Examination of Witnesses (Questions 48-59)
DR ANDREW SENTANCE
12 OCTOBER 2006
Q48 Chairman: Good morning Dr Sentance.
Can you introduce yourself to the Committee, please?
Dr Sentance: My name is Dr Andrew
Sentance; I am a member of the Monetary Policy Committee.
Q49 Chairman: I will ask the same
question as I asked previously, how were you appointed to your
key role? When were you approached and who did you speak to?
Dr Sentance: Like Professor Besley
I was first approached by the Permanent Secretary of the Treasury,
Nick McPherson, during the second week of July. I then discussed
with the Governor of the Bank of England but most crucially I
had to discuss with my employer at the time, British Airways—with
the Chief Executive of British Airways, and with my immediate
boss—about whether I could be released from British Airways
in the timescale that the Treasury were looking for because they
wanted to make an appointment as soon as possible. We were able
to conclude those negotiations successfully and so the Chancellor
was able to make an announcement later that week. I did not have
too much hesitation in my own mind about this; this was something
I wanted to do. I think it is a very prestigious appointment for
an economist in the UK to take part in the Monetary Policy Committee
and contribute to its deliberations. Obviously there needed to
be a process of negotiation with British Airways and that was
completed quite speedily.
Q50 Chairman: You say you spoke to
the Governor?
Dr Sentance: Yes, I spoke to the
Governor in that process and one of the issues that we needed
to resolve was to make sure that things that I was continuing
to work on within British Airways were not going to conflict or
get in the way of then moving onto the Monetary Policy Committee
at the beginning of October.
Q51 Chairman: You were part of The
Times Panel from January 2006 to July 2006. In that time you
disagreed with the MPC twice, calling for cuts on both occasions.
Why did you support a cut in interest rates in March and April
of that year?
Dr Sentance: I think the situation
has changed quite a lot in the UK economy over the last six to
nine months, but earlier this year we were faced with a situation
where a lot of the data that was coming out from 2005 was pointing
to a weakening economy. Indeed, GDP growth in the UK economy in
2005 was quite a bit below trend at below 2%. We also saw at the
time rising unemployment so there were a number of indicators
around that time that suggested that perhaps the economy was continuing
to be soft. As we went through the spring and the summer I think
the evidence turned out that the growth of demand and activity
has been much more robust. Also that rise in unemployment that
we have seen may be a lot more to do with supply factors in the
labour market than demand side factors. That evidence has come
through over the last six months but at that time it was not so
clear and to me it seemed the balance of risks suggested that
actually the economy was in danger of remaining weak through 2006.
As it happened that fortunately was not borne out.
Q52 Chairman: Can you easily swot
away The Guardian's July assessment that you are a dove?
Dr Sentance: I do not find this
hawk and dove classification very helpful. I am quite taken by
a quote from John Maynard Keynes who was accused by people of
changing his mind quite a bit. He said to the person who put this
to him, "When the facts change, I change my mind. What do
you do, sir?" I think Professor Besley's comments have indicated
that it is quite possible, as evidence comes in about the state
of the economy, to arrive at different conclusions as you go through
time. The view that you might have taken in one set of circumstances
is not necessarily a guide to the view that you will take in a
different set of circumstances.
Q53 Chairman: That is what we do
as politicians, but maybe not always with such a sound basis.
Dr Sentance: I am not making a
virtue of changing your mind, but I think it is something you
have to be prepared to do if circumstances change.
Q54 Mr Fallon: You have not really
changed your mind, have you? In July you were still saying that
the Bank should be cautious about raising rates at that stage.
You are a serial dove, are you not?
Dr Sentance: I think you will
just have to judge my performance on the Committee as it goes
through. I do not think I want to be pigeon-holed into a particular
camp in that way at the moment.
Q55 Mr Fallon: In his press conference
Mervyn King said that there is a 50-50 chance that inflation would
rise above 3% in the next six months. How would you rate those
chances?
Dr Sentance: I think the chances
of inflation rising above 3% have gone down slightly in the short
term because of the fact that oil prices and petrol prices have
fallen back. Some of the short term upward pressure on inflation
is abating but I think that the Bank obviously has to focus on
the medium term inflation outlook and that is obviously something
that is going to be the main influence on the interest rate decisions
over the next six to nine months or so.
Q56 Mr Fallon: How much risk do you
think remains on the upside?
Dr Sentance: I would not want
to put a percentage on it in the way that Mervyn did there, but
I would say that it has receded from that 50-50 in the short term
because of the evidence that has come in on oil and petrol prices.
Q57 Mr Fallon: What is your view
of the degree of spare capacity in the UK economy?
Dr Sentance: I think that measuring
the degree of spare capacity is quite a difficult thing but I
think also that it is important to distinguish between a short
term and a long term context when you are looking at that. In
the mid-1990s we had unemployment at about 10% and I think if,
at that time, demand had increased quite rapidly in the short
term we might well have had inflationary pressures, yet through
a process of good demand management and beneficial supply side
changes we have actually moved to a situation where unemployment
is a lot lower and we have not seen inflation coming up. I think
the answer to the question depends on whether you are taking a
short term or a long term view. I think in the short term we are
probably close-ish to round about the sort of capacity limits
of the economy. I do not think those capacity limits are set in
a very tight and hard way and it is possible that over the longer
term developments could take place which would allow us to get,
for example, to possibly lower unemployment. We will have to see.
Q58 Mr Love: Can I turn to this conundrum
of business investment? Perhaps you could give us your view as
to why, with conditions being so benign over recent years, we
have not seen until recently an upturn in business investment.
Dr Sentance: Looking at this from
a business standpoint where a lot of my experience has been, I
think in the early phases of a recovery from a period of weakness
in the economy—which we did see in 2001-2002 certainly in
a number of businesses—companies wait to take up some of
the slack before they then begin to think of significant new investment.
That is probably one of the elements but I do not think there
is any single, complete explanation of this. I think there is
some data uncertainty; Professor Besley alluded to some of the
factors there. I think, however, that people have observed that
the investment to output ratio in the UK has tended to be relatively
low compared with other European countries for quite a prolonged
period of time. I think there may be structural features of our
economy compared with other economies which contribute to that.
The fact that we do have more flexible labour markets than other
European economies may help in ensuring that investment can be
used more efficiently. It may also encourage—I think there
was some reference to this in the earlier discussion—some
substitution of labour for capital at the margin which means that
structurally we would tend to have a lower investment rate than
other countries, but that is not necessarily a bad thing. I think,
however, that it is an area where there is no absolutely concrete
and complete explanation so in that sense there is still a bit
of a puzzle. There are a number of different hypotheses around.
Q59 Mr Love: We talk a great deal
in this Committee and in general about globalisation and competition
internationally. Since the capital stock per worker is much higher
in equivalent economies that supposedly we are competing with,
why have we not seen Britain catching up? You have given some
of the explanation, but surely there should be more competitive
pressure on the UK to increase its capital stock per worker.
Dr Sentance: I think the way in
which companies respond to those globalisation pushes depends
on the circumstances of the company. In some circumstances increased
investment may be the right thing to do, but it is not necessarily
the case for all companies. I think it is also worth observing
about the investment picture that investment has been much weaker
in manufacturing activities than in non-manufacturing. That could
reflect another side of the point that you are pointing to, that
international companies are choosing to invest in lower cost labour
locations where they are building up production facilities and
may not be investing as much in the UK as before this globalisation
issue became a much more significant factor. I can see globalisation
operating in two directions on investment. Yes, as you say, it
should perhaps be encouraging companies to innovate and invest
in new technology more quickly, but on the other hand they may
be putting more of their investment overseas.
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