Select Committee on Treasury Minutes of Evidence

Examination of Witnesses (Questions 1 - 19)



  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.

previous page contents next page

House of Commons home page Parliament home page House of Lords home page search page enquiries index

© Parliamentary copyright 2005
Prepared 30 December 2005