Select Committee on Treasury Minutes of Evidence

Examination of Witnesses (Questions 180-199)


24 APRIL 2007

  Q180  Chairman: In terms of your review of housing I think one former civil servant mentioned that these were what you would call "celebrity" reviews by the Chancellor. First of all, would you agree with that comment and, secondly, how useful has it been given that you have undertaken one of those reviews for the Chancellor?

  Ms Barker: Useful for the Committee do you mean, or useful more generally? I was rather startled to hear myself described as a celebrity, which I would have thought was rather unlikely. The reason for having independent reviews, a little bit like the reason I suppose for drawing in management consultants, is that you want to have somebody in sometimes when there is disagreement between different people in government or when you want to bring someone in to take a good, hard look at the evidence. One of the things I think that is important when you are doing independent reviews is the interim report stage when you lay a lot of evidence out for public debate, and in some sense because you are independent that can be done very openly. It is a little bit more difficult sometimes for government, who after all has been involved in setting the policy that is concerned, to lay it out in such an open and honest way. I think that is the contribution that external reviewers of a subject can make. They come to it with genuinely fresh eyes.

  Q181  Chairman: Good but like management consultants you do not want too many, do you?

  Ms Barker: When you are working in a company you certainly do not want too many. The Treasury has of course run a number of reviews. They are running rather fewer at the moment. Last year of course the reviews that were run were on related topics. It made quite a lot of sense to run my review alongside the Eddington, Leitch and indeed Lyons Reviews. Personally I think the four independent reviews there added up to a big body of work. I look forward to the Government taking it forward.

  Q182  Chairman: Good. As we know, the Governor wrote a letter to the Chancellor last week because inflation is above 3%. This session is nothing to do with that. We do that business in the Inflation Report when the Governor and the rest of the MPC Committee come before us. Maybe one question that arises from that is the issue of low inflation and the need to cement low inflation. Does the Bank have more to do to convince people about low inflation and the fact that it is non-negotiable?

  Professor Besley: Obviously when you say there is more to do it is an on-going challenge for us, particularly at this time when CPI inflation is running at 3.1% and RPI inflation at 4.8%. I think a very central part of the success of the monetary regime we have had is the way it has anchored inflation expectations around the target. If we were in danger of losing that anchoring that would of course be deeply problematic. I do not believe at this point that we are and I think it is going to be critical in the May Inflation Report for us to lay out our thinking about inflation going forward over the medium term and to see through what seems to be short-term level of volatility. I do not think personally think that there is more that we need to do beyond what we would be doing anyway, which is to convey our views clearly.

  Professor Blanchflower: I agree with that. I think it is very important that we communicate our views to the general public and make it clear that we are going to contain inflation. Clearly there has been some degree of volatility recently and I think that is some of the story that Tim has talked about. Going forward we obviously need to communicate what our strategy is and that we will do everything we can to keep the inflation rate down.

  Q183  Chairman: Kate, you have made comments.

  Ms Barker: In terms of doing more to convince the public, one of the things that I have looked at over the time I have been on the Committee is the responses to the Bank's survey in terms of people's knowledge about who sets interest rates and how the whole process works. It is perhaps a little bit disappointing that we have not seen a greater growth of knowledge from the public. Those percentages have not risen very much during the time that the MPC has been around, so the work that the Bank has been doing is important, particularly with young people. We of course run a schools competition, we have also prepared quite a lot of material for schools, so certainly at the younger end of the audience we are doing quite a lot to communicate, but obviously that leaves a lot of people we do not get to. One thing I would say about the Bank's agents—and we often talk about the work they do in the business community bringing information back to us—something we talk about a bit less is the amount of time they will spend talking to different groups such as Women's Institutes and other groups of people who meet who look for speakers. The Bank's agents are good speakers on our behalf and they are very good about helping to spread the message more widely. But I am concerned we still have more to do there.

  Dr Sentance: In my view the most important thing for anchoring expectations is people's experience of inflation. I think the fact that since 1992 we have had a long period of low inflation has been a great benefit in the current framework. I think the longer that inflation remains above the target the more there is the risk that that does begin to affect people's expectations, so I think, as the Governor's letter indicated, the expectation that inflation returns to target quite quickly is quite important in this context.

  Q184  Chairman: On the issue of the Governor's letter how are you as external members involved in the letter writing process and do you feel your views were adequately represented?

  Professor Besley: Yes.

  Professor Blanchflower: Yes.

  Dr Sentance: We participated fully in the drafting process.

  Q185  Chairman: And you had adequate discussion? Did you have a meeting on it?

  Dr Sentance: Obviously there was a limited time available, but, yes, we met together as a Committee and had an opportunity to give a further round of comments.

  Professor Blanchflower: We have met in the past to talk about what would happen if this occurred, so we have planned it and prepared for such an eventuality and talked about it in the past as well.

  Q186  Chairman: We did question some former members of the MPC and they felt it would have been good if they had been involved in the letter writing process so it must have been quite good for you, was it not?

  Ms Barker: Yes.

  Chairman: Kerry?

  Q187  Kerry McCarthy: Can I ask about the housing market. One of the banks that gave written evidence to us said that they felt the MPC's decision to downplay the role of the housing market has gone too far. Do you agree with that or would you agree with the analysis in the first place that the MPC has made that decision?

  Dr Sentance: I am not conscious that we have made that decision. We are following the housing market because experience has taught us that housing market developments, while they do not necessarily cause broader demand conditions to change in the economy, are often associated with changes in demand conditions. Factors like income expectations and interest rates affect both the housing market and broader consumption decisions which is the biggest element of demand. So I think if you look at the Inflation Report and the communications in the minutes, you will see there is still a considerable amount of discussion about housing market developments. I think the sense in which we are maybe down-playing it is we are not reacting to every minor movement in the housing market by changing interest rates. Certainly to my mind, looking at the demand conditions that we have seen changing in the UK economy over the last year, the fact that the housing market picked up strongly has been a very important signal that demand had picked up.

  Ms Barker: It is true that we had a discussion a little while ago, I cannot remember exactly when it was, when house prices were rising very strongly, about the relationship in the model between house prices and consumption. Of course it is a matter of some dispute whether or not rising house prices really add to consumption directly or whether they only do so through their role in terms of giving people more collateral to borrow against. The conclusion we drew then was that if you looked back at the historical tie between house price and consumption, a lot of that had been driven by the fact that previous periods of strong house prices were linked with strong periods of rising income expectations and that that was what had led consumption to rise more strongly in those previous periods. The rise in house prices that we have seen over the few years has not been so strongly linked with rising long-term income expectations, it has been linked rather more with the big fall that we have seen in long-term real interest rates, and to some extent with the restrictions of supply in the housing market relative to demand. In those circumstances, it seemed to us more likely that the link between house prices and consumption would not be so strong so we took the decision to reduce that a little bit in our thinking. Subsequent experience with continued rising house prices and continued growth of consumption has not led us to need to go back and retake that judgment, so I feel that that was the right judgment. I do not feel we are downplaying it relative to what empirically seems to be going on.

  Q188  Kerry McCarthy: Would you say that the rise in household debt is the other side of the same coin as the rise in house prices, which are both linked to the low level of interest rates? Is that something that you would take in tandem when you are making decisions?

  Ms Barker: The rise in long-term debt clearly is linked to the rise in house prices. The Bank published a study on this, again around the same time, pointing out that as house prices rose you would of course expect, as different cohorts moved into the mortgage market, rising long-term debt, and I think that is added to by increasing evidence that parents of course are borrowing against their houses in order to fund their children's mortgages, so both those things you would expect to be linked to a rising level of secured debt, and to the extent house prices prove to be sustainable in the long run I do not think that is a matter for concern. The concern on debt has always been much more the rise in unsecured debt, where we are aware—and I do not think it is a big concern to monetary policy but it is certainly a big concern more generally—that there are a number of households which have unsustainably high levels of unsecured debt and that of course has led to the difficulties we have seen. However, it has not led to difficulties in monetary policy and the consumer has obviously gone on spending, because although this is personally very difficult for those individuals there are not so many of them that it has actually so far sent the economy off track.

  Q189  Kerry McCarthy: We are here to look at 10 years of the Committee. On a historical level, the perception now that investing in property is the safe bet and the increased number of people that are entering the buy-to-let mortgage market and building property portfolios; is that a major factor or is it a small, fairly insignificant factor in terms of looking at both people taking on more debt by borrowing to buy these properties but also the impact on house prices?

  Ms Barker: It is not surprising in a period where you have got falling long real rates to see asset prices rise because of course that changes the fundamental valuation of those asset prices, a point that has been made particularly in speeches by Steve Nickell and I have also made that point in speeches I have given. To some extent of course, this creates difficulties for the housing market but it is not necessarily a concern for monetary policy. There is a real question about how influential the role of buy-to-let has been in pushing up prices. It obviously has pushed them up a little bit. Whether or not this is a bad thing this is not the place to discuss and whether or not this is a bad thing for the market as a whole is difficult it say. It has, after all, opened up a lot of private rental opportunities. We used to argue in the UK that not having a good private rental market was a bad thing because it reduced labour mobility so there are good sides to that coin as well.

  Q190  Kerry McCarthy: In terms of setting rates you have already talked about the rise in personal debt. How big a factor is that and is that something that has increased over the various periods on the Committee?

  Dr Sentance: It is difficult for me to comment on the period of the Committee as a short-serving member, but I think—

  Q191  Kerry McCarthy: I suppose I am interested in how do you decide which factors become more important over given periods?

  Dr Sentance: One of the key things at the moment particularly has been tracking the change in demand conditions in the economy over the last year. It is quite clear that demand conditions did change from the end of 2005 when demand appeared to be much weaker. Consumer spending is the biggest element of demand and these factors like household debt all can have a bearing on consumer spending, so we are interested in building up—certainly I am interested in building up-a-picture of what is happening to the consumer as one of the big drivers in demand. That is the sense in which we look at it, as something that feeds into demand pressures in the UK economy, or certainly in my case.

  Kerry McCarthy: Thank you.

  Q192  Mr Gauke: Can I turn to the question of monetary aggregates. Dr Sentance and Miss Barker have previously given evidence to this Committee specifically on that point but can I ask Professors Besley and Blanchflower how much weight you place on monetary aggregates?

  Professor Besley: Personally I regard the growth in monetary aggregates that we have seen since 2004 as potentially creating an upside risk to inflation going forward, but I would class that as a risk because there is a variety of things that have been going on in terms of where money balances have been accumulated and the extent to which they will ultimately or could ultimately spill over into demand side pressures in the economy and therefore lead to a different nominal path which leads to higher inflation. I think that is something that we do not understand particularly well empirically. The Bank is engaged in a significant and I think excellent project to really get to the bottom of what is going on as an empirical matter, but to my mind it is something that we as a Committee cannot simply ignore, and if you look at our minutes, at least in the period I have been a member of the Committee, it is a factor that we cite regularly as imposing upside risk. Let me make clear that one has to join it up with what is going on in credit and in asset markets more generally. I think it would be a mistake to simply view this as a phenomenon that is entirely about some simplistic story of if you have an elevated money stock that implies you are going to have higher inflation down the line. I think we have to see it in the context of the portfolios that people are holding and choosing to hold money alongside other assets, asset prices have changed to reflect that, so I think one has to have a joined-up view of all of this. I do not want my views to be misrepresented as saying that somehow there is an inevitable monetarist logic to this because I do not think that is true, but it is a cause of concern to me personally.

  Professor Blanchflower: I think I would say the same thing that it is a cause of concern. Perhaps I am rather more sanguine than Tim is about what the growth in monetary aggregates actually means.

  Q193  Mr Gauke: You are described as "disdainful" of monetary aggregates.

  Professor Blanchflower: I have no idea where that came from. Nobody actually interviewed me about it. I did not actually say such a thing. I am not disdainful at all. I have perhaps less of an upside concern than Tim does. Certainly it seems to me if you look at some of the household balances, that has not changed to the degree that the overall aggregate has, and the velocity of circulation appears to have come down as well. The holdings by other financial corporations are a concern. I take Tim's view that it is a concern but I certainly would not take the view that I was disdainful. I think if you look back in history the relationship between these money aggregates and other macro phenomena have been somewhat variable over time so I am an empiricist. I share Tim's view that there is an upside risk but in my view the jury is still out on what the relationships are. I would certainly not say that I was disdainful. I have somewhat less of a concern than Tim has but it is a reasonable argument.

  Q194  Mr Gauke: Would it be fair to say that the more concerned about monetary aggregates an individual MPC member is at this precise moment the more likely that member is to be hawkish? Is that a fair comment? Dr Sentance and Professor Besley have both been relatively hawkish of late. Professor Blanchflower, you are seen as somewhat of a dove. Is that a fair characterisation?

  Dr Sentance: I was going to come in as someone you might be referring to as being hawkish. In my mind I see it very much as Tim has said, there is a risk there, and you put that risk into the mix with all the other factors. The other factors that are weighing heavily with me have been that we saw quite a change around demand conditions and previous experience has shown that when demand begins to pick up sometimes all the statistics do not properly reflect that. We saw in the late 1980s and the late 1990s that when the conventional National Accounts Statistics were underplaying the growth in demand in the economy then we did have rapid monetary growth as well, and so it might have been telling us something about the strength and durability of that demand. The other issue that I have been looking very closely at is the business surveys, which have generally been very positive, and particularly business surveys of price expectations. Given that our prime objective is to control inflation, the signal that that has provided about the pricing climate and linking that to other demand pressures is one of the big worries that I have had over the last six months or so.

  Q195  Mr Gauke: Ms Barker, you will be aware of the criticism reported today from Professor Charles Goodhart, Tim Congdon and Gordon Pepper of the MPC of not placing sufficient weight on monetary aggregates. Do you feel that a failure to do that in 2005 may be one of the reasons why inflation is now at a relatively high level?

  Ms Barker: I think it is always very difficult, when you are in the middle of something, to disentangle exactly what has driven it, but I am not sure that I would draw that conclusion. If you think back to the factors that have been driving inflation up, we of course know that one of the main things that has driven inflation so far away from target in the short term is the move upwards in energy prices which I do not think was very much related to monetary aggregates. However I think it is quite right to say that beyond that demand growth has turned out to be rather stronger than we anticipated. Whether that is due to the influence of the monetary aggregates or whether it is due to other things—the greater buoyancy of employment and migration in the economy—is pretty difficult to disentangle, but the main point I would make is that stripping out the energy prices, the move of inflation away from target at the moment is not quite so impressive.

  Q196  Mr Gauke: Can I just move on very briefly to the relationship between monetary policy and fiscal policy. How important is that relationship and how important is the Government's fiscal policy in determining the level of interest rate that you need to set?

  Dr Sentance: We are helped by the fact that the Government has some medium-term fiscal rules, and I think we noted in the submission that the Bank of England put in as written evidence to this Committee[1] that that helps to provide a more stable background. I am not conscious that fiscal policy has been a major factor swinging around demand over the recent few months. In terms of feeding it into our forecasts, I think probably the main thing we have been trying to factor in is some of the restraint that the Government is now putting on the expenditure side in its spending plans. There has been some upward drift in the effective tax rate. We try and take into account, as I have observed it, the outlook for fiscal policy, but I would not say it has been a major swing factor causing us to change judgments over the period that I have been on the Committee.

  Q197 Mr Gauke: Ms Barker, obviously you have been there longer. Did the fiscal loosening from 2002 onwards have much of an impact on monetary policy?

  Ms Barker: Of course, we take into account in our decisions the demand impacts of the change in fiscal policy and you will know from previous evidence sessions that we have done some work on how we interpret government spending, and how government use of resources feeds into the economy and adds to demand pressure. So to that extent of course it was an influence in the decisions we took because it influenced the demand relative to supply, and that is the way in which you would expect us to take it into account. The other way in which you might take fiscal policy into account is if you had a wider concern about sustainability—and of course that concern has not arisen.

  Q198  Mr Gauke: Would you agree with the NIESR that interest rates were higher than they would otherwise have been because of that fiscal loosening in 2002?

  Ms Barker: It is always very difficult to go back and say what would have happened because of course if we had not had the growth of government spending and the change in fiscal policy in that sense the pattern of growth elsewhere in the economy might have been a little bit different. It is possible that if we had not had the fiscal loosening that interest rates would have been different but of course that would not necessarily mean that growth would have been any different. Interest rates would have been lower precisely because growth was a little bit lower and the balance of demand in the economy would have been different. That of course is a matter, I think rightly, for the Chancellor to decide.

  Q199  Angela Eagle: We have a symmetric inflation target but in the period in which the MPC has been in existence we have shifted the definition of inflation from RPI to CPI. Has it caused confusion that the definition of the inflation target has shifted?

  Professor Besley: Only one of our number was on the Committee at the time so it becomes slightly awkward.

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