Examination of Witnesses (Questions 40-55)
Q40 Mr Newmark: Do you want to explain
to me what it is because it keeps moving the goalposts?
Sir John Gieve: The golden rule
is that you should balance current expenditure and revenues over
the economic cycle. The broad point is that the government should
pay for its current expenditure over a period of years. I rather
agree with the Committee, whose report I have of course been looking
at, that what matters for policy is the future prospect. Of course
the government has to explain what is its record and has it kept
to its rules in the past; that is one debate. But what matters
for policy is, from where we are now, are the policies going to
keep to those rules in the future? That is the key question. The
Treasury's PBR says that they are, it reasserts its determination
to keep to that golden rule over, if you like, the next cycle,
the cycle starting today, and to offset today's deficits with
surpluses in the future. That is what the plan shows and that
is what they have said they are going to do; I think that is a
good policy and a sustainable policy.
Q41 Mr Newmark: Do you not think that
it is important, having told the markets to set out a framework
in which the golden rule is, that the Chancellor then, when things
do not quite match up to the initial parameters that he set, he
should not be slightly time shifting those rules, or is that really
not a concern?
Sir John Gieve: As I say, the
key thing for us in assessing the strength of the economy and
how it is going to develop is what is going to happen from now
on? The question of how you measure what exactly has happened
in the past is inevitable in politics because rightly you are
going to hold the Treasury and the Chancellor to account for whether
they have done what they said they were going to do. So inevitably
you are going to be saying, "Since 1997 have you kept to
the golden rule or not?" So that is an important debate in
terms of accountability, but in terms of what is going to happen
to the economy the key thing is: where are we going from here?
Why I said I think the golden rule is a good rule—it is
not the only rule he can have—is because it is definitely
sustainable and it is easily understood. I am not going to get
drawn on the fine print of when did the cycle start? And when
did it finish? and so on and so forth because I think that is
not a matter for me.
Q42 Chairman: You started in the Treasury
in 1978, Sir John, and in your answers to us about oil prices
you mentioned the impact on prices and the wider impact of the
rise on the economy will depend on the causes of the increase,
which seem different now than in the late 1970s, and there has
been comment that unlike the late 1970s inflation has not ripped,
or there has been recession. What is the difference between now
and the 1970s?
Sir John Gieve: I suppose the
1970s was more of a pure supply shock; it was a cartel forcing
prices up and restricting supply in order to do that, whereas
today I think the obvious explanation of the rise in prices is
simply that demand is increasing, particularly demand from China,
India and the developing economies. So the cause is different.
What we saw after the 1970s was a decline again in oil prices,
and I am not sure that that is so likely this time, although I
am not getting into forecasting whether it is going up or down
in the next few months. The underlying cause of the rise is partly
some supply difficulties and hurricanes and so on and so forth,
all of those are factors, but underlying that is a rapid growth
in demand for oil. So we have a simple supply and demand change.
Q43 Mr Love: Do you think there is any
potential conflict between your two roles, one as a member of
the Monetary Policy Committee and the other as the person responsible
for financial stability?
Sir John Gieve: No. Sorry, do
you want me to elaborate?
Q44 Mr Love: I was hoping that you might
elaborate slightly; that is a very definite response. Perhaps
I can ask the question in a slightly different way. Do you think
the fact that you have responsibility for financial stability
will in any way influence whether or not you turn out to be a
hawk or a dove as a member of the Monetary Policy Committee and
have you made any assessment of the likely impact that your role
for financial stability will have on it?
Sir John Gieve: I have three roles
because I am also a member of the FSA Board and so I have that
angle too, and I think it is highly desirable to have a very close
working relationship with the FSA. The point is, looking at things
like asset prices, risks of disruption in the market and so on
I am worrying about that from two points of view. The MPC worries
about that and you will have seen that practically every member
of the MPC has been talking over the last few years, about global
imbalances and risks and so on to the future. I suppose I have
a particular angle on that which is that a disorderly correction
of those imbalances could well give rise to problems in the financial
system. So I am bound to think a lot about it in both roles, so
that perhaps gives me a particular angle coming to the MPC. On
the other hand, like other members of the MPC I am working there
to a particular remit, and that is a practical judgment of what
is going to produce 2% inflation in two years' time. I hope I
will bring an open mind to that and I will take account of the
risks as indeed the other MPC members do. But I am not coming
into it with a feeling of, "I would much rather it was 1.5%
so I will aim off on the downside," I am going to try, as
other members do, to get it right.
Q45 Mr Love: Let me press you a little
on that because in a working paper from the Bank of International
Stability they said that there should be a greater willingness
of the monetary authorities to respond to the occasional development
of financial imbalances that cause a threat to the economy. Do
you think that is a legitimate claim and will that influence you
strongly in your role in the Monetary Policy Committee?
Sir John Gieve: I am pretty cautious
about the idea of pricking asset price bubbles by changing interest
rates. If you had perfect foresight and you were certain that
an asset price rise was a bubble then life would be a lot easier
and it would be open to the Bank to consider at any rate trying
to prevent asset prices getting out of their long-term trend.
But in practice that is extremely difficult. You have watched
the papers over the last few years and how many times do you see
scare stories about house prices about to fall like stones and
so on? Several times a year, every year. So there is a great risk
that you get these things wrong. Secondly, it is not altogether
clear what the appropriate action is, and there is a great danger
that you utterly distort monetary policy and therefore its impact
on demand and underlying demand in an attempt to manage asset
prices. So I am very cautious about it. I absolutely understand
why, looking back over history, you can see times when severe
asset price bubbles have happened, broken and afterwards people
can say, "It would have been better for someone to try and
take some preventive action." So in theory, yes, you have
to be alive to that, but I would be pretty cautious in practice.
Q46 Mr Love: Can I turn to the risks
to financial stability? There has been quite a lot of discussion
recently about the lag between financial innovation and setting
up some sort of controlled environment to ensure that you do not
have instability. Have you had an opportunity to make any assessment
of where you think those risks may lie in the financial system?
Sir John Gieve: Not really. This
is one of the areas where I am going to have to do a lot of work
to catch up with where we are in the financial markets. There
are two different angles on this: one, the FSA is naturally concerned
about consumers and consumers getting into difficulties, partly
because they do not understand what they are buying, and they
have given some warnings—yesterday, I think—about
that and that is one point. I guess from the Bank's point of view
the question is not so much that as what are the risks of these
things leading to a real financial crisis and systemic risk? It
is one of the things that is on the list, absolutely, particularly
where you get a lot of innovation and you are not sure that the
markets will remain open, for example, if there are shocks. That
is a cause of worry, I know, and I will be thinking about that
a lot.
Q47 Mr Love: Are you confident that the
Bank has the necessary competence and expertise in recognising
that there is an increasingly complex environment and an increasingly
fast moving international financial market place, and that it
is up to being able to ensure financial stability into the future?
Sir John Gieve: You never reduce
these things to a zero risk, that is the first point. The people
I have met at the Bank have impressed me; the Bank has the advantage
that it is actually a player in some of these markets as well
as an observer, so it can bring to the party people who actually
operate in the markets with the main banks and other counter parties.
I absolutely see the risk that the Bank could get detached and
I see it as part of my job to make sure that it does not.
Q48 Susan Kramer: Sir John, I shall be
fascinated to see how you adapt to the culture of actually taking
a view and voting on a number. Can I pick up one issue that was
touched on a few moments ago, the issue of asset prices, to clarify
something? You talked about the risk of doing more harm than good,
in effect, of focusing on something like a house price bubble,
but would you completely rule out taking a specific action if
you felt that the bubble was getting extreme, or are you leaving
yourself some room to say there might be situations in which you
might indeed target that bubble?
Sir John Gieve: No, I think I
am leaving myself room. That will depress you further, but I am
leaving myself room. All I am saying is that you need to be very
certain of your ground, (a) on assessing the state of the market,
and (b) on assessing how you can actually impact on it. Of course
there are things that the Bank can do short of changing interest
rates to have an impact on expectations for example it can talk
about things; it can talk to the market participants and of course
it does that a great deal, and that will be one of my roles.
Q49 Susan Kramer: To talk about another
kind of shock, somewhat related. In November Sir Andrew Large
told us he was concerned that beyond a certain limit of leverage
it is possible that a shock can influence households' consumption
and behaviour much more significantly compared with the case where
households have lower levels of debt. Do you share Sir Andrew's
concerns in this area and, if you do, how would you reflect that
in your financial stability work?
Sir John Gieve: I can see what
he is talking about. As I say in my answers to the written questionnaire,[5]
you have to look at the household balance sheet as a whole: assets
and liabilities. I would expect both to continue to grow over
the next few years, mainly because this is very housing dominated
and over time you expect to see people selling houses and putting
the proceeds into financial assets while new buyers build up mortgages.
So I would expect over time to continue to see both sides of the
household balance sheet increasing and I do not think that that
is worrying in itself. So in a sense I think this comes back to
the house price question. Obviously what could cause disruption
and has been a source of worry in the past is if you have a sudden
fall in house prices. I think I am less worried about that now
than I would have been a couple of years ago when house prices
were increasing very fast, but actually over the last 18 months
we have seen a period of a fair degree of stability in house prices
so we have had what you would hope to have in terms of an adjustment
without disorderly reductions, but obviously that is something
you have to keep watching. In terms of financial stability I think
the main risks that the Bank and others have identified to systemic
instability arise outside the UK. Of course there are things to
worry about: there are risk premia and the narrow spread of those
within the UK, but I think the greater risks come from the effect
on our system of a correction in global imbalances and that is
the big black cloud, if you like, which is worrying people concerned
with financial stability.
Q50 Susan Kramer: Another black cloud
is obviously the whole issue of terrorism, which is a risk in
that sense to financial stability, and obviously coming from the
Home Office you have a particular background in this area. Given
that background and your knowledge of emergency planning how robust,
in your view, is the UK financial system and its ability to recover
from some sort of major operational disruption?
Sir John Gieve: You are right,
that operational risk is something that is very important and
is as important, in my mind, as the risk of a financially generated
crisis. I think the banks individually and the system more generally
are far more resilient now than they were a few years ago. What
we were discussing yesterday in the Standing Committee was next
year's programme of exercises with the private sector and also
among the FSA, Bank and Treasury, to make sure that we are in
a position to handle operational breakdowns of a variety of sorts
and I think that programme has been very valuable. But the exercises
always show that procedures do not work perfectly, and you will
see that the FSA put that right at the top of its publication
yesterday. Their advice to firms is to do more stress testing
of their operations, and I think more of that needs to happen.
Q51 Susan Kramer: Lastly, since you have
essentially said that the biggest risks that you see are ones
that essentially beyond our control because they are global and
beyond the borders, are there any missing tools that would make
a difference in being able to respond and achieve that orderly
adjustment that you have talked about as being so important?
Sir John Gieve: I obviously have
to get into this in more detail. I think the most difficult thing
in this area is international coordination and making that real,
and the exercise programme that we are talking about includes
working with some other countries on how we interact, and so on,
and I think that is essential—I am going to go to various
international meetings in the next two months which will be discussing
how we coordinate—and there is no doubt that is the most
difficult thing. From the Bank's point of view, looking at Britain,
we need to take account of the fact that there will be imperfect
coordination in planning what we do and what we need to be ready
for. In terms of levers, I suppose one thing that I will be looking
at with the Treasury and the FSA is whether we have the right
oversight levers around payment systems because the Bank obviously
has a particular concern about the high level payment systems,
and we will be looking at that.
Q52 Chairman: Sir John, last February
the Governor made a speech in which he said that there needed
to be a more cooperative outcome to resolve the global imbalances
in the International Monetary System. If so, and you agree with
him, do you think that the IMF is the body to do that?
Sir John Gieve: I do not know
is the answer to that. As it has developed the IMF has focused
increasingly on dealing with macroeconomic instability in developing
economies; it has not been the leader for the whole world monetary
system. I know that they have set up a strategic review to see
whether it should be redefining its role and I will be interested
to see how that develops and to play a part in it, but I am not
sure whether it can play that role.
Q53 Chairman: What are your thoughts
on the appropriateness of that review which was undertaken in
September by the IMF? Do you have any at the moment or would you
be willing to forward us your views because one of the inquiries
we are undertaking very shortly is into the IMF and the World
Bank, and then we are going to go on to globalisation. So these
are areas that, you being responsible for the International Finance
Division of the Bank, seem to be very germane to us.
Sir John Gieve: I saw that you
had started an inquiry and I do not think we have yet seen the
result of the IMF's initial work. The IMF has set up various working
parties, has it not, to look at different aspects and we do not
have any of that output. So at some point I am certainly willing
to come back and talk about that. Actually this is of as much
concern to Rachel as it is to me because she is the Governor's
deputy on many of these IMF issues. I know that the Governor is
going to talk about this in the next few months again, about the
reform of the IMF. It may not just be me but I think the Bank
would certainly be willing to contribute.
Q54 Chairman: Thank you. Lastly, Sir
John, in your questionnaire which you sent to us, question five
on accountability, you made the point that the parliamentary process
needs to include some individual accountability. We have spoken
about that a bit this morning, but you have made me think that
if it needs some individual accountability is it not a case for
taking back to your colleagues the possibility of an initiative
where you provide us individuals with a written account of your
work progress views over the year as well as coming before us?
Why do you not take that back with you?
Sir John Gieve: Okay, fine.
Q55 Chairman: Thank you very much for
your time, Sir John, and every success in your role as Deputy
Governor.
Sir John Gieve: Thank you.
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