Select Committee on Treasury Minutes of Evidence

Examination of Witnesses (Questions 420-439)


14 JUNE 2007

  Q420  Mr Todd: Chancellor, could you expand on what you mean by "the balance of skills"? What sorts of skills are you thinking about, because you will be seeking to publish these criteria following the announcement that you made at the start of this hearing.

  Mr Brown: That is the essence of the debate that we can now have. The Act says "knowledge or experience relevant". Funnily enough, the European Central Bank—and maybe you would expect this—says it is not just that but relevant standing in their field, so I think we have to look at both the experience that people can bring to bear and at the expertise they have. As I said, there are two points that I would bear in mind in setting out the criteria for the future, that we have to get the balance right between, if you like, market skills and academic skills, and that is what I have always tried to take into account. For example, when it was controversial that we appointed a business leader to the Committee, in the context of a large committee to have someone who had that experience was the right thing in my view to do. Equally, I think we need a balance between the macroeconomic skills and general skills related to the economy, so again I think it was controversial for the Committee that we appointed people who have expertise in employment as opposed to macroeconomic expertise, but, again, getting the balance right between Mr Nickell and Professor Blanchflower, for example, who had long term projects related to employment in the economy, and those who had more specific skills in relation to the macro economy was a very important part of what we did as well. These would be the two essential criteria, but we will obviously publish a paper on this and we will elaborate on what is in the Act, "knowledge or experience relevant".

  Q421  Mr Todd: Would that also include the technical aspects, because one of the tasks that the MPC has is to work with a model that the Bank of England operates to provide forecasts for our economy, and having at least one member of the MPC who has a strong technical knowledge of the model might appear to be an advantage. Would you share that view?

  Mr Brown: That could be said to be the case. On the other hand, all members of the Committee have access to the very considerable expertise of the Bank of England's own staff. Some of them are engaged in their own research projects and that is part of the work in the Bank of England. They are perfectly able to draw on the experience and expertise that exists outside the Bank to inform their research or their thinking, and I do not think at the moment in British economic policy, or even in the Bank itself, that there is a shortage of expertise available to the Committee itself if they want to either look in detail at the models of economic behaviour or any other aspect of economic policy. I think we are learning quite a lot and this suggests to me that the debate ought not just to be narrowly focused in the future of the MPC on membership. I think we have learned a lot over the last 10 years about how we manage inflation, and I think the behavioural changes that are taking place in the British economy as a result of the new system are something that this Committee might want to look at at some point as well. I think in particular that if we had started in 1997 with our inflation target first of all nobody could have predicted, as did happen, that inflation expectations would come very much in line with the inflation target. Before 1997 you had a 2.5% inflation target but you had a 4% inflation expectation. Very quickly these inflation expectations and the inflation target aligned themselves and I think that was a great success of the new system, so it did command confidence. The second thing to say is that you might not have expected that wages or earnings would have come in line in the way they did, in other words that people would have acted as if you did not have the inflation target rather than that if you did, and I think what happened quite early on, and it may be good fortune but it did happen, is that wage expectations also moved in line with the inflation target and, while we had great difficulties over average earnings figures for a while because they were factually wrong, that is a big change that has happened over these last few years.

  Chairman: Chancellor, we are conscious of the time. We know you want to get away and we understand that but we have a lot of questions and we are looking for your wisdom.

  Q422  Mr Breed: One of the consequences of the lower interest rates has been the rise in household debt. It has been described to us as not of importance in terms of monetary policy but very important in terms of a social issue. Do you think enough is being done between the Treasury and the Bank to address these social issues, like household debt?

  Mr Brown: There are two issues here. One is a group of people who themselves get into real difficulty as a result of either over-extending themselves or something happening to their employment position or their family income, and I think we are putting in place measures that give proper advice, proper help, proper debt counselling, proper support, and obviously, we want the banks and the mortgage companies to be sensitive to people in the position that they find themselves in. That is one aspect of it. The second aspect is the general economy and how it is moving forward, and I would suggest to you that if you look at the level of debt as a percentage of overall income, the level of people's borrowings as mortgage holders and what they have to pay back as a percentage of their income, we are not in as bad a position as you are implying by your question. In other words, in an economy where you have relatively low inflation people are able to pay back their debts generally. The wider issue about affordability in housing is something that we might deal with separately and I have already said that I think that is a priority for our country.

  Q423  Peter Viggers: How much weight do you think the Monetary Policy Committee should be placing upon monetary aggregates when assessing future inflation?

  Mr Brown: I am rather pleased that I set out the four points in my Mais Lecture right at the beginning, and this is what has guided our economic policy since 1997. I said then in that lecture, and I will be very happy to give the detail of what I said to the Committee, that rigid monetary rules that assume a fixed relationship between money and inflation do not produce reliable targets for policy. I know that in the European Central Bank there are the two pillars of policy that include the examination of monetary aggregates, but our experience of the eighties was that in an open economy, far more open, far more global in its capital markets than ever before, this assumption that you had a fixed relationship between money and inflation and that you could therefore set quite rigid and fixed monetary rules was found not to be workable.

  Q424  Peter Viggers: I think the consensus view is that the creation of the Monetary Policy Committee, where you appointed experts and then exercised reticence, has indeed been a great success and it contrasts starkly with the interventionist micromanagement in the disaster areas like pensions and means testing and tax credits. Do you think there is a wider lesson here for the Government?

  Mr Brown: I disagree with you fundamentally. There are millions of people who are better off as a result of tax credits. I think you forget, despite what happened to the Stock Exchange and the loss of Stock Exchange value for pension funds, that the value of the pension funds in this country over these last 10 years has risen from £500 billion to a trillion, in other words has doubled. I think you forget that in the question that you are putting forward. As far as general wealth in this country is concerned, as a result of all the changes we have brought about the 60% increase in the personal wealth of this country is a reflection of the fact that, while you say these things have not worked, in actual fact people are in a better position now than they were 10 years ago. I am grateful to you for acknowledging the success of monetary policy but I would ask you to look at the growth rate of the economy as a whole, the growth in employment in our economy, the growth in living standards in our economy and the growth in personal wealth.

  Q425  Mr Simon: I was at Hay a couple of weekends ago listening to you talk about how the political class needs to find completely radically new ways of involving and engaging an alienated populace. How does that transfer to this, where you have interest rates set by a committee of experts for a generation of consumers under Labour that have never heard of inflation?

  Mr Brown: I think it transfers into saying this. In 1997 we took perhaps the boldest decision in monetary policy that had been taken in a century where, after 20 years of the failure of governments effectively to deal with inflation, we set up a new system and we gave up power. The executive was prepared to surrender power over interest rate decisions in the interests of having a better system and in the interests of making sure that the system itself was credible to deal with the inflation problem that we had inherited, and I think that model does have application to other areas of policy and perhaps this is not the right time or place to detail that. The Chairman would rule me out of order if I did so.

  Q426  Chairman: Absolutely.

  Mr Brown: The idea that an executive in the modern world is prepared to surrender its power in the interests of better decision making is, I think, the fundamental principle here, and I think the relationship between the executive and legislature and the executive and the people of our country is something that is subject to both criticism and the potential for reform in a whole series of different areas similar to what we have managed to do with the Bank of England.

  Q427  Mr Newmark: Sally is going to talk about RPI versus CPI but I just want to focus on CPI, Chancellor. It would be helpful if you could explain why the average CPI inflation rate is higher in the UK now than in the rest of the EU, why it is twice as high as it was in 1997, and why you have now missed your target for over a year. Who is to blame? You or the MPC?

  Mr Brown: As you know, there are three forces governing inflation around the world. The first is manufactured import prices; that is effectively the China and India effect. The second is oil and commodity prices, which I think you are mistaken in believing hit every economy in exactly the same way. They hit economies in quite different ways. Why we have been hit by oil prices later than America is simply because the second round effects on utility prices have been what have been most prominent in our inflation figures, and the third is service sector costs. America moved to inflation of 4.4%. It was at 4.3% or 4.4%, I stand corrected; it may be 4.3%, but America has been—

  Q428  Mr Newmark: I am talking about the UK versus the EU, Chancellor, not America.

  Mr Brown: Exactly, but America was 4.3%. If I am right, the European peak was 3.3% and our peak was 3.1%, so our peak has been a lower peak than the European peak.

  Q429  Mr Newmark: Chancellor, do not play semantics with me. We are now 2.8% in the UK versus 2.2% in the EU. In 1997 it was 1.6% inflation. We are now at 2.5% inflation. Why is that the case? You put great stock in achieving your targets. You have failed.

  Mr Brown: And you are completely wrong again in your analysis.

  Q430  Mr Newmark: It is not my analysis. These are the facts.

  Mr Brown: It is the peak of inflation that you should be looking at and, as I keep explaining to you and you do not want to understand,—

  Q431  Mr Newmark: I do understand. You want to hear something different.

  Mr Brown:— the reason that the oil effect in the United Kingdom is quite different from the oil effect in other countries is that it is the second round effect, the utility price effect, that has had the biggest impact on our inflation. Our inflation was a lot lower last year than in other countries. It has been higher but only to the point of 3.1%. It is now down to 2.5%, and I just repeat for your information that the peak of inflation in the USA was 4.3% and the peak of inflation, as I understand it, in Europe was above the 3.1% figure that we have had and we are now down to 2.5% in the latest CPI figures, so I think my case is made by the information I am giving you.

  Mr Newmark: I do not think it is but I will pass on to Sally.

  Q432  Ms Keeble: You said just now, Chancellor, that you wanted a new deal. You thought that you should deal separately with the issue of house prices and the pressures which that puts on people, but I wonder if you would say whether you think there is any merit in including in the calculation of inflation something to reflect house prices, given that the increase in interest rates is putting increased pressure on this and this is indeed the biggest single factor in household incomes. If you are not going to look at CPI and changing that slightly, how else will you deal with the housing price issues that you referred to earlier?

  Mr Brown: I think housing is a big issue that is about demand and supply. It is about the rising demand, through the changing composition of households, for new housing and particularly for smaller new housing, and it is about supply, and that includes the issues of planning and the issues of the construction industry itself and its ability to deliver the house building numbers that are needed. At the moment we are not supplying enough houses to meet the demand and that is one of the reasons why house prices are high but it is also one of the reasons, obviously, why a lot of young people find that the houses they want are not affordable. The second thing which is an issue is the form of the mortgage market at the moment, and remember the Miles review looked at that, and there are certain things that I believe we can do about that and one of them is shared equity, but there are other things that we can look at. I would say the third thing is the lack of supply of rented as well as houses to buy, which is an issue in the housing market as well.

  Q433  Ms Keeble: Can I come back on that because I appreciate all the stability that the MPC has brought but the one lever it has is to put up interest rates which feeds through into mortgages and it is not about people coming into the housing market; it is about people who—and I am thinking about most of my constituents—put their household incomes together very carefully and plan out their spend and a small increase in the interest rate feeding through to their mortgage can be very destabilising and then all it needs is somebody to lose a little bit of overtime or whatever, so what would you do about the issue of interest rate rises and the impact on people's household incomes?

  Mr Brown: Interest rate rises are a matter for the Bank of England, so what would I do about them? I would retain the power of the Bank of England to make the decisions about interest rates.

  Q434  Ms Keeble: What about CPI?

  Mr Brown: CPI is the internationally accepted measure of inflation and I believe it is right to continue to work through the CPI. There are international analyses now being done about what should and what should not be included in the CPI, but I think it would be better for us to follow the general trend of what is happening in other countries. It is in our view a superior measure and there is the ONS paper The New Inflation Target: the Statistical Perspective, if you would like to look at it. Housing demand and supply, however, are a wider question and the Committee may wish to come back to that at some point.

  Q435  Mr Love: Can I turn to the recent experience on letter writing? It has been put to us that it should not be regarded as a sanction. How do you regard the recent experience of letter writing?

  Mr Brown: Rare. I have had two letters: the previous Governor of the Bank of England writing to me to say he was pleased he had not had to write a letter and the new Governor writing the one letter that I think to some extent demonstrated the credibility of the system because people accepted that this was a proper way of dealing with a problem, and one of the problems obviously had been the very big rise in oil and commodity prices that we are dealing with, but he also looked at what was specific to the United Kingdom economy and I think the experience of the exchange of letters was a good one.

  Q436  Mr Love: In the evidence to us the most interesting feature has been a focus on the letter that you write back to the Governor rather than the Governor's letter to you and it was suggested to us whether or not you as Chancellor would consider writing a letter suggesting to the Governor that he may be bringing inflation back to target rather faster than you would like in terms of the overall impact on the economy. Would you consider writing such a letter?

  Mr Brown: It has obviously got to be at the discretion of any Chancellor to take a different view from the Governor about the overall effect on the economy, but fortunately over these last few years we have generally been in agreement and a lot of the arguments have been arguments held with the votes that are taking place in the Monetary Policy Committee. I think you underestimate the extent to which these are heated debates that are taking place themselves, sometimes in the Monetary Policy Committee where there have been very tight votes on certain occasions, and the tradition of voting, including members of the Governor's staff not voting with the Governor, has been pretty well established over these years. Again, I come back to the results of the process. We have been successful. The average UK inflation rate since 1997 is 1.5%. In France it is 1.61%, in Italy it is 2.32%, in Germany 1.5%, the same, but, of course, Germany has had to suffer four million unemployment while it is trying to keep inflation low. Generally speaking our record has been superior to Europe and I believe that that is something we should be proud about.

  Q437  Mr Mudie: Chancellor, why are you so adamant against the dual mandate?

  Mr Brown: When you say "the dual mandate", do you mean in relation to inflation and employment?

  Q438  Mr Mudie: Yes.

  Mr Brown: We take into account employment in the decisions. That is clear.

  Q439  Chairman: I know you do. Why are you so adamant against it?

  Mr Brown: Because I think the old system was built on the idea that you were trading off inflation and employment and that at some point you should make the decision to go for employment against inflation, and there may be other points where it is inflation against employment. The new understanding is that there is that there is no long term trade-off between inflation and unemployment. If you cannot get inflation low you are in the end probably going to have high unemployment and if you cannot keep a stable economy it is not good for either growth or employment, so that is the new understanding of how modern economies work.

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