Examination of Witnesses (Questions 160-176)|
BELL CBE, DR
JULIUS CBE, DR
CBE AND PROFESSOR
20 MARCH 2007
Q160 Chairman: We have had the opportunity
to visit the Bank and meet the Court. Do you think it is the Court's
job to pick up weaknesses in MPC members? What is its job?
Dr Julius: That is a good question.
In some ways the Court is a rather grand body with very little
to do, particularly since the introduction of the new Bank of
England Act and the FSA regulatory side split away from the Bank.
Yet the Court is still required under the Act to meet monthly
and to have regional representation, but the MPC gets the bulk
of its regional knowledge from the Bank's agents, not from an
occasional anecdote that might be present at Court. The role of
Court is not very well defined which I believe is a fault of the
Act rather than either the people on the Court or the internal
Bank of England people. It would be possible under the proposal
made in my evidence to have the internal appointees to the MPC
de-linked from hierarchy in the Bank, choosing the best internal
people to serve three-year terms as part of the MPC. It would
be possible to give the Court a role in selecting those people,
because if they are internal they certainly should not be selected
by someone to whom they report, ultimately the governor. That
is a possibility but it would have to be considered along with
Q161 Chairman: Dr Julius, I believe
that you are the only one here who has been a member of the Court
as well, so your evidence is very pertinent to that. I gained
the feeling from talking to the Court previously that its role
was ill-defined and perhaps it is something on which we should
comment in our report.
Ms Bell: That might be the practice,
but I believe the Act is quite clear about its role: it is to
make sure that the MPC's procedures are appropriate and it is
getting the right sort of information. It receives a set of documents
annually. When Pagan made a report on modelling at the Bank that
went to Court; when observers from other central banks sit through
some of the so-called pre-MPC briefing meetings there are peer
review questionnaires prepared and all of that goes to Court.
It receives quite a lot of information. Perhaps it could make
more of it.
Q162 Chairman: Perhaps an education
process must take place here.
Dr Julius: I think that the Court
has a useful role as backstop. At times of strainthere
was a period of strain when the external members felt that more
resources were needed to support themthe Court played a
very useful role. Certainly, one would hope that if there should
be any sort of financial irregularity inside the Bank the Audit
Committee, which is a subset of Court, would discover that weakness.
Q163 Chairman: Therefore, it acts
as a good shop steward?
Dr Julius: Yes.
Q164 Mr Gauke: I want to follow up
the point about resources more generally. How do you feel about
the amount of resources provided to external members? Is there
anything that you feel you could have done that you were not able
to do because of lack of resources?
Dr Wadhwani: When I got there
the quantum of resource was not enough but that was resolved.
I was then perfectly content with the situation. There have been
rumours around that there may be an attempt to take these resources
back from external MPC members which I believe would be a retrograde
Dr Julius: One element that would
have been useful, even after the expansion of resources, was more
modelling capability in the external MPC staff. Ms Bell has been
there more recently than I have, so she will have a better view
on what is available now, but during the time I was there it would
have been useful to be able to have the capacity between forecast
meetings, for example, to run the model with some different assumptions
that I might think were a little more appropriate than whatever
might have been the joint view of the committee. That capability
was not there, and the internal Bank modelling staff was entirely
preoccupied, naturally, in preparing for the forecast rounds in
which we were involved.
Ms Bell: I think that some of
that is to do with the sort of people who are recruited into the
unit. I see no reason why you could not have modelling, and at
times there have been people with that capability. My experience
was that the resources were adequate. I do not say that they were
overly-generous. At some points they were really needed. For example,
when the new model was coming in the staff in the external unit
spent a lot of time working with the external members to make
sure they understood the model. There were lots of in-depth briefing
meetings with the modelling team. Little seminars were run by
the external unit staff for themselves and for us about the new
model. All of that was quite resource-intensive and essential.
I agree that it would be wrong if that resource was diluted in
Professor Goodhart: It takes us
back to the earlier question of whether there should be at least
one expert in modelling. Ms Bell has just talked about the model.
There is not just a model; there is an infinite number of macro-economic
models. One of the dangers for the Bank is that people place too
much weight on whatever the current bank model may be. There is
no such thing as a correct model. One of the points that always
needs to be considered is whether possibly the model that the
bank currently uses may be insufficient and inadequate in certain
ways, and one of the roles of the externals ought to be to be
able to challenge the bank model.
Q165 Mr Gauke: I move back to the
issue of the appointments process. Do you have any views as to
the adequacy of the current process or suggestions as to how it
could be improved? Professor Goodhart has raised one or two issues
in this area and perhaps he would wish to kick off?
Professor Goodhart: I think it
is a very difficult question. The question about whether your
Committee should have the ability to refuse appointment is part
of a much wider issue of the relative role of the legislature
and executive and the position of the MPC is one among many. It
is a very much wider issue that should perhaps be looked at in
a broader sense. Subject to that, there are difficulties. One
cannot go too public because for a variety of reasons various
people may be approached and not want to accept the position.
I think it would be unfortunate if their names became known and
somebody realised that they were not necessarily the first choice.
The difficulty is that nobody knows anything at all about the
whole process. The word that has been used is "opaque".
There is no information or attempt to give any specification about
what is wanted. How the Chancellor and Treasury go about obtaining
names and what the role of the Governor of the Bank is in this
is simply unknown.
Q166 Mr Gauke: How much do you think
that is to do with the structure of the arrangements about appointments
and how much of it might be more to do with the individual personalities
Professor Goodhart: I do not really
know the answer to that. If my colleagues are better able to answer
it I would be very happy.
Dr Wadhwani: There has been a
lot of criticism about the appointments process, but when I think
back to 1997 and the introduction of the independent Bank of England
and it was explained that the external members would be technocratsindeed,
the first crop wereI remember having a fear that over time
that would be eroded and one would have increasingly overt political
appointments. That has not happened. One should congratulate the
Chancellor or Government for the fact that that did not happen.
It may be that over time that will not prove to be resilient.
A different Chancellor may act differently and that may be the
justification for changing the process.
Dr Julius: In my view the process
has not been very professional. It is known that these are three-year
terms and so it is public knowledge well in advance who is coming
to the end of the term. In most organisations when you know that
you will be losing someone in a year or so you begin to figure
out the specification for the kind of individual you want to replace
that person. Possibly you will hire head-hunters, go out yourself
or look internally to find that person. How to replace someone
in a structured, organised way is not rocket science. I think
that it would be easily possible to do that also for an MPC member.
I suggest in my evidence
that at least six months before someone's term is coming to an
end there should be a conversation between that individual and
the Chancellor, or whoever he designates, on both sides about
whether or not that person should go for a second term and it
should be agreed. If that person is not to stay on, or it is the
end of the second term, there should be a published specification
for the kind of expertise that would be sought, because one does
not want one uniform external member. One might want an academic
depending on who else was on the committee; one might want a business
person or a forecaster or modeller; one might want a City person.
One wants a diverse committee that has the ability to look at
the economy from different dimensions. Based on that published
specification, which this Committee could well review or have
an input intobecause it should be an open specificationthe
process should take place to find the person. I do not support
using the Nolan process as suggested by Stephen Nickell. Because
it is such a narrow specification and one is looking for a rather
technical person one is more likely to find such an individual
if it is a confidential process. That could take place very easily.
When the person is presented to this Committee it will be able
to look at the specification on the one hand and the person on
the other and make its own judgment as to whether the individual
Q167 Mr Gauke: It has been suggested
to this Committee that there should be some formal report from
external MPC members annually. Does that find favour with you?
Do you believe that there is a need for more to be done to allow
external members to express their personal views?
Ms Bell: I believe that a lot
more can be done within the current structure. I see no reason
why the votes should not be published when the decision is made,
although it would be harder at that early stage to have accompanying
explanations. There have been times when the market would have
benefited from knowing it was a close vote as opposed to a unanimous
one. That sort of information can be given. I would be against
members turning up at the policy meetings with a prepared text
feeling that they would be quoted verbatim in the minutes, because
it would make it a much more stilted and a less dynamic discussion.
As a result the decision might be less good, but I see no reason
why when you get to the minutes meeting and the immediate policy
decision paragraphs are being written individual views cannot
be identified by name. Occasionally, if someone is in a minority
of one it is quite clear what his or her views are but if it is
more than one person it may be helpful to start to break down
who said what. Perhaps where there is a divergence of view in
the Inflation Report that could also be brought out a little more.
I think that it is then the job of this Committee to be a bit
stronger in eliciting individual views.
Professor Goodhart: We are much
more individual at the MPC than any other equivalent central bank.
The ECB does everything by consensus and in America the FOMC very
rarely dissents from what the chairman indicates. The criticism
in most other countries is that the UK is far too individualist
and indications that x says this and y says that
are likely to confuse the market. I do not believe that. I think
that individualism in this country is splendid, and it has already
gone far further than any other country. To ask for much more
at this stage is probably going too far.
Q168 Chairman: Dr Wadhwani, were
Dr Wadhwani: I was collegiate.
Q169 Mr Gauke: Is there a consensus
that you are all individuals in your own right?
Professor Goodhart: Absolutely.
Q170 Mr Breed: I turn briefly to
house prices and household debt which come up on a number of occasions
in our discussions. To what extent is it right to characterise
the rise in house prices and household debt as two sides of the
same coin which have been caused for so many years by the generally
low level of interest rates within the economy?
Ms Bell: One certainly could characterise
it in that way. The job of the MPC is to understand what is going
on, but the role is to target inflation so these things should
be taken into account only insofar as they affect the forecast
and outlook for inflation. I disagree with some other members
of the panel about the time horizon over which that should be
looked at. If issues such as debt and house prices start to affect
the monetary transmission mechanism that is something that needs
to be taken into account. Perhaps one of the downsides to the
incredible success of the Monetary Policy Committee is that there
is a feeling out there that it has done well with inflation and
perhaps a few more targets should be thrown at it to see if it
can control everything. I believe that that misunderstands the
nature of monetary policy and how really narrow it is. I think
that the best job the MPC can do is to focus very precisely on
achieving exactly the target that has been set for it and not
try to stabilise asset prices as well.
Dr Julius: I believe that the
issue of house prices in this country is mostly a supply side
phenomenon. I am a fan of the Barker report and the finger that
she points is to the planning system. Those are matters which
the MPC has no competence or ability to influence.
Q171 Mr Breed: We should not worry
about it at all?
Professor Goodhart: I am not entirely
in accord with my two colleagues to my left. My view is that housing
prices ought to be in the CPI and the fact they are not is a grave
disadvantage. The problem as to how to include housing prices
in the CPI is an extremely difficult one. Nobody has yet come
to a consensual agreement about the right way to do it. There
has been a great study in EUROSTAT about which of the alternatives
is better. Since it cannot come to any agreement the simplest
way out of it is not to include housing prices at all, which in
my view means that the inflation measure in this country has been
wrong. I entirely agree with Lord George and my colleagues that
it is crucial the MPC should control a broad measure of inflation.
I also agree that the fact the CPI is not best designed at the
moment is a secondary issue. The MPC is doing a very good job
and anyhow the index is the Chancellor's choice, but I believe
that one way or another housing prices ought to be in it. It is
a major issue, because the question of what inflation is will
vary quite a lot if housing prices move quite differently from
the price of other goods and services, as they have very frequently
over the past 10 years.
Q172 Mr Breed: I was quite interested
in reading your evidence about contra-cyclical and pro-cyclical
recall competition and credit controls in about 1970 when the
bank took special deposits out of the banking system in order
to reduce the money supply and act as a flywheel. All of that
went out of the window and now everybody is lending money on houses
left, right and centre, and I believe that that has contributed
significantly to the overall increase. The amount of money available
for house purchases is significantly greater than it was. To what
extent is the fact that in the UK housing is such an important
factorperhaps more important than in many other countriesa
problem in bringing house prices into the CPI? Is that situation
unique to the UK economy as opposed to others?
Professor Goodhart: No, it is
not. Everybody has difficulty with housing prices and I can think
of at least three ways that one might try to include housing prices
in the CPI. In different countries there are different approaches.
It is a complicated, technical issue but a very important one.
Q173 Mr Breed: In your opinion could
it be done?
Dr Wadhwani: Even if you do not
include housing in the CPI because you await resolution of some
of the technical issues there is something that the MPC can and
should do, in the sense that historically the major monetary policy
mistakesone thinks of Japan in the 1990s and the US in
the 1930swere associated with taking the eye off the asset
price ball. For those reasons, I continue to believe that the
MPC should be leaning against the wind in terms of asset prices.
One continues to target consumer inflation but one does it in
a way that one leans against the wind vis a" vis asset price
Q174 Mr Breed: Looking at household
debt, different commentators take different views. What is your
view on the current levels of household debt, secured as well
as secured? Do you think that the bank should take account of
that in any analysis?
Professor Goodhart: It does take
account of it in looking at the developments in the broad economy.
Remember that household debt has also been matched by very considerable
increases in household financial assets, but they are not held
by the same households. The problem is that this is a distributional
issue, and it can also be an important social issue. It does not
necessarily play so much of a role in trying to maintain the inflation
target overall. The Bank and also the FSA have been very careful
to consider how far the debt issue may affect the stability of
the financial system. You are all aware of sub-prime mortgages.
Very considerable studies and stress tests have been made that
have asked banks and building societies what might happen if house
prices suddenly came down and people were unable to pay their
debt. The general result of those tests has been that it would
not affect the British financial system very much but it could
have serious adverse effects on some people who got in over their
Q175 Mr Breed: It is not a new phenomenon.
I remember so many years ago the secondary banking crisis and
things called lifeboats and so on. There does not seem to be anything
new in this. Is the level of household debt a concern of the bank?
Dr Wadhwani: Broadly, I agree
with virtually everything that Professor Goodhart said on that
subject so I will not repeat it. The only small qualification
is that what we are seeing in the US currently may be quite illuminating
for us. The consensus view is that the sub-prime mortgage problem
is confined to the poorer sections of society; it is a distributional
issue and it will not have wider macro-repercussions. That belief
is about to be tested and we will have to wait and see.
Dr Julius: It is also relevant
that much of that segment of the market is not an element to which
commercial banksthe basic financial institutions in this
economy, or indeed the US economyare exposed. That is the
reason they sell prime mortgages. Although the risk has been spread
in the economy when the banking system is profitable and in pretty
good shape the issue of household debt is not nearly as big a
concern as it would be if the banking system was also marginal.
Mr Breed: Those who have the assets may
have the ability to service the underlying debt; those who do
not have assets may not have that ability.
Q176 Chairman: Before we finish perhaps
I may ask each of the witnesses for their views on the next 10
years, because that is part of our inquiry. What is the one thing
that should be done in the next 10 years, or what message do you
think we should be considering for the next 10 years?
Professor Goodhart: Do not get
too worried if the economy does not behave as well in the next
10 years as in the past. We have to recognise that we have been
living in a golden age, but it is really too good to last. Do
not let your expectations get too high.
Dr Wadhwani: Again, I agree with
Professor Goodhart. The only other comment is that I hope in the
next 10 years the MPC becomes more confident in some sense. In
the past 10 years as it has felt its way there has been a reluctance
to project forward some of the supply side benefits that it has
begun to see in its forecasts. I think that that has led it to
be too cautious in terms of setting policy. I hope that it does
not repeat that in the next 10 years.
Dr Julius: I am more optimistic
about the next 10 years. Nonetheless, I think that it is very
important that the excellent structure we now have for monetary
policy in this country is continually monitored by this Committee,
the press and others to ensure that the calibre of the people
who make the decisions within that structure remains high and
that individual accountability, equality through the voting system
and the competence of all members of the MPC is retained.
Ms Bell: The next 10 years will
undoubtedly be different from the past 10 years and I do not think
we can guess at what the shocks might be. I believe that the framework
is a good one and the MPC ought to be able to continue to do pretty
well, although it would be nice to have the odd letter. As to
confidence, which Dr Wadhwani mentioned, it may need to continue
the battle on the importance of low inflation. Professor Goodhart
said earlier that a lot of people did not remember the problem
of inflation in the past, and I do not believe that we should
become too relaxed in believing that the importance of maintaining
a stable monetary framework is accepted widely. Those areas of
communication and continuing to build a consensus for low inflation
are matters that might have to be strengthened and built upon
over the next decade.
Chairman: We have lots of written evidence
for which we thank you. As I went through it, I have good news
for one of you. Mr Austin Mitchell wrote to us to say that soon
after the MPC was established, as MP for Grimsby, he invited the
Governor and the members to Grimsby to see the real problems in
the world. That invitation was declined but to her great credit
DeAnne Julius came and was impressed and influenced by what local
business told us. Dr Julius, I am sure you are popular everywhere,
but you are really popular in Grimsby. I thank the witnesses for
their time and evidence.
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