Examination of Witnesses (Questions 40
THURSDAY 24 NOVEMBER 2005
Q40 Angela Eagle: Have you given
any thoughtI am sure you have, but perhaps you would like
to explain to us what it isto the prospect of the cold
winter and some of the scaremongering which I think is going on
at the moment about volatility of energy prices for business?
Has that played a part in any of your deliberations up to now
in the decisions you have made on interest rates?
Mr King: I referred to it briefly
earlier when I said that there might be some risk to economic
activity over the next year if there were to be reductions in
supply as a result of the inability of firms to have as much gas
as they wanted. Here I feel tremendous affinity with the Met Office.
Q41 Angela Eagle: You are doing a
very similar thing in many ways.
Mr King: They too employ extremely
qualified and talented people, they too are very careful in their
statements and they too find that many journalists and newspapers
find the concept of probabilities extremely difficult to understand.
The Met Office made it absolutely clear. They said that there
is a two-in-three chance that there will be a colder winter than
normal. That is a very reasonable and sensible statement based
on their analysis of all the data, in particular the North Atlantic
oscillation and the likely fact that that may become negative.
There is a very good intuitive story behind it, which is that
if that happens, then, given the change in the likely direction
of the winds, we shall have more east and north-east winds in
the winter than we would normally have. On average that would
lead you to expect it to be colder.
Susan Kramer: You really have spent time
following this, have you not?
Q42 Angela Eagle: I must say that
I find it rather reassuring.
Mr King: Let me make clear as
a matter of record that I am an Associate Fellow of the Royal
Meteorological Society. The important point here is that this
is a matter of balance of risks and what the Met Office said was
that, in their judgment, there is a two-in-three chance that it
might be a colder winter than normal. That is the kind of statement
that they are paid to make. If it turns out not to be a colder
winter than average, that does not mean to say that they were
wrong and the rest of the world was right and they were incompetent;
it is merely the fact that you cannot judge this kind of forecast
record except over a long period. It is just as true of the MPC
and I refer you to an article in the August Quarterly Bulletin
which pointed out that when we make judgments about the central
projection, there will be many occasions when the outturn will
be different from the central projection. Every now and then,
the outturn will be a long way from the central projection. That
does not mean to say that we are wrong or that other people were
right. It is a question of balancing probabilities. So that is
a rather long-winded way of answering your question. I go back
to the point that one of the most important roles that you have
to play in public life, you have to play as politicians leading
public opinion, is to make sure that you understand probability
yourselves first and do not jump on the band wagon of saying,
ex post, when an outturn is different from the central
projection, that these people do not know what they are doing.
That is a completely silly reaction and I want to flag that in
advance before some of the journalists decide to jump on the Met
Q43 Angela Eagle: Perhaps you could
give that lecture to the editors as well, and then we might all
be in a more predictable situation.
Mr King: I am hoping that some
of them are listening by default.
Q44 Kerry McCarthy: In your Inflation
Report, there is a comment that UK export performance has
been somewhat disappointing in recent years given the expansion
in world trade. How do you explain that disappointing performance?
Mr King: What we have looked at
is the share of exports in world trade and that has continued
to fall. It fell faster after the sharp appreciation of sterling
against the euro and it has continued to fall. The position during
the course of 2005 looks more encouraging. The growth rate of
exports in the first nine months of this year, exports of goods,
has risen at its fastest rate for five years. So the signs are
that there is beginning to be a rebalancing in the economy, but
only the very flickering of an early sign. Over the next few years
we need to see a continuing expansion of exports. World trade
is growing solidly and there is no reason to be overly pessimistic
on that front. It is also an areaand I think this makes
our life extremely difficultwhere the data are particularly
problematic. If you look at the export data, you certainly cannot
look at them monthly and draw any conclusion. In my view you cannot
even look at them quarterly and draw a conclusion; you need to
look at them in half years. There is often a straight zigzag pattern,
quarter by quarter, which is a classic symptom of measurement
error. So you have to look at the pattern of exports in half-yearly
frames. Even there the picture in the last few years has been
distorted by alleged fraud, whereby goods are both exported and
then imported as a VAT avoidance device. This has inflated the
figures for trade. The ONS try to make an adjustment for it to
produce what you might then think of as "economic" imports
and exports. But when the data themselves are subject to large
measurement error on a quarterly basis and there is a very significant
amount of fraud the data themselves produce a very cloudy picture
here which complicates our attempt to tease out what is happening;
it is not easy to see what is going on. There are some encouraging
signs during this year and the underlying picture is one in which,
given the exchange rate and the very solid growth of world trade,
we should expect to see continuing growth in exports.
Q45 Kerry McCarthy: To what extent
do you think the UK's dependence on exports to the euro zone,
as compared to the US and China which are doing better, is a factor?
Mr King: Undoubtedly the fact
that over 60% of our trade is with the euro area means that the
weakness of domestic demand growth on their part is a depressing
factor for our export growth. It continues to be the case, and
we see it as we go round the country and listen to exportersthey
are still awaiting a significant pickup of domestic demand in
the euro area. Again, we are beginning to see now some more encouraging
signs. We expect even in Germany, that over a period domestic
demand would rise to match their quite sharp pickup in exports.
There are some countries in the euro area, particularly in the
southern part, which are experiencing more softness. We are beginning
to see now in the euro area some signs that growth is likely to
pick up towards trend, but in their case the major economic challenge
is that the trend growth is relatively low.
Q46 Kerry McCarthy: The report also
notes that rising energy prices have resulted in large current
account surpluses in oil producing countries, particularly the
OPEC countries, Russia, Norway. What evidence is there that they
are beginning to spend these surpluses?
Mr King: There is evidence that
they are beginning to spend them, particularly on purchasing manufactured
imports, and particularly capital goods. There is no doubt that
that is one reason why German exports have picked up so much.
This was mentioned to us at international meetings by the Bundesbank
six to nine months ago, as something that they were already seeing
and now it has been visible in the data for Germany. We have also
picked up from comments in the UKperhaps not quite to the
same extentthat people are now finding there are more opportunities
to export to the oil-producing countries. There are clear signs
of a pickup, but maybe Andrew or Rachel heard other comments on
their visits around the country.
Sir Andrew Large: No, I have heard
the same thing. You ask how they are spending their money. You
only have to look at the stock markets in the oil-producing countries
to see some evidence of that. On spending externally on goods
that would be exported from us and from other countries, certainly
I have the impression that there is a reasonably robust amount
of activity there.
Ms Lomax: It is just going to
take time. They cannot crank up their spending overnight and some
of these domestic markets are booming, but even so, if you look
at the current account positions, the impact of higher oil prices
has been one reason why the divergence in current account positions
across countries has widened this year.
Q47 Kerry McCarthy: From what you
say, it looks as though there is both investment in infrastructure
going into manufacturing again, but also in financial assets as
well, so it will have a knock-on effect on savings.
Mr King: Certainly much of the
surplus they now have on their current accounts through the export
of much more valuable oil is being saved and therefore invested
in overseas financial assets. Some of that, as Rachel said, is
beginning to come through now to actual spending on imports. It
would be crazy on their part suddenly to massively buy things
they cannot implement; it will take time. The effect of that is
already being seen, in the UK too, not just in Germany.
Ms Lomax: Relative to the 1970s,
it is a very different situation. Most people would say that the
ability to spend is much greater than it was in the 1970s.
Q48 Kerry McCarthy: Economists have
said that when the US deficit is reaching the 5% point it is getting
to the point where it has to correct and you recently pointed
out that now it is topping 6% of GDP the dollar has tended to
strengthen. What is the explanation for that?
Ms Lomax: I should be a rich lady
if I knew. Economists are not very good on timing. I think everybody
agrees that this is not a sustainable position, but that it can
go on for quite a long time. Why is the dollar tending to strengthen
at the moment? Possibly David is better placed to answer this
than I am since he understands the mind of a trader from previous
experience. Relative interest rate differentials are probably
one reason why the dollar looks a good buy at the moment and the
US economy looks very strong and so on. I guess people may get
bored: the dollar has not gone into freefall, and something that
is not going to happen for a year may be not worth trading on.
Many people may have decided that the relative interest rate story
is enough to keep the situation stable for the next year and the
longer term is not something which is worth factoring into their
considerations at the moment. My American colleagues describe
the situation at the moment as one of "stable disequilibrium"
and I could not improve on that.
Q49 Kerry McCarthy: Can you improve
Mr Walton: I am pleased to say
that in my previous life I was never paid to forecast exchange
rates, so no, I do not have anything to add to that.
Q50 Mr Ruffley: I was interested
by your comments at your press conference about the factors which
caused the slowdown in consumer spending. You referred to two
causes worth emphasising. "One is the quite sharp rise in
the ratio of taxes to household disposable incomes, that ratio
has gone up by almost two percentage points over the last couple
of years and contributed to a sharp slowing in real disposable
incomes in the second half of 2004. It is not surprising therefore
that with that slowing households spent less". I know you
have already given an explanation to my colleague, Mr Green, but
could you just remind us whether that sharp rise in that ratio
is more than you would expect from normal fiscal drag?
Mr King: Yes, it is more than
one would expect from normal fiscal drag because it reflects in
part the rise in national insurance contributions which took place.
Q51 Mr Ruffley: Which was a policy
Mr King: Yes; absolutely.
Q52 Mr Ruffley: Does that 2% rise
include other taxes, taxes other than NICs and income tax? Does
it include council tax? I am just asking you to unpack that rise.
Mr King: It is income tax and
national insurance contributions.
Q53 Mr Ruffley: It is direct.
Mr King: Yes.
Q54 Mr Ruffley: What is interesting
is that in reply to Mr Green you implied that the ratio going
forward will not really have much impact on consumer spending,
other than maybe keeping it at the level which is sustainable.
It is historic average or just approaching historic average.
Mr King: Clearly the Government
planned for an increase in the ratio of taxes to disposable income
and indeed, it was not just household taxes but also corporate
taxes that were planned to increase. The increase in taxes was
designed to meet the fiscal rules and to finance the higher public
spending on health and education. So this increase of two percentage
points is meant to apply, not just to household incomes, but to
national income as a whole. It is too early to judge what is going
to happen to corporate taxes but we have already seen a good part
of that increase in household taxes come through to household
Q55 Mr Ruffley: On page 31 of the
Inflation Report, you say "It is also likely that
real post-tax labour income growth will recover moderately in
the first part of the forecast period, in part reflecting a gradual
pickup in earnings growth. In addition, there have been signs
of a gentle recovery in the housing market, providing support
to the pickup in consumer spending growth". You conclude
"Overall the Committee's central view is for consumer spending
growth to edge up towards its historical average". In that
you are making some assumptions. You are making an assumption
about the effect of a gentle recovery in the housing market, are
Mr King: I think our view is that
the housing market is probably continuing to be broadly stable
in terms of prices. We have seen a recovery in activity through
this year and loan approvals are actually slightly ahead of their
historical average. The way I should want to describe the housing
market is one of broad stability.
Q56 Mr Ruffley: May I just pick you
up there? I am just reading from page 31, ". . . there have
been signs of a gentle recovery in the housing market, providing
support to the pickup in consumer spending growth".
Mr King: What we mean by gentle
recovery in that sense is that house prices have risen a littlea
little faster than we had expected in August in factso
house price inflation is positive. I do not want to over-stress
that. Surely broad stability is the right way of describing it
but activity has recovered in the housing market and we feel that
recovery of activity and house prices will add a little bit to
support consumer spending; we do not think there is much of a
wealth effect from house prices to consumer spending but there
is a collateral effect. The fact that people have now seen that
house prices have not fallen in the way that many people anticipated
they wouldand there were many scare stories in the latter
part of 2004 that we would see very sharp falls in house prices,
which did not materialise. Indeed, in the last few months there
have been small signs of a gentle rise in house prices. That will
give greater confidence to the view that we may be less likely
to see those falls in house prices than people might have thought.
You can never rule it out, anything can happen. Now the view is
that there is this stability in the housing market which, if it
persists, will remove some of the uncertainty. That itself will
mean that consumer spending growth will not be quite as weak as
it was at the turn of the year.
Q57 Mr Ruffley: That is useful. You
say on page 31 that ". . . real post-tax labour income growth
will recover moderately in the first part of the forecast period".
When Mr Green was asking you about the tax burden point you were
giving us a strong impression that that was backward looking and
going forward real post-tax labour income growth will recover
in the forecast period. You have made assumptions in the part
of page 31 I read out about the housing market. I rather wonder
whether the Bank, in the interests of good policy making, have
made any assumptions about future tax rises. Before you leap in
and say of course you are not going to answer that, may I just
say it seems to me that if you are making assumptions about the
housing market, you made assumptions on the supply side about
what oil prices might be and what migration might be, it would
be sensible to have a view on some of the predictions that the
IFS make that two years out from now, the Chancellor, to meet
his golden rule, might have to raise taxes by up to £10 billion
a year, a kind of fiscal tightening that I would have thought
you might want to make assumptions about. Have you anything to
say on that?
Mr King: We do make assumptions
about the path of taxes; you are right that we do need to do that
and we do. The assumption we useand it is one we have always
madeis that we take the figures from the latest published
government plans, both for nominal spending and for the ratio
of taxes to income. We do not take the Government figures for
tax payments at face value, because we may have a different view
about the path of the economy, but we take their planned and stated
intentions for the structure of the tax system, for effective
tax rates, as given. What the IFS might be saying is that they
think the Government will be forced to change their policy in
two years' time. We do not make that kind of judgment, because
there is nothing to force the Government. The Government have
made their plans clear, they have stated what they will do with
the ratio of taxes to incomes and we use that as a basis for our
forecast until such time as they change that. What I have often
said in the past, and at this Committee, is that many commentators
are inclined to draw strong conclusions from the monthly path
of revenues, spending and the borrowing requirement that there
is no prospect of meeting the tough fiscal targets at the end
of the year. The one thing we do know is that revenues tend to
be bunched, particularly the unpredictable parts of revenues,
at the end of the fiscal year. It is very, very difficult to judge
what is actually likely to happen to those numbers and hence whether
any further action will be required. So we take the position that,
when the Government say that the ratio of taxes to incomes will
rise by two percentage points, as it did, we take that as our
central view. The Committee is always entitled to take the viewpoint
that we think there are risks to that and it may move on either
side. The Committee has not formed a view that there are risks
to that at this stage, but it is open to the Committee to form
that judgment, if it so wishes. So far, we have taken a central
view from the published government documents, both at budget time
and PBR time, as to what the ratio of taxes to incomes will be
and that we factor in. Of course, our view as to what will happen
to the tax baseincomesis different from the Government's,
because we form our own judgment about the pace of economic activity
Q58 Mr Ruffley: I just conclude by
saying that it follows, does it not, from what you have said of
what we know, that if there are policy changes of the kind the
IFS indicate might be necessary, taxes go up, the consumer spending
path will be hit and growth will be affected? But we know that,
do we not, that if taxes go up it is going to hit consumer spending
Mr King: What we do not know are
the circumstances in which that policy change might be made. It
is possible that policy change would be made in circumstances
where public spending was stronger, in which case the weaker consumer
spending might be offset by stronger public spending.
Q59 Jim Cousins: May I ask a question
of Rachel Lomax and David Walton, both of whom have made reference
to the forthcoming wage round in the remarks they have made to
the Committee? The Chancellor, in the last 24 hours, has made
it clear that he would like public sector pay to be pitched at
2%. Do you think that was a helpful remark?
Ms Lomax: I have no view on that.
As I understand it and as I recall from the past, Chancellors
and the Treasury frequently provide some input to the Review Body
deliberations. I just assume that was what would have been happening
this time. It is just part of the normal process.