Examination of Witnesses (Questions 20-39)
PROFESSOR ANTON
MUSCATELLI, PROFESSOR
SIMON WREN-LEWIS,
MR RAY
BARRELL AND
PROFESSOR TIM
CONGDON CBE
6 MARCH 2007
Q20 Ms Keeble: Ray, what do you think
about that?
Mr Barrell: I think you can see
that in the discussion on which index we should be using is an
indication of the success—
Q21 Ms Keeble: I am sorry, I cannot
hear you.
Mr Barrell: Even discussing which
index we should use is an indication of the success that we have
had, because the indices all tend to move together in the medium
term. Consumer prices, retail prices, producer prices—there
are reasons why they might move apart which we can understand
but they all tend to move within 2% or 3% or so together and therefore
any of them will actually do, and in 1992 anything would have
done when we had inflation running at 10%. Stabilising anything
would have been a good idea. One could argue that perhaps we should
either include more things in the CPI (but that has got to be
a Europe-wide decision because we use a common index) or we should
move to a producer price index, which is harder than it might
look to get more exact control over inflation. I think those are
secondary issues and we have to stabilise something. The CPI will
do; the CPI as measured will do, as long as we know what is missing
from it and what the problems are with it.
Q22 Ms Keeble: The question was about
credibility. Obviously what Professor Congdon referred to as the
debate about inflation has been missing for quite some time and
it is around the current public sector pay rises. Do you think
that it remains credible for the MPC to retain a very rigid definition
of inflation at a time when there is divergence in the public
debate and when there is pressure to look at perhaps including
house prices, one of the effects to which Ray referred. Professor
Congdon, I know you think that it is not the MPC's job to worry
about these things but there is obviously an issue about the public
perception of inflation.
Professor Congdon: As far as one
can tell, there has been some deterioration (or some rise at any
rate) in pay settlements, but it is not that dramatic, in fact
rather less than one might have expected given that the Retail
Price Index has gone over 4%. I do not think house prices should
be included in a large way in any measure of goods price inflation.
They do come in in various ways in the indices and I have not
much to add, frankly. The present situation is very interesting.
May I just make one point, and it may seem slightly political?
In my view there is a link between money growth and asset prices
and that then affects the incomes of people involved in trading
assets—stockbrokers and chartered surveyors and people like
that—and at the moment they are doing very well. Then you
have got public sector workers being told they are going to get
1.9%. This is a classic situation where you get trouble. There
have been many cycles like this in the past.
Q23 Ms Keeble: Ray, is there not
a slight problem of "ivory tower-ishness" if this definition
of inflation is far adrift from the public perception?
Mr Barrell: I think public perception
is not always the thing that really matters in pay bargaining.
Outside the public sector one can go along and say, "I want
RPI as my wage increase," and the employer has to say whether
he can afford it or not. That is a wage bargain. Inside the public
sector there is also a bargain and the public sector employee
can go along and say, "I want RPI," and the Chancellor's
response might well be to say, "The public sector has been
expanding; I want it to stop expanding and in order for it to
do that, my side of the bargain is not to give you RPI."
Pay bargaining is not just about fairness; it is about demand
and supply in the market, and it is demand and supply in the market
which will determine wages.
Q24 Ms Keeble: I know that the other
people wish to say something. Professor Muscatelli, you said in
your evidence that you thought one potential inflation target
measure was domestic output price inflation. I wondered if you
wanted to say some more about that.
Professor Muscatelli: Essentially
one of the arguments there is that there is a feedback effect
from the exchange rate on to consumer prices and essentially by
focusing on the domestic price index you can avoid some of these
issues. In the written evidence that Professor Wren-Lewis provided,
[1]he
expands on that quite a bit. The other point I would add just
to follow up on the discussion which I think is important is I
think CPI is a narrow index. Obviously if housing costs can be
incorporated that would be a positive step although, as Ray said,
it has to be done at European level. If that does not happen,
I think it could ultimately have an impact on the credibility
of monetary policy. Going back to what we were discussing earlier
about anchoring expectations, if you start targeting an index
which is a million miles from what people perceive to be the inflation
they are experiencing, then I think (especially at a time when
inflation is higher) that can have a big impact on expectations.
I think there is an issue there to confront in the medium term—if
not now then quite soon—in terms of incorporating at least
housing costs into CPI.
Professor Wren-Lewis: I just want
to make three points. The first is I think the Bank of England
has to stick to one index for a long period of time. It cannot
keep changing the index that it is targeting because that would
destroy credibility. That is the first thing to say. Secondly,
however, it is wrong to believe there is one right index or price
inflation measure to look at. I think the Bank should be looking
at a range of price indices, not just consumer prices but also
producer price indices and also wage inflation, so I think it
needs to be looking at all of those and if it is the case that
the CPI inflation is an outlier and all these others are rising
then I think it should act. That is the second thing I want to
say. The third thing is I am far from convinced that some measure
of housing costs should play a very big role in the Consumer Price
Index. It is not obvious to me why movements in house prices have
an affect on people's welfare. I think that is an interesting
debate to have and it is not obvious which way the answer would
come.
Q25 Ms Keeble: I just have one further
question for Professor Muscatelli. You suggested that there may
be evidence that although the target is symmetrical there is an
anti-inflationary bias and I wonder if you could say a little
bit more about that.
Professor Muscatelli: Essentially
I cited some work which we had done to look at the extent to which
the Bank had reacted symmetrically to deviations of output from
trend and of inflation from the inflation target. We seemed to
find some evidence, certainly from 1997, that there seemed to
be some bias towards being more cautious, if you like, on inflation
control. [2]However,
that is subject to the same caveats which a number of commentators
have made, which is that there is a limited span of data, all
of this conditional on the economic models. I think the evidence
we have produced is intriguing because it might suggest that as
the Bank was trying to build up its credibility it might have
been quite cautious and therefore inflation stayed below its target
but you cannot be 100% sure for the reasons that we were discussing
earlier about the uncertainty of macroeconomic models.
Q26 Ms Keeble: Is that not just historical
experience that is telling people to be cautious?
Professor Muscatelli: The historical
data seems to tell us that they were being cautious.
Professor Congdon: Can I just
say something? I think the Bank was very surprised at that time
by how strong the exchange rate was. They were surprised by that
and that is what kept inflation lower than expected. I think that
is fair.
Q27 Jim Cousins: Professor Wren-Lewis,
You have argued in favour of giving the Bank control over short-term
fiscal instruments to achieve stabilisation. Could you give the
Committee some idea of what sort of instruments you had in mind
and in what sort of circumstances they would be used?
Professor Wren-Lewis: Thank you,
yes, I have for a number of years argued that certainly the question
of whether the Bank should be given additional instruments is
something that should be looked at. This is an issue for the long
term. I am not suggesting that this is something that should happen
overnight, but I think it is something that should be considered.
The essential argument is that we have been through quite a benign
period where moving interest rates around seems to have been enough
and has not caused serious difficulties but there may well come
a time when the Bank would like another instrument to do its job
effectively, and particular tax instruments could be appropriate
in certain circumstances. So one might think about the VAT rate
for example or perhaps some instrument particularly targeted on
the housing sector. If you believe that a serious problem—a
shock to the housing sector—and using interest rates to
deal with this is rather difficult, then you might think about
having an instrument that is more targeted to that sector. This
is something, in a sense, to think about in the long term and
one would certainly want to do a lot of research on what the best
instruments to be used were and whether they could be moved in
a quick fashion, etc. I think this is something for long-term
discussion about how things might move on.
Q28 Jim Cousins: Clearly the rest
of the people do want to comment.
Professor Muscatelli: I would
disagree with that approach, I have to say. I worry a bit about
the democratic deficit issue here because it is one thing to argue
that interest rates should be under the control of the Bank because
ultimately it is affecting a variable which everybody agrees should
come under control, which is inflation; it is another to give
taxation control to an unelected body. I think there may be ways
however to try and tackle this issue of co-ordination. I do not
disagree that that is an issue. I think there may be an issue
of co-ordination at a time when in more turbulent macroeconomic
times than at present when there is simply an observer of the
Treasury in the Bank, there is very close communication on what
the Budget implications are for fiscal policy, but there may need
to be closer liaison between the Bank of England and the Government
of the day if there is more of a disjuncture between fiscal and
monetary policy, but I do not think handing fiscal policy to the
Bank is the answer.
Q29 Jim Cousins: Should that liaison
be transparent?
Professor Muscatelli: My intuitive
answer is yes but it would be interesting to do some research
on it.
Professor Congdon: This is where
the doctrinal disputes really become quite—In effect, what
has happened in the last 10 or 15 years—
Q30 Jim Cousins: —You did not
say what doctrinal disputes became.
Professor Congdon: I will elaborate.
In the last 10 or 15 years macro policy has in effect become monetary
policy. This is why we are having a discussion about the performance
of the MPC in its first 10 years. For heaven's sake, we did not
have the MPC in the 1940s, 1950s, 1960s or 1970s because that
was not the way macro policy was conducted and, as Professor Muscatelli
has said, you cannot have the Bank of England deciding fiscal
policy. What has made this framework possible is the neutralisation
of fiscal policy by the medium-term rules, which goes back in
a way to the late 1970s but actually to the early 1980s. I think
that has been a good thing. Then we get Professor Wren-Lewis saying
that we should bring fiscal policy back. I do not deny fiscal
policy can have some short-run effects on the economy. I am however
strongly opposed to reactivating fiscal policy and I think that
there are very fundamental disputes about what causes the economy
to move. Can I just try and explain where I am coming from? I
believe that in the long run there is a link between money, asset
prices and goods prices, so when the quantity of money rises by
1% so also does equilibrium wealth. Since wealth is about £6
trillion, this means wealth rises by £60 billion and when
money rises by 5% wealth rises by £300 billion. Some of that
is consumed, which affects behaviour. That is far more powerful
than anything fiscal policy can do. Monetary policy is the effective
instrument and recognising that has been crucial to the success
of the MPC. This is where you get to the really big doctrinal
debates, because obviously my colleagues do not agree with me.
Professor Wren-Lewis: No I agree
with you 100% that the interest rate is the instrument, but the
question is whether you might want to supplement it on quite rare
but important occasions by giving limited temporary control of
certain fiscal instruments to the Bank. That is all I was suggesting.
Chairman: I think we will have the Bank
of England Governor standing as an MP so that he is down in the
House of Commons explaining why he is doing all these things.
How about that?
Jim Cousins: I think he should stand
on a list and be elected for 15 years.
John Thurso: Hear, hear.
Q31 Jim Cousins: Professor Congdon,
in your evidence you have lots of nice things to say about our
opposite numbers in the House of Lords and one of the things they
say on this very point is that "from time to time monetary
policy would have to respond to fiscal policy", paragraph
25 of their report, and they are concerned about what they see
as the consistently overoptimistic GDP growth forecasts and over-estimates
of tax revenue and under-estimates of the budget deficit and borrowing
requirements. Despite that, you see no attraction in either the
Bank of England having access to fiscal instruments or perhaps
some kind of tax equivalent of the Bank of England?
Professor Congdon: There has been
no fiscal policy in the Keynesian sense in the last 25 years and
you could not have the present framework of policy if that were
to be restored. That is not to say that what happens to the budget
deficit is not relevant to monetary policy. As I said in my own
evidence, if there is a large budget deficit which is monetised
then that is very important. What I also said in my evidence was
that it may be the case that at some future date debt management
should again become part of what the Bank of England does—and
by the way the Bank was responsible for that until 1997. They
had discussions with the Treasury about it, but the responsibility
for debt management really lay with the Bank of England, and that
is again a subject that the Committee could think about. In my
view, debt management policy is part of monetary policy and it
should be considered as part of monetary policy, but again one
could discuss that.
Q32 Jim Cousins: Professor Wren-Lewis,
to go back to you, in your evidence to the Committee you were
arguing in favour of an inflation target that was a "soft
target",[3]
perhaps to take account of some of the very points that Professor
Muscatelli was saying earlier, that people's experience of inflation
is not homogenous and different parts of society have their own
very different inflation rates. Perhaps you would care to put
that point to the Committee.
Professor Wren-Lewis: I think
in a sense it relates to an answer already given and that is if
you found that CPI inflation was on target but wage inflation
was substantially above target, RPI was above target, producer
price inflation was above target, I think then you would want
to raise interest rates. In a sense, that is why I think it should
be a soft target because you should be looking at other measures
of inflation rather than just CPI, and the circumstance I have
just given is when you would want to depart from your target.
Q33 Jim Cousins: Can I ask Professor
Wren-Lewis's colleagues whether you would perhaps regard that
as muddying the waters?
Professor Congdon: I rather agree
with Professor Wren-Lewis on that. The puzzle—and this is
in a way whether it has been benign circumstances or whether it
has been policy—is that the last 10 or 15 years has been
an extraordinary period because one would have expected far more
divergences between the RPI, the CPI, and wages and asset prices
than we have seen for most of this period. Obviously at the moment
we are getting a bit of a problem with the gap between house prices
and consumer prices but it has been an extraordinary period. I
would rather agree with you; I think one should not expect this
incredible period of over 15 years, basically staying within 2%
or 3%, to continue. These years have been extraordinary, really.
Q34 Angela Eagle: I was just wondering,
Professor Wren-Lewis, how on earth you could come to the thought
that we should hand over taxation policy to non-elected people
without effectively abolishing our democracy? Would you feel happy
if your VAT rate went up or down that it was a non-elected person
at the Bank of England doing it? Why would you bother voting in
general elections if you did that?
Professor Wren-Lewis: First of
all, the Bank does change interest rates, which has a very big
effect on a large number of people.
Q35 Angela Eagle: Within a parameter
set by an elected body. It is not a tax rate, though, is it?
Professor Wren-Lewis: My proposal
would be if power was delegated to the Bank of England it would
be to change just a few taxes on a temporary basis.
Q36 Angela Eagle: VAT is a fairly
big tax instrument for most people.
Professor Wren-Lewis: I did not
say unimportant, I said a few tax instruments on a temporary basis
within set limits, so in that sense it is not very different in
terms of the impact on people to changing interest rates.
Q37 Angela Eagle: So you are one
of those people who thinks that fiscal policy should somehow be
made independent as well as monetary policy, are you?
Professor Wren-Lewis: No, I do
not actually think that. I think that it is very important that
tax rates in the long run are set by a democratically elected
government; absolutely I do.
Q38 Angela Eagle: That is good to
hear.
Professor Wren-Lewis: That is
why I very carefully specified that only changing these instruments
on a temporary basis should be something that the Bank should
be allowed to do within set elements as a way of stabilising the
economy.
Angela Eagle: VAT rates do not go up
and down very often though, do they? They tend to go up and stay
up.
Chairman: I think one of your students
could get a good PhD in that and then you can come back to us
with the findings. Mark?
Q39 Mr Todd: Can we turn to the MPC
as a body and how it works. First, briefly, is it too large? By
the silence I take it no, you are happy that it is about right.
Professor Wren-Lewis, you have commented flatteringly on the model
that the Bank of England uses and suggested that at least one
external member of the MPC should have a working knowledge of
the model. Are there people available who have that knowledge
because I think you later go on to discuss the transparency of
the model and its replication outside the Bank, which would suggest
that that skill may be extremely rare?
Professor Wren-Lewis: What I actually
suggest is that there should be one external member of the MPC
who is familiar with the kind of model that the Bank operates.
Obviously they do not need to have knowledge of the particular
Bank model before they get appointed because if they know the
kind of model that the Bank is using then it is quite quick to
be able to look at the particular model the Bank is using and
understand it. I think it is very important that there should
be someone on the MPC who essentially is involved in producing
and using the kinds of models which the Bank's current model is
a class of.
1 1 Ev 37-43 Back
2
Ev 64-66 Back
3
Ev 42 Back
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