Examination of Witnesses (Questions 1-19)
MR MERVYN
KING, SIR
JOHN GIEVE,
MR CHARLIE
BEAN, PROFESSOR
TIM BESLEY
AND PROFESSOR
DAVID BLANCHFLOWER
30 NOVEMBER 2006
Q1 Chairman: Governor, good morning to
you and your colleagues and welcome to the committee. Would you
introduce your colleagues for the shorthand writer, please?
Mr King: Indeed. On my right is
Charlie Bean, the Executive Director for Monetary Policy and Chief
Economist, on his right is Professor Tim Besley, one of our new
external members, on my left is Sir John Gieve, the Deputy Governor
for Financial Stability, and on his left is Professor David Blanchflower,
also one of our external members.
Q2 Chairman: Governor, you have a
short statement to make.
Mr King: I do. I am very grateful
for this opportunity to explain the reasons for the Monetary Policy
Committee's decisions on interest rates since we last appeared
before you in June. Since then the bank rate has been increased
twice, in August and November, and it now stands at 5%. The British
economy has continued to experience steady growth with low inflation.
For the past year GDP has grown at a rate close to its long-term
average, but inflation has picked up and has been above the 2%
target since May. It was 2.4% in October and has risen by half
a percentage point since the beginning of the year. Over that
period official estimates of the growth of consumer spending have
been volatile, but business investment has been stronger than
the committee anticipated and surveys of exports remain at high
levels. The outlook remains one of a continued modest rebalancing
of demand, with consumer spending growing at close to its long-run
average rate over the forecast period, business investment continuing
to recover, and net trade making a small positive contribution
to growth. In its November Inflation Report, the MPC published
a central projection in which output continues to grow at around
its average rate over the past decade. Inflation is expected to
rise further above the target in the near term before falling
back to the target as energy price inflation falls. The risks
to the outlook for inflation appear broadly balanced, although
they are large in both directions. That is why the fan charts
for inflation shown in both the August and November Inflation
Reports are wider than in the recent past. In the medium term,
the main risks concern the ability of firms to raise prices in
order to rebuild profit margins and the extent to which pay growth
remains muted. Continuing rapid growth of money and credit and
uncertainty over the future path of energy prices illustrate the
magnitude of the risks. There is particular uncertainty about
the supply side of the economy. As a result, assessing the margin
of spare resources in the British economy at present is unusually
difficult. Unemployment has risen over the past year. Some of
that rise probably reflects the impact of higher energy prices
and some deterioration in the terms of trade. Despite muted pay
growth, the total cost of employing labour has risen, so it is
difficult to know how much of the rise in unemployment actually
represents increased slack in the labour market, and capacity
utilisation within companies, as measured by surveys, has risen
since August. There is, of course, great uncertainty about the
scale of migration from Eastern Europe and elsewhere, and that
has clouded estimates of the supply capacity of the economy. Given
these data uncertainties, the committee will, therefore, need
to monitor particularly carefully developments in costs, pay and
prices. Since the beginning of last month the committee has, I
am glad to report, been back to its full strength of nine members.
Chairman, those are the remarks that I would like to make this
morning, and I and the other members of the MPC here today stand
ready now to answer your questions.
Q3 Chairman: Thank you, Governor.
You mentioned that the risks to growth are broadly balanced. Why
is there greater than usual uncertainty?
Mr King: I think we are genuinely
uncertain as to how price setting in the economy will respond
to large movements in certain costs, such as energy prices. One
might have expected that energy prices would simply just add to
the movement of underlying inflation and one would be able to
calculate the addition to inflation from increases in energy prices
and these would simply drop out as energy prices fell back. I
think the situation is more complicated. It is not at all obvious
that, in fact, inflation of other goods and services has remained
independent of the actual changes in energy prices. There are
a number of reasons for that, one of which, I think, is the credibility
of the inflation target. Another is the impact of higher energy
prices on the ability of households to spend as much on other
goods and services as they might otherwise have done. And there
is the fact that companies, in the wake of higher energy prices,
have pushed down on other costs, which I think that has helped
to keep pay growth relatively muted. So one of the challenges
facing the committee, I think, is to judge how far you can think
of inflation as being some underlying inflation plus energy prices;
a view which we on the committee feel is too simple—we need
to judge what is driving inflation as a whole. I think the other
aspect that is particularly difficult at present is that, as I
said in my opening remarks, we are particularly uncertain about
the supply side of the economy and the rate at which the economy
could grow without generating inflationary pressure.
Q4 Chairman: Could I ask the other
witnesses if they agree that the risks are broadly balanced and
whether they have anything to add to that?
Mr Bean: To a first order, yes.
If anything, I would have some slight upside risk to my inflation
outlook and some slight downside risk to my growth outlook relative
to the central projections of the committee, but they are pretty
small beer.
Professor Besley: I would tend
to think of the inflation resource though as somewhat to the upside,
but I do agree that it would be very difficult with the degree
of uncertainty as outlined by the Governor to form a very strong
view.
Sir John Gieve: Within the range,
I am broadly balanced perhaps a bit more upside on both.
Professor Blanchflower: I am probably
at the other end, some concerns on both sides but, on balance,
somewhat concerned about what is on the downside and what has
gone on in the labour market, but there is not a great difference
between us, I would say.
Q5 Chairman: Governor, on equity
prices the Inflation Report discusses the continued rise,
especially since the end of July. The FTSE All Share Index averaged
3162 in the 15 working days to 8 November, some .1% higher than
the starting point in the report. What factors do you believe
are driving these rises, how sustainable are they and what effect
would they have on consumption?
Mr King: When we last appeared
before you we thought that we were beginning to see a correction
to the very low level of long-term real interest rates, which
had been described by Alan Greenspan at the Fed last year as a
conundrum. We did not really understand why long-term real interest
rates had been pushed down so low (and it did not look to be a
sustainable feature of the world economy) and, when we last appeared
before you there were signs of that unwinding. In fact long-term
real interest rates have fallen back somewhat since then and,
I think, given those very low levels of long-term real interest
rates, it is not terribly surprising that asset prices of all
kinds have been rising. We have seen this not just in equity markets;
we have seen it bond markets, you can see it in house prices;
indeed, you can see it in the market for fine art. Asset markets
of all kinds have been remarkably buoyant in the last half year.
Q6 Mr Fallon: Governor, there seems
to be a lot of uncertainty around this morning. In your opening
statement you said there was uncertainty of energy prices, you
said there was particular uncertainty about the supply side, you
said it was difficult to know about unemployment, there was great
uncertainty about the scale of migration, data uncertainties.
You put rates up this month; does the bank actually know what
is going on?
Mr King: The quotes you have made
there do not all refer to independent issues. The question of
migration and data uncertainties on the supply side are all wrapped
into the same area. What I said was that the committee, in these
circumstances, given the particular uncertainties about the supply
side, is bound, I think, to put slightly more weight than it might
normally put on the indicators of cost, pay and prices themselves.
The drawback, of course, is that this is very much at the end
of the transmission mechanism. We would like to be able to go
further back to anticipate what may happen, but that is particularly
difficult. I think the worst thing we could do is to pretend to
know things that we do not know. There is enormous uncertainty
and it does cloud the interpretation of the statistical picture.
Q7 Mr Fallon: You are certainly not
pretending to know things you do not know. Your Deputy Governor,
Rachel Lomax, made a speech on Monday and she said, in the case
of monetary policy, "taking out insurance against risks that
do not materialise can inject unnecessary volatility into the
economy". Do you agree with that?
Mr King: Of course, as a theoretical
proposition, yes. But I think those who voted for an interest
rate increase in November did not say to themselves "We are
taking out insurance against something." They looked at the
overall outlook for inflation: the central projection and broad
balance in risks—perhaps for inflation slightly on the upside.
I think the central projection and the outlook for inflation shown
in the fan chart suggested that a rise in interest rates was necessary,
and that was certainly my view.
Q8 Mr Fallon: How costly was the
insurance that you bought with the increase in the number?
Mr King: I do not think we have
taken out insurance. We have made a judgment about the outlook
for inflation and raised interest rates in order to keep the outlook
for inflation on track to meet the target.
Q9 Mr Fallon: She says there could
be a cost if we get this wrong in terms of jobs.
Mr King: Of course there could.
There is always a cost. Every decision on interest rates, whether
to change them or leave them unchanged, has a cost in both directions.
If you fail to make a change that later proves necessary, there
will be clearly costs for that. If we had not moved and inflation
had picked up, looking ahead 12, 18 months, two years, there would
have been a cost to that. It is always a question of balancing
the costs of action versus inaction. That is a decision we face
every month and it is always perfectly reasonable for people to
take different views on that. The whole merit of the committee
is that no-one can say it is obvious that one course of action
is right and the other is wrong. It is never like that. The merit
of the committee is that you have nine people who are chosen for
their abilities to make that decision and, in the long-term, I
think you get better results by relying on the majority view of
those nine people and, in turn, all of us, I think, have been
in a minority, but the committee structure is what gives the framework
strength.
Q10 Mr Fallon: One uncertainty you
have not mentioned particularly this morning is house prices.
How concerned are you, not just by the continued growth in house
prices but the current level of house prices?
Mr King: As I said, I think my
concern is about the level of asset prices in general, not just
one particular example of that. That does carry with it, I think,
the implication that the outlook for demand is stronger than many
people thought. When we last came before you, even in the late
spring, there were still many people who doubted whether the UK
economy had really recovered from the slowdown in 2005. We are
now seeing four successive quarters of pretty steady and buoyant
growth, so the economy clearly has recovered, and I think it is
no accident that that has gone along with rapid growth in money
and credit which has helped to underpin the level of asset prices.
These, therefore, are things which we have to take into our judgment
about the outlook for demand and inflation over the next two years
as well.
Q11 Mr Fallon: I pick out house prices
because most of our decisions probably do not deal in fine art.
That was one of the other asset prices that you mentioned. On
house prices, where do you think the vulnerability is now?
Mr King: The reason I did not
pick out house prices is that, if what we are seeing is a generalised
increase in asset prices, then you would not look for an explanation
of that particularly in the housing market, you would look for
it in terms of factors which apply to all assets, for example
long-term real interest rates, which I think is the major factor
underpinning the level of asset prices. The question, and this
is the issue, I think, confronting those who have a particular
interest in the housing market, is that if there were a change
in the general level of real interest rates around the world economy,
then all asset prices will be affected. House prices will be affected
too; but I simply do not know what the outlook is for long-term
real interest rates.
Q12 Chairman: There has been an increase
in the median loan to income rate on new mortgages. What can you
tell us about the distribution around that median?
Mr King: The data series for the
loan to value ratios in the mortgage market has a break in it
around 2003, or a couple of years ago, when the data source switches
from the Council of Mortgage Lenders to the FSA, but, broadly
speaking, if you look at high loan to value ratios—this
is not loan to income but loan to value ratios—they are
still very much lower then they were in the early 1990s. If you
take as an example what fraction of new mortgages are taken out
which are more than 90% of the value of the property against which
they are secured, that ratio was in excess of 50% in the early
1990s and now it is between 20 and 25%, so it is markedly lower.
I think this is one reason why lenders, in particular, feel that
there are fewer risks associated with home lending than there
were in the late 1980s early 1990s. There is a very telling chart
in the Inflation Report which shows that if you look at
mortgage arrears there has been a small pick up recently, and,
indeed, all measures of areas of indebtedness have picked up,
but the increase is tiny in comparison with the change between
where it was in the early 1990s and where it is now. On the basis
of that, I do not think that there will be any enormous concern
about serious problems in paying debt. The significant negative
equity problems that we did see in the early 1990s would only
occur now after a very significant fall in house prices. Clearly,
it is not our central view.
Q13 Chairman: There has also been
a slight rise in the level of repossessions, and Abbey recently
announced that they would lend borrowers up to five times their
income. Are you surprised that some of them are relaxing their
lending criteria at such a time?
Mr King: I have said before, and
I am happy to repeat it, that all lenders and borrowers should
think very carefully before they either lend or borrow. I do not
think it is particularly surprising that we have seen an increase
in loan to income ratios because we have moved to a point, as
is the implication of Mr Fallon's question, where house prices
are higher relative to other components of spending than for some
considerable while. If that were to be maintained, you would expect
that a larger fraction of a household's income over their lifetime
would have to be devoted to housing if they wanted to buy the
same degree of housing services. Even if they did not buy quite
the same quantity of housing services as previous generations,
one might well expect that the fraction of their lifetime spending
on housing would be high. That means, I think, that they are likely
to start with a mortgage relative to income which is higher than
in the past. That does not mean that they will not pay it off.
I think if you look at the figures, although there has been a
small pick up, as you say, over the last year or so, the degree
of mortgage arrears is well, well down on where it was in the
early 1990s.
Q14 Angela Eagle: Sticking with the
housing market for a while, do you worry that some of the price
increases are being driven by speculation that what happened in
the past will continue to happen in the future at the same level?
In other words, house prices will continue to rise very much above
other prices and, therefore, people are expecting that and acting
on a wrong expectation.
Mr King: People will always (and
they are right to do so) think about the future value of the house
when buying it. When they buy a house they are not buying a house
whose value is determined by some aggregate nationwide housing
index, they are buying a particular house in a particular location
in a particular community and they should think very carefully
about what value that house might have in the future. That is
part of the decision. I think the word "speculation"
can also be used to describe a completely rational judgment of
whether it is sensible to invest so much in a house in that particular
location. I think families have to do that. Whether these judgments
turn out to be correct or not is very hard to say, and I do not
think anyone buying would pretend to themselves that they knew
how far the value will change in the future. None of us know that.
It is a judgment. That is not a reason for not buying a house,
it is simply recognising that there is bound to be uncertainty
about future values, and that applies, obviously, to any asset.
I do not think using the word "speculation" is helpful
in understanding the judgments that people have to make. In answering
the question, "What will happen to house prices?", I
think that is a very difficult judgment and it would be foolish
of me to pretend that either I or anybody on the committee has
any deep insight into something that none of us can really pretend
to know.
Q15 Angela Eagle: Being the soothsayers
of doom for many years that have forecast bubble after bubble
after bubble, almost like an Aero chocolate bar, and none of them
have really appeared, but they are at it again forecasting bubbles.
You are all fairly sanguine about that. You do not lose sleep
over it?
Mr King: We are never sanguine.
Central bankers try not to lose sleep, but we always worry. We
are concerned about all of these things, and, as I said, there
are risks in the housing market, as in all asset markets, but
none of us can easily know. I point to the factor that I think
is the biggest risk facing us in the world economy, which is that
low levels of long-term real interest rates have led to very high
asset price levels. That has helped to sustain demand. It is quite
conceivable that these low levels of long-term real rates will
continue, but they may not and, if they were to adjust quickly,
then you might see quite sharp movements in asset prices overall
and that would have some impact on the world economy, not just
the UK but the world economy, and that would make it a more difficult
situation for us to handle.
Q16 Angela Eagle: In essence, you
are more worried about other asset prices than house prices?
Mr King: We are worried about
all asset prices, but the last thing I am going to do is to make
it easy for people to say that the Bank is concerned only about
one asset price. We are not. We are targeting inflation, not house
prices, and we are concerned about the outlook for the economy
as a whole, not just one market within it.
Q17 Chairman: The fine art one is
not your one number consideration, is it?
Mr King: Of course it is not.
Inflation is our number one consideration.
Q18 Mr Breed: In the November Inflation
Report you have a very interesting box detailing some survey
work you have done in respect of the distribution of debt and
repayment difficulties, particularly in respect of unsecured debt.
Some quite interesting information came out there. First of all,
you chose to use terminology within that chart which asked people
to say whether they thought the burden of their unsecured debt
was somewhat of a burden, or a heavy burden, or perhaps not even
a burden at all. In my experience some years ago when I was a
lending bank manager, I am not quite certain that the majority
of my customers who I thought were in a bit of a problem actually
considered they were in a bit of a problem. First of all, are
you sure that those who indicated what they thought was somewhat
of a burden actually was probably more of a heavy burden and that
those heavily burdened probably were disasters?
Mr King: I am sure after they
met you and you helped them understand that they were in trouble,
their views changed.
Q19 Mr Breed: So the ability of someone
to define whether they are really in that sort of subjective area
is something I personally find a bit difficult to believe. Anyway,
just looking it up, the proportion of those that were reporting
a problem has begun to rise and yet we know that people going
into IVAs has increased. There are some strange sorts of figures
here. Do you think that there has been a real change in the way
in which people are dealing with this unsecured debt now that
the IVA system has come in? Do you think that is having an effect
on some of the figures and that people reporting heavy burdens
is perhaps falling back because they have actually got rid of
this heavy burden on to somebody else through an IVA?
Mr King: There are several questions
in all of that. I would like to ask Charlie in a minute to talk
about the survey. You are quite right, these are subjective classifications
and one cannot attach too much weight to them, but I think the
point of it is to look at changes over time. If you saw significant
changes in the responses to the same question over time, that
might give you a real indication that something was happening
in a way that you might not get by trying to put rather arbitrary
quantitative questions into the same survey. I think the IVAs
will have changed behaviour—they were intended to create
a new opportunity for people. I think all I would like to say
before handing over to Charlie is that the results of this survey
and the comments I have just made on secured debt do still leave
us with the view that the real problems in indebtedness are not
in the mortgage market but in the unsecured debt market where
a number of people have got themselves into desperately serious
trouble. For them and for their families that is a really serious
problem, but there are not enough of them and they are not rich
enough to mean that this is likely to have a significant impact
on total household spending, which is, of course, our concern,
in judging the path of the economy as a whole. Indeed, part of
the IVA process is to allow families in that position to put in
place a programme to restructure the debt such that their spending
does not have to fall drastically. It will not increase in future
at the rate that they would have liked as they are paying off
their debts, but they will not have to experience a sudden reduction
in living standards. That is the point of the arrangement. I think,
therefore, if you put all that together, you end up with a conclusion,
as far as we are concerned on the MPC, that that is not likely
to have a major impact on consumer spending. Of course there are
risks, and further down the road, if the problems became much
more serious and many more people were in trouble, we would have
to revise that view, but so far, I think, our judgment is that
it is not going to affect the economy as a whole, though, as I
said, it is a major problem for those in trouble. Perhaps Charlie
can say something about the survey.
Mr Bean: As far as the question
itself goes, we have adopted the form of the question precisely
to keep continuity with an earlier survey question which was in
the British Household Panel Survey. If you look at Chart A in
the box that you are referring to, the data prior to 2004, which
is in a slightly lighter shade, comes from that British Household
Panel Survey. That question ceased in 2003, and what we wanted
to do was maintain continuity so we could see how things were
evolving over time. So that was the primary thinking behind the
particular wording that we used. The thing I think I would pick
up from what the Governor has just said is the blue bars down
there, the people who are saying that debt is a heavy burden,
are about 8% of the sample, but they correspond to only about
5% of income because they tend to be poorer households. You made
reference to the number of households going into IVAs or bankruptcy.
That is a much smaller fraction than this; it is about 0.2% of
households per year. So that group is the very tail of this blue
bar at the bottom. From the perspective of the Monetary Policy
Committee, obviously if we saw the burden of debt rising sharply
from these charts, we would be starting to get concerned that
maybe that would be starting to have a significant macro-economic
effect. But, as you can see from this chart, it does not look
as if there has been much change there as regards unsecured debt.
Also, Chart B is quite interesting because it shows that the upper
tail of people with high debt has actually moved leftwards, which
suggests that households with high debt are starting to get it
under control. That is actually quite a positive sign; there is
something that goes in a slightly different direction. Next week
we will be publishing more analysis from this survey, and one
thing that does come out in that is a slight increase in the fraction
of households with secured debt (mortgages) that are finding it
a burden, where a little bit under 8% of households have found
that at some time in the last year they have thought they might
have struggled to make a payment, and that is up a bit from a
little under 7% a year earlier. There is a little bit of a sign
of increased stress there, and that is consistent with the pick-up
in repossessions. But the numbers are still way below what we
saw in the early 1990s—less than half the levels that we
saw then.
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