Examination of Witnesses (Questions 80-99)
MR MERVYN
KING, MR
PAUL TUCKER,
MR CHARLES
BEAN AND
MS KATE
BARKER
29 JUNE 2006
Q80 Mr Love: Except that in Germany
it seems to be export-led growth in their economy, which will
impact on our market?
Mr King: I am sure the wives and
girlfriends of our team out there are doing a great job, at least
in Germany if not here.
Q81 Chairman: Paul, the sterling
money markets operations, could you tell us what your objectives
are for that, and how would you measure that performance if asked
to do so in a year's time?
Mr Tucker: Absolutely. We have
four objectives, Chairman. The first is to reduce the volatility
of our overnight money market rate from where it has been. Relative
to many markets abroad, for as long as the Governor and I can
remember, our overnight money market rate has been unusually high,
especially unusually high for a great global financial centre.
I want to put emphasis on this, because this is the key objective,
and it has made the sterling money markets a relatively unattractive
place unless you were already an expert. That was the first objective.
I will come back to that. The second was to give the banking system
more flexibility in managing their liquidity, both as a system
and at the level of individual banks. The third was to make the
system simpler. The fourth, connected with all of those, is to
foster a more efficient money market. In terms of how I would
measure it, the first one is straightforward; we would measure
simply the day-to-day volatility of the overnight money market
rate relative to the past and relative to that in the euro area
and in the dollar money markets. So far, and we are only six weeks
into this thing, it is much lower than in the past and in line
with the dollar area and the euro area. But I rather agree with
what is implicit in your question, this is something to look back
on after a year rather than to declare a victory after six weeks.
The second objective, in terms of making the system more flexible
for their liquidity management, I think we can be reasonably confident
that is achieved. Historically, very few banks have banked with
the Bank of England and participated in our operations; that has
roughly tripled and, in terms of the share of the sterling banking
system, now accounts for about 90% of banking activity out there.
That has given far more banks direct access to our balance-sheet
(a); (b) for the first time ever, banks can borrow from us on
demand during the day, at a penalty rate, against high quality
collateral, in unlimited amounts; and (c) rather than having to
balance their books with us at the end of each day, now they target
an average balance over a month and that gives them much greater
day-to-day flexibility in their liquidity management. The third
objective, as I say, was to make it simpler; that was associated
with the hyperactivity which characterised our system in the past.
We would conduct what are known as open-market operations, which
is just lending to the banking system, up to four times a day;
now we do so once a week. Also, we have aimed to explain, for
the first time, in this document which we put out in the middle
of May, how our objectives are achieved, so we stand to be accounted
for on that as well. The fourth, whether we succeed in fostering
more efficient money markets, will take longer to judge and is
associated with the benefits of bringing volatility down and making
the system more comprehensible. When we announced these reforms,
the European treasurer of one of the biggest companies in the
world wrote to me and said, "We have used the sterling money
markets relatively little; if you achieve your objectives, we
think we will use them rather more." That is the kind of
thing which, qualitatively, at least, we should be able to track
over one, or two, or maybe three years, and even longer.
Chairman: Alright; we will come back
to it in a year's time. Thank you very much.
Q82 Kerry McCarthy: You talked about
business investment picking up but there does not seem to be a
great deal of evidence, there is evidence but it seems to be fairly
mixed. The CBI have suggested that there is going to be a continuing
decline in investment, and your own agent survey has said that
business investment remains subdued. What are the grounds for
the optimism?
Mr King: The latest figure does
suggest an increase but the surveys are more optimistic than the
data—there is a mismatch between the two—it has been
a bit of a puzzle as to why investment appears to have been weak
relative to the path of output growth, compared with past recoveries,
so I think we would expect it. You are quite right in saying that
there is no evidence, and certainly I would not want to use a
figure of, I think it is, 1.7% growth in the first quarter as
any hard evidence, because these are volatile data, they move
around and they can get revised. We certainly do not have any
hard evidence as yet. There was a very similar puzzle in both
the United States and the euro area, why was business investment
weak when they were beginning to recover after the downturn in
2000; in the past year they have seen business investment pick
up and, in large part, that puzzle has gone away. We have not
seen that yet. I think it would not be unreasonable to suppose
that we will see some recovery, but there is a lot of uncertainty
about that.
Q83 Kerry McCarthy: I think the underlying
point is, on the evidence that we have been given, I think Professor
Muscatelli said that eventually you would expect some of the pent-up
investment to happen, but it does seem predicated very much on
the idea that it has not happened for a while and therefore it
has got to happen at some point, rather than any hard evidence?
Mr King: When we make our forecasts
we have a central view. That is not a statement of what we say
will happen, the probability that it will actually happen is pretty
low, as I have already said, almost negligible. We feel that a
sensible, central view would be to expect some recovery, not a
dramatic recovery but some recovery, for the reasons that we have
seen it elsewhere, and you would expect it, given the fact that
we have seen a recovery now in output and the surveys have been
stronger than the actual data. I think some recovery was not an
unreasonable central view, but certainly I share your view that
there is a lot of uncertainty about that.
Q84 Kerry McCarthy: To what extent
do you think factors such as pension contributions are a contributory
factor?
Mr King: It is very hard to know.
We have used our Agents and talked to firms and we get mixed responses,
to be honest. There is no doubt that on our visits around the
country, if you ask businesses, some certainly will say that it
has been a contributory factor, others will say that it has been
a major problem. It is very important logically to separate out
the amount of money that has to be put aside to fund past pension
accruals about which you can do nothing. They are a fixed cost
and should not alter decisions about whether it make sense to
invest to ensure the continuing success and profitability of the
business. Of course, firms also have said, "The cost of these
pension schemes is sufficiently high that we can't continue to
offer the same pension benefits for current and future service,"
and certainly that has been cut back dramatically in the last
five years. In terms of having to fund the deficits which are
reflecting the additional computed cost of past service, about
which companies can do nothing, they have to meet that, it may
be just cutting off your nose to spite your face to say, "I've
got to pay this money into the pension fund therefore I simply
won't invest." While companies are severely cash-constrained,
that may well be the outcome, and undoubtedly some firms are in
that position; but others who feel they can afford to borrow to
finance investment will try to separate out these two factors.
Q85 Kerry McCarthy: Are you saying
that there is evidence that the fact that some companies are really
shaping their pension provision, going forward, is likely to have
a positive effect on investment?
Mr King: It may have one on employment.
I think that there has been a very significant change in the provision
of private pensions in the UK in the past five years or so. Clearly
that has altered the total cost of employing the workforce going
forward. It may be, particularly for new entrants into firms,
that firms actually have found a way to reduce their labour costs
in a way which encourages employment rather than investment.
Q86 Kerry McCarthy: In terms of the
current debate about pensions, going forward, and particularly
compulsory employer contributions, I think Mr Tucker said, in
a recent speech, that the actual risk of further increases to
pension contributions was having a negative impact on business
investment. Is that a view which you share; is that a concern?
Mr King: Many firms have raised
that, and of course they can control the liability which they
incur for future pension contributions. There is nothing now which
firms can do easily to alter the changes in the computed cost
of meeting liabilities they have incurred already. If longevity
rises and interest rates were to fall back again, the present
value of meeting those liabilities might well increase, yet again.
To the extent that does create uncertainty about the cash flow
position, it may well as I say, lead some businesses to be more
cautious, but not all. Some firms may be able to separate out
these two factors and it does not make sense to forego investment
opportunities if those investment opportunities definitely would
be seen as profitable in their own right.
Q87 Mr Gauke: It was put to us by
Michael Saunders of Citigroup that there is a view within the
MPC that trend productivity growth may have weakened of late and
therefore trend growth in the economy may also have weakened.
To what extent do you agree that there is that view within the
MPC; do you share that view yourself?
Mr King: Different people have
different views, so you can ask the four people here what they
think. I think the discussion that we have had, on the Committee,
was not about trend productivity growth but a combination of two
things. One was the observation that productivity growth had fallen
quite markedly, and I think, by and large, we thought the main
explanation of that was the fact that firms were still continuing
to employ people in a period when output growth had slowed. As
output growth has picked up, that impact on productivity indeed
has started to unwind. The other factor we looked at was higher
oil and energy prices, as happened in the 1970s, may well have
raised questions about the growth of productivity which would
result; maybe there would be an impact on wage costs, which, because
it reduced the real take-home pay of employees, would actually
make it harder to generate the increased supply which was necessary
to validate the trend productivity growth rates. Also, it might
mean that some of the capital equipment in use was made redundant
because it was using an inefficient amount of energy, and so there
might be scrapping of capital equipment. Those possibilities were
raised and they were discussed. I do not think the Committee feels
there is a great deal of hard evidence, but it is a possibility
and we have raised it as a risk. It was something therefore that
we took into account. In our projections, in the central view,
there was no impact on productivity growth from either of these
developments, and I think there were different views on the Committee
as to how important they might be. Those views did vary quite
widely, from a view that there would be no impact to a view that
there might well be some impact. Probably there was, and indeed
it had contributed, in part, to the rise in unemployment—not
as the major factor but as some part of it.
Q88 Mr Gauke: Can I ask whether anyone
has anything else to add on trend productivity growth or deal
on trend growth?
Mr Bean: That is a pretty fair
description of the key channels that we discussed. As the Governor
said, different members of the Committee took slightly different
positions on the relative likelihood of things like capital scrapping
effects. For my part, my interpretation of the slow-down in productivity
growth through 2004 into 2005 was that it was primarily a cyclical
phenomenon and did not really indicate a slowing in underlying
productivity and that capital scrapping effects were probably
fairly modest; there is no doubt that there will be some effect
there. I recognise that certainly one could take a different view
and frankly it is very difficult to draw a firm conclusion with
the data that is available.
Q89 Mr Gauke: When you are looking
at productivity growth, to what extent do you distinguish between
the private sector and the public sector? There is an argument
that public sector productivity growth is lower and that drags
down the average, therefore the average figure is unsophisticated
and that one needs to look at the private sector productivity
growth. Is that a fair analysis and do you distinguish between
the two?
Mr King: It is certainly relevant
to us, when making our inflation projections, not to get bogged
down in a debate about how to measure public sector output. That
is, however, a very important debate in order to measure the contribution
of the public sector to national income. What we can do is ask
a different question, which is, what is the impact of the public
sector in terms of its demand on the resources which it is using
to produce whatever it is that it is producing? That is primarily
in terms of the labour demand but also in terms of the goods and
services which the public sector is buying from the rest of the
economy. That is how we would calculate the impact of the public
sector. I think you are right to say, "Well, do concepts
of our trend productivity growth help or not?" I think, in
the private sector, probably they do, in the public sector they
do not, because the methods used to calculate the output in the
public sector have been changing in recent years, so you would
expect there to be changes in the measured productivity growth,
even if you did or did not agree on what was actually the underlying
growth rate of productivity. The numbers that are produced by
the ONS have been changing, and that is a challenge to them, it
is a very important one to try to work out, as far as possible,
what is the output produced, but it is not one in which the MPC
need to get embroiled, because actually we can look at the impact
of the public sector and the resource demand it is putting on
the rest of the economy.
Q90 Mr Gauke: Briefly, how would
you describe the impact of the public sector in that way, given
that in recent years it has grown quite substantially?
Mr King: Obviously, it has employed
many more people and those people then are not available for employment
in the private sector, so that is something which is relevant
when assessing the degree of pressure in the labour market, and
we can look at that.
Q91 Mr Gauke: Would it be fair to
say that means that interest rates may be higher—may be
higher—than otherwise they would be had that not happened?
Mr King: Not if the Government
is financing the higher public expenditure in terms of higher
taxes, because the higher taxes then will be slowing the growth
rate of private spending in order to release resources to finance
the higher public spending. I think, in part, that is what has
happened, and we talked about that as part of the explanation
for the timing of the slow-down and the sharpness of the slow-down
in consumer spending; it came at a point when real, disposable
take-home pay was actually slightly negative rather than positive.
Q92 Mr Gauke: Can I just return to
the issue of trend growth. Professor Muscatelli told us that low
investment over the past couple of years may have impacted upon
trend growth and therefore that gives you less flexibility when
it comes to the interest rate cycle. How would you respond to
those comments?
Mr King: I will ask Charlie to
comment in a minute because he has looked at this issue quite
carefully. When thinking about the growth of the economy, obviously
one is looking at growth of business investment, but in terms
of its impact on the potential supply capacity of the economy
it is the level of investment. If investment is growing more slowly
than otherwise it would have done the level is going to be less
after a few years, but, remember, we had pretty high levels of
business investment in the late 1990s which brought up our capacity.
Whether the level of productivity and supply capacity is lower
now than we would have expected 10 years ago is not obvious to
me, because what you are seeing is different timing of the path
of business investment. Charlie is much closer to that and he
has looked at that issue quite closely.
Mr Bean: The thing I would say
is that we build our estimate of the economy's supply capacity
from the bottom up, if you like, and automatically that means
that when there is a slowing in investment it feeds through directly
into our assessment of the supply capacity of the economy. In
that respect, we are rather different from the Treasury and the
way that they construct their estimates of trend productivity
growth, which does not rely on taking on board what is actually
happening to investment, and then working out what that implies
for firms' supply capacity. The direct implication of the relatively
subdued rates of investment over the last few years has been that
our estimates of spare capacity have been growing that bit more
slowly, and if they pick up in the future, as we expect them to,
albeit modestly, that would lead to a pick-up in the rate of growth
of supply capacity. We do not see any particular reason for thinking
that the rate of growth of productivity which is not associated
with capital, what economists refer to as total factor productivity—sort
of disembodied productivity growth which is associated with research
and development and more efficient management techniques, and
so forth—there is no particular evidence that has picked
up, although it is one of the areas that we have been studying
particularly closely. Of course, if you look in the US, there
has been a marked acceleration in that component of productivity
associated particularly with the ICT revolution. There has been
some consideration of whether we might see the same ICT-driven
pick-up in productivity growth here, but so far there is relatively
little evidence of it in the data.
Q93 Mr Gauke: Obviously, this Committee
is very interested in globalisation, and so on, to discuss these
more mobile factors of production; in those circumstances, to
what extent are spare capacity and the link to spare capacity
inflation weakened, does it matter any more?
Mr King: I think there is a lot
of confusion on this topic. We have our own currency, we determine
the inflation rate of that currency; it does not matter what the
output gap is in the rest of the world. If we want to have a lot
of inflation or a lot of deflation, we can give you that. The
fact that the output gap in the rest of the world moves around
a lot may make our job harder, but the fact that we have our own
currency is what determines the fact that we can have our own
inflation rate. Where there is an issue, I think, which has changed
the transmission mechanism of monetary policy, is that with much
more open capital markets and mobile capital flows, the asset
prices in the economy often are determined as much by what is
happening overseas as developments in the UK economy. Indeed what
has been discussed quite a lot in the last decade is the extent
to which investors have been moving towards a position in which,
around the world, everyone has got rather similar portfolios,
so pension funds in the US will have some US shares, some European
shares, some Japanese shares, maybe even Chinese shares, in proportion
to the weights of these countries in the world, and so will British
pension funds and European pension funds. In other words, the
portfolios are becoming closer. If that is the case then our asset
prices may be being driven as much by monetary policy overseas
as by here. That does not mean to say that we cannot determine
our own inflation rate in the longer run, but it does mean to
say that the transmission mechanism may be somewhat different,
because we do not simply determine our own asset price levels
in the way that we would if we lived in a completely closed economy.
Q94 Chairman: Governor, can I say
that is the first thing you have ever offered this Committee,
and it is totally and utterly unacceptable, higher inflation.
Mr King: I agree, Chairman.
Q95 Mr Todd: Going back to some questions
that Kerry was asking about, the implications of increased contribution
towards pension costs, would you endorse the call for greater
transparency in the declaration of the cost of pensions so that
they are clearer in collective bargaining terms among those who
have to analyse their impact? At the moment, many employees do
not understand the implications of the additional costs which
may be involved and are not entirely sure that those bargaining
about them always do either.
Mr King: I do not want to endorse
any call for compulsory changes. That is not for me; that is for
others involved in reporting.
Q96 Mr Todd: A good PSO?
Mr King: Certainly it would be
of value if we all understood it better; the question is how we
get from here to there. There is no doubt that some of the calculations
that are presented are not the easiest to understand or follow.
I think a greater economic input into the sorts of calculations
that are made would be of enormous value, as opposed to purely
the accounting calculations, and I do think that it must be very
confusing for people to see that there are two or three different
ways in which the valuations of their pension scheme are presented.
I think there is value in individuals understanding that, in addition
to their wage packet, there is also an amount of compensation
which is being put to one side which is financing the future pension
benefit they will receive as a result of that employment.
Q97 Mr Todd: Would you also share
the view that there is a possibility of pension cost, corrective
measures, actually having an inflationary impact at some point?
You have noted, obviously, that companies have been dealing with
deficits or responding to worker demands for improved pension
terms, but presumably over time that can drive up business costs
and potentially contribute to inflation?
Mr King: I think firms then can
take steps to control their own costs, and of course that is exactly
what they have been doing in recent years, in reforming their
pension schemes. One of the benefits of a greater understanding
of the cost of providing pensions, to which you referred earlier,
would be that it would make it clearer that there is a trade-off
between benefits in the form of pensions or benefits in the form
of pay today.
Q98 Mr Todd: Turning to broader labour
market issues, would you take the view that the labour market
has loosened substantially over the last six months, and perhaps
much greater than it has for quite some considerable time?
Mr King: Let me ask Kate to come
in and comment on that.
Ms Barker: I think certainly it
is true that the labour market has weakened over the past six
months, it is correct to say, more than it has in the recent past,
but to say it is a significant weakening of the labour market
would be overstating it. There have been, of course, different
trends going on, and a particular trend which has been quite marked
over the past year is that we have seen a rise in people's willingness
to participate in the labour market. In fact, that comes back
to some of the questions raised about productivity. We are not
seeing people withdrawing from the labour market, although the
proportion of people who are wishing to participate in the labour
market is higher, and that, of course, has been one of the things
which has caused unemployment to rise. Alongside that, in some
sense, we discussed this when we were talking about the productivity
cycle. We have been through a period where output growth has been
a bit slow and, although firms did not actually get rid of a lot
of people, they have not been hiring quite as much and so employment
has not risen quite as quickly, but, on the whole, if anything,
employment has been at least as strong as we expected and in some
periods last year was rather stronger. So it would be overstating
the case to say that the labour market has weakened significantly;
certainly it has slackened a little bit. On top of this, of course,
we have had effectively an influx of migrant labour, so in some
sense the supply side of the labour market has grown quite a lot
and a little bit faster than the demand for labour. That is a
better way of putting it. We have had a slackening, which has
not necessarily reflected a big weakness in the economy, and,
looking forward, I suppose that is uncertainty. I would not anticipate
seeing the slackening going very much further.
Q99 Mr Todd: In quite an active month
for speaking, Governor, you did make some references to the impacts
of migration on our economy and some guarded remarks about the
relatively incomplete information on which we work at the moment.
Are you seeking to commission more robust research on the way
in which migration and other challenges in the composition of
our labour market may impact on our economy?
Mr King: Our staff are examining
all of these questions, but the big handicap is lack of data,
the data are both scarce and inadequate to carry out a full study.
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