Examination of Witnesses (Questions 1
- 19)
THURSDAY 24 NOVEMBER 2005
MR MERVYN
KING, SIR
ANDREW LARGE,
MS RACHEL
LOMAX, MR
DAVID WALTON
AND MS
KATE BARKER
Q1 Chairman: Governor, welcome to
you and your colleagues to your first meeting with the new Committee.
Can you first of all introduce your colleagues and then make your
opening statement?
Mr King: On my immediate right
is Rachel Lomax, Deputy Governor for Monetary Policy. On her right
is David Walton, one of our new external members of the MPC. On
my immediate left is Sir Andrew Large, the Deputy Governor for
Financial Stability and on his left, Kate Barker another of our
external members whom I know you know well. If I may, I should
like to take this opportunity to explain the reasons for our decisions
on interest rates since we last appeared before you in March.
Since then the Committee has reduced interest rates by 25 basis
points, at our August meeting, and the official rate is now 4.5%.
Inflation rose from 1.1% in September 2004 to 2.5% in September
this year, before declining to 2.3% in October. Over the next
year, inflation is likely to fall back to below the 2% target
as higher energy prices drop out of the 12-month comparison. But
the rise in inflation over the past year was not solely the result
of higher energy prices; it also reflected the pressure of demand
on supply. In its November Inflation Report, the MPC said
that its central projection for inflation remains close to the
target over the next two years. Economic activity in the United
Kingdom is now reported to have weakened in the second half of
2004 and early 2005, but to have picked up over the course of
the year. Excluding energy extraction, which was erratically weak
in the third quarter, it now appears that output growth has risen
a little from a low point at the start of 2005. Domestic demand,
led by consumer spending, has been weaker than expected over the
past year, in part because household disposable income has grown
much less quickly than for some time. But there has probably been
some recovery in consumer spending during the year. The MPC's
central projection is for annual GDP growth to rise, with the
weak growth rates in the latter part of 2004 and early 2005 dropping
out of the annual comparison. Quarterly growth rates are expected
to recover more modestly. Consumer spending is expected to pick
up, but only to below average rates, and the Committee expects
some further rebalancing of the economy away from household consumption
towards foreign trade and business investment. With a trade deficit
of around 3.5% of GDP, its highest level since 1990, a rebalancing
will at some point be necessary. One source of uncertainty about
the inflation outlook concerns the impact of higher oil prices
and flows of migrant workers on potential supply, and, more generally,
about the balance between demand and potential supply in the economy.
In assessing that balance, there is considerable uncertainty not
only about the rate at which the economy has grown in the recent
past but also about the extent to which higher oil prices and
future flows of migrant workers may affect supply capacity in
the future. Since we last met, I have been able to learn more
about those issues during visits to seven regions of the UK. It
is too early to be sure that the recent pickup in inflation will
not lead to further second-round increases in pay and prices,
although the Committee draws comfort from the observation that
so far neither inflation expectations nor earnings growth have
risen. The Committee will be monitoring developments in those
areas carefully. And the level at which the Committee will set
interest rates in the months ahead will depend on the extent to
which the risks to the present outlook materialise. Finally, I
should remind the Committee that Sir Andrew will be leaving the
Bank in January after almost three and a half years' sterling
service. I should like to thank Andrew for his contribution to
the Bank in a number of areas and particularly for all his help
and support during my term as Governor. Chairman, those are the
remarks that I should like to make to you at the outset today
and I and the other members of the MPC here today stand ready
to answer your questions.
Q2 Chairman: Thank you very much
Governor and thank you Sir Andrew for your contribution. Governor,
in your recent appearance before the House of Lords Economic Affairs
Committee and in your CBI speech in the North East you acknowledged
that over the past year the UK economy has seen a traditional
supply shock with the economy slowing and inflation picking up.
What factors do monetary policy makers need to take into consideration
when deciding how to respond to such a supply shock? What are
the key questions the MPC needs to consider?
Mr King: This has been one of
the most important issues facing us in the past year and it is
new for the Committee, since its creation in 1997, to see this
kind of shock. I think there are probably three areas that we
have to focus on. The first is the impact of a shock of this kind,
a rise in oil and energy prices, on demand because, as far as
the UK is concerned, this does reduce our overall purchasing power,
despite the fact that we are an oil producer. Overall we feel
that net it is likely to reduce demand to some extent and particularly
consumer spending. Second, there is the supply impact which is,
if anything, even more difficult to assess; it is conceivable
that the rise in energy prices will reduce temporarily the supply
capacity growth of the economy. Third is the direct effect on
inflation. This is something that, in principle, we look through
because we are concerned about where inflation is going, not so
much in the next few months, but looking ahead two years. But
that short-term rise in inflation might dislodge inflation expectations
and could lead to attempts to push up earnings growth to compensate
for the loss of purchasing power; a loss that it is inevitable
that we accept. It is in those three areas, demand, supply and
whether the short-term impact on inflation will have any impact
on inflation expectations looking ahead.
Q3 Chairman: The August meeting was
the first time a serving Governor has been in the minority on
the MPC. There has been quite a lot of coverage in the press about
that approach and your approach seems to be different from your
predecessors. Your predecessors would perhaps act as chairman
and at the end sum up the view of the MPC and then vote. You obviously
have a different approach on that. What is your response to the
critics?
Mr King: I am not sure that there
were actually very many critics. First of all, I do not accept
that the approach is different from that of my predecessor. He
made it very clear to this Committee when he came for the last
time that he certainly was prepared to be in the minority and
in some ways he regretted that he had not been able to do that
in order to cross the Rubicon for his successor; those were his
words. I made clear when I came to see you for the first time
as Governor that I too would be prepared to be in a minority,
if I felt that was the way I wished to vote. I think the whole
spirit of the Committee, and not just the spirit but the reason
why the Committee is successful, is because each member of the
Committee agrees that what we have to do is for everyone to say
what they personally really believe should happen to interest
rates. Then the decision falls out by majority vote. We do that
because we feel that that process will lead to better decisions
on average and over time—that the Committee as a group will
reach better decisions on average and over time than any one member
of it will. That is an absolutely fundamental part—a building
block—of our system. Once you accept that as a key part
of our framework, it logically follows, as night follows day,
that there will be some times when each and every member of the
Committee may find themselves in a minority, including the Governor,
and I was in that position. I felt comfortable about that and
the Committee did not find that a particularly difficult period
to go through. There was some initial press commentary, because
it was a first, but we crossed that Rubicon. I do not think in
fact that many people felt that this illustrated a weakness so
much as a strength of the system. We had the self-confidence as
a Committee to behave in that way. Interestingly, I find that
no-one in this country talks about it any more. The only people
who have any interest in this and seem rather excited about it
are people in other countries. It is when I go abroad that people
in other central banks seem to be interested in it, but in this
country, I have found no real interest. I go around the country
talking to business groups and no-one raises this as an important
matter. What they care about is that the issues they see are discussed
by the Committee openly and fully and that whatever our judgment
is, even if they do not always agree with it, they feel that at
least all the issues have been debated clearly and openly around
the table.
Q4 Chairman: Your position as chairman
can be strengthened by you declaring, straightforwardly and unequivocally
your position, rather than the chairman's role being weakened.
Mr King: Yes, because I think
our Committee is rather different from many other committees.
We are not trying to reach an artificial consensus. We believe
that the right thing is that at the end everyone says what they
honestly believe is the right thing to do. People do not enter
the room at the beginning of our monthly deliberations with a
fixed viewpoint saying "I am determined that my viewpoint
will prevail"; that is not the way the Committee behaves.
We are engaged in an absolutely collaborative effort, with a common
2% inflation target, to work out in that meeting the right decision
on rates to meet the target. In that sense it is not a question
of trying to win over other people to your point of view, it is
a question of jointly trying to work out what is the right thing
to do.
Q5 Chairman: Governor, may I ask
you for a quick comment on BCCI? After 12 years, the case brought
by the BCCI has collapsed. What impact do you think that has had
on the reputation of the Bank? How much public money has been
spent by the Bank defending the case? Has the Bank started proceedings
to recover the costs?
Mr King: I am delighted that the
case has collapsed. We always felt that it would, one way or another.
What I felt particularly strongly about was that, not just the
reputation of the Bank, but the reputation of 22 decent and hard-working
public officials, had been publicly dragged through the courts,
they had been accused of dishonesty and they had no chance to
offset that. Two of them appeared in court as witnesses and I
am delighted that the judge, when he commented after the case
had collapsed, said that in his view, having listened very carefully
to the evidence given by the witnesses, having studied carefully
all the documents, the charges made against our officials of dishonesty
were, in the judge's own words, wholly without foundation. Again
in the judge's words, he had been surprised for more than a year
that this case was still being pursued. I am delighted that it
has been dropped, I think it was disgraceful that the case was
pursued for so long and it has led to a significant expenditure
which, unless we are able to get our costs back, will undoubtedly
fall on the taxpayer. Over the course of the almost 13 years now
that this case has been continuing, the total costs of the Bank
of England are of the order of £85 million, of which about
£70 million relate to the trial. We are pressing now—the
action will go before the judge and court in January of next year—to
recover as much of our costs as we can through the usual legal
processes and we will pursue that resolutely.
Q6 Chairman: Sir Andrew, your letter
of resignation to the Chancellor says that you indicated to him
in 2002 that you might not wish to serve a full term.
Sir Andrew Large: That is correct.
Q7 Chairman: In the questionnaire
which you submitted to the Treasury Committee in September 2002,
you answered yes to the question "Do you intend to serve
out the full term for which you are appointed?". Why the
inconsistency?
Sir Andrew Large: It was not going
to be very easy for me, having taken on the position with a formal
five-year term, to have in the public domain at all the thought
that I might wish to leave before the five-year term was up.
Q8 Chairman: Well actually, from
the Treasury Committee's point of view, it is very important when
we send questionnaires out to individuals that they reply very
openly and honestly to us.
Sir Andrew Large: Well I understand
that.
Q9 Chairman: So no further explanation
then?
Sir Andrew Large: I have given
you the only explanation I can give you.
Q10 Chairman: Okay. Governor, if
any of your possible appointees are going to fill in questionnaires,
perhaps you could remind them that it is very important that we
get very straightforward answers.
Mr King: I shall. What I should
say in addition is, if you cast your minds back to when Sir Andrew
was appointed, I was not Governor at the time, but I do remember,
that this was an extraordinary rush and Sir Andrew was in fact
given a matter of hours in which to decide whether or not to accept.
To leave a position as Deputy Chairman of Barclays and become
Deputy Governor of the Bank of England is normally a decision
I would expect people to have a chance to reflect on and to take
proper action to consult with people. Sir Andrew was not able
to do that and I think that is where these conversations came
from.
Q11 Chairman: Let us move on. I think
it is important for the process.
Mr King: Indeed; I certainly take
your point.
Q12 Chairman: Sir Andrew then, what
would you say has been your greatest contribution to the work
of the MPC and the Bank's work in the financial stability area?
Sir Andrew Large: In the Monetary
Policy Committee I have brought perhaps a somewhat intuitive approach.
I am absolutely clear that I am not a professional macroeconomist;
I have brought an approach where I have been able to marry the
data and the information that we get each month with my own observations
and experience of how I have found that people behave and circumstances
evolve. I have tried to put that to best advantage in the decisions
I have made each month; no more than that. I am one of nine people
and I hope I have made a contribution in that respect.
Q13 Damian Green: May I move on to
the growth projections and in particular the components making
them up? I was fascinated Governor that you said you think consumer
spending will push up next year. A week ago you said that the
rising tax burden had been a significant drag on consumer spending
and therefore on growth generally. The tax burden is unlikely
to go down, so why do you think consumer spending is going to
go up?
Mr King: It already has recovered
during the course of this year. I think the point that I was making
last week at the press conference was that the sharp slowdown
in the rate of growth of consumer spending can be attributed in
part to the sharp slowing in the growth rate of disposable incomes
and also to a shift in the relative prices of the items that I
described as the more boring items of consumption, in favour of
the items which may be more fun, but where there is much less
income available to spend. That explained the sharp slowdown in
spending on the high street. What we have seen overall is a very
sharp slowdown in the growth rate of consumer spending from wholly
unsustainable rates in the beginning of 2004; well over 4% or
5% a year in the first half of 2004 according to the latest ONS
estimates. They may yet be revised. The average growth rate of
consumer spending in 2004 was 1% a quarter, which is not sustainable
in the long run. Consumer spending did slow, it slowed very sharply,
0.1% in the first quarter of this year, then it rose in the second
quarter to 0.4% and we await the news for the third quarter. Retail
sales growth has picked up during the course of this year. What
I was pointing to was a slowing in the growth rate of consumer
spending, but actually it has recovered during the course of this
year.
Q14 Damian Green: In your opening
statement you talked about a necessary rebalancing. I assume that
means you think consumer spending needs to slow further, or the
growth needs to slow further.
Mr King: No, it does not need
to slow further, it just does not need to pick up to where it
was growing in the early 2000s and late 1990s. That would be unsustainable
and would prevent a rebalancing. What we have seen is that quarterly
growth rates, we think, will pick up relatively modestly, but
we would expect that some of that will come from an improvement
in the net trade position and from increases in business investment.
The horizon over which that will occur is very hard to predict
and certainly at present business investment looks relatively
weak; we shall see over the next two years or so. That rebalancing
is a relatively modest rebalancing, but it does need to take place.
In our central projection consumer spending growth does pick up,
but it picks up to still a bit less than the average growth rate
of consumer spending over the last 40 or 50 years.
Q15 Damian Green: That is very slow
then.
Mr King: It is not very slow,
with respect: it is slightly slower than its long-run historical
average.
Q16 Damian Green: If we are going
to move to a lower growth of consumer spending than has been the
trend case for 50 years, then clearly that has enormous implications
for large and important sectors of the economy. Do you think that
the rising tax burden will act as a long-term drag on consumer
spending?
Mr King: No, I do not, because
what we have been through is a transition. It is a transition
from lower to higher levels of public spending, particularly on
education and health, financed by a step increase in the overall
level of taxation. That was what the elected Government decided
to do. What the Bank is concerned about is to ensure that any
higher spending is properly financed. That increase in taxes is
continuing and as far as the household sector is concerned, much
of it has already taken place. So the basis on which the rebalancing
will occur is, in effect, largely there as far as the household
sector is concerned. There is no reason to suppose that the burden
of tax will continue to rise indefinitely; that is a judgment
which governments can make. There is no necessary reason for that
and when the tax burden has reached its new level, consumer spending
growth will simply return to its long-run average level.
Q17 Damian Green: There are clearly
two long-term views. You have famously talked about the nice decades:
not inflationary, consistently expansionary growth. I see a City
economist has risen to the challenge to come up with an alternative
which was a vile decade to come: volatile, inflationary and low
expansion. There is clearly a spectrum. Where do you think we
are likely to be over the next few years with nice at one end
and vile at the other?
Mr King: Certainly not necessarily
at the vile end. No-one can be entirely confident of where we
will be, but it would not be a sensible view. We have already
seen during the course of this year that inflation has turned
down towards the target; it has reached its local peak and economic
activity growth has picked up a little. The point that I have
been making in a number of speeches over the last year or so and
the analogy I have used is the one about driving along the very
smooth highway. If you are on a very, very smooth piece of road
and you suddenly find a few more bumps, the correct conclusion
to draw is that the road has become a little bumpier, not that
the wheels have come off the car. There may well be, in the course
of a rebalancing, a slightly more volatile position than we have
seen in recent years. After all, it is wholly unprecedented to
go through a period of 53 consecutive quarters of positive economic
growth and to go through a period where inflation has not deviated
from its target by more than one percentage point every single
month now since December 1992. That is wholly unprecedented and
at some point there will be slightly larger moves, but those are
moves which will reflect shocks to the economy which are not easy
to anticipate. What really matters is that the MPC will respond
to those shocks in order to bring inflation back towards the target
and hence, by doing that, to achieve once again, a fairly stable
outcome.
Q18 Damian Green: One other area
of concern is the quality of the information that the MPC has
to work on. Despite the slowing GDP growth, the Inflation Report
describes employment growth as reasonably robust and the most
recent labour market statistics from the ONS show that the employment
rate is at a 15-year high. There seems to be a superficial inconsistency
there. Why do you think that is?
Mr King: I do not know why that
is. In the report we talk about the fact that it is possible,
particularly in the services sector, that the current estimate
of growth rate by the ONS will be revised up and may be underestimating
the extent of growth in the economy. That view is supported by
what is happening to business surveys and we have charts in the
Inflation Report to document that. It is also supported
by the rather buoyant employment growth. It is conceivable that
the official data on economic growth will, at some stage two or
three years down the road, be revised up and that is something
which the Committee must be cognizant of and take on board and
we have; we have made a judgment that, on average, and it can
be no more than that, we would expect some upward revision, not
a lot but a little.
Q19 Damian Green: Is it possible
that the inconsistency, possible inaccuracy, is the other way
round? The employment data from the ONS suggests that public sector
employment has grown by 400,000 over three years and private sector
employment by only 300,000. Might that explain slower GDP growth
than the employment figures would suggest?
Mr King: Not in our view, because
what we look at is the growth rate of total private output in
the economy. In our view the figures we have on employment in
the private sector and the business surveys of the private sector
appear to be slightly out of sync with the ONS's current estimate
of service sector growth and that is something that we shall look
at as we go forward. I want to make clear that one should not
expect precision in this area. I do not want to criticise the
ONS. There is no reason why they should be expected to produce
very precise estimates of growth in the service sector. We should
certainly like to see more resources devoted to trying to understand
what is happening in the service sector because this is now many
times larger than the manufacturing sector. We feel that the official
data for manufacturing output are very reliable and we do not
feel that there the other sources of information to which we have
access really add very much to the official data. I do not think
we feel quite the same about the services sector. This is a problem
facing statistical agencies around the world and it is a problem
which results from the changing structure of our economy and we
need to try to cope with that.
| 
