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
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 manufacturesthat 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 saidand
there is no disagreement between any of you, as far as I can seethat
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
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
globalisationgreater interdependencemay 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 millionlet
us, for argument's sake, say that Scotland goes independenton
the narrow issue of inflation would it be able to address that
through its own monetary policy but be vulnerable to external
Mr King: There are issues on both
sides. I am not going to tread into the question of political
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
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
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
Mr King: I think you are the winners.