Examination of Witnesses (Questions 142-159)|
BELL CBE, DR
JULIUS CBE, DR
CBE AND PROFESSOR
20 MARCH 2007
Q142 Chairman: Good morning and welcome
to the second session this morning of our inquiry into the MPC
ten years on. As with Lord George, we are privileged to have the
benefit of your experience. We hope to finish at about half-past
11. We shall ask crisp questions and I am sure you will give very
crisp answers to them. To what extent do you think that the record
of the Bank of England and the MPC over the past 10 years has
been the result of the institutional reform since 1997? I asked
Lord George how much of a watershed it was.
Ms Bell: Perhaps less 1997, but
the overall inflation targeting framework has been a big contributor.
One must remember that lots of developed economies have had similarly
favourable experiences, though perhaps not as favourable as ours,
because there has been a global consensus about the way to run
macro-economic policy, in particular monetary policy. We have
been part of that. Having said that, I think it would have been
quite easy for the MPC to get it wrong at different stages and
notably it has not. I think it is quite wrong to think that it
has been plain sailing and there have not been any risks. There
have been big structural changes in the world economy and the
UK economy and also a considerable number of shocks. The MPC has
dealt with that extremely well.
Dr Julius: I would agree. It has
certainly been a mixture of international factors and improvements
in policies here and some pretty good judgments by the various
people who have been on the committee.
Dr Wadhwani: I would certainly
endorse that. It has been a mixture, but I would not underestimate
the significance of the change in 1997. What it did markedly was
to bring down inflation expectations, as one sees in a variety
of measures. It also gave one much greater confidence that inflation
expectations would stay anchored. I believe that that has made
a significant difference to the way in which the economy has responded
to shocks. For example, it has made it much easier for the economy
to handle the fluctuations in oil and commodity prices that we
have seen. I believe that the anchoring has been very important.
Q143 Chairman: Professor Goodhart,
in your submission to us you mentioned that the stability of inflation
since 1992, particularly since 1997, has been extraordinary in
comparison with previous eras, but it could be taken for granted
by the younger generation and maybe down the line the MPC will
be blamed for things which it really should not be blamed for.
Professor Goodhart: Absolutely.
I believe there is great danger that because the past 15 years
have been so incredibly stable people now think that if inflation
varies by 0.3% in a month things are going wrong. One used to
have variations of 1% or 2% a month quite regularly. The stability
has been quite remarkable. I think that now people take it rather
too much for granted. There could be occasions when there are
greater shocksother countries get into difficulties and
all kinds of things could happenand it might not be possible
in future to repeat the stability of the past 10 to 15 years.
Q144 Ms Keeble: How supportive is
each of you of the CPI as a measure of inflation, especially in
view of the fact that the RIP is used in wage bargaining? What
do you think about the current discrepancies in the public debate
between the public's perception of inflation and the measures
which the MPC is using?
Ms Bell: I do not think it matters
so much what measure of inflation one takes. I think what matters
is that it is consistent and credible, and to achieve that it
should not change around too much. As long as it is fairly representative
of the cost of livingperhaps one can argue about whether
or not house prices should be includedI believe that it
is fine and for statistical reasons CPI has superior properties.
It would be nice if it included house prices. I do not believe
that RPI itself is particularly usefulthe previous target
was not RPI but RPI excluding mortgage interest paymentsbecause
interest rates themselves should not be directly included in the
targeted measure of inflation.
Dr Julius: Of the measures currently
available the CPI is the best one to target. There are advantages
in having a geometric mean and various reasons why RPI would be
the wrong measure to target because it includes mortgage interest
rates. Having said that, one has to look at the practicalities
of how one can include the impact on inflation of house prices.
It is not a clean-cut exercise and that is part of the reason
the European Commission has not so far succeeded in coming up
with a way to do that. Unless a good way to do it can be found,
I think it is better to leave the clean-cut measureCPIas
we have it. When we were looking at RPIX, which includes a measure
of house price inflation with the owner occupied equivalent of
rental costs, it was not a very good element and it destabilised
that particular measure. I add that in times like the present
when commodity prices are quite volatile it is useful to look
at a core measure. The MPC does not currently pay a lot of attention
to core measures of CPI, but I think that that can also add knowledge
about where inflation is going in future.
Q145 Ms Keeble: I can see the point
of having a fairly stable measure that is reliable as a statistical
tool, but there is an issue about the public perception being
completely out of kilter. You may think it does not matter whether
or not the public thinks that the Government and MPC use credible
measures. Nonetheless, there is a credibility issue especially
when the use of interest rates can widen the perception because
increases have a knock-on effect on mortgages.
Dr Wadhwani: I wonder whether
it is a matter of attempting to educate the public, because it
is quite dangerous to endorse public views that they deserve wage
rises in line with RPI. Ultimately, in an idealised labour market
wages should be going up in line with what a competitive business
can afford and that need not be RPI. In the specific instance
where RPI is boosted by interest rate increases that may not be
something that businesses can afford to pay. If in the labour
market people insist on getting RPI-style wage increases they
may just end up boosting unemployment. Therefore, it seems to
me that it is our duty and, with the greatest respect, possibly
your duty to help educate the public about this issue. I also
strongly suspect that in periods when RPI is running below CPIthat
was certainly part of my experience when I was on the committeethere
was not much heat from the public about the issue.
Q146 Ms Keeble: Do you believe there
is any bias, particularly anti-inflationary bias, by the MPC despite
the fact that the target is symmetrical?
Professor Goodhart: There was
certainly no bias of which I was ever aware. I think the reason
why inflation came out at a tiny bit below target was essentially
that we all expected the exchange rate to come down a bit. It
rose enormously in 1997 and the general expectation was that it
would decline slightly from then on, but it never happened. Because
the exchange rate was always somewhat higher than we expected
inflation turned out to be just a tiny bit lower, but the deviations
Q147 Ms Keeble: Do you think that
the interest rate should be the only tool used by the MPC, or
should it have other tools at its disposal?
Professor Goodhart: The central
bank has other functions as well. It is concerned with financial
stability and it has to consider what kinds of instruments it
might want to use for that purpose. There is also a question of
whether the central bank should ever intervene in the foreign
exchange markets. You probably are aware of issues in France about
what the ECB should do. The question of whether there should ever
be intervention in the foreign exchange markets is a very lively
Q148 Ms Keeble: I do not believe
you agree that letter-writing is a form of sanction?
Professor Goodhart: Certainly
not. Letter-writing is usually an explanation of what has happened.
The MPC is always trying to achieve the inflation target. Shocks
are bound to occur from time to time and they will drive inflation
up or below the limit. At that point the MPC must explain why
it has happened and what it intends to do. It is a form of explanation,
and it also gives the Chancellor a chance to reply so that if
inflation has deviated from what the MPC is trying to achieve
the Chancellor can say that it should try to return quicker or
more slowly than the bank suggests in its letter.
Q149 Ms Keeble: I was interested
to hear Lord George say that he wished he had perhaps used it
when inflation went too low. Do you believe that it is differently
Professor Goodhart: My belief
is that every central bank governor and most members of the MPC
are looking forward to the first occasion of letter-writing. Obviously,
they do not want a deviation from target to occur, but they are
quite looking forward to getting this part of the institutional
instrumentation in operation and showing how it ought to work.
Q150 Ms Keeble: But it has not been
used in 10 years and is seen almost as a tool of last resort.
Professor Goodhart: It is not
a tool of last resort. When the MPC was founded in 1997 the historical
experience and expectations were that there would probably be
about two or three letters written per year. The decline in the
volatility of inflation over the past 10 years has been quite
extraordinary. If one went back to the kind of normal variations
in inflation that occurred in all historical experience one would
certainly expect letters to be written fairly frequently. Stability
has been so great that it is almost unimaginable. It was not imagined
that there would be anything like this when the MPC was established
Q151 Chairman: Are there any other
comments on letter-writing to be added to Professor Goodhart's
Ms Bell: I agree that it is not
a sanction and should not be seen as such. It is definitely part
of the communication process. I also agree it is disappointing
that we have not had a letter yet. I wonder whether perhaps the
bounds should be narrowed or the committee should start writing
letters when they get towards the end of it just to make use of
that communication tool.
Dr Wadhwani: It would be dangerous
if it was seen as a sanction. If it was seen as a sanction by
the committee it would stop it doing the correct thing which is
occasionally to allow inflation to stray outside and to bring
it back only gradually.
Q152 Mr Love: We are all pining for
a letter, and maybe we will get it one day. I move on to the characteristics
of a good external member. Who better to answer that question
than former external members. Perhaps I may start with Professor
Goodhart who in his submission wrote a detailed spec as to who
should be external members. 2
Perhaps he would elaborate.
Professor Goodhart: The MPC is
a remarkable institution which is charged by Parliament and the
Chancellor with the job of changing interest rates in such a way
as to hit an inflation target. That is a technical requirement.
Effectively, the specification ought to be that the person involved
is capable of achieving within a reasonably short time the ability
to make a sensible and informed choice.
Q153 Mr Love: Do any of the witnesses
believe that in trying to reach a balance of the external members
there is a role for non-technical persons? You have had one such
person on the committee.
Dr Julius: With the current structure,
particularly the central role of the forecast in the MPC process,
it is quite difficult for a non-technical person to participate
fully in that exercise. It depends exactly on how one defines
"non-technical". I do not believe it means that one
needs a huge amount of econometric model-building in order to
be an MPC member. I note that one of the submissions suggests
that at least one of the external members should have substantial
experience in model creation.
Q154 Mr Love: What is your view of
Dr Julius: My view is that certainly
one or more should have real experience in using and interpreting
forecasting models of the economy. I am not persuaded that experience
of building models is required, but every external and internal
member needs to be professionally competent in interpreting models,
asking the right questions about them and so forth. Without that
the internal functioning of the MPC process and communication
of the output is compromised.
Q155 Mr Love: Dr Wadhwani, Professor
Goodhart says that it can take six months for the non-specialist
to become comfortable with the forecasting procedures. The outside
experts said to us that in order to keep the bank on its toes
at least one member needed to be thoroughly acquainted with it.
Do you support that view?
Dr Wadhwani: Yes. It certainly
takes time to adjust to the model and to be on the committee.
That is why I now feel that terms should be longer; instead of
three years perhaps the term should be five or six years. Members
should be given the option of perhaps serving a somewhat shorter
term, but certainly should be encouraged to serve a longer term.
Q156 Mr Love: I want to come to that.
I hope to seek a consensus among the four of you. First, for how
long do you think members should be appointed? Should members
be eligible for reappointment? There seems to be a broad consensus
Ms Bell: If I may comment on the
external member who is a modeller, I am not sure there is a need
for somebody who is able to be hands on and run his or her own
model, because the external members do not work as a block, or
should not do so; they should all be there as individuals. I am
not sure one gains anything by having one person who can go through
the nuts and bolts of the model. What one needs is that all the
members understand the broad properties of the model and how it
is put together and can hold the bank to account. There is plenty
of technical expertise within the bank.
Q157 Mr Love: You appear to suggest
in your evidence that four years without reappointment is the
correct way to go forward.
Ms Bell: I agree that perhaps
terms should be a little longer. I also think there should not
be reappointment. The suggestion of four years arose because with
four external members one would have a very neat roll over. We
had a problem a few years ago when there were big internal changes
going on at the bank and two external members came to the end
of their term at the same time. I think that potentially it causes
difficulties. Were we to have a committee with five external members
and four internal members perhaps we would have rolling five-year
Dr Julius: Reading everyone's
evidence, it seemed to me that most if not all of the former members
of the MPC felt that there should be longer periods and more protection
for the independence of external members. There was a difference
in terms of length of appointment. My own view is that a three-year
term is quite a good length for the first time and a second term
should be permitted if both sides feel it is appropriate, but
that the six-year total limit should be applied to both internal
and external members so there would be an equality of historical
experience and continuity on the committee. The reason I am not
in favour of a single five or six-year term is that it has two
disadvantages. One is that it may well be somebody is appointed
who is not really competent for the job, and to be stuck with
that person, as it were, for five or six years is not particularly
helpful. In the public or private sector often one does not know
that. Someone can look very good on paper and do very well at
interview and in the job it just does not work out. I think there
is a risk in having a long-term appointment like that. The second
issue is that if it is an appropriate, good person a five or six-year
appointment is quite a long commitment to a rather cloistered
job that may be out of the mainstream of the individual's own
career path, particularly if he or she is not from academia and
comes from the private sector or financial markets. Although that
person could resign, say, four years into a six-year term it would
be something of a political issue; it would be in the newspapers
and there would need to be a good reason. It might be difficult
to attract that sort of person to a job for which the term was,
say, six years.
Q158 Mr Love: Professor Goodhart,
you talked of the possible danger that internal Bank members could
become subject to "group-think".
Do you think there are any dangers of a herd mentality among external
members; if so, how would you guard against it? How do you ensure
that all the external members do not think similarly?
Professor Goodhart: They certainly
have never had a herd mentality.
Q159 Mr Love: That is reassuring.
Professor Goodhart: One of my
colleagues, Willem Buiter, was particularly individualistic. How
do you guard against group think? I would encourage some of the
externals to keep a foot outside the Bank. The kinds of people
who would be appointed are at a sufficiently mature stage of their
careers that they are unlikely to be subject to excessive pressure.
I do not believe that this is likely to be a danger, and there
certainly never has been any kind of danger.
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