Select Committee on Treasury Minutes of Evidence


Examination of Witnesses (Questions 40-56)

PROFESSOR ANTON MUSCATELLI, PROFESSOR SIMON WREN-LEWIS, MR RAY BARRELL AND PROFESSOR TIM CONGDON CBE

6 MARCH 2007

  Q40  Mr Todd: I sense the other three of you are non-modellers or not perhaps the enthusiastic modeller that Professor Wren-Lewis is. Do you share his views?

  Mr Barrell: Can I answer that first because I am a modeller and I provide models to all sorts of people. They are slightly different to the sorts of models at the Bank, but I have spent much of my career using models for forecasting, and I do it every quarter, and I do recognise that there is a significant amount of investment in human capital in understanding what people are talking about. It is very easy for somebody like me to pull the wool over the eyes of almost any academic or business person in terms of the information I give them. It takes someone very bright to crack through the words I give them. Not everybody has the capacity to crack through that. I think there are some people who have got used to the patterns of doing those. It does not have to be somebody who has got a PhD in Dynamics Stochastic General Equilibrium Analysis, if somebody knows a bit about the techniques of separating signal from noise in forecasting and understanding whether this model tells you anything about the economy at all and which model you use. So I think expertise would be of great value but at the minute I suspect, with such a complicated model, the Bank staff are at a significant advantage over most outsiders, including most of the people sitting at this table, because they know this toy much better, and it would useful to have somebody outside saying, "You are actually wrong there and I can prove it." That is difficult to do.

  Professor Muscatelli: I would agree with Professor Wren-Lewis's judgment that there has to be some academic input into the external membership and in fact I have suggested that we should retain a range of skills because I think everybody brings something very different to the table. I would also support what Ray Barrell said because I think the more discussion there is of the model, the easier it is for a non modeller, external member of the MPC to gain not only some knowledge from the Bank staff but also from the outside which may balance their view about what the model is actually saying. There is an argument for making it more widely available and in the sense of understanding how the Bank is using it as opposed to making the equations available.

  Mr Barrell: If I could say something before Tim. Charles Goodhart said something to the House of Lords Committee which I thought was very insightful because he has been on the Committee but is also a very good technician. He said it can take up to a year for a non-specialist to understand what is going on. I think that is a very important point, especially at the minute.

  Professor Congdon: I think the role of computer models in British policy-making is very chequered. I would say that the improvement in the last 10 or 15 years has been partly because these have been put in the background. The improvement in information flow is not because of computer models; it is because of more business surveys. The quantity of business survey information available today is dramatically higher than it was 30 or 40 years ago. As I pointed out in my written evidence, [4]purchaser manager surveys every month are very important. If you look at what then affects interest rates, the financial markets know that those surveys matter and that is why they are very valuable. On the computer model, can I say one other thing? Again these are doctrinal disputes. Most of these models are based on what is called the Keynesian income/expenditure model. They are very complicated things but in essence spending depends upon income. That is fine generally until you get something going dramatically wrong with asset prices when people can spend by selling an asset, so these models failed very badly in the early 1970s and the late 1980s, when you had big movements in the money supply and big movements in asset prices. In my view, they should not have much prominence in policy-making. Having said all that, I am all in favour of technically equipped and skilled members of the MPC.

  Q41 Mr Todd: Can I broaden that from modelling to other skills. Are there other particular skills which you think should always be present amongst external members? I think there has been a reference to labour market economists from one of you, but are there other skills which people feel should always be there?

  Professor Congdon: I think there should be someone who understands money and banking but I would say that, would I not!

  Mr Barrell: What the Monetary Policy Committee is doing is slightly different from what is being done in, say, financial markets. If you are involved in financial markets often what you are interested in doing is looking at a survey or some piece of information to find out what is going to happen next month or next quarter. The Bank of England should not be concerning itself so much about next month or next quarter. The skills and the tool sets involved in that very short-term forecasting are very different to what is going to happen to inflation over the next year or two. That is a skill set that is unusual in the academic profession and in the financial professions. The academic profession tends to specialise in a skill set as to what happens in the long run and then building these theoretical models. The Bank of England needs people with the skill set in the middle, and where they get them I am not absolutely certain. It is not necessarily the best theoretical academic and it is not necessarily the best financial market operator. It is somebody who is used to operating and thinking about the medium term. They can be somebody from either end of that but there is a specific bundle of skills which again I would say Charles Goodhart had because he had been used to the whole range of things. It is the skills of the generalist who understands things that are the skills needed, not so much those of the specialist.

  Q42  Mr Todd: Professor Wren-Lewis, you have suggested that there should not necessarily be a majority of internal Bank members. Which member do you think should be ejected from this gilded life?

  Professor Wren-Lewis: To be honest, I have not given that a moment's thought so I cannot possibly answer that.

  Q43  Mr Todd: You were incautious enough to venture a view.

  Professor Wren-Lewis: The context of that remark was simply building on my earlier remark that it seems to me that you need someone with some knowledge of the class of models that the Bank uses there. If that meant that you had to get rid of somebody else who also had some important expertise as one of the external members, you do not necessarily have to do that, you could expand the number of external members.

  Q44  Mr Todd: Do any of you share the view that there should be an external majority on the MPC?

  Professor Congdon: In my view, no. We tend to treat the MPC or the Bank as if they were the same. If the MPC had a majority of non-Bank members and then things went wrong the Bank would say, "It is not our fault."

  Professor Muscatelli: I would agree with that.

  Q45  Mr Gauke: Can I do a quick straw poll on the subject of external members. What do you think should be their term of office and should they have the right of reappointment or the possibility of reappointment?

  Mr Barrell: I notice that Steve Nickell, for instance, suggests that six years would be a good term and I would agree with that. Six years with no reappointment is a good idea because it takes time to build up the knowledge you need to do the job. You cannot just walk in and understand it instantly.

  Professor Muscatelli: There is some argument perhaps for extending the period of office given what has been said. I think we have to normalise the nature of the reappointment process because at the moment there is a huge amount of uncertainty as to which members are reappointed and which ones are not and why. Normalising that and perhaps going to six years with no reappointment is one way of doing that.

  Professor Congdon: I think six years is long for people with a business background and business career. I do not think they should be entirely academics.

  Professor Wren-Lewis: I agree that it should not be entirely academics. I do not really have any strong views about the length of time. I can see the attraction of Steve Nickell's comments and I certainly think that if you have an external member of the MPC who is being very helpful and very productive you would want to keep them on there for six years definitely. However, you can appoint external members—it has not happened but it could happen—who turn out not to be up to the job and you would want some way of making sure that you are not saddled with those six years.

  Q46  Mr Gauke: Could I also ask on a similar subject, currently external members are part time; does anyone see an argument for them being full-time or any disadvantages in that. Do you have any strong view, Professor Wren-Lewis?

  Professor Wren-Lewis: I think it is potentially a full-time job so if someone wants to do it full time I do not think they should be stopped. However, I think that you could have very good people who are just not able to do it full time and if they wanted to do it 50% of their time I think that also should be an option, so I think it should allow both.

  Q47  Mr Gauke: Anybody else?

  Professor Muscatelli: I think that one or two former members of the MPC who are non-academics have highlighted a problem with having part-time employment and I would support that. Although they can take up part-time employment as academics or quasi academics, it does make things more difficult for them, so I think that is an issue.

  Mr Barrell: I would agree that full-time employment seems wise from certain occupations; in others you can find something else to do with your time.

  Q48  Mr Gauke: Moving on to the appointment process, and Professor Muscatelli you mentioned that a moment or so ago and, Professor Congdon, you have been critical and said that better procedures are possible. [5]Have you any ideas for improvement in the procedure of appointing members of the MPC?

  Professor Congdon: I did not say much about that at all in my evidence.

  Q49  Mr Gauke: You touched on it and you did say that a better procedure should be possible.

  Professor Congdon: Many people have been surprised that the external members have not been more obviously monetary economists. There is a large number of academics in Britain who are monetary economists who, in my view, would have been better qualified than those who have actually been appointed.

  Professor Muscatelli: I simply said in my evidence that the nomination process has to be speedier. [6]Whether that is done through a process of sounding people out well in advance on vacancies arising to avoid difficulties such as we experienced last year is one possibility, but it is difficult to judge because we do not know what has been going on behind the scenes in terms of people being approached and perhaps turning it down, so it is difficult to comment in detail but I certainly do not think we can have a similar situation to last year.

  Q50 Mr Gauke: Is there an argument for a pool of economists would could be considered to speed up the process?

  Professor Wren-Lewis: I certainly think there should be transparency and there is clearly no transparency at the moment. We have a system which potentially could be abused by the Chancellor. This Chancellor has not done that but we cannot rely on Chancellors never doing that. The moment there is a suspicion that they are doing that it casts doubt on the whole process. I really do think the process should be more transparent.

  Q51  Mr Gauke: Does anyone see an argument for this Committee having a greater role, whether perhaps by veto in a Senate-style hearing or greater involvement at an earlier stage? Is anyone sympathetic to any of those views?

  Professor Congdon: I am in favour of that. I think it should not just be the executive, the Treasury. The legislative Parliament should be involved. How one structures that is very complicated.

  Q52  Mr Gauke: Conceivably a veto system or something softer?

  Professor Congdon: The Americans have that and every now and again it is used. I would hope it would be used very rarely. You could give some input to the Chancellor and say perhaps these are the right sort of people or whatever.

  Q53  Mr Gauke: Or perhaps drawing up a short list?

  Professor Congdon: Yes.

  Professor Muscatelli: I have argued against it. I think it politicises the process too much and I think the public scrutiny that this then presents might have an impact on the financial markets. I also think one could argue as to whether this Committee should require stronger accountability of members once they are appointed to hold them to account if there is any evidence that perhaps they have not displayed competency once in the job, but I am reluctant to see US-style confirmation hearings.

  Q54  John Thurso: It has been suggested by a number of market practitioners that the Bank should publish a forecast for trends in interest rates. How do you feel about that? What are the pitfalls and what are the benefits of such a concept?

  Professor Congdon: I am against that because if there is a big movement of rates for any reason people will then say, "Look, we relied upon the Bank and the Bank has given these official forecasts." The system is working okay. That is quite a radical change so why bring it in; I can see no point at all.

  Professor Wren-Lewis: Can I put the case. At the moment the procedure the Bank uses is entirely inconsistent, in the sense that it has in it a set of projections for interest rates which is not necessarily sympathetic with the rest of its forecast, so there is a problem. The obvious solution is for the Bank to also produce a forecast for future interest rates. That is a forecast, not a decision, and I think people tend to get confused between the two things It would have lots of advantages as well as getting rid of that inconsistency: it would allow the Bank to give a signal about how long it expects any monetary tightening to persist, for example, and that is a very useful hint to give. It has been done, it has been in done in New Zealand for a long time, it is done in Norway, the world has not fallen apart and that extra information is useful, people understand it is a forecast, not a commitment or a decision, it is an obvious step to take it seems to me.

  Professor Muscatelli: I have argued against it and I will not repeat what I have said in my written evidence, but I think it matters less if it were to happen now because of the relatively low volatility of interest rates. One can imagine a scenario where interest rates have to be adjusted quite dramatically, where the Bank would then decide to move away from its original forecast and that could cause potentially quite a bit of disturbance in terms of expectations adjusting in financial markets. It is also, as I said in my paper, a bit like a goldfish bowl where every action that the Bank takes and every element of discretion is subject to scrutiny in a way that is possibly not allowing the Bank any room for manoeuvre.

  Mr Barrell: There is a case for doing it. When I produce a forecast I can either just have fixed interest rates, which we know will be wrong, I can take market expectations which is what the Bank now does, and because I am not a central banker I can say if market expectations happen inflation will go well above target. I can say that, but the Bank of England cannot say that, so if it actually thinks inflation will go above target with market interest rates it cannot publish that, so at the minute it might feel constrained to push down its forecast for inflation and it might be much better for it to say market expectations are expecting this, but we think this shock is driving inflation above what the market thinks, and if that happens we will raise interest rates and that is our forecast. There is a strong case for doing that; it is not saying we will raise interest rates, it is saying if, when we get there, this has happened, we will raise interest rates. It is announcing your plan in advance, knowing that you will never actually have to fulfil it, and it might be more effective to announce your plan in advance so people know you are going to react in the right way. Producing a forecast where inflation will actually explode, although the Bank says it will not, means the Bank loses credibility. We luckily have not been in that position in the last decade or so, but that could easily be happening if we found the exchange rate collapsing, the oil price rising, the Bank saying market interest rates say it is going to be 3% and inflation will be on target, and the rest of us know it is not going to happen, it is very implausible.

  Q55  John Thurso: Can I ask a quick question on a completely different subject? This Committee has regular hearings with the Monetary Policy Committee on the inflation report; what more could we be doing or should we be doing as a select committee to ensure transparency within monetary policy, if anything?

  Professor Muscatelli: One thing which is not strictly related to the activities of the committee but is important and has been echoed by others is the need for the minutes of the MPC to become rather more transparent. At the moment there are these rather cryptic discussions towards the end of the minutes which explain why there was a minority view in a particular set of circumstances, but it cannot possibly encapsulate the full nature of the debate and it would be much more helpful if dissenting members of the committee were able to set out their positions more clearly in the minutes.

  Professor Congdon: I agree with that. I have been told kind of hush-hush that actually some of the debates in the MPC are quite fierce, and this does not come out at all in the minutes. For example, I know that some MPC members despise any mention of quantity of money; others think it is quite important. I know, I have been told this by people, but it is not in the minutes at all. There should be scope for members of the MPC to say a few things on their own, signed by themselves, and I think that actually the minutes should be a little bit more forthcoming. Some of this of course comes out in your own exchanges with the MPC.

  Q56  Chairman: We have asked for that. Professor Nickell was before the Committee and I suggested that each member of the Monetary Policy Committee gave at least an annual report to this Committee so that there is something in their own name. It is an issue that we have looked at.

  Professor Congdon: At the Treasury Panel, everybody put in a submission every meeting, signed by themselves.

  Chairman: That is even more radical; that is a great suggestion. Can I thank you for your evidence, it has been very, very helpful to us this morning. It is the first evidence session in what will be quite a lengthy inquiry, but your contribution is well appreciated, thank you.


4   Ev 25 Back

5   Ev 31 Back

6   Ev 65 Back


 
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