Examination of Witnesses (Questions 242-259)
MR MERVYN
KING, MS
RACHEL LOMAX,
SIR JOHN
GIEVE, MR
CHARLES BEAN
AND MR
PAUL TUCKER
24 APRIL 2007
Q242 Chairman: Governor, good morning
to your and your colleagues and welcome to this inquiry, ten years
on. Inflation reached 3.1% in March and you wrote a letter to
the Chancellor explaining what the MPC were trying to do to keep
inflation on target. What was the principal aim, in your mind,
of that letter? Governor, may I say that we are not going to be
talking about the Inflation Report here; that is for another time.
Mr King: Indeed. I think it was
to give an opportunity to explain in greater detail what otherwise
had been the case—why the Committee thought that inflation
had risen to that level—although of course there was little
opportunity for the Committee to have an in-depth discussion of
that to point out again what our framework for policy is and to
say what we would do to deal with that situation. That was the
purpose of the letter and I think it served it pretty well.
Q243 Chairman: Some commentators have
said that the Bank needs to do more to cement low inflation and
to convince people that low inflation is non-negotiable. How far
have you got to go on that?
Mr King: That remains to be seen.
Most of the measures of inflation expectations are still close
to the target. There is not very much evidence of any significant
pick-up. We have spent a lot of time in the last 12 months thinking
about whether inflation expectations have risen. That is referred
to in almost all the minutes over the past year. We have talked
about that. We have spent a great deal of time talking to people
around the country to make clear that we are completely determined
to bring inflation back to target. In the end, I think what people
should draw most comfort from is that the arrangements for the
Monetary Policy Committee give each member of the MPC individual
and personal accountability for taking decisions in a way that
ultimately will bring inflation back to target. That is our purpose
in life and we are held publicly accountable by you and others
for that. It is that strength of the incentives that we face that
should give people comfort.
Q244 Chairman: You mentioned in your
submission to us the tailwinds of globalisation and the expansion
in the labour supply. If these do go, do you think you are doing
enough to prepare people for that?
Mr King: As conditions change
then we will need to rethink our policy stance and decide what
the level of interest rates needs to be. I think we have done
a good job in explaining to people that the main aim of the MPC
is to maintain a balance between demand and supply in the economy.
As the supply conditions change in the economy, we need to take
steps to lead to a change in the outlook for demand.
Q245 Mr Gauke: We heard last month
from three of you about your views on the importance of monetary
aggregates. Can I ask Paul Tucker and Charles Bean to what extent
do you think monetary aggregates should play an important role
in your deliberations?
Mr Tucker: We cannot deliver our
objective by just looking at real economy variables such as output
growth and employment and so on. We have to look at so-called
nominal things and that includes inflation expectations which
the Governor has already mentioned and discussed, and money forms
part of that. I see it as probably no more than an amber light.
I do not think the relationship between money and inflation over
the past 20 to 30 years has been sufficiently reliable that we
can say: yes, we have something that we can really rely on. To
have put that part of our history behind us is a good thing, but
it can be an amber light. What does that mean? It means that if
one sees rapid money expansion, or indeed very low money growth,
one should take the lid off and try and see what is going on underneath.
That is my own approach and I did that in a speech in December.
Mr Bean: I would very much endorse
that. People used to think that there was a close relationship
between money stock and nominal demand and therefore you could
control the level of spending in the economy by keeping the money
supply growing at a steady rate. What the experience of the last
20 years or so has shown us is that relationship is not a tight
one. That is not the same as saying there is no information in
movements in various measures of money, but it does suggest that
you need to try and understand exactly what is driving the relationship
between money and nominal spending in the economy. At the current
juncture quite a lot of the rapid money growth is confined to
a particular sector—other financial companies—which
is a very heterogeneous collection of institutions. It is not
clear what is driving all of those factors, so a task that we
have been faced with is trying to dig down to better understand
what is going on. The real answer is not to look at it as a single,
all powerful indicator, but to look at it as one of a range of
variables that potentially provide useful information; look at
it alongside measures of the development of credit in the economy,
look at what has happened to asset prices as well and try to form
an overall picture of the monetary forces that are embedded within
the economy.
Q246 Mr Gauke: Governor, you said
to us last month that you were more concerned about the monetary
aggregates than some of your colleagues. Do you feel there was
something of a criticism made yesterday by the likes of Charles
Goodheart, Tim Congdon and Gordon Pepper that we had a recent
double digit rise in the monetary base and that this is storing
up trouble and that perhaps the MPC has not done enough about
that?
Mr King: I believe you are referring
to a letter that I saw published this morning in the press. I
think they made two very important points in the letter which
I do not think members of the Committee would disagree with. First,
the two key points they make are the need in present circumstances
to look beyond the short-run volatility of energy prices. We saw
in the last part of last year the pick-up of CPI inflation reflecting
partly a rise in domestic energy prices. We now expect a fallback
reflecting the "base effects" of those changes last
year and cuts in gas and electricity prices this year. Our view
is broadly as it was in February, that there could be quite a
sharp fallback in inflation over the next four to six months.
But we will see. For monetary policy the important point is not
to get caught up in all that, although it was important to draw
that to people's attention in the wake of inflation hitting 3.1%,
but to look beyond that through this fog to the medium term picture.
I totally agree with that. The second important point they make
is that, when looking at inflation beyond the fog, you do need
to think carefully about inflation expectations and about monetary
and credit growth, because these are the nominal variables that
will shape the path for inflation. That is an extremely difficult
thing to do and I think in their letter they acknowledge and,
as Paul pointed out, there is great difficulty in making a clear
numerical link between a picture growth rate of money and credit
and the consequences for inflation, but that there is a link I
am perfectly confident of and think it is an important factor
for the Committee to look at. There is a third point where I would
not agree with them and I thought they did not give enough weight
to this because they rather linked together money and credit growth
in the UK with the behaviour of asset prices in the UK. I think
that in recent years that has not been so obvious a link. In a
global capital market, where money can move in and out freely,
what determines asset prices in the UK is very much a function
of what is going on in the world capital market. A big feature
of recent years has been the very sharp fall in real interest
rates, not just in the UK but around the world, and also a fall
in risk premia around the world. That has driven up asset prices—all
types of assets—as we have discussed before. That is not
something that you can easily say is the logical consequence of
rapid money growth in the UK. It may well reflect, and it probably
to some extent does reflect, easier monetary policy around the
world, but UK assets are being bought by overseas' residents,
and we in turn are buying overseas' assets. The impact of higher
asset prices, if that is thought to be important, cannot just
be linked solely and exclusively to UK monetary policy and the
growth of money and credit here. That is an area where perhaps
the letter did not do enough justice to the openness of the capital
market, but in the end I totally agree with them that inflation
is made at home. Whether or not we have inflation in the UK does
depend on the monetary policy stance of the MPC. As we all pointed
out in the letter that I sent to Gordon Brown, the MPC to a person
is determined to bring inflation back to target.
Q247 Mr Gauke: Do you think that
in particular the cut in interest rates in August 2005, with the
benefit of hindsight given where we are with inflation just at
the moment, was unfortunate and that one of the reasons why that
may have happened was because insufficient weight was placed on
monetary aggregates?
Mr King: That kind of judgment
I leave to the commentators and to the historians. For the Monetary
Policy Committee the only meeting that matters is not one that
took place two years ago, but the next meeting.
Q248 Mr Gauke: You sound like a football
manager.
Mr King: It is a very good principle.
The only meeting that matters to the MPC is the next one. There
is no point playing today meetings that we are going to have in
August, September, October; the one that matters to us is the
next one in May. Equally, I am not going to revisit the ones we
have had in the past. We do, as a Committee, look back and learn
from what has happened in the economy and whether the outturns
were different from what we had expected (or the same for different
reasons)—that is an important part of our work—but
I do not think it makes sense to go back and say what would we
have done then had we known what we know today. That is the proper
role of a historian and we should not be judging that ourselves.
Q249 Mr Gauke: Can I move on to a
different area which is the relationship between monetary policy
and fiscal policy. How important is that relationship and how
important is the Chancellor's decisions on fiscal policy in determining
interest rates in your role on the MPC?
Mr King: At one level it is very
important in that if fiscal policy were set in a way that would
lead to a prospect of very large budget deficits, then I think
it would be extremely difficult for us to manage inflation expectations
which have been the anchor of the framework for monetary policy.
In a big sense fiscal policy does matter because it can undermine
monetary policy. I do not think that has been the case in the
past decade. Equally, I do not think there is a great deal of
fine-tuning here. The most important point about the link is that
when decisions in the Treasury are made about taxes and revenues—and
the consequences for borrowing—that they know we on the
Monetary Policy Committee will be looking at the impact of that
on the level of demand in the economy and taking steps to ensure
that nothing that happens in the budgetary side is going to affect
the chances of our meeting the inflation target. The Treasury
itself knows when making its budget that we will take offsetting
action if that appears necessary. The fact that they know that
we will be behaving in that way gives them a pretty strong incentive
to stick to their fiscal rules.
Q250 Mr Gauke: In your time on the
MPC—we had a tight fiscal policy after 1997; in 2002 there
was something of a loosening—would you agree with what the
National Institute of Economic and Social Research have said in
their evidence to us that: "there is little doubt that the
conduct of fiscal policy in recent years has meant that interest
rates have needed to be higher than they would otherwise be"?[2]
Did you detect any changes in fiscal policy in 2002? Is that a
matter that you were conscious of and adjusted policy accordingly?
Mr King: I think it is very hard
to know what would have happened to interest rates had fiscal
policy been somewhat different because I cannot judge how the
Committee as a whole would have responded to that. I do not think
there has been any real significant change. What happened was
that spending grew much quicker than it did before and taxes rose.
There has been a significant increase in the share of taxes in
household incomes in GDP but then that was necessary. What matters
to us is not the rate of spending growth or taxes taken separately,
but looking at them together. I do not think there has been a
dramatic change but your own report made clear that it makes sense
for the rules to be set in a somewhat more forward-looking way
and I see some merit in that. We are a million miles away from
some of the fiscal problems that we have experienced in the past.
Q251 Angela Eagle: Governor, the
day it emerged that you had sent a letter to the Chancellor explaining
the current rate of inflation as required, I was phoned up by
a journalist who was wondering whether I would be demanding your
immediate resignation.
Mr King: I did not receive it
if you sent it.
Q252 Angela Eagle: You did not see
me demanding it. Do you think that this response says more about
your successes as a Committee in never having to send a letter
for 10 years, or your failure as a Committee to communicate to
the journalistic profession precisely what your role is?
Mr King: I think the ambition
of explaining monetary policy successfully to the journalistic
profession, as you put it, is a continuing task that we engage
in all the time and we repeat this at all of our Inflation Report
press conferences. I think there has been a significant improvement
in the quality of reporting among the specialised economic press.
Undoubtedly when something like this happens it has what I might
call "political overtones" and then you drag in a different
kind of journalist who writes about it from a different perspective
and I rather suspect that is a large element of what you have
been seeing.
Q253 Angela Eagle: You are a very
perceptive man, Governor. Earlier we were talking about perhaps
some changes to the way the MPC works, Rachel Lomax. The independent
members used the phrase that the whole process has been "dynamically
evolving"; in other words, there has not been any great shift
in structure but there have been tweaks and changes in the past
10 years. Is that your experience of the way the Committee has
worked and do you think that the system needs any radical change
or the dynamic evolution just needs to continue?
Ms Lomax: I think there have been
modest changes during the time that I have been on the Committee;
for example, in the way that we run the briefings from the staff
for the monthly policy meetings. It is actually quite a stable
process, very heavily engineered. We do the same thing every month
and every quarter. There is not a huge amount of change; it is
very predictable. That is actually part of its strength. You can
envisage doing it quite differently. I do not think there is any
real need to do it quite differently. I do not think there is
a pressing need to change the way that we do it but I could certainly
envisage approaching it in a slightly different way, as indeed
other people do. "Dynamic" is not quite the word I would
use for the amount of change we have had.
Q254 Angela Eagle: Do you think there
is a risk on the other side that if there is radical change it
might actually disrupt the process and cause a volatility in the
way the Committee works that might be damaging?
Ms Lomax: I think that is one
reason why the amount of change has been pretty modest. There
is a great strength in behaving in a predictable way in terms
of communicating with the outside world and in terms of going
through the data in a systematic way as it comes in. We probably
ought to avoid radical change unless there is a really good reason
for it.
Q255 Angela Eagle: Do you think that
if there is this predictability and it is not dynamic, but marginally
evolving as a process, that there may be a risk of it becoming
institutionalised and somehow staid and not able to respond?
Ms Lomax: It is always a challenge
to keep the process fresh and that is one of the reasons why it
is good to have turnover on the Committee and to have fresh people.
We have had rather a lot of turnover on the Committee in the last
year, but the idea of having new people come on is one of the
most important ways in which the whole process keeps itself fresh.
Q256 Angela Eagle: Therefore are
you happy with the kind of length of appointments that there are?
Do you think that is about right or that it should be wider or
smaller?
Ms Lomax: If one were starting
again one would probably go for longer terms for the externals.
Three years is actually quite a short period of time for somebody
who has not been engaged in this kind of process before to fully
get themselves up to speed, to make a real contribution, to develop
their own ideas and see the consequences of their own past decisions
come back to haunt them. On reflection, three years is probably
too short.
Q257 Angela Eagle: John Gieve, do
you think that there is any obvious tension between the internals
and the externals on the Committee, or are you all just mucking
in together?
Sir John Gieve: I do not think
it does split down into the internals versus the externals. All
the meetings I have about monetary policy, apart from meetings
I arrange with individual members of staff, are with the whole
Committee. We do not have a pre-meeting of the internals. I have
not noticed a particular tension. It is a collective process but
it is not a consensus process. The important thing is that each
individual is coming to their own decision and their own personal
credibility is on the line. It is not a team event in that way.
Q258 Angela Eagle: This is possibly
an odd question to ask of an ex Permanent Secretary, but do you
think there is a potential problem of institutionalisation on
the Committee; that you just get into grooves that you cannot
get out of?
Sir John Gieve: I do not think
it is happening to the MPC but I think that there is a very important
risk in setting up an independent body that it gets into ruts.
You get into a particular way of thinking and you get group think.
What has happened here is that because you have external members—this
is the main reason for having external members -you have people
who challenge and who bring different viewpoints to the party
and constantly shift the debate; I think that works very well.
I was talking, for example, to another central bank which is thinking
about its arrangements and currently has only internal members
appointed working full-time in the bank. I think that arrangement
would risk an institutionalisation of certain attitudes and approaches.
Q259 Angela Eagle: We have got it
about right in terms of turnover and mix and adding different
things to the mix, do you think?
Sir John Gieve: Yes, I think it
does work well.
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