I said in my speech in Edinburgh two weeks ago, a degree of uncertainty has entered the economic landscape. That has been brought into focus by the recent turbulence in financial markets. After a period of unusually strong growth in the world economy, a rebalancing of global demand is desirable but it is unlikely to be smooth. And after a decade in which import prices, on average, have fallen, recently they have picked up. Together with higher energy prices, that will dampen the growth of real incomes and consumer spending, but by how much is uncertain. As the MPC enters its tenth year, we look forward to discussing with your Committee the framework and arrangements for monetary policy in the UK. The strength of the process, in my view, is the clear institutional arrangements for the setting of interest rates and for explaining our decisions through the monthly Minutes and our quarterly Inflation Report. We are always keen to learn and improve, and to the extent that there are issues on which we could reflect further they are likely to stem from areas where the institutional arrangements are not as clear, such as the appointment process for members of the Committee. Chairman, those are the remarks that I wanted to make this morning, and I and the other members of the MPC here today stand ready to answer your questions.

  Q50  Chairman: Governor, thank you very much for that statement and, as a Committee, we do look forward to engaging with you next year, on the tenth anniversary of the MPC, looking at the way forward with our inquiry. You mentioned rising energy costs and wage pressures being muted, so far. Given the talk in the newspapers about the global inflation and energy prices and commodities being responsible for that, do you see that situation likely to remain, namely wage pressures, but muted?

  Mr King: To the extent that input costs are rising, I think firms have a strong incentive, knowing that we intend to meet the inflation target, to hold down other costs, and I think, in part, that has been responsible for the modest nature of the degree of wage pressure we have seen in the labour market. If that were to change, and other input costs were to fall instead of to rise sharply, it is possible that degree of resistance to higher wage pressures might diminish. I think we should draw comfort from the fact that the argument that the two are linked stems from the fact that firms really believe that inflation is going to stay close to the target. Therefore there is a limit as to what they can expect to be able to put up their output prices.

  Q51  Chairman: In your opening statement, you also mentioned the rebalancing of global demand being desirable but unlikely to be smooth. Could you elaborate on that statement; what do you think the economic landscape could look like in the future?

  Mr King: I wish I knew what it would look like; there are enormous uncertainties.

  Q52  Chairman: That is why you are here?

  Mr King: If you expect a statement about what will happen, I am afraid you will be disappointed. Clearly, we start from a position in which the imbalances are not only still there but, if anything, have grown. This results, in part, from low savings rates in the United States but also from very rapid growth in China and other parts of Asia, which has been based very much on export demand. That has led to significant current account imbalances and question-marks about whether the current constellation of exchange rates can in fact be sustained. I think it is clear that all the players in this would like to see some change in the balance of demand. China itself has set out as its objective for the next decade to rely much less heavily on external demand and much more on domestic demand, and the United States clearly will wish to see higher national saving rates and its current account imbalance come down. How these occur and whether they can be synchronised it is very hard to say, because they depend on domestic policy decisions. It is very hard to make predictions about when domestic demand will slow down in one part of the world and pick up in another. A year ago, I think there was real concern that the US might slow down but we would not see the pick-up in domestic demand elsewhere in the world economy. Now are seeing a recovery in, say, Japan and we are seeing a recovery in the euro area and we are beginning to see signs of a slow-down in the United States. Really I have no idea how these two forces will balance out, but it is one reason for supposing that there could be some uncertainty about the smoothness of the path for the world economy moving ahead. We should just recognise that we have been through the fastest three-year period of growth of the world economy for a generation and I think it would be unreasonable to expect the world economy to grow quite as rapidly in the next three years as it has done in the past three.

  Q53  Chairman: Could I ask a question on the Inflation Report. Despite the fact that every member voted for no change in the last two meetings, the Inflation Report was considered by the markets to be a signal of a tightening stance. Is that how you intended it to be read?

  Mr King: We do not give signals about what we are going to do in the next month or two. What we did was give a clear statement, rather than a signal, of the Committee's judgment about the outlook for inflation if interest rates were to follow the path which then was expected by the markets. In fact, after we had published that Report, it was not very surprising perhaps that the market yield curve actually did move up slightly. The market did take notice of what we said and interest rates now are a little higher along the yield curve than they were when we published the May Inflation Report. Other things have happened since the May Inflation Report. Even by the time of our May meeting, the exchange rate had moved up quite significantly from the 15-day moving average on which the published forecast was predicated. That is why I think it is very important for people not to get too excited about the precise path of interest rates or exchange rates along which a forecast is predicated. It is a view conditional upon a particular statement and it tells you a great deal about what we think the outlook for the economy is, but there is no unique answer as to what these conditional paths should be. I think it did affect the market and, since that May meeting, we have seen quite significant falls in share prices; not much change in the exchange rate since the May meeting, it is still noticeably higher than it was when we made that forecast. These are things we have to examine month by month and, of course, what the yield curve was saying in May was that in order to meet the inflation target it was likely that some increase in interest rates will be needed, at some point, over the next year or so, but the market was not expecting an immediate increase in interest rates.

  Q54  Angela Eagle: Could I just take you up on something you said in your statement, Governor, about the appointment process, which you coupled with I think the words "more transparency"; do you want to say a little bit more about that?

  Mr King: I think it is something that you have commented on yourself in your own reports—your confirmation hearing reports—that it is the timeliness, not the people or how the process works. In that sense, it is trying to find a mechanism for ensuring that decisions are taken in a timely way. I think that is the essence of it. We have processes for public appointments in a variety of areas. I am not saying that any one of those is necessarily the right one, and it is not for me to say what the process should be. But I do think it will be worth investigating, because we have something which at present is very informal and seems to result in appointments being made very much at the last minute. I cannot think that anyone benefits from that.

  Q55  Angela Eagle: It is not a question of there being vacancies on the Monetary Policy Committee but the last-minute nature, the sort of management of appointments which is worrying you?

  Mr King: There will always be vacancies when people leave unexpectedly and it is more important to take one's time to get the appointment right than to rush into a replacement. The FOMC, in the United States, has had a vacancy for over a year. I think what matters is getting it right; but to do that, I suspect, it does need a slightly more systematic process.

  Q56  Angela Eagle: In terms of the unwinding of global imbalances, when we talked to the experts who came before us recently, the thing they worried about most, I think, in the current economic outlook, was the disorderly unwinding of global economic imbalances. Could you say anything about how this may be spotted and what contingency you think there is to deal with it, if such a trend were to emerge?

  Mr King: Of course, there is no collective body which is in a position to implement any contingency plan; what happens will be the outcome of a series of national decisions taken by the major players, primarily the United States, the euro area, and China, oil-producing countries. I do think that one of the encouraging developments since we last met has been the creation by the IMF of a multilateral consultation involving those main players, the United States, the euro area, China, Japan and representing the oil producers Saudi Arabia. I think that provides an opportunity for an informal discussion among the major players on the imbalance issue; an informal opportunity to discuss what they perceive as the problems facing them and what their policy stance is likely to be. I think that is extremely valuable. The big international meetings do not provide an effective opportunity for doing it and certainly the G7 does not; the major players are not there and the quality of the discussion is not that which you would wish to see in a serious analysis of these imbalances. I am optimistic, perhaps I should not say optimistic, I am very glad that the IMF has done this. I think it is the right approach. I think now it is down to the individual players themselves to participate in this in the right spirit, not to attack each other but to say, "Look, this is the issue that we face, from our perspective; what's the issue from your perspective?" It is in the mutual interest of them all to find an orderly way to resolve these imbalances, not a disorderly way, which might lead to a significant downturn in the world economy.

  Q57  Angela Eagle: Obviously, we saw in the 20th century what catastrophic results there can be from a disorderly unwinding of imbalances, and chaos in the world economic markets. Since that time, of course, they have become much more rapid and much more interrelated. Do you see that this informal body which the IMF has set up is the sole protection, or do you think there is an argument for having a look at the world global economic institutions, to see whether perhaps we need another, more formal design to help cope with the 2st century economy?

  Mr King: As you know, as we have discussed on other occasions, I do think there is a case for changing the way the IMF operates and recognising that it has a very important role in this sphere. I think the fact that capital flows are much faster and the financial markets respond very quickly is not in itself a reason to be more concerned, because the causes of problems here are as much the fact that policies may be adopted which people believe to be in their national interest, but actually turn out to be in no-one's interest. Protectionism is the ultimate problem that we would all be deeply concerned about. That is no faster to implement than it was in the 1930s. I think it is those sorts of policy issues which are important. That is why the value of something like the multilateral consultation is to enable governments to say to their domestic audiences that there is a way in which it is possible to talk to other countries to try to resolve some of these issues without resort to unilateral protectionist pressures, which, as you say, in the 20th century were disastrous and I think certainly would be extremely problematic were they to surface again.

  Q58  Angela Eagle: You mentioned energy prices as a worry and uncertainty. Is there anything else which keeps you awake at night, at the moment?

  Mr King: There are lots of things.

  Q59  Angela Eagle: To do with the economy, of course?

  Mr King: In terms of the world economy, I think there are some signs of inflationary pressure in other parts of the world not just in the developed world but also a little bit in China. That, I think, does create some uncertainty about the policy responses to that. The United States economy is in a rather delicate position; there are some signs of inflation but also signs of slowing in the economy and a weakening of domestic demand. These are difficult times in which to take decisions. There are uncertainties there, undoubtedly. I think wherever we see large imbalances there is not just macroeconomic risk but also risks from balance-sheets all round the world of governments, financial sectors—households also have risen very markedly, so the size of assets and liabilities relative to income flows now are pretty high. There can also be shocks transmitted through the balance-sheet and spillover in the balance-sheet from one country to another, one sector to another. Those are risks and those are uncertainties. That is why we spend a lot of time monitoring them and why the IMF itself now is moving more of its surveillance activity away from some of the more traditional focus on flows of income and spending and more towards balance-sheets and the linkages through financial sectors.

  Chairman: Thank you. Governor, you very kindly gave us evidence on the IMF Report and we hope to be publishing that in the next couple of weeks and your evidence will feature; thank you very much.

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