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
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
Mr King: I wish I knew what it
would look like; there are enormous uncertainties.
Q52 Chairman: That is why you are
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 reportsyour
confirmation hearing reportsthat 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
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
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 sectorshouseholds 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.