Select Committee on Treasury Minutes of Evidence


Examination of Witnesses (Questions 100-116)

MR MERVYN KING, MR PAUL TUCKER, MR CHARLES BEAN AND MS KATE BARKER

29 JUNE 2006

  Q100  Mr Todd: Yes, that has been discussed for other reasons.

  Mr King: It has, and I do not want to claim that ours is in any way the most important, but the data are extremely poor on this issue.

  Q101  Mr Todd: I think you would agree that anything we can do to improve the quality of that data, so we can understand more readily what is actually happening, will be of value to you in your work?

  Mr King: If you found acceptable ways of providing us with better information and data we would be deeply in your debt.

  Q102  Mr Todd: Turning to one of the points which Kate made, I think, which was the increased participation in the workforce from those perhaps approaching or over retirement age, is there any view of the differential impact between those people participating in the workforce and those who are much younger, say, claiming their first job? Certainly to the outside impression there is probably a differential effect, in terms of someone who has an established household already and is earning something on top of what they have already provided for and someone starting out on their working career who may become locked into longer-term unemployment.

  Mr King: I think it is very hard to know what has caused the changes in participation. Amongst the older age group, there could well be a cohort effect as well as a purely age effect. The cohort effect would be that we saw a very sharp decline in labour force participation, particularly among men, during the recessions in the early eighties and early nineties, when a lot of men working particularly in traditional heavy industries lost their jobs and never went back into the labour force. Once that cohort had passed through into retirement over 65 then they were no longer there. The question of who would participate in the age group 55 to 60 was a question being asked about different people, people who had not lost their jobs earlier on. It could be just a cohort effect which explains some of the rise in participation. There can also be an age effect, which is, it may well be that people over 60, between 60 and 65, now feel that, because of the change in pension provision and the uncertainty, they would like to work longer. Of course, far and away the most important effect ought to be that, compared with, say, certainly 15, 20 years ago, life expectancy is significantly higher and presumably also the number of years of active, healthy life, and why should people choose to spend every single year of that in non-employment, they may well decide that actually they want to be in employment. I suspect also that employers are adjusting to being able to provide more part-time jobs, which may well suit people in that age range who want to divide their extra longevity between work and non-work. It is quite possible that this is a very natural development in terms of what people are demanding in work patterns as well as the cohort effect.

  Q103  Mr Todd: On the face of it, it has a beneficial economic impact, which we would all welcome, but does it have any other impacts of which we should be more aware? I have hinted at one, which is that, in theory, one might be substituting older, more flexible workers, who are supplementing an income, for younger workers who may not enter the workforce subsequent to that negative experience. It is a point of view.

  Mr King: I think it is too early to judge. Of course, that description would work from the supply side, in terms of participation, but not necessarily from the demand side, because if you take a traditional, final-salary pension scheme, it is those older workers who are the most expensive and the younger ones who are the least expensive. The reform that firms have been introducing in their pension schemes has been primarily to lower the pension cost of younger employees, new entrants, rather than older people already on the staff. Where it is relevant to us, clearly, is if it alters, even temporarily, the underlying growth rate of the available labour force. The population may grow steadily but the labour force which is available to employers may rise, either because of greater participation of any age group—if participation rises that is an increase in the labour supply available to firms—or, of course, from migration, as you mentioned earlier. The immediate impact probably is to ease wage pressures, but, of course, those people then will be spending money, so they add into demand. Certainly it may well affect the growth which the economy is capable of achieving, at least for a temporary period, while this rate of participation is rising, so judging trend growth becomes quite tricky.

  Q104  Mr Todd: Though we are operating at a participation rate which is much higher than many other European countries already?

  Mr King: It is, but there is no reason to suppose that ours may not go even higher. There are other reasons to explain the differences between ourselves and those European countries.

  Q105  Chairman: Kate, the Inflation Report discusses the recent rise in household inflation expectations, and surveys showing the evidence of the gilt markets show an increase of 2.8% or more. How concerned are you by these increases, and what do you think is driving them?

  Ms Barker: Certainly we looked very hard at the path of inflation expectations in the May Inflation Report, in particular there are a couple of focuses for our concerns; our own Bank survey, which showed that people's expectations had risen from 2.2% to 2.7% now, which is quite a big rise. Our sense at the time was that the reason why people's expectations of inflation had risen was because the survey was conducted around the time that people were facing very big increases in their electricity and gas bills, which was likely to push up people's inflation expectation and indeed also push up the actual rate of inflation, so perhaps it was not very surprising. Just to finish on that, it has also been of some interest to see what happened in the next survey, and, in fact, in that survey, inflation expectations, in the Bank's survey, declined a little bit. Other surveys have also moved around and some of them have picked up and then fallen back a little bit. On the whole, I do not think the movements in these surveys have been enormously dramatic and I was rather comforted by the fact that the last month we saw was down rather than actually continuing a rise, which I think would have sent a rather different signal. It seems that we have had a pick-up in inflation expectations; it is uncertain how durable it would be. At the moment, it does not seem to me of such a scale, it is not way out of line with where the history of the survey has been, to be a matter of great concern. We have referred also to the fact that in financial markets inflation expectations have picked up, and that is something we look at and are concerned about; again, it has not picked up to the point where there is any sign that there is a loss of credibility in what we are doing. I think it reflects a very natural response to some of the inflation pressures we are seeing coming in from imported inflation, commodity prices, at the moment, and a sense that in the rest of the world there is a little bit more inflation pressure, but it is something that we have taken account of but not, I think, something which is a matter of acute concern. Of course, what has been worrying quite a lot of us on the Committee for some time is whether or not we would see any response in wages to changes in these inflation expectations; as yet, we have seen practically no evidence of this whatever, and I draw some comfort from that. At present, I would say it is something we note and we will be taking into consideration, but certainly it has not changed my view, fundamentally, about where things are going.

  Q106  John Thurso: I want to ask you a little bit about energy and commodity but, if I may, first of all, I noticed in your speech in Edinburgh you talked about companies facing higher costs for energy raw materials and the fact that they had been willing to offer only moderate wage increases, and you used the phrase `the rapid rise in input prices and muted degree of pay pressure are not independent of each other'. Again today you have used very similar language, so clearly it is something which is being thought about. I understand what you are saying but I would be interested if you could explain perhaps a little more why you are saying it?

  Mr King: I think, in large part, because many companies have told us on the visits we make around the country. Although we have been through a period, until about a year ago, of a tight labour market, the rise in energy prices, which goes back now over two years, was something which led them to have to be very tough on all other costs, not just wage costs alone but all other costs had to be pared back. Competition was intense, they were not able to raise their output prices. There were some cases where energy increases could be passed on, where all other competitors were facing the same increase and they could pass it on, but what is very marked is actually how small the impact of energy prices has been on domestic inflation apart from the direct contribution of energy and gas prices to consumer prices—the prices of fuel and petrol to households. The indirect effect through raising business costs have been absorbed by businesses themselves. It is difficult for them to absorb that indefinitely in lower profit margins, therefore they have had to take steps to lower their other costs. Therefore, they have been pretty resistant to any suggestions that those increases pick up. I think what is surprising, in a way, is how small have been the fluctuations in inflation around the target. I think one of the benefits of having a clear target is it is a very clear signal as to where inflation is going to be, and firms have been trying to take actions to ensure that their costs are evolving overall in a way which is consistent with that target. If some externally-driven cause has been pushing up energy prices then they will do their best to try to control all other costs. I think that is what we have been seeing and certainly it is what firms have been saying.

  Q107  John Thurso: Is there a danger that is what they are doing while they can, but there comes a moment when the relationship of the individual, particularly between their costs and their income, is such that they will actually arrive at a point where they have to have more? Particularly, one looks at those on a fixed income, pensioners and so forth, for whom the costs have become very, very high in relation to their income, who are not able to do anything, but those in work, the waged, will they arrive at a point where this will be a kind of tectonic shift? Is that a danger you are signalling obliquely in this?

  Mr King: There is always a risk, we have always said that there is a risk from the higher energy prices, but since this has to be absorbed in lower, real, take-home pay, this is a cost to the UK. At some point people might try to push for higher wages to compensate for that fact. Again, I think one of the benefits of the inflation target is that it makes clear that this is not something which in the long run can benefit anybody, because we do have to pay these higher oil prices that are determined in the world economy. There is nothing that we, in the UK, can do about it. Just pushing for nominal wage increases which, in the end, lead to higher inflation is not the answer. The inflation target helps to give reassurance to everyone—firms and employees involved in wage bargaining—that, in fact, we will keep inflation close to the target and I think in large part, that is what we have seen. It is certainly possible that if we were to see significant falls in energy prices firms then might be a little bit more relaxed on some other costs, but not to the extent that would threaten our ability to keep inflation close to the 2% target, because that is what is providing the discipline.

  Q108  John Thurso: We have recent evidence from Professor Quah, who said that energy is actually much less important now than it was in the 1970s, so I think, based on your answer, you agree pretty much with that?

  Mr King: It is certainly true. Even though energy prices have risen a great deal, the fact is that the intensity of energy usage is about only one-half what it was in the 1970s, so for the same developments in the oil market it will have only half the effect that it had in the 1970s. It would still have, clearly, a noticeable effect but much smaller than then. The main difference, I think, is that in the 1970s these increases in costs came on top of what was an underlying move upwards in inflation. Without a clear monetary framework and with inflation picking up it was not a good time to have to absorb a very significant increase in costs from the rest of the world.

  Q109  John Thurso: How much danger do you think there is from the volatility in the energy markets as opposed to the actual price? In other words, what you are describing is an ability to deal with actual prices; perhaps the danger is much more in the relative volatility?

  Mr King: The example which shows volatility most clearly is the gas price, where the wholesale gas price moves by large factors, it goes up 100%, comes down 50%, often in a matter of a few days, so there is tremendous volatility there. Of course, there is a futures market, it is rather thin, and retail prices have not moved around to the same extent. I think that, in terms of the long-run impact on costs, it is the level of the price to which it is expected to gravitate; we are seeing both volatility and a rise in the underlying price, but there must still be significant uncertainty as to where prices will go. I am very struck by the fact that in the energy market as a whole you can hear, on the one hand, people who are obviously real experts saying that in their view oil prices will come down to $35 or $40. On the other hand, people will say, "Well, not much sign of a diminution in demand from China, and we're not clear where the extra supply is coming from," so at least for the next few years prices could go even higher. All of these people are well informed about the market. I think this is a reflection of the genuine uncertainty, because in a market like the oil market relatively small changes in the balance between supply and demand can lead to big changes in the price.

  Q110  John Thurso: John Butler, when he spoke to us, said very much as you have been saying, that effectively firms were reducing profits rather than putting up prices to accommodate shocks. Is there a danger, again it is a similar question to the one I asked you about wages, is there a point at which they can no longer do that and therefore there is a more rapid unwinding, and having held your price for a year, two years, or whatever, then you say, "If we're going for it we might as well go for it in a fairly big way"? Do you think there is a risk that there is a building inflationary pressure in there?

  Mr King: It need not necessarily be a direct inflationary risk; it could be a risk in terms of output and demand that firms simply close down. Ultimately, that might reduce capacity and in turn create some inflationary risk. What I have seen is that firms are very conscious of the need to reduce costs and it may make sense to accept the rise in energy prices as a hit on profit margins temporarily, if you believe that looking six months ahead, or maybe even 12 months ahead, you can get through this and energy prices will have fallen back. I suspect there was some of that in the earlier part of the rise in oil and gas prices, but I think that has probably gone away now and that firms realise there is no obvious reason to pin all their hopes on falls in energy prices. What they need to do is adjust to the current levels, to find ways of saving costs elsewhere to make their operation viable at these levels of energy prices.

  Q111  John Thurso: We have talked mostly, when we talk about the impact of policies, really around energy; what about the non-energy commodities, the actual raw commodities that we bring in to this country? Relatively speaking, we are a much smaller manufacturing country than we were, but is there any risk or danger in the increase in cost of those raw commodities, the fact that they are being used so much in emerging economies?

  Mr King: There is no doubt we have seen very sharp increases in the prices of many metals and other raw commodities. This is driven by the world market; it reflects in part the extraordinary growth in China but also elsewhere in Asia. You can see China looking around the world for sources of supply of many of these minerals and metals. The UK is buying in a world market and we have seen very significant increases in prices. Of course, it is not entirely an increase in cost to the UK. We have firms which process and sell commodities and materials, like nickel, for example. I have visited a nickel plant, they are able to sell at a much higher price. They can sell their output but the problem they face, like many firms, is that there can be real volatility in those prices. Their total contribution to the costs of UK plc, if I put it that way, is really pretty small, so I would not expect this to have major consequences for the Consumer Price Index. Most of the costs which go into that are completely other costs, largely labour costs but also energy in general, other raw materials, but the contribution of the volatile components, metals, minerals and the raw commodities that we have seen move up and down a lot in the world economy, is pretty small.

  Q112  Mr Fallon: Governor, our Sub-Committee has been conducting an inquiry into the very welcome Government proposals to make statistics more independent. Have you put in a submission on behalf of the Bank to the Treasury on its proposals?

  Mr King: We have, yes.

  Q113  Mr Fallon: Can you make that available to us?

  Mr King: No. I think they are going to publish it, as I understand it.

  Mr Bean: They implied that they were going to put it on the Treasury website along with all of the other submissions.

  Mr King: I think the submissions as a whole are being put on it as a batch.

  Q114  Mr Fallon: Thank you. One aspect we have been looking at quite closely is the whole issue of pre-release. You collect statistics, I think, for the ONS, in some respects, you supply them with statistics, financial and banking data, presumably you also use their statistics. How important for the MPC itself is this issue of access to statistics pre-release?

  Mr King: We have very, very clear and formal arrangements for the ONS. The Governors see the official statistics on the economy 36 hours before they are released; no-one else on the Committee sees them, except if we are at a position where there is a meeting of the MPC, where it is clear that other people should see it. For example, if a pre-release comes in on a Tuesday night or a Wednesday night for release after the MPC has finished its meeting then I will share that with the MPC and that is approved by the ONS. Otherwise there is no pre-release access to the MPC in general, but where we have a meeting, and the same would apply if we had an emergency meeting for example, any meeting of the MPC would have access to the data which I had under the convention of pre-release information.

  Q115  Mr Fallon: On your 36-hour convention, are you able to define what statistics you would like included within that 36-hour convention, or is that defined by the ONS?

  Mr King: That is defined by the ONS and it is the normal statistics you would expect for the economy, so it would not include statistics which they put out which are not related to the macro economy.

  Q116  Chairman: In your answers to John, Governor, Martin Wolf, in his article in the Financial Times, made the same point as you have done regarding energy consumption in the seventies compared with now, and he is looking at energy consumption and its economic and wider implications within a globalised context. As you are aware, we are conducting a wider inquiry into globalisation and perhaps, on that point and others, we could come back to you at some time?

  Mr King: Fine. Whether we have much to offer you I do not know, Chairman, but we will offer you what we have.

  Chairman: Thank you for what you have offered us this morning, apart from that free gift, which we are not taking, on inflation. You have been very helpful to us this morning, Governor. Thank you to you and your colleagues.





 
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