Examination of Witnesses (Questions 20-39)|
30 NOVEMBER 2006
Q20 Mr Breed: IVAs are going to double
this year, it looks like. To what extent is that the result of
pretty heavy marketing of IVAs and whether they are an appropriate
form of action for everyone that perhaps enters into them?
Mr King: I think that is more
a question for you to discuss with those who provide and offer
them. It is not really in our territory at all. You made them
available as a legislature and you should ask the people who are
engaging in it how it is working.
Chairman: A fine answer!
Q21 Kerry McCarthy: The outlook for
each of the components in the GDP forecast is pretty robust. Does
this mean the economy is beginning to rebalance?
Mr King: It is going to rebalance.
As I said, the central view we have is that it will continue to
rebalance, but we have had false starts before. There is still
a long way to go, there is still a significant trade deficit,
but during the course of the past year what has been encouraging
has been that the business investment, which before that had looked
surprisingly weak, has now has now started to pick up. Admittedly
it has done so more in services than in manufacturing. Exports
also seem to be more buoyant, at least as far as the surveys are
concerned. So, I think we are beginning to see some rebalancing
and I would expect that to continue. None of us have a central
view that consumer spending will grow at the rates that it did
in the late 1990s and early 2000s. We expect consumer spending
to grow at a rate really no more than the growth rate of the economy
as a whole, and we expect to see some further recovery of business
investment, some falling back in the growth rate of public spending
and some strengthening in exports. That is only a central view
and all kinds of things could change that outlook. But that is
what we would expect to see, and I think that rebalancing would
Q22 Kerry McCarthy: How important
is the slowing up of public sector spending as a factor?
Mr King: No one factor is important
and another unimportant; they are all key numbers that feed into
the total outlook for growth. As I have said before, what matters
is that public finances are well balanced, the fiscal rules are
met, but, within that, what that means for the overall levels
of spending and taxation is matter for you and others in Parliament
to debate and vote on. We will see a new PBR next week. The numbers
in the budget are now relatively dated in terms of the outlook
for the economy, and I think we all look forward to seeing the
PBR next week.
Q23 Kerry McCarthy: Can I ask the
others quickly what they see as the greatest risks, the greatest
elements of uncertainty within the forecast?
Mr Bean: As far as I am concerned,
I think I would put the most significant risks as being from the
external side. Our central view is for the slowdown in the US
to be relatively short-lived and for growth there to pick up back
to a round trend through next year. But there is the possibility
that that slow down, which so far has been concentrated in the
housing market and residential investment, spreads to the wider
economy and that the rate of growth there continues to be depressed
for a while and that that also has bigger spill-overs to the rest
of the world than we have factored in. That, of course, would
hit our export performance. Personally, I would regard that as
the most significant risk, but there are clearly risks to both
consumption and investment. On the consumption side, it is quite
possible that the build-up of household debt in the past may act
as a drag on consumer spending. On the other hand, we have been
surprised, on the upside, by the strength of the housing market,
and that may continue to add support to consumer spending going
forward and lead to consumer spending outstripping our expectations.
Similarly, as far as the investment goes, we have a central view
which sees a reasonably firm recovery in investment, but it is
easy to see the outturns being either stronger or weaker than
that. Investment is very volatile and very hard to predict.
Sir John Gieve: On the down side,
I agree with Charlie, it is the US and whether the world economy
will slow down faster than we are predicting. I think consumption
is on the upside, and we are expecting it to perhaps slow down
a little bit at the end of the year a bit below where it has been
for several years and I think we have yet to see that happen.
So, on the upside, the British consumer could prove as resilient
as in the past.
Professor Besley: Also, I think
a component of the rebalancing we have seen comes from the renewed
strength in euro zone growth; so that is something, if it is sustained,
which could be to the upside but it is something that is obviously
a further risk factor. Then just down the line, what we discussed
earlier in the context of asset prices obviously has implications
potentially for consumption in both directions.
Professor Blanchflower: I think,
following on more from Charlie's point, my concerns for quite
a while have been about the US economy, especially the housing
market, and I think I have been rather more concerned than others,
particularly given where I live. The housing market latest numbers
last Friday were that house prices in new England had fallen by
about 5% in the last 12 months and nationally, for the first time,
there has been an overall house price fall, so there is a serious
set of questions and debate in the US about the extent of that
fall. It is an open question, but the recent data are rather softer
than they were in the last few months. So I have rather more concerns,
and I have expressed them several times, about the decline in
the US. It is still an open question, but the recent data are
Q24 Mr Love: In your statement read
out earlier on you indicated that business investment was continuing
to recover and that the recovery was stronger than the committee
had anticipated, but, if I heard correctly, Charlie Bean just
said that you are expecting a firm recovery in investment. Is
it that optimistic or over optimistic?
Mr King: No. Investment growth
is very volatile and when it recovers it tends to grow at growth
rates above that in the rest of the economy. What we are factoring
in is not something that looks at all strong in comparison with
recoveries in the past. We have been concerned that investment
growth had not picked up as we might have expected when the economy
did start to recover earlier this year. The same puzzle, interestingly,
was seen in the euro area and the US. It went away in those two
parts of the world economy, as investment did recover there, and,
finally, we have now seen a recovery here too. Business investment
has picked up, it is likely, I think, to continue to recover.
Of course, there are significant risks but, given the weakness
in the past, there is some ground to make up and I think that
the central projection we have of a recovery in business investment
is a reasonable one.
Q25 Mr Love: Manufacturing seems
to have been one of the areas that are disappointed, yet manufacturers
continue to say that they are optimistic about an increase. How
do we square that? What is the problem in manufacturing?
Mr King: Of course, over a very
long period the share of manufacturing outputs in total GDP has
fallen. In the past year manufacturing has had its strongest year
for a long while, the growth in manufacturing has been not far
short of 3% over the past year, but it is true that investment
has not been strong and that, partly, I think, reflects a change
within manufacturing. It is not the case that all manufacturing
companies have grown by 3% over the last yearthere are
big changes within manufacturing. But I suspect that if this recovery
is sustained then you would start to see investment pick up too.
Despite the falls in manufacturing investment, it has not actually
been as bad as the average of the past decade or so, which has
been an even more depressed outlook for manufacturing investment.
We are going through big structural changes in our economy and,
based on the regional visits I have made, there are some very
successful manufacturing companies out there. It is not a question
of being high-tech, it is a question of having a niche for your
own product, knowing your customers and producing something that
people want. That has certainly been possible. We have had a lot
of stability in the economy as a whole. Manufacturers have seen,
some of them, very significant increases in their costs, energy
costs and raw materials, which have been very difficult for some
of them. But wage costs, which have been typically a concern in
the past, have not been a problem. Exchange rates have moved in
a way that has made it easier than it was for companies competing
with the euro area but harder for companies competing with the
dollar area. There are always changes going on in the fortunes
of companies within manufacturing, but, overall, the past year
has been a good one.
Q26 Mr Love: Let me press you on
that. As I understand it, quite a lot of the comment from manufacturers
has been the need to export more. You mentioned about the different
areas, but exchange rates are now almost at their highest level
overall (I think it is 195 to the dollar) and we have had two
modest increases in interest rates. Is that the climate which
we are likely to get, both the modest increase in the balance
of trade that you are talking about to rebalance economy and the
increase of business investment?
Mr King: You have talked about
the fall in the dollar against sterling, and this morning the
rate was, indeed, 1.95, which is high relative to the past decade.
But our effective exchange rate against an average of all other
currencies has not risen in anywhere near the way that we have
risen against the dollar. In fact, for a number of years now,
our effective exchange rate has oscillated in a small range. There
is a chart on page 11 which shows that our effective exchange
rate, which is only an average against other currencies, has moved
within a pretty narrow range compared with much of our past experience.
That is on page 11 of the Inflation Report, bottom right-hand
corner. I think that if you take that view, that does suggest
that the stability we have had in the economy as a whole has carried
over to stability in the exchange rate. Of course, no individual
manufacturing firm is the average, and those who are particularly
concerned about exporting to the dollar area have found life much
more difficult in the last six to 12 months. In the late 1990s,
the pressure was the other way round: those companies had no concerns
about exporting to the dollar area; it was companies that tried
to export to the euro area or were competing with euro area companies
in third markets that were suffering then. There are swings and
roundabouts. All we can do is to try to think about stability
on average. There is a lot of change going on within manufacturing,
even though, in terms of the effective exchange rate and, indeed,
overall manufacturing growth, things look pretty stable at present.
Q27 Mr Love: The Inflation Report
commented on disappointing public sector investment. Is this a
criticism of the Chancellor?
Mr King: No. I think our job in
the Inflation Report is simply to take the numbers. We
base our judgments on the stated spending plans of government,
but as long as those plans are financed
Q28 Mr Love: But it is disappointing?
Mr King: It is a question of what
has happened in the data relative to the previously stated plans,
but there are always swings in investment from one quarter to
another. The Government must determine the level of public spending.
It is not for the Bank of England to comment on. The Bank of England
will comment only if the spending gets completely out of line
with the tax revenue, and that puts up the pressure on borrowing
and perhaps, eventually, in turn on inflation. No, it is for you
to have the debate on the appropriate level of public investment.
Q29 Mr Love: We will.
Mr King: No doubt next week you
will have an interesting debate.
Q30 Mr Love: Can I turn to Sir John
Gieve. You have commented on business investment in a recent speech.
Would I be correct in characterising that you may be a little
more pessimistic about the possibilities of a significant increase
in business investment looking forward? You seem to be puzzled
in your speech.
Sir John Gieve: No, actually somewhat
the reverse. The puzzle in the speech was why has investment been
so low in the UK for so long. For many years we had a ready-made
explanation, which was that macro-economic volatility would put
people off making long-term decisions. We have now had a long
period of stability but we have not yet seen the increased investment
that we might have expected. My speech was saying that the ground
seems set for a stronger investment performance. I would not be
surprised to see quite a strong investment performance, but I
do not know whether the increase we have seen this year is the
start of that.
Q31 Mr Love: Let me just press you.
We have been waiting for this adjustment process to take place
in the economy in overall demand. The Governor has recognised
that consumer expenditure will not continue to rise at its previous
level, yet we do not seem to be seeing either the increase in
the net exports or the business investment. Why should we be confident
that that rebalancing is going to take place?
Sir John Gieve: We are seeing,
in this last year, an increase in investment. Whether that will
prove part of a sustained increase over a period of years, we
do not know, of course, and, on the evidence I am gettingless
from the figures (which are pretty cloudy) than from talking to
manufacturers and so onI think exports also are doing quite
well at the moment. Again, the question is will that be sustained
in the long-term. My speech was saying that, looked at objectively,
you would expect investment in Britain to catch up with the average
elsewhere and, therefore, there is no reason to think this will
not be part of a sustained increase, but you have to check what
is happening each time. We have been disappointed before.
Mr Love: Maybe global free trade is not
as free as we think it is.
Q32 Chairman: Why are you puzzled
if you think things will move on?
Sir John Gieve: My puzzle was:
why has investment been so low in the UK, despite the long period
of economic stability, pretty good profitability and very easily
available funding? I could not come up with a convincing answer
to that, so I said I would not be surprised to see it recover;
I would expect it. In other words, the puzzle is that it has not
recovered so far. Maybe we are now seeing it do so.
Q33 Chairman: So you are really puzzled,
but you have a great amount faith.
Sir John Gieve: I do not think
I am particularly. You asked earlier where I saw the balance
of risks, and I think I see them as slightly on the upside both
for output and inflation, partly because I think there are good
reasons to expect investment to be strong and exports to be strong
and I do not see much evidence yet that the consumer is reining
Q34 Chairman: You are puzzled that
we are walking hand in hand to a better future?
Sir John Gieve: I obviously should
not have chosen an interesting title for my speech.
Q35 Peter Viggers: The American economy,
of course, is the elephant in the room, representing, as it does,
appreciably more than 50% of the world's market capitalisation
in Stock Exchange terms and a huge economy, and one of the members
of the Monetary Policy Committee expressed concerns about the
US economy as being his reason for expressing a view. Can you
give a further weather forecast on the US economy, please?
Mr King: No. I do not attempt
to forecast the US economy, I am quite happy to leave that to
the Fed. We made judgments about the risks, and I think, very
much as the Fed and others would think, that the risk of a sharp
slowdown in the US economy, which is always possible, looks a
little less than it did. We are starting to see the other parts
of the economy in the US, outside residential investments, still
maintaining some buoyancy, but we will see. I think you should
not exaggerate the significance of the US economy to our judgments
about the UK economy. In terms of the effective Exchange Rate
Index, the euro area is three times more important than the US
economy in affecting our trade in goods and services. One of the
features that has been clearly concerning us in recent years has
been that, despite the great strength of the US economy, we have
not been seeing strength in the euro area economy and that had,
as Mr Love pointed out, affected our trade. As Tim Besley said
a few minutes ago, one of the reasons for the recovery in the
export outlook is the fact that the euro area economy, although
not growing at anywhere near the sorts of rates that the US did
five years ago, has now started to recover. No one can be certain
about whether it will continue but it is not as much in the doldrums
as it was. That is good news for exports in total because the
euro area is much more important in terms of trade to the UK than
the US. Of course, there is a broader world economic picture,
but I think we are starting to realise that when you think about
the world economy you have to give enormous significance now to
Asia, not just Japan but China and other economies there. We are
in a world economy which is not just the US, it is not just the
euro area, it is the whole of the world economy that matters.
We have been through the strongest three-year period for the world
economy for a generation and that has helped us to sustain the
growth. After a period like that there are always bound to be
downside risks, and we have tried to factor those in. Overall,
I think we would want to look at the world economy in total and
not just focus too much on the US.
Q36 Peter Viggers: The property market
is a greater proportion of GDP in the United States than in the
United Kingdom. The property sector has been a little weak, but
this has not been reflected in consumer spending.
Mr King: Yes.
Q37 Peter Viggers: Can you explain
that? Do you sense some stresses here that will come through in
Mr King: People may take different
views on it. I have always maintained that the link between house
prices and consumer spending was a lot more complicated than many
people would have you believe. If the value of your house goes
up a great deal, what are you supposed to do? Unless you actually
sell the house and move to a smaller one, you cannot use the proceeds
to spend. It may make it easier to borrow against the greater
equity in house prices, and that is, I think, the main link that
we see between house prices and consumer spending, but you require
a motive for wanting to borrow in the first place to trigger a
pass through from house price increases to consumer spending,
and so we are not particularly surprised. Sometimes house prices
seem to be correlated with consumer spending growth and other
times not. The real difference between the US and the UK is, interestingly,
in the investment aspect. The movements in house prices in the
US do trigger either increases or reductions in investment in
housing, and in the UK residential investment does not respond
anywhere near as quickly as it does in the US. So the US economy
is more sensitive to its own housing market than we are to our
housing market, because our investment in housing seems to be
remarkably immune (at least in the short run) to changes in house
prices and, obviously, the whole gamut of issues concerning planning
and the supply side of housing is responsible for that.
Q38 Peter Viggers: Can I ask Professor
Blanchflower to comment on the last question.
Professor Blanchflower: Certainly
the evidence now in the US is that residential investment has
been falling quite strongly. Residential investment there really
means new construction and refurbishments, and we have seen shares
of companies that are doing that kind of activity have strongly
fallen recently, so that is where the major declines have come.
As I think I said a little earlier, for the first time now, recently
we have seen falls in actual prices and we have yet to see whether
that will feed through to consumption, but I agree with the Governor
that up to this point it has not done that. For the first time,
these house price falls may start to feed through, but up to this
point we have not really seen it, it has really been in residential
investment, as the Governor has said, rather than in prices and
hence in consumption, but, if those declines continue, that might
occur. It does look to be fairly regional in nature, in the sense
that the declines really are in New England and the mid west,
but it has not fed through to consumption there yet.
Q39 Peter Viggers: Governor, your
comments about the euro economy just now were really very positive.
There has been recent comment that the weakness of the dollar
might cause difficulties to some manufacturers within the euro
zone because of the effect on prices of the euro. Can you comment
Mr King: Yes, of course. The fact
that the growth in the euro area economy has picked up this year
does not mean to say that it will carry on doing that, there is
always uncertainty, and the rise in their effective exchange rate
may be something that will dampen the growth of export demand,
which has been a key factor in the growth of total demand in the
euro area economy. I think we should put the recent changes into
perspective. We have not seen a really big change in the effective
exchange rate of the euro or, indeed, the dollar over the last
few weeks or months. There has been a big fall in the effective
exchange rate of the dollar in the last four years. It has fallen
by around a quarter, and that is a big change, but it has been
gradual and cumulative. I think that factor is one of the reasons
why there is some optimism that maybe big changes to imbalances
can be brought about in a way that does not inevitably lead to
sharp and disturbing changes in the pattern of demand around the
world, but that is really still to be seen in the future.