Select Committee on Treasury Minutes of Evidence

Examination of Witnesses (Questions 60-72)


30 NOVEMBER 2006

  Q60  Mr Gauke: Good. May I ask about the impact of globalisation on your role in setting interest rates. Mr Bean, you made a speech to the LSE in which you mentioned that variations in aggregate demand become rather less effective as a means of controlling inflation in a globalised world and therefore any slowdown sometimes needs to be deeper or more prolonged to bring down inflation and therefore we need to err on the side of caution. Sir John, on a related but slightly different matter you appeared to be more sanguine about globalisation and talked about the disinflationary impact of the Far East enabling interest rates perhaps to keep lower than they otherwise would be. Sir John, do you share the concerns of Mr Bean about the need to err on the side of caution on interest rates, given the apparent difficulty there may be in bringing down inflation in a more globalised world?

  Sir John Gieve: I share the analysis. I can see the point he is making. I do not think I disagree with Charlie either, in thinking that globalisation and the entry of China into the world economy has not determined the inflation rate in Britain (which is a product of policy here), but it may have made our job a bit easier because it has produced a downward pressure on goods prices across the world.

  Q61  Mr Gauke: And therefore interest rates have been lower in recent years than they otherwise would have been.

  Sir John Gieve: Possibly. In very crude terms, if you look at what has happened to our prices over the last several years, goods' prices have been going down on average or been around zero or negative and services prices have been a little bit above our target of 2%. Globalisation has helped to keep that goods price low, which has of course enabled services' prices in the same average to be a little bit higher.

  Q62  Mr Gauke: Mr Bean, do you agree with that analysis?

  Mr Bean: Yes. I will draw your attention to Chart 4.4 of the Report, on page 28, which brings this out quite nicely. We saw, for the first four years of this decade, falling prices of finished manufactures—that is basically the China effect working through. That provided, as John said, a beneficial tailwind behind our efforts to keep inflation down. But you do notice that over the past two years that process has come to a halt and the prices of all imported goods, as you can see, have been rising. A chunk of that is obviously associated with what has been happening to energy prices, to oil prices. Not all of it, it should be said; some of it appears to reflect the high level of demand in the world economy, but some of it is oil related Moreover, the upward pressure on oil that we have seen over the past two years is itself a reflection of the development of China and India and the rapid increase in the demand for oil that has gone with the rapid growth there. That is the flip side of the beneficial downside impact that we have had on the prices of finished manufactures that we saw for the 2003-04 period. So that beneficial tailwind from which we benefited in the first part of the decade has been replaced by the doldrums or even something that is working slightly in the other direction, a modest head wind, which makes it that bit harder for us to achieve our objective.

  Q63  Mr Gauke: You have all said—and there is no disagreement between any of you, as far as I can see—that inflation is a monetary phenomenon and countries have the ability, if you like, to choose the inflation rate they want if they have independence for their monetary policy. Does that remain true however globalised you are? In a world with increasing overseas trade, do you think there could come a point where the job of the MPC just becomes too difficult and it gets buffeted around by these external points, or does the theory remain true that if you determine the interest rates you can determine your inflation rate?

  Mr Bean: The key ingredient here is the fact that we have a floating exchange rate and it is that which essentially allows us at the end of the day to choose our own inflation rate. It may well be true, though, that the changes in the structure of the economy that we are seeing connected with globalisation—greater interdependence—may mean that we become more subject to shocks from abroad, and, also, because of the weaker link between domestic excess demand and inflationary pressures, that monetary policies have to operate through a different route. That may make it somewhat harder for us to achieve our objective. The world is changing for central bankers. We are not the only central bankers grappling with this issue, but, at the end of the day, ultimately we should be able to determine our own inflation rate because, as you correctly say, inflation is ultimately a monetary phenomenon.

  Q64  Mr Gauke: Governor, do you have anything to add to that?

  Mr King: No. We have our own currency, we can determine our own inflation rate.

  Q65  Mr Gauke: We are a relatively large country; we have, more or less, 60 million people, from what we were hearing earlier. We cannot be too certain about that but we have more or less 60 million people. As a fairly large country we are able to do this. Does the same point remain true for smaller countries?

  Mr King: It still remains true for smaller countries, though the problems that Charlie identified become more significant for those countries. To take a very extreme case of a tiny island economy, it could still have its own currency and determine its own inflation rate but there would be very significant movements in its exchange rate on shocks from the rest of the world. That is why very, very small economies often decide to adopt the exchange rate of neighbouring larger economies. But it is certainly an argument that would hold for bigger economies.

  Q66  Mr Gauke: A country of 5 million—let us, for argument's sake, say that Scotland goes independent—on the narrow issue of inflation would it be able to address that through its own monetary policy but be vulnerable to external shocks?

  Mr King: There are issues on both sides. I am not going to tread into the question of political union.

  Q67  Mr Gauke: I am talking on very narrow issue of inflation.

  Mr King: We are in a monetary union, which many people seem to forget, between England, Scotland, Wales and Northern Ireland, and that monetary union has worked pretty well.

  Q68  Chairman: You said that in Scotland a couple of weeks ago.

  Mr King: I did and I was referring to the monetary union.

  Chairman: A lot of people agreed with you; a minority disagreed with you.

  Q69  Jim Cousins: And different parts of England too!

  Mr Bean: Absolutely right, Mr Cousins.

  Q70  Chairman: Enough of this regionalism. Governor, you know that we are having an inquiry into the MPC after 10 years. We announced the terms of reference last week and I know you will be giving us every assistance in that, but are there any comments you want to make on that?

  Mr King: I do not think so, Chairman. We will submit to you, via your deadline of the end of January, a detailed document setting out our views on the economics of the challenges that have faced the MPC. It may well be that on some of the procedural aspects we would prefer to come back and listen to the views of others from outside the Committee first and then respond to you in a formal oral testimony in due course. We would like to hear the views of those who are not on the Committee about how they think it has worked in the first 10 years before we come back.

  Q71  Chairman: We hope to have quite a few sessions on that before you do come back. We will look forward to that, Governor,

  Mr King: We look forward to exchanging views with you on that too.

  Q72  Chairman: May I thank you and your colleagues this morning. We are in very distinguished company today. We have you this morning and Professor Amartya Sen this afternoon. We are going home on a high tonight. Thank you very much.

  Mr King: I think you are the winners.

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