Select Committee on Treasury Minutes of Evidence


Examination of Witnesses (Questions 40-59)

MR MERVYN KING, SIR JOHN GIEVE, MR CHARLIE BEAN, PROFESSOR TIM BESLEY AND PROFESSOR DAVID BLANCHFLOWER

30 NOVEMBER 2006

  Q40  Peter Viggers: How confident do you feel about trade data? I am referring specifically to missing trader intra-community fraud. The swings there have been a quite dramatic?

  Mr King: They have.

  Q41  Peter Viggers: Some 13 billion down to 4 billion. How confident are you as to the data?

  Mr King: We are very unsure as to what the true picture is. Some years ago, when people were studying the black economy, the fairly obvious point was made that, by definition, the black economy was rather difficult to measure by the official statisticians. Here we have an extraordinary position in which we have an official estimate of fraud. I am not in a position to judge the extent of fraud, but the numbers are very big, and so they do matter in terms of judging the underlying trade picture. It is also the case that there are real measurement problems in trying to gauge the value of international trade. It is no longer quite as simple as weighing the containers that went out through the ports or weighing the containers that came in. Trade in services is now very large, and, if you look at the data on a quarterly basis, you can see very clearly that the estimates have a complete zigzag pattern. It is up one, it is down the next, a classic sign of measurement error in the data. Even in the six-monthly series—I used to not look at the quarterly data for trade but just the six monthly figures—even there you see a zigzag pattern, and so I am inclined to think that the data on trade may be only valuable on a calendar year basis, not on a more frequent horizon at present. I think the honest answer is that we really do not know. I do not think you can blame the Office of National Statistics (ONS) for this, they did not instigate the fraud, they have to try and cope with the measurement consequences of it, and it is extremely difficult.

  Q42  Peter Viggers: Another (a Rumsfeld expression) "known unknown" is immigration numbers?

  Mr King: Yes.

  Q43  Peter Viggers: Do you have any comment on the uncertainty there?

  Mr King: I have obviously commented at length before and I am happy to answer the question today. There is enormous uncertainty about it. We do not have in the UK any particularly accurate method of measuring migration, either gross or net. It is the net migration numbers that matter, and the gross flows in and out are very large. The only basis we have really, that is used by the ONS, is the International Passenger Survey (IPS). There are other sources of data, and I think we are trying to encourage everyone interested in this area to try and look at these other sources of data to give a cross-check, and I think the Civil Aviation Authority Data on the number of flights in and out will prove very helpful, but it is not a magic answer here. The IPS is just one example which I think illustrates the problem. Obviously, we do not know how many people have come on a net basis from eastern Europe (the accession countries) to work in the UK. If you look at the International Passenger Survey for the answer, the numbers are surprisingly small. I think the official estimate is below 100,000 a year. There are some reasons for that. One is that in the International Passenger Survey to be counted as a migrant you have to say that you intend to stay for at least a year. There are many people who may come to do seasonal work who may go back and return again, so there could be a lot of people coming all the time to do seasonal work, or there could be people who intend to come in for only three months and end up staying longer, or there could be people who think it is pretty dangerous to say they intend to stay for more than a year. What is the incentive to say that? That is one difficulty. Another one is that the change in the pattern of arrivals has been pretty dramatic, and that is very hard for the ONS to catch up with. The example, I think, which illustrates it most clearly is the change in movements between the UK and Poland. In 2003, I think there were 516,000 passenger journeys between the UK and Poland. That is both in and out. Five hundred and five thousand of those—that is almost all of them—were to Gatwick, Heathrow or Manchester. Over the next two years the number of passenger journeys between the UK and Poland went from 516,000 to about 1.8 million. Almost all of that increase was in airports other than Heathrow, Gatwick, and Manchester. So, from a figure of 11,000 in 2003, there were more than a million passenger journeys between the UK and Poland only two years later, all in airports outside Heathrow, Gatwick and Manchester. Why does this matter? Because most of the people handing out the questionnaires for the International Passenger Survey were at Heathrow, Gatwick and Manchester, so they missed a lot of these people. It is very hard for them to anticipate the increase in traffic, they cannot hire so many people to go round, and, in fact, the number of migrants who actually said in the International Passenger Survey, "Yes, I am a migrant coming into the UK", was 79. The numbers are tiny in the survey, and this survey was never designed to measure migration, it was designed to learn more about tourism and business travel; and it is a perfectly good survey for understanding tourism and business travel, but it was not designed, and you should not expect it to come up with, particular answers for net migration between the UK and the rest of the world.

  Q44  Peter Viggers: Leaving aside the sociological and economic effects of these two great big areas of uncertainty, purely to do your job, as the people whose duty it is to measure these things, is there more that should be done get a clearer grasp on these two huge areas of uncertainty?

  Mr King: Yes, and, obviously, each year we state our priorities to the ONS within the framework of the relationship we have with them, and for some time we have been drawing attention to migration as a high priority area. But the demands on the ONS, relative to the resources which they have, have grown, and that is not a question for us, that is a question for you.

  Q45  Chairman: Is it affecting our analysis of the statistics? I am reminded of the inquiry we did into the scotch whisky industry, and Customs came back with ONS figures saying that the level of estimates vary between 150 million and 1,150 million, and so the opportunity for doing any rational analysis on that was right out of the window.

  Mr King: There is no easy answer to any of this, because in a free market economy you always have to use samples to obtain data. We can certainly do our job. I am not saying our job is impossible; it is not. It is made more difficult by the statistical uncertainties.

  Q46  Chairman: You if get figures like 150 million and 1,150 million, Governor, you cannot work on that?

  Mr King: What we are trying to do on the migration front is to look at figures from all other sources—so the Workers' Registration Scheme numbers, the number of National Insurance numbers which are granted for employees, these data from the Civil Aviation Authority—to see whether we can use them as a cross-check to get a feel for the plausibility and the orders of magnitude. But these are developments which will always occur in an economy. I think what I would like to stress more than anything else is that, if anyone thinks that setting interest rates is like a text-book case in which there is a well-known model of the economy and seven equations, we know exactly what the equations are and we know the parameters, we know exactly what the data are, we feed it in, turn the handle, out comes the interest rate, it is very, very different from that.

  Q47  Chairman: You have educated us to know that we do not go along those lines, Governor, so do not worry about that?

  Mr King: Thank you, Chairman.

  Q48  Chairman: Professor Blanchflower.

  Professor Blanchflower: Obviously we have had difficulties understanding how many people flow in, and the passenger surveys and so on are indicative to some degree of that, and we have the work of registration schemes and the national insurance numbers, but we do not have any really good estimates of the number of people who have flowed out. We can count the number of people who have a national insurance number, but are they still here at any moment in time? We really do not know that. Not only do we not have a very good measure of the inflow, we do not have a great measure of how many people have left or come back or any sense of how long workers here intend to stay for, so we have difficulties both on the inflow side and on the outflow side too. We do not really have any surveys designed to help us in knowing how many people have left.

  Q49  Chairman: You are making a good case here for identity cards. Do you want to help the Government?

  Mr King: No, I think this adds up to a good case for a properly resourced national census the next time round.

  Q50  Mr Breed: I have a quick question, Chairman, and it may be slightly naive, but, on the back of what you were saying to Mr Viggers in respect of housing costs and everything else, is the CPI now an accurate reflection of inflationary pressures in the country?

  Mr King: Yes, it is. I think there has been a lot of nonsense written on this, to be honest. Perhaps the first thing to say is that if we were each to calculate our own individual inflation rate around this table then we would come up with quite different answers because the patterns of our spending will vary enormously.

  Q51  Mr Breed: Certainly pensioners would.

  Mr King: Pensioners or people on low incomes. The inflation rate for particular groups can differ and there are indeed separate indices for precisely that reason, to be used when setting benefits and so on. Our concern in setting monetary policy is to know what is the average inflation rate across the economy. From that point of view, the Consumer Prices Index (CPI) is an extremely well constructed and well-researched index. This is an area in which there is not anywhere near the sort of uncertainty that we have just been talking about. There are thousands of inspectors who go out on a particular day every month to collect prices in different outlets all around the country and those prices are returned and they are weighted together by the expenditure pattern of households, on average, collected for very detailed household expenditure surveys. There is still a choice about the conceptual structure of the index. The CPI does not include owner-occupied housing—and you can argue whether that is a good or a bad thing: those are conceptual issues—but, once you have defined what it is you want to measure, the CPI is an accurate measure.

  Chairman: Thank you very much. That is very helpful for the Government because we do get a number of submissions on the CPI and various criticisms.

  Q52  Jim Cousins: One of the difficulties we are, I suppose, struggling with here is that change may not be driven by average positions. It may be driven by more extreme positions. I wonder if I could ask Professor Bean on this. We have just been talking about the impact of immigration. This has come at a time when costs have been rising quite steeply in the economy and there is a whole section of the Inflation Report that is set to looking at the implications for labour costs in this. I am quite confused by what I am trying to be told in the Inflation Report, because, on the one hand, it is being suggested that take-home pay has not kept up with the increase in energy and import prices, and that would certainly lead you to think that the immigration factors have had an impact on take-home pay, and, on the other hand, the costs to employers of employing workers have risen quite steeply and it looks as though the impact of energy and import prices has been born by employers rather than by employees. Have I worked this out properly?

  Mr Bean: Yes. Essentially—and this cannot really be avoided—the cost of higher energy has to end up being borne by the labour force, by workers. Over the past couple of years, when energy prices have risen markedly, we have seen that, although pay growth has remained subdued, in a sense it has not been subdued enough. So real take-home pay for households has been growing more slowly. It should be said it is not just energy prices here, it is also effective tax rates that have a role to play. But the post-tax real purchasing power of the wage has grown relatively slowly (there has been some pick-up in the last year but that has been relatively mild). But the growth has not been subdued enough because the cost of labour for firms (that is, the labour cost relative to the price of firms' output) has continued to grow quite rapidly, and more rapidly, it appears, than underlying productivity. Effectively, the cost of employing workers has been rising too fast and that is something that would be a discouragement to employment going forward. It is important for us that we continue to see subdued pay growth going forward over next year to avoid, essentially, labour pricing itself out of jobs.

  Q53  Jim Cousins: Let me try to understand what you have just been saying. You appear to have told us that we have been through a period in which immigration into the country seems to have been quite high; energy prices, tax rates, import prices have risen quite steeply; and real take-home pay, as a result of all of these factors, has fallen. You are telling us that it has not fallen enough.

  Mr Bean: Correct.

  Q54  Jim Cousins: Is that the view of other members of the Monetary Policy Committee? Professor Blanchflower, what about you?

  Professor Blanchflower: There is a question, in some sense, about to what extent real pay has fallen, in the sense that many of our measures exclude about 27% of all the workers. Workers in small firms are excluded from our aggregate pay measures; self-employed earnings are excluded. In some sense, our measure of what has happened to pay takes out the most flexible, so I have the somewhat slightly different view that these numbers probably even overestimate the extent to which there has been wage growth. There has been, to some degree, more flexibility downwards than perhaps others see, partly because our wage series exclude those people whose pay is most flexible. I think there is an issue at that end. There are concerns there about what really has happened to real pay. I think it has probably been more flexible downwards perhaps than others think.

  Q55  Jim Cousins: Professor Besley?

  Professor Besley: I hesitate to answer because the term "enough" here is a somewhat loaded term and I want to achieve some clarity on that. The issue is: has it fallen enough so as not to lead to a significant reduction in the number of workers taken on by firms? That is the sense of enough. It is not a normative judgment about the right level of wages in the economy. In that sense, I would agree with what Charlie has said and the announcement in the Inflation Report which says we have not observed real wages falling enough so that levels of employment have not suffered as a consequence. I think it is part of the explanation—maybe only part—of why we have observed a rise in unemployment in the recent past.

  Q56  Jim Cousins: I find that very interesting. The next session of the Inflation Report goes on to discuss something equally interesting which is inflation expectations, on the one hand, compared with inflation expectation volatility. I am not clear about which of these two things you see as being the more important. What is going to affect the labour market more, a general rise in inflation expectations or a switch-back effect?

  Mr Bean: It is certainly not the volatility bit. It is inflation expectations. That is the thing we are concerned about, and, in particular, were we to see a substantial rise in inflation expectations and that to be associated with an increase in nominal pay growth, then that would obviously tend to lead to inflation turning out higher. Our concern is that inflation expectations stay anchored near the target. We have seen our measures of household inflation expectations—and it should be stressed that these are not particularly good measures: we have to rely on various surveys, including the survey that the Bank carries out—bounce around a bit during the course of this year. We do not understand very well what drives inflation expectations. But it appears to be the case through this year that inflation expectations moved up noticeably in the early part of the year at about the time when there was a lot of press coverage of the increase in gas and electricity bills. It eased back during the summer and then there was another movement up, again at around about the time that there was a lot of press coverage about higher utility bills and other aspects of inflation, including all this stuff about inflation as measured by the CPI not reflecting true inflation. The unfortunate thing is that these movements in inflation expectations have not been tied that closely to what has actually been happening to the measures of inflation. Because of that lack of a clear link between expectations and the actual measure—instead they appear to be linked to perceptions of inflation—it makes it harder for us to form a view about how expectations are likely to evolve going forward. But it is crucially important to us that those expectations remain anchored reasonably close to the target.

  Q57  Jim Cousins: Governor, if it is the case that real take-home pay, though it has fallen, may not have fallen enough, and if that also comes alongside a situation in which inflation expectations may be rising, then, in order for you to patrol effectively the distant frontiers of the great stability (to use a phrase that the Deputy Governor used in one of her recent speeches, in a very interesting way) are you not going to have to start expressing views about such matters as the level of energy prices or the fact that 4,200 people in the City of London this year are going to get bonuses of more than £1 million? Because, in the situations we are dealing with, these could have a real impact on how people behave in the real economy.

  Mr King: The way in which we can influence how people behave is in terms of stressing our commitment to meeting the inflation target in the medium term; hence, as Charlie said, meeting the objective of having inflation expectations close to the target, and that means low volatility of inflation expectations. I do not think the Bank should be in the business of commenting on individual prices or wages, because there is a great deal of change within the economy and we are concerned with the average as a whole. We will simply behave in such a way as to react to the changes in the economy in order to move interest rates to keep inflation on track to meet the target. I do not think our job should be to give sermons about who should be paid what.

  Q58  Jim Cousins: Governor, if the problem of maintaining the great stability is not in the average but it is in the extreme, the extremes of 4,200 people in the City of London getting bonuses of £1 million, real take-home pay having fallen but not having fallen enough, are you not going to have to strike a position about some of these things?

  Mr King: I do not see why commenting on 4,200 people is germane to our particular challenge of keeping inflation on track to meet the target. It has particularly struck us that so far wage increases have been pretty muted. That has led not to a fall in real take-home pay but to much slower growth in real take-home pay, but, as Professor Besley said, that has not been sufficient to prevent there being some incentive to firms to cut back on employment and that may have led to some pick-up in unemployment. We are concerned with trying to judge what will happen in future and we are pointing out very clearly that we intend to keep inflation close to the target of 2%, and all of those involved in bargaining for wages, whether on the side of employees or employers, should take that into account.

  Q59  Mr Gauke: I am relieved that incomes policy is not going to be part of the fix.

  Mr King: We are certainly not in the business of doing it.


 
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