Select Committee on Treasury Minutes of Evidence

Examination of Witnesses (Questions 360-379)


8 MAY 2007

  Q360  Mr Gauke: Do you think the change to CPI itself was in some respects regrettable?

  Mr Lambert: No, I do not. I think the CPI is a good index for the purposes that it serves, but I would think it would be very regrettable were the index to be changed again, simply because it would confuse the public. As far as wage bargaining under the RPI is concerned, it is for the market to decide. That is for individual employers and employees to decide what is appropriate for them, but the Monetary Policy Committee in its deliberations obviously spends a lot of time thinking about trends in earnings and trying to project that forward and drawing conclusions about the likely impact on inflation and that bears through on their decisions about interest rates. So the fact that bargainers may or may not use the CPI for their settlements does not have any implications on the MPC's judgments about the path of inflation going forward.

  Q361  Mr Gauke: Do you think there are any dangers in house price inflation not being included in CPI?

  Mr Lambert: I think ideally that you would find a way of getting house price inflation into the index because obviously it is a very important part of everybody's budget. It turns out to be a very difficult thing to do. As I understand it, it is not in the HICP and continental Europe either; no-one has completely cracked that one, have they, Ian?

  Mr McCafferty: That is right. It is not in the current HICP for the ECB or for any of the individual countries. There is, however, a good deal of work going on centrally in order to try to include house prices in the HICP as followed by the ECB, and that work would also lend itself possibly to include house prices into the UK defined CPI as well. As Richard Lambert says, because of the differences in ways in which you can do this, it is not an easy calculation as to how you include house price valuations in this instance.

  Q362  Mr Gauke: Mr Page, would you be sympathetic to house price valuations being included within the inflation target?

  Mr Page: I would be very sympathetic to that because house prices are such a large part of any working person's monthly outgoings, so an inflation rate that does not reflect house prices is a less than perfect inflation rate from that point of view.

  Q363  Mr Gauke: Looking at the last 10 years, it has clearly been a good time for the MPC both about benign conditions and, as the Governor has pointed out, there is no guarantee that the next 10 years will be as successful. Can I ask Mr Barber: in the event that circumstances are not as strong in the next 10 years and that we see interest rates having to rise because of perhaps inflationary pressures and so on, how strong is the support for the MPC within the trade union movement and, in the event of higher interest rates and higher unemployment, to what extent do you think that the trade union movement would be much more critical of the MPC?

  Mr Barber: I think in the trade union movement there has certainly been a real appreciation of the degree of economic stability that has been achieved over the last 10 years. I certainly remember earlier periods when wage bargainers were chasing inflation rates at ever higher levels and not being able to deliver real improvement in living standards in those periods. The benign circumstances you describe that we have enjoyed over the last 10 years I think have been appreciated by the trade union movement as a very important component in providing a platform on which we can really see people's living standards progressively improved. Against that background, I think there has been real appreciation for the role that an independent Bank of England has played and that the MPC has played by taking some of the politics out of short-term decisions on interest rates and helping to create a climate in which there are widespread expectations that the low inflation environment that has been created can be sustained.

  Q364  Mr Gauke: The MPC has had a fairly fair wind behind it in the sense that globalisation has meant that the prices of a lot of goods have come down and so on. The next 10 years might not be the same. There might be more international shocks than we have seen in the last 10 years. How resilient do you think that consensus that we have in the CBI and the TUC at the moment, under the current structure, is in the event of waters becoming choppier?

  Mr Barber: As the Governor has pointed out, the problem with shocks is that they come as a surprise! We cannot anticipate what those shocks might be and where they might come from and of course, in circumstances where there has been a major shock to the economy, that potentially throws up all sorts of pressures and concerns. I have a concern at the moment, for example, just about the extent to which unemployment has been creeping up over the recent period, but a major shock to the system puts all sorts of pressures on our arrangements, but I think the MPC has established itself very solidly over the last 10 years. It has acquired a lot of respect for the way in which its decisions are made, the evidence on which its decisions are based and the objectivity the members of the MPC bring to their deliberations, and that provides a very solid basis for coping with shocks that might arise.

  Q365  Mr Gauke: Mr Lambert, do you think more could be done for the MPC or whoever to educate the public as to the role of the MPC in the event that times prove a little bit more difficult in the future?

  Mr Lambert: It is worth remembering that there have been some very big shocks over the last 10 years, ranging from the Russian defaults and the quadrupling of energy prices, and they have been absorbed but you are right to raise the question for the future. I think the MPC could probably do more to educate the public on its role and its mission. It is very good indeed at communicating with financial markets and economic analysts about what it does and why it does it. It might well be in its interests to think about—and I know it is thinking about—how to inform and educate a broader public about its mission because, as you suggest, when times get tougher its role will be more controversial and it would be a good thing, ahead of that, if more people knew why what it did was important and why its decisions, properly made, are to the benefit of the whole of society.

  Q366  Mr Gauke: One point that has been raised with us is the relationship between monetary policy and fiscal policy. Mr McCafferty, to what extent do you think fiscal policy is important as far as inflation is concerned, that the MPC has to take into account fiscal policy? For example, the argument has been put that fiscal loosening in 2002 has resulted in slightly higher interest rates than would have been the case. Do you agree with that?

  Mr McCafferty: Clearly, fiscal policy is important to take into account when considering the inflation outlook because, of course, fiscal policy affects demand in the economy and that clearly has a knock-on effect into potential inflation. To that extent the Bank does have to pay close attention to the fiscal conditions and their impact on total gross domestic product or the growth therein. I think there is an argument to say that we have not yet achieved the optimal balance between fiscal and monetary policy and that fiscal policy has been somewhat loose over the course of recent years, with very rapid rates of public expenditure and a rising budget deficit, and this has led to interest rates being slightly higher than would have been the case. That suggests that there is room for further discussions between the two bodies in order to try to achieve that optimum balance between the two sets of policies.

  Q367  Mr Gauke: Do you think the Bank should say more publicly if it has concerns about fiscal policy or is that straying into areas best left alone?

  Mr McCafferty: I think I would start by discussing it more privately and if there are concerns in the Bank about this balance they should perhaps express these to the Treasury individually, but there is finally a role for public comment if that is required.

  Q368  Mr Gauke: Mr Lambert, you have worn various hats with regard to this issue. Would you agree with that?

  Mr Lambert: Yes. Obviously the Bank, in making its central projections, incorporates the Treasury view of public spending going forward and it deduces from that the inflationary effect in the way that Ian said. I think the Bank should be strongly advised to steer out of politics and not get involved in political debate. Its job is to get involved in monetary conditions. If, however, it thought fiscal policy was seriously and adversely affecting monetary policy it should say so. It would come out in the minutes in the first instance.

  Q369  Mr Gauke: Mr Barber, again the TUC evidence has said that "a monetary policy framework that recognises the need to support industry as well as to keep inflation low would be welcomed by trade unionists." [3]How do you think the MPC might go about doing that? How, indeed, could the Government change the structure to enable it to do so?

  Mr Barber: Within the constraint of a body that has a decision to make each month on interest rates, it is clearly not possible to target one particular sector of the economy. The point we were making is a broader point, in a sense, that, in weighing up the pressures within the economy, the pressures on the manufacturing sector are an important part of the mix that need to be considered by the Monetary Policy Committee, but clearly it cannot make a decision month-on-month specifically targeted to the needs of one sector of the economy alone.

  Q370  Mr Gauke: When you say that the need to support industry as well as to keep inflation low should be recognised within the monetary policy framework, are you, in saying that, suggesting that perhaps the target should be widened or that there is a higher inflation target? What should be the response to that?

  Mr Barber: I think we are saying that the remit to the MPC is a remit relating to monetary stability but taking account of the implications for growth in the economy more generally. As an element of that slightly wider description of the remit, the needs of the manufacturing sector and the pressures on the manufacturing sector need to be taken into account.

  Q371  Mr Gauke: Do you not think that would weaken the counter-inflationary credibility of the MPC?

  Mr Barber: No, I think the real needs of the economy are to maintain a viable economy going forward, including a vibrant manufacturing sector, maintaining high levels of employment to reduce pressures on the public finances. These are all part of the mix.

  Q372  Mr Gauke: Mr Lambert, do you think that the MPC could give greater weight, say, to the manufacturing industry when determining monetary policy?

  Mr Lambert: I think the Monetary Policy Committee has a single instrument, which is interest rates, and that it has a single target, which is a symmetrical target—which is really important. Within that, it is very difficult—and I do not think it would be advised to be trying, as it were—for it to deconstruct the economy and aim at particular sectors of it within its forecasting work. Obviously it takes into account its projections of the output of the manufacturing sector and the services sector but it also has to think about the likely implications for the exchange rate acting in a particular sector's interests.

  Q373  Mr Gauke: You state it is important that it is a symmetrical target. Some evidence to us has suggested that there is an anti-inflationary bias, or perhaps there has been in the earlier years, to establish credibility. Do you detect that at all?

  Mr Lambert: I was on the Committee when we were one basis point above having to write a letter for being on the down side. I can tell you we were nervous about that and we took that very seriously.

  Q374  Mr Gauke: Mr Barber, do you detect an anti-inflationary bias?

  Mr Barber: During that period that Richard describes, when for a long period we were coming out well below the target, I think there was a concern in the trade union movement that there appeared to be a bias, if you like, on the down side. We have now seen a period when it has gone the other way, of course.

  Q375  Mr Love: I would like to go back to a comment made by Mr Barber earlier on about inflationary expectations. Earlier this year there was some notable concern, most notably by the Monetary Policy Committee itself, that there may well be in this wage round inflationary awards given. That has not turned out to be the case and I would be interested to get both your views about why that is. Is that a one-off, or has there been a change in the signalling mechanism between the Monetary Policy Committee and the wage bargaining process; in other words, a longer term improvement?

  Mr Barber: As you say, there were some signals of a degree of apprehension that wage bargaining might lead to settlements that put up-side pressure on inflation but I do not think that has been the evidence of what has occurred in recent months. I think that has been acknowledged by the Bank in its own inflation report. Why that is the case, I am not sure. In the public sector at the moment we have a very tight squeeze on pay settlements, to a level that I do not think is justifiable, with the limit seeking to be imposed by the Chancellor coming in under the 2% inflation target, when inflation, of course, as measured by RPI, is running currently at 4.8%. That is applying major, major pressures on the living standards of public service workers in a way that I do not think is advisable. We are still in a period where wage bargainers have not been fazed by the rise that we have seen in inflation and still regard that as a short-term change and a short-term pressure rather than signalling a major change in the inflation environment and I think that led to settlement levels at a level that have not contributed to inflationary pressures.

  Mr Lambert: I think there has been a long-term change in the outcome of wage bargaining over the last 10 or 15 years, which is that inflationary expectations have been well anchored around the target and people broadly trust the idea that, over time, the target will be met. That has changed the behaviour of bargainers on both sides of the table and that is a really important gain. Going around the country I see quite different stories coming out of different sectors of the economy. In some areas there are real bottlenecks and, as you would expect, wage awards are going up in those areas, but, taken overall, it is clear so far, at any rate, that the wage round appears not to have had the inflationary implications that might have been a concern at the beginning of the year.

  Q376  Mr Love: I am going to assume that both of you think the Monetary Policy Committee, by anchoring those inflation expectations, has been a major contributor towards that. If we look back in history, we have often had one year, perhaps even two years when things were relatively turbulent and wage awards have been subdued, only to find them racing forward again. What confidence do either of you have that if we have further turbulence, further increases in inflation as a consequence, that will not lead inevitably to the sort of wage rounds we have seen in the past?

  Mr Lambert: Because if you look back over history and see the changes that happened around the early/mid 1990s—the process started before independence—there has been a clear and marked change in inflationary expectations which has been sustained now for 12, 13, 14 years. Somebody like me, who can remember the seventies and eighties very well, finds it absolutely amazing that this should have happened but it is a clear and I think sustainable change, going forward, in the way people think about inflation. That is a very important success that must be sustained.

  Q377  Mr Love: I would expect you to be a little more cynical than that, Mr Barber, and discussing it with your trade union members you may find there is some considerable concern. I noted your concern about the public sector norm. How concerned are you that the Monetary Policy Committee and, indeed, everyone has to realise that inflationary times will inevitably lead to a greater demand in the wage bargaining round?

  Mr Barber: Of course people at work want to see their living standard maintained and improved. I agree with Richard. Essentially, we are in a period where there is widespread acceptance of the low inflation environment being the environment in which we all operate, but I am concerned that, in particular in the public sector, we are in danger of creating again, to use a phrase, a "boom and bust" approach. We have had a period of reasonable increases in earnings for public sector workers in recent years but to be faced with pay awards coming in at less than half the level of inflation and for the Government to seek to impose those in the way they are looking to do at present, is in danger of creating a backlash, and I do not think that is in the interests of the services concerned or the economy more widely.

  Q378  Peter Viggers: To focus on appointments to the Monetary Policy Committee, specifically appointments of external members of the Monetary Policy Committee, Mr Lambert, what criteria should be used in selecting external members of the Monetary Policy Committee?

  Mr Lambert: The criteria should be that the appointments should sustain and enhance the credibility of the Committee.

  Q379  Peter Viggers: Should it be balanced? Are there particular skills you would wish to see on the Monetary Policy Committee; for instance, business experience?

  Mr Lambert: No, I do not think the Monetary Policy Committee should be representative in that sense. In other words, I do not think there should be somebody there who is there because they are a business person or because they are a trade union representative. I think you need around the table a group of people focused on a single goal, articulate enough to express their views on that goal, and—you would expect me to say this—the notion that they do not all come from exactly the same background adds to the quality of the decision-making. If everybody had a PhD in a particular line of economic research, it might not lead to as lively a debate as if there were a few people with different experiences sitting around the table.

3   Ev 95-96 Back

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