Select Committee on Treasury Minutes of Evidence


Examination of Witnesses (Questions 160-176)

MS MARIAN BELL CBE, DR DEANNE JULIUS CBE, DR SUSHIL WADHWANI CBE AND PROFESSOR CHARLES GOODHART CBE

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 other changes.

  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 strain—there was a period of strain when the external members felt that more resources were needed to support them—the 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 step.

  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 any way.

  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 involved?

  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 technocrats—indeed, the first crop were—I 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[4] 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 into—because it should be an open specification—the 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 is appropriate.

  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 you consensual?

  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 trends. [5]I 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 factor—perhaps more important than in many other countries—a 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 mistakes—one thinks of Japan in the 1990s and the US in the 1930s—were 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 imbalances.

  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 heads.

  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 banks—the basic financial institutions in this economy, or indeed the US economy—are 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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5   Ev 15-19 Back


 
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