Select Committee on Treasury Minutes of Evidence


Examination of Witnesses (Questions 140-159)

MR MERVYN KING, MS RACHEL LOMAX AND MR CHRIS SALMON

27 APRIL 2006

  Q140  Mr Todd: Is anyone inside the room taking any notice?

  Mr King: Certainly I could be in lots of interesting places where it would be more valuable to be, but this last weekend was the first occasion, I think, where I felt genuinely that there was some real interaction among the people around the table and where we actually took a decision and did something useful.

  Q141  Mr Todd: To whom or to what do you attribute the improvement?

  Mr King: I think there were three people who played a very important role in this. One is the Managing Director, who really was determined to see a new approach to the running of the Fund. He has been very clear that he wanted to go ahead with the multilateral consultations and he drove this new approach through the IMFC. That is one. Secondly, John Snow, US Treasury Secretary, who in a very quiet but very determined way actually started to run with this under the US Presidency of the G7 in 2004, and under the US Presidency we made some progress. Under the UK Presidency last year, inevitably, because the UK priorities were on debt and development, the issue took a bit of a back seat, but again this spring John Snow, chairing the G7, ensured there was a lot of time to discuss it and he made very clear and forceful contributions, both at G7 and the IMFC. Thirdly, Gordon Brown, who as Chairman of the IMFC made sure that we did discuss the issues of multilateral surveillance and that we did sign up, all of us, to a new remit for surveillance for the Fund. It was actually a different meeting than many of the previous meetings and one where, probably for the first time, I thought this was a better way of spending that particular Saturday than any other previous Saturdays I have spent at these international meetings.

  Q142  Mr Todd: One of the British innovations has been the introduction of the IEO and that gets a nod also in the weekend's conclusions as playing an increasingly important part in the surveillance of the effectiveness of the IMF's management. Do you have any qualms about the governance of the IEO in ensuring that they are genuinely empowered to question the capabilities and competencies and delivery of the Fund?

  Mr King: I do not think it is a question of governance. I think they have shown that they can do it. I think it is a question of leadership, and we look forward, to see how effective the IEO will be under new leadership, I think it is a question of personal drive and leadership, and they have done it, the first Head of it was very effective and we hope we will see the same under the new leadership.

  Q143  John Thurso: I would like to turn, if I may, to the general question of some globalisation phenomena, in particular to the relationship between globalisation and resources. It seems to me that, given some of the shocks we have had in the last century to the world economy, we are in a period of some relative stability, but that the big, potential fly in the ointment is resources, and particularly energy resources. I would like to ask a couple of questions, both how that impacts domestically and on the world scene. Turning to domestically, first of all, we have seen the problems of gas supply that we have had over this last winter; do you think that the UK Government should be seeking to secure supplies in some way, or is this something which can be left to the markets and to individual companies?

  Mr King: I think I would want to draw a distinction between the UK position vis-a"-vis natural gas and the more general question of resources in the world economy. There are steps which have been taken that in due course will make sure that it will be a perfectly reasonable in the UK to expect that changes in demand for gas would indeed be met by corresponding changes in supply. That may well be beyond next winter; it will depend on how quickly the link to the new pipeline to Norway opens up. More generally, I think one of the changes in the world economy, over quite a long period, has been a growing recognition by countries that prices are helpful, and we should not shoot the messenger. If the oil price goes up, rather than blame the oil price we should recognise this is a symptom of what is happening in the world economy. It is helpful, in a sense, that the higher price will help to discourage demand and encourage investment in new supply, so perhaps we should welcome that. There are messages which tell us that there are these big swings and there are genuine questions about issues such as security of supplies of something like oil, where it is very difficult, in the short run, to find alternative supplies of energy. That is very much a political question, not an economic one, so that is more for politicians than central banks, but I do accept that there are real questions about security of supplies. What I would say is that one of the roles of a body like the IMF is to be part of an approach of working together .The spirit behind the IMF was initially that the world had been through not just war but also protectionism and a deep recession, individual countries realised that pursuing their own national self-interest had not served the world well, some form of working together, however ill-defined, was desirable. In 1944-46 with the IMF, it was thought to be fixed exchange rates—that was in a world of no capital movement. Countries were trying to find a way in which they could operate together, retaining national sovereignty over their own policy but recognising that there are spill-over effects of one country on another and trying to put in place a framework for enabling us to work together to resolve big conflicts. There is no simple instrument for the international institutions, nothing easy that they can do and clearly no track record of great success. Nevertheless, the Fund could enable countries to come together to talk about these questions. To hear the Saudi Finance Minister explain his policy, his approach and the problems that he faced and to get the oil-consuming countries in the same room, around the same table, listening and talking, is a lot better than people staying at home and making comments to camera which can be dismissive of other countries' problems. It helps people to recognise that we are trading with other countries and not just with some impersonal market force. I think there is some benefit to that but I do not want to claim it is enormous. I do think, however, there are cases where the breakdown of the international trading and financial system will be deeply damaging and in that sense, it is analogous to a central bank. When things are going fairly well no-one should take any notice, no-one should realise it is there, no-one need bother with it really. When things really go wrong that is when it matters that you have a well-run institution rather than a badly-run institution.

  Q144  John Thurso: In your response there, and it is fascinating to hear you make that response, largely I agree with it, it seems that there is a basic assumption, if you like, that there is a system which is working well and that things start to go wrong in it and by coming together one can improve it. If you look at resources, in particular energy resources, and, say, the growth in China, I think in the 17th century it was the world's largest economy and it is projected to be back there within 20 years, or whatever it is, the massive increase in consumption of not just oil but steel, copper, every form of raw resource, I would have thought must be putting a very considerable strain on other economies and it is almost as big a strain as to be changing the system. Looking at it from an IMF point of view but looking at it also from a UK economy point of view, is that something which should be of major concern, and what can we be doing and should we be doing about it?

  Mr King: It is certainly of major importance, but I think one of the great strengths of a body like the IMF is that it does not look at this in a piecemeal way by saying, "Oh, China's caused a problem because oil or metals prices have gone up." I went to a nickel plant in Swansea last week and the price of nickel has been rising rapidly. This has big effects for companies all over our country, so China is having a big effect. The great virtue of the IMF is that it can look at it in the round, so that, yes, the oil price has gone up, the prices of metals and other commodities have risen, but the prices of many of the other commodities that we import from China have gone down. The net result has been that over 10 years our standard of living has risen faster than it would have done had not China and India and other economies integrated into the world trading system. The whole point of something like the IMF is to pull off what is a very, very difficult political trick, which is to persuade the majority of our citizens that being integrated into a world trading system means that we are all better off, even though any one of them may simply see the adverse impact of competition in the world economy, because their company is laying off people if they are facing competition. Trying to look at this on balance and as a whole is most important; we have all benefited from the success of the international economy. In 1944, when Keynes and the others sat down at Bretton Woods they did so because of how much damage had been done by the collapse of the world trading system in the early 1930s and all the problems which flowed from that. Even though you cannot easily point to an instrument for the IMF, the fact that we have a way of drawing to everyone's attention the benefits of thinking about the world economy and our being integrated into it is of immense importance.

  Q145  John Thurso: It seems to me that there is one aspect which may be new and outwith that thinking and that is the climate change agenda, in that for the first time we are actually looking at a bad, if you like, impact on the planet of our consumption of resources, and we are beginning to understand the need to measure that and to look at that, and our problem is how to keep the world economy going whilst, at the same time, tackling that. What do you see as the tensions between the need to ensure secure energy, both for the UK and for the world, and the fact that the UK wishes to be a leader in reducing the causes of climate change?

  Mr King: Clearly there are trade-offs between what actions it might be sensible for the world as a whole to take, in dealing with climate change, and policies on particular forms of energy consumption. What is most interesting about this is that everyone must recognise that, although there may be intellectual disagreement about the right way for the world to approach it, nevertheless it is a world problem and not a national problem, and if we try simply to deal with this on our own we will fail. I think climate change is very similar to many of the other problems which the IMF faces, which is, here are examples of issues where we can all be better off if we work together than we can be if we simply go it alone. That does not give you the answer as to what we should do about climate change, and clearly there are genuine differences of view, particularly between the US and other countries, about what is the right strategy for dealing with it. What I think is accepted is that this is a global issue, in exactly the same way as the Americans at the IMF accept that the global imbalances are a matter for the world as a whole and not just for the United States or even the G7.

  Q146  John Thurso: Is one of the challenges, therefore, that, for example, if we take the method in which we generate energy or consume fossil fuels, we might have a domestic solution but which would have not a great impact across the whole world? Therefore, if we look to China and India, we have to be looking to solutions which are non-consumptive of fossil fuels and help to lower world carbon emissions, which actually may be a different solution on an international stage from one we might be looking for on a domestic stage?

  Mr King: If we look purely at our own self-interest, in a purely domestic sense, the impact that we can make on global warming is tiny, so you just ignore it on the grounds it will be too small. We are concerned about it, because we can see the problem facing the world, but it is one which can be tackled at only the international level, not purely at the domestic level. That is not to say that you cannot do something at the domestic level, but if you approached the problem purely from a domestic point of view you would not be giving very much weight to these global issues. Of course, that is exactly an analogy to the global imbalances. It is why, only when they become sufficiently serious and countries see that they are important, they are willing actually to come together and talk about it. I think we have pretty well got to that stage now on the global imbalances. That is why at the weekend I think the IMF did take this quite significant step forward in setting up the new framework of multilateral consultations to enable us to talk about all these issues. They are quite different from climate change but they have one, very big thing in common, which is the need to talk together internationally rather than approach the problem as a purely domestic one. Even if the United States did not care about the rest of the world, which is not true, but even if it did not, it would not make sense for the United States to think about the resolution of its own current account deficit solely in terms of domestic policies.

  Q147  Jim Cousins: Do you not think, Governor, that despite all the very interesting and insightful things that you have told the Committee this morning the risks that imbalances will unwind in a chaotic way of their own accord are increasing rather than decreasing?

  Mr King: I think it is very hard to judge. The risks are real. I am not sure whether they are bigger now than they were last year. I think you can argue that, if they were to continue for several more years, the risk of a major adjustment, which would be disorderly, would be greater, because they would be that much bigger. There are many different scenarios that you could imagine for how these imbalances would unwind. They could happen gradually over 10 years in fits and starts, with movements in the exchange rate, not all in one day, such that, after 10 years, we could look back and detect a gradual fall in exchange rates and unwinding of the imbalances. It is very hard to disentangle the underlying trend from what is going on at present. That is not to say that there is not also, at the same time, a significant risk of a sharp adjustment in exchange rates, but what we do not know yet are the consequences of that. We saw in the 1980s there was a very sharp fall in the dollar, which in fact did not have major consequences, at least for the developed world. It is conceivable that we could get big changes in exchange rates, which led to gradual adjustments of imbalances and, provided policy responds in other parts of the world, outside the United States, might well lead to a relatively stable adjustment. Certainly also you could imagine cases where a sharp change in exchange rates could lead to further financial instability and start to lead to a disorderly adjustment, which would be very costly and might involve recessions in some countries; that certainly is a possibility. It is very, very hard to judge the relative probabilities of these events. This was discussed at the special IMF seminar on Friday in Washington, and I suppose it is fair to say that the consensus view around the room was that the probability of a disorderly adjustment was less than a half, much less than a half, but nevertheless it certainly was not negligible. That is why I think there is some urgency to try to renew the efforts for these multilateral consultations.

  Q148  Jim Cousins: Do you not think, in that context, that it would be wise of governments to consider how they could protect their people and their own labour markets and their own energy markets from the possibility of these shocks, without actually being protectionist? Indeed, if governments do fail to protect then the demands for much more overly protectionist policies are going to become very forceful?

  Mr King: I think that is right, but I think that I would suggest, as the appropriate policy response to avoid getting into that position, trying to make sure that countries have suitable monetary and fiscal frameworks which allowed them to adjust policy when there was an external shock. I think it is important, in monetary policy for example, that if we can keep inflation close to the target, when we get some very adverse shock we can cut interest rates in order to cope with it. What you do not want is a situation in which countries have allowed inflation to pick up and find that when there is an adverse shock their scope for relaxing policy is constrained. Equally, on the fiscal front, one of the main arguments for having a sensible fiscal framework is to ensure that if you are cautious fiscally in the good times then you have got room for manoeuvre in the bad times. Again, if you start with too high a fiscal deficit you do not have room to make that adjustment when the bad time occurs. I think it is not a question of protection, and I am not quite sure what you meant by the "protection" there, but I would suggest putting in place a macroeconomic policy framework which would give countries an opportunity to respond to shocks when they occurred. I am not sure if that is what you had in mind?

  Q149  Jim Cousins: It is, but I am left with the feeling that in the end it may be Hugo Chavez rather than Gordon Brown who is offering the right framework of political responses to these situations; not "the right" in terms of how we would like it to be but the right framework in terms of how it turns out?

  Mr King: Can you say what it is about Hugo Chavez that you think is more attractive than Gordon Brown?

  Q150  Jim Cousins: That I think is an interesting matter, for another occasion. I do actually have views about that.

  Mr King: I would love to hear them.

  Q151  Jim Cousins: Yes, indeed, and I would love to share them with you, but really on another occasion. What I mean by that is that the dramatic, populist, immediate political reactions to events and the attempt to wind things up and screw things out may become very, very attractive political mechanisms. That is really what I mean.

  Mr King: In addition to a parliament of people who do not respond like that and who continually try to talk to people about the long-run benefits from open markets and integration into the world economy, I think the only defence we have against that, is for policy-makers to ensure that we try to maintain a stable economy and full employment in normal times to demonstrate the real benefits from a market economy. For example, if we had 10 years of high unemployment in Britain then I think it would be much, much harder politically to resist the populist argument when a shock came along. The fact is that over the last 10 to 20 years we have had a stable economy and falling unemployment, at the same time as lots of companies have closed down, as a result of competition with the world economy. New companies have started up. We have seen massive industrial change in Britain in the last 20 years and yet it has not led to mass unemployment, it has not led to economic instability. We have been able to cope with that adjustment. Moreover, the fact that we have made those changes in our industrial structure has led to faster growth in our standard of living. If we can demonstrate that, over a period of time, that is the best defence we have got against someone using the populist card.

  Q152  Chairman: Governor, I have just a few questions, in the wash-up, which are important for our inquiry. Evidence given to us, or submitted to us, has suggested that the IMF is developing into a ratings agency for private members and policy support instruments could be seen in this light. How accurate is that assessment?

  Mr King: Certainly it should not be seen as a ratings agency, it is not there to take responsibility; otherwise, if it does take on that responsibility, it will come under great pressure to continue to lend to countries when they get into trouble. Perhaps I could ask Mr Salmon to comment on this, because he has been involved in some of that debate about the Fund.

  Mr Salmon: On the particular policy support instrument, as I understand it, its main focus is low-income countries, which do not have a lot of market access. It is something which the community itself wants so the Fund can signal if a country is following sensible policies to the rest of the international community which has dealings with those countries. I am not sure there is much of an overlap between the Emerging Market Economies, which care about their ratings, and the countries for which PSIs would be relevant. That is my sense, but I need to go back and look in more detail at the PSI and who it is designed for to give you a fuller answer[1]

  Q153 Chairman: If you would write to us on that, that would be good; is that possible?

  Mr Salmon: Yes.

  Mr King: Yes.

  Q154  Chairman: Given that the 13th review of IMF quotas is currently upon us, what reforms of the IMF's governance structure would you like to see? Would one possibility be that surveillance issues are dealt with via "one member, one vote", which would reduce the scope of one country to affect the analysis?

  Mr King: I am not sure if voting is directly relevant to what I think of as successful surveillance qualifying, because what we agreed at the weekend was this new approach, of multilateral consultations, switching the focus fromfrom bilateral surveillance, at least for the major economies in the world, more towards the spill-over effects which those economies have on other economies. What I think is more relevant is ensuring that the Fund has a clear, independent voice but that we hold them accountable for it, so they have to think very carefully about what they say. In that sense, it is not a question of voting. Voting I think is more important when it comes to changes in the financial structure of the Fund, or indeed the lending programmes. Typically, with lending programmes, the management does it and asks the Executive Board ex post for agreement to it. Again, I just do not see voting as being a major factor in day-to-day decisions. That is not to say that a proper reform of quotas and voting rights is not important, it is, because that produces the legitimacy of the institution.

  Q155  Chairman: The framework that you have outlined this morning indicates that there are big changes required in the IMF. The lending element I imagine has gone down anyway, with Argentina and Brazil having repaid that. With these changes, how can we ensure an adequate income stream for the IMF?

  Mr King: That is a very interesting question. I will ask Rachel to comment, in a minute, because she works closely with the deputies on the development of these ideas. Clearly, the peak lending of the fund was over 70 billion SDRs, now it is down to 25 billion. Their income has come from a turn on the difference between borrowing and lending rates, so it is going to shrink quite considerably in the next three or four years, and that will focus minds, undoubtedly. I think, at this stage, it makes more sense to focus on the question of what the Fund is for and what do we want it to do. Once we have clearly answered that question then we can work out how best to finance that role. Rachel is closer to some of the more detailed discussion than I am.

  Ms Lomax: I think there is quite a lot of thinking still to do on this; there are a lot of possibilities. You can move towards something which involves annual subscriptions or contributions of some sort; there are lots of disadvantages in doing that, in terms of assuring the Fund a steady flow of income which is not too dependent on political pressure. Or you could give the Fund an endowment, which would generate an income over a period of time. Or you could do something which I guess is more akin to the kind of framework we have got for the Bank of England, which is a sort of medium-term financial framework which you look at every five years or so and maybe have some form of non-interest-bearing deposit. I think there are a lot of possibilities that people still need to discuss. As the Governor said, it is some way down the track. The important thing is to get some of these more high-level issues resolved.

  Q156  Chairman: Maybe one suggestion, would it be possible to levy, say, a basic surveillance fee, further to detach funding quotas and lending from the surveillance function of the IMF?

  Ms Lomax: Basic fees; yes, fees is another possibility.

  Q157  Ms Keeble: Throughout this morning's session there has been repeated reference to the way we do things in the UK, in terms of the financing, in terms of the models for working, in terms also of the kinds of economic frameworks. Do you actually see, if you like, the Bank of England model as being an important one in the IMF? Do you think we have a particular role to play there? Do you think they should look at what we are doing for a model of how to move forward?

  Mr King: I do not want to put it like that. What I will say is there are certain core issues which are relevant. The thing I do believe in very strongly is that public sector institutions should have one very, very clear core mission. It is very important to know what that is and it is very important for everyone in the institution to know what that is in order for it to be effective. The debates we have been having about what the Fund is for are very important. Secondly, you need a very clear framework for accountability of the people who run it. Thirdly, in terms of governance, you want something which is transparent and not vastly bureaucratic. Those are the three key principles I think I would draw out, from our experience.

  Ms Lomax: I think they are actually good, general principles of public sector reform which go wider than central banking; they have been applied very successfully to central banking, and not just in the UK. I think that Governor Dodge, of Canada, gave a very interesting speech recently, in which he was drawing an analogy between the lessons that we have learned from central banking and how they might be applied to the IMF.

  Q158  Ms Keeble: Do you think Britain has particular lessons to give on this?

  Ms Lomax: Central banks have lessons and I think we are regarded as a good example of how you do modern central banking, a very good example.

  Q159  Chairman: Governor, just the last point. What certainly I have taken out this morning is that in a global economy the IMF is going to be of increasing importance and I think that is threaded through the responses you have made. To take John's and Jim's points on globalisation, one of the aspects we want to look at is the type of policy responses that the UK will meet in this increasingly globalised world, but the issue of protectionism has been mentioned. I met German politicians the other day who visited us here and I got the feeling there was a much more negative approach to globalisation in parts of Europe than there is here, and indeed seven of us went out with the Foreign Secretary this week, I think he reinforced that particular point. In a bigger inquiry on globalisation, what advice do you have for us, in general terms; yourself and Rachel, just before you leave?

  Mr King: I am tempted to say, pat yourself on the back. What I mean by that is that, more than any other country in the world, Britain has resisted the temptations of protectionist, popular sentiment and has seen the benefit of integration into a world trading system. It is easy for a central bank or a central banker to talk about the benefits of an integrated world trading system and for an economist to talk about the benefits of free trade. It is much harder for politicians to do that, faced with constituents who may have lost their jobs, and it is hard for trade unions and it is hard for businesses. Yet Parliament, on all sides, and the trade union movement in this country and the CBI have all not tried to play the protectionist card. I think they deserve enormous credit for that. I think it reflects the fact of our own experiences, that we went through very difficult times, particularly in the 1970s, and we learned that trying to hold back the stem of change and progress was counter-productive. As I said in one of my speeches, if we had the same industrial structure now as we had 30 or 50 or 100 years ago, we would be a lot less well-off. The long-run lesson is that, as a country, we are much better off by embracing change and trying to manage it than we are by trying to resist it. In the end, that does require leadership, it requires political leadership in Parliament, in the trade unions and in business, and we have been fortunate in getting that. There are not many countries in the world where you can say that.

  Ms Lomax: I must say, I agree with that. I was thinking, over the weekend, when we were in the States, notwithstanding the fact that they have got a fabulously successful economy, it is quite striking how much more edgy the political debate is there about these issues. I was talking to some of my American counterparts about it. I simply cannot understand really why, and some of that must be to do with the political system, I think; the economy alone does not do it for you.

  Mr King: Please do not give up the effort to persuade many of your constituents.


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