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.
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