Examination of Witnesses (Questions 20-39)
MR MERVYN
KING, MR
CHARLES BEAN,
SIR JOHN
GIEVE KGB, DR
ANDREW SENTANCE
AND MS
KATE BARKER
25 NOVEMBER 2008
Q20 Mr Fallon: You think the path
is credible. I want to be clear about that.
Sir John Gieve: It is certainly
achievable.
Q21 Mr Fallon: Mr Bean, can you help
us on the immediate effects? Is it not more likely, given the
pressures on household finances at the moment and the reduction
in credit that we have been discussing earlier, that people will
simply save now, having been warned about tax increases to come,
rather than spend, and pay off credit cards rather than use them?
Mr Bean: There is always a worry
with temporary tax changes that it may not lead to very much effect
on spending. A temporary cut in Income Tax is likely to be saved,
for instance. What you can argue, I think, is that a cut in Value
Added Tax at least gives households an incentive to bring forward
some spending from the future to the present—a sort of switching
over time. In that sense, I personally think it is quite a sensible
measure to go for in the current conjuncture, it is a measure
that works because it is temporary.
Q22 Mr Fallon: Dr Sentance, what
was your view of yesterday's package?
Dr Sentance: If you look at the
borrowing numbers they are a product of two things: one is the
stimulus that the Government provided through its cutting VAT
and other measures but, also, the bulk of the increase in borrowing
is a reflection of the deterioration in the outlook for the economy.
When it comes to interest rate decisions looking forward, I think
we will be making a judgment, on the stimulus from the fiscal
package but, also, assessing the evidence that we have got from
the progress of the real economy. The issue that we were just
discussing, about how lower interest rates are feeding through
into the rates actually paid by businesses and individuals, also
has an important influence on the monetary stimulus that we are
providing at the moment.
Q23 Mr Brady: Governor, how long
would you expect it to be before you can see whether the stimulus
package is starting to have the kind of effect that was hoped
for?
Mr King: The "stimulus package"
meaning yesterday or—
Q24 Mr Brady: Yesterday in particular.
Mr King: I think well into next
year. As Charlie Bean said, obviously one of the likely impacts
of the temporary reduction in VAT is that during the second half
of next year there will be a lot of advertisements saying: "Buy
now before VAT goes up in January 2010". So precisely when
this expenditure-switching will occur is not entirely easy to
judge. However, of course, the real problem is to know what the
counterfactual is. It is very hard to judge the impact of any
policy measure without knowing precisely what the counterfactual
is—what would have happened had you not done it. That, simply,
we do not know; we do not know how quickly spending would have
tailed off, how orders would have declined. That is why in these
circumstances almost any policy measure is really about trying
to balance risks.
Q25 Mr Brady: So it is not likely
to have a direct effect on your decisions at your next meeting?
Mr King: We will certainly look
at our judgment of all the measures taken; we will go through
the PBR very carefully and all the small print to see what other
measures are in there in order to work out the overall impact
and see what judgment we make about the time path of activity
and output and, hence, the path of inflation. The big picture
here, which we should not lose sight of, is that we are facing
an extraordinary set of circumstances in which confidence in the
banking system around the world has collapsed, thus making the
finance of ordinary industry and purchase very difficult—not
just expensive but very difficult. That is potentially very damaging
indeed. Therefore, we do need to take measures to ensure that
we solve that big problem. That is the big downside risk, and
that is why I attach enormous weight to re-establishing the firm
lending to the economy as opposed to marginal changes in the outlook
for demand and activity which are the usual minutia that forecasters
and policy makers focus on. This is really about a big downside
risk.
Q26 Mr Brady: Can I ask you and,
perhaps, any of your colleagues to comment on the particular decision
to reduce VAT on a temporary basis rather than some of the other
things that might have been done? Does that impact more obviously
on inflation in the medium term as opposed to demand, or is it
principally a demand stimulus?
Mr King: I think, as Professor
Bean said, the idea behind it, at least in the textbooks, is that
you can try to switch expenditure from one period to another.
That has pluses in that you may be able to move expenditure to
a period when otherwise you would expect demand to be rather weaker;
it has minuses in that if you get the timing wrong and demand
turns out to be weak just after you put the rate back up, then
it may be switching expenditure at the wrong time. These are risks
that need to be taken. There are enormous challenges for policy.
Mr Fallon rightly pointed to the challenge posed by the overall
scale of borrowing, and there is no doubt this is a major challenge,
but we have to try and balance the risks. We are going to have
a long, hard path back to fiscal sustainability because the debt
has been increased not just by a downturn in the economy but,
also, by the need to recapitalise the banks and provide so much
lending to the banking system. This is a problem facing all Western
governments—indeed, governments around the world.
Q27 Mr Brady: Many people, after
yesterday, are saying that a 2.5% cut in VAT is not going to make
much difference; if you walk down the High Street you will see
shops making cuts of 20%, 30% or more in prices. Would it not
have been more effective, perhaps, to reduce National Insurance?
Mr King: I do not think so. If
you want to have the impact on expenditure switching, then actually
doing it through VAT is probably more likely to be effective.
We have seen in the past temporary incentives to capital spending
have been used, like changing the rate of investment allowances.
That is another measure that has been used in the past. People
have focused on measures directly trying to switch the timing
of expenditure.
Q28 Mr Brady: So the effect comes
towards the end of a temporary period, not towards the beginning?
Mr King: It is more likely to
but, of course, people who have been thinking of spending may
decide that some point in the next year is a good time to spend,
why not do it now rather than the second half of next year? Decisions
will vary from one individual or household to another.
Q29 Mr Brady: Finally, could I ask
something completely different, to go back to your comments about
the banking recapitalisation? One of the messages we were given
fairly clearly in Japan was that one of the things that was crucial
to them sorting out their problems was dealing with troubled assets.
Is it not the case that one of the things we have failed to do
so far in the UK is really get to grips with that problem of bad
debts and troubled assets? Should some focus be turned to that
rather than further recapitalisation?
Mr King: That is very hard to
judge, for two reasons: one is that I do not think it is obvious
that we have, on the same scale of the United States, the same
degree of bad assets—certainly originating in domestic lending.
The second is that the United States found it very hard to work
out a practical method for buying those assets without getting
themselves in a position where they, on behalf of the taxpayer,
were overpaying and getting the wrong assets offered to the government
in an auction process. So from a process which began as a process
designed to put in place auctions to buy toxic assets, in the
end, they could not actually work out practical ways of doing
it sufficiently quickly, and they switched the focus of their
scheme more towards a recapitalisation of the banking system along
the lines that the UK carried out. So I think there are good reasons
for preferring the recapitalisation route, and if you go far enough
with the recapitalisation then it should actually allow banks
to absorb the losses that may occur on what bad assets they have
down the road. The financing of those bad assets we have been
able to provide help with through the special liquidity scheme.
So we are the only central bank that has offered a scheme under
which we are willing to lend for three years against assets held
when the crisis hit in the second half of 2007. That enables the
banks to finance those assets without transferring to the taxpayer
the risk of loss on bad assets, because the banks may know which
are the bad ones but we do not. Therefore, in any process of a
sale the ones that you get offered in the auction are the ones
you really do not want to buy.
Q30 Nick Ainger: Governor, in response
to earlier questions from the Chairman, you spoke about the availability
of credit for the real economy. Obviously, the monetary stimulus
comes through from the substantial cut in Bank Rate. How concerned
are you that, in fact, that significant cut is not being passed
on to the real economy whether it be for mortgage holders or small
businesses?
Mr King: I think we recognise
that part of the process by which banks are recapitalising themselves
is to increase the margin between the rate at which they borrow
and lend. That margin reached unsustainably low levels in the
first half of 2007—quite remarkably low levels. At times
some of the lending that was being carried on was being carried
on almost at a loss in the middle of 2007. So it was not surprising
that from then on we have seen the wedge between the rate at which
banks borrow and the rates at which they are willing to lend widen.
We have seen, in the last couple of months, that the Libor rate
has actually fallen by the full extent of our cut in Bank Rate.
The spread has not fallen back, which we might have hoped, but
the rate did fall back. It is clear that the rate on standard
variable rate mortgages has fallen back by the full amount, but
some of the banks that have tracker mortgages, following the cut
of 150 basis points (1.5 percentage points) that we made earlier
this month, withdrew some of the tracker products. They are now
reintroducing them but at a higher rate, so that they have not
fallen back by the full amount of the cut in Bank Rate. They have
fallen back but not by the full amount. At one level I think the
Committee understands that this means in such circumstances that
we may need to cut Bank Rate by more than we would otherwise have
done precisely to have the right impact on the rate that is being
charged to final borrowers. We are conscious of that and that
enters into our judgment about how we calibrate the required scale
of the cut in Bank Rate. I think this is tied up with the issue
of the willingness of banks to lend. My feeling is that the right
strategy is to try and tackle head on this question of banks being
willing to lend, and to cut the amount of Bank Rate that we think
is necessary to ensure that after the margin has widened a bit
then the appropriate cut is made in the rate charged to final
borrowers. I think we should accept that part of the process of
restoring the banking system to a more normal state is to allow
that margin to widen. If we can solve the problem of the amount
which banks are willing to lend then we will start to see the
rates adjust in line with Bank Rate as they used to.
Q31 Nick Ainger: How does that square
with the statements that have been made by the Chancellor that
he wants to see credit availability at the same levels as 2007
following, as you indicated earlier, the massive injection that
has been made of taxpayers' money into the banking system?
Mr King: I think that is a question
you will have to put to him. We do not want to go back to the
levels of the first half of 2007. I would not put it, myself,
in terms of a particular number; I would like to feel that the
banks would be in a position where they would be able to say to
their branches and their managers: "Look, if you find profitable
lending opportunities, lend". What is happening, at present,
is that what the banks are saying to themselves is: "Even
if we see some apparently profitable lending opportunities, we
had better forgo them because we are under enormous pressure to
reduce the scale of our leverage" (to use that awful word)
"and we have to reduce the scale of our balance sheet."
So they are giving up profitable lending opportunities in order
to behave defensively and reduce the size of their balance sheet.
Individually, it makes sense for a bank to behave in that way;
collectively, it makes no sense at all, because if all the banks
behave in that way not only will the economy go into a steep recession
but the banks themselves will start to see even bigger losses
on their pre-existing loans. So it is not collectively in their
interests to behave in this way, and that is the challenge that
we have to confront in dealing with the banks, which is to find
a way in which their individual incentives do not lead to a collective
outcome that is clearly adverse.
Q32 Nick Ainger: Governor, on that
point, what role will the new lending panel have? Will it be able
to address those sorts of issues that the Bank is going to be
represented on the lending panel? Is that a forum where these
issues can actually be thrashed out? Thrashed out they must be
because whatever the MPC does in terms of Bank Rate it is not
having the effect that we would all like to see on the real economy.
Mr King: I totally agree, and
I think they have to be thrashed out. I think you will find that
in a statement today there will be an announcement about widening
the remit and the membership of that panel to make sure that it
achieves exactly the conversation and discussion that you have
just mentioned.
Nick Ainger: Thank you.
Q33 Chairman: Governor, on Nick's
point about Libor, the Committee would like a note from you on
Libor, because when the debate was taking place about the 1.5%
cut being passed on, the banks, in discussion with me and others,
said: "Wait a minute. This is getting too far. It's saying
we are being forced to pass this 1.5% on; we've only charged people
the Libor rate for mortgages." Amongst other things, Governor,
it is a three-month rate. So if people are being charged that
for their mortgages it would just produce chaos in the market.
So we need to have a more fundamental understanding of Libor,
and I was taken by Willem Buiter's blog when he said: "Libor
is the rate at which banks don't lend to one another". There
is a lot in here, and as a Committee we really want to explore
this, so could you give us an initial answer on that and give
us a comprehensive note?
Mr King: You would like both an
answer and a comprehensive note?[1]
Q34 Chairman: Yes.
Mr King: I can't better Willem
Buiter's blog. It is in many ways the rate at which banks do not
lend to each other, and it is not clear that it either should
or does have significant operational content. I think it is convenient,
very often, for people to justify what they do for other reasons,
in terms of Libor, but it is not a rate at which anyone is actually
borrowing. It is hard to see how it can actually have much of
an impact. There is no doubt that what it is representing is the
widespread loss of confidence in the financial community at large—not
just banks but the financial community at large—in banks,
as such. Eighteen months ago it was quite normal for anybody,
including companies, to be willing to lend to a bank unsecured
for three months at a very tiny margin over Bank Rate, because
it was felt unthinkable that this was a risky loan. The world
has changed totally; people are very worried about lending, and
indeed hardly anybody is willing to lend to any bank around the
world for three months unsecured; they want to lend secured. As
I have said to the Committee before, I think that in future we
will see far less lending to banks on an unsecured basis and far
more on a secured basis. The inter-bank market has very often
been a market in which overnight or short-term cash holdings can
be distributed around the banking system, and banks were willing
to do it with each other unsecured at Libor. I just do not think
it plays that role now, and I think we are going to see developing
over the next few years a much more intensive method in which
banks can redistribute cash surpluses and shortages among each
other on a more secured basis. At present they are doing it directly
with the central bank, and that is true around the world, not
just in the UK.
Chairman: So there is more to it than
meets the eye. We look forward to your comprehensive note. That
was a great primer. Thank you.
Q35 Sir Peter Viggers: May I return
to the point of fiscal stimulus? You have been completely consistent
in saying that fiscal stimulus could be justified if it is temporary
("strictly temporary", to quote you, Governor) and that
tax and spending come back into a sustainable balance over the
medium term. The Government's proposals will bring the tax and
spending back into a sustainable balance in 2015-2016, which is
after the election after next. That is even on their optimistic
assumptions. Are you saying that that is temporary, or have you
changed your mind?
Mr King: No, the measures that
are being taken to stimulate activity are temporary. I have said
there were two conditions: that the measures be temporary (they
are temporary) and, secondly, that there was a path back to fiscal
sustainability. As you rightly point out, that path is long and
hard and the implied ratio of debt to national income only starts
falling in 2015-2016, which is a very long way away. That is an
indication of how serious the fiscal position is at present.
Q36 John Thurso: Governor, as you
said, the most pressing thing is to ensure that normal bank lending
is resumed, and you have given a very full answer to the Chairman
and Mr Ainger. Can I press you on just one point on that? A number
of the bankers that I have spoken to seem to think that having
passed Go and got the £500 billion it is business as usual
and they do not need to worry too much, and heads down and they
will soon be kind of all right. Should not the Government, or
the Bank, or somebody, actually produce a memorandum of understanding
or a concordat—something—that actually sets out clearly
the principles? We seem to have a divergence of view between the
bankers, who kind of are going: "Phew! Thank you very much,
now let's get on with life", and all the rest of us who are
saying: "We're giving you the money for a purpose."
Mr King: I do not think I know
many bankers who think it is sort of "business as usual"
or that they are saying: "Phew!" The reason is because
they have been given massive amounts of public support. You are
absolutely right; hundreds of billions of taxpayers' money has
been lent to the banks. However, it has only been lent to the
banks, and they are going to have to repay it. The problem facing
the banks is that they feel under enormous pressure now; having
gone through a long period in which the amount of money they borrowed
grew very rapidly, they now realise that their gearing ratios
and leverage was much too high and they are under enormous pressure
to reduce it—this is pressure coming from the market—because
if they do not take steps to reduce it their share price falls.
So one can understand why the banks individually think that it
is in their interests financially to reduce lending to reduce
the size of their balance sheet. Collectively, of course, I do
not think this does make sense because they are merely exacerbating
the downturn which will increase their own losses in the future
and damage their underlying capital position. So there is, I think,
a real chance here to bring the banks together in order to say:
"Look, how can we, collectively, get out of this?" I
do not think it is in the banks' collective interest that we go
into a deep recession or downturn. However, individually, I think
one can understand the pressures that they are under. The recapitalisation
has certainly eased those pressures and it prevented the banks
from failing, which is where they would otherwise have been, but
it has not got them yet to a position where they feel confident
enough to resume lending. We have to get to that point, and if
it means some kind of concordat, so be it. One way or another
we have to find a means to get the banking system to resume lending.
I do not think, at this stage, I want to rule anything out, though
I do think there is a sequence to start here, and the first thing
is to start with more intensive monitoring and then discussions
with the banks.
Q37 John Thurso: It does seem to
me, Governor, that—and you quite rightly make a difference
between what is in the interests of an individual bank and what
the collective system requires, which appears to be diametrically
opposite at the moment—without some form of formal concordat
or MOU or something that lays out the principles (not telling
how the bank has to run its business but lays out the principles),
then there is nothing for the individual institution to be guided
by. It seemed to me it was a pretty strong need to arrive where
you want to arrive.
Mr King: I do not want to prejudge
what is the right way through this. What you say may well turn
out to be necessary. I think we should, first of all, find out
what answers the banks have as to how we are going to get through
this, and then see. I certainly do not rule out the approach that
you suggest.
Q38 John Thurso: Can I turn to another
point you made in your opening statement, which is the impact
of Lehman Brothers and the destabilising factor that that was.
With the benefit of hindsight, do you think Lehman Brothers was
actually a systemic risk and was too large to have been allowed
to fail?
Mr King: I think with the benefit
of hindsight it was clear that after Lehman Brothers failed the
sequence of events occurred which led to the collapse of confidence
in the banking and wider financial system that has proved deeply
damaging. I do not think it was inevitable that that happened.
I do not think questions of confidence are ever questions of inevitability,
but it happens. I just do not think it makes sense to blame the
US authorities for that; I do not think they could easily have
known, nor did many people say so immediately—and they did
not have any powers. In fact, one of the most interesting things
about the experience was how many of my colleagues in the United
States said: "Now I realise why you, the UK, have been talking
about having proper powers to deal with banks", because Lehman
Brothers was not a deposit-taking institution, it did not come
under the FDIC and they did not have the powers to deal with it
as they would have been able to do with a deposit-taking institution.
They will obviously want to look at that in the future. Be that
as it may, we are where we are, Lehman Brothers did fail and it
did lead to a quite extraordinary sequence of events, which has
led to the biggest banks in the world getting to the point of
virtual collapse. I do not think anyone had anticipated that that
was likely, or even remotely likely, to happen. It is something
that people thought was associated with reading about the financial
history of the 19th Century. However, it happened and we have
to confront the circumstances and find a way through it.
Q39 John Thurso: You make an interesting
point about their not having the powers. In this country do you
feel that we have the appropriate powers if, God forbid, anything
similar were to happen?
Mr King: We will have, I hope,
thanks to all of you voting through—
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