Examination of Witnesses (Questions 20-39)
MR MERVYN
KING, MR
CHARLIE BEAN,
MR SPENCER
DALE, MS
KATE BARKER
AND PROFESSOR
DAVID MILES
15 SEPTEMBER 2009
Q20 Chairman: So there was a slow
start then?
Ms Barker: To some extent; but
if you said to me, "Did it make any difference to the meetings?"
No. Around the meetings I always had the information that was
wanted when it felt appropriate to ask the questions. I did not
feel it appropriate to ask people a lot of questions when they
were in the middle of dealing with what was, after all, a pretty
intense financial crisis.
Q21 Mr Fallon: Charlie Bean, let
us look at quantitative easing. You have purchased, by my calculation,
around £143 billion worth of gilts and during that period
the Government has issued, through the Debt Management Office,
about £95 billion of gilts in the same period. How can we
be sure that all this money is not actually going round in circles
without touching the sides of the real economy and affecting final
demand?
Mr Bean: Ultimately it takes time
for quantitative easing to work; I think that is one point I would
really like to stress. The mechanisms whereby quantitative easing
work through into nominal spending are varied. Essentially what
happens, when we buy gilts from the private sector that means
that people in the private sector now have monetary deposits that
they can do something with; typically they will go and buy other
assets. The effect is to drive up the prices of those assets,
so this will include corporate assets, equities, a whole range
of things. That reduces the cost of capital to firms, the cost
of borrowing for businesses, and ultimately that should feed through
to nominal spending. But I would expect the lags here to be of
the same order of magnitude, or possibly longer, than we see with
respect to normal interest rate cuts. Obviously what we are doing
at the Bank is monitoring things as they unfold. We are moderately
encouraged by, if you like, the near-term indicators in the transmission
chain that it is having an effect. Some channels are perhaps not
working particularly strongly. There is quite a lot of attention
that has been paid to the fact that the counterpart to our purchases,
the increase in central bank money, appears to be being hoarded
by the banks. That is pretty much what we expected on the basis
of Japanese experience. In our assessment of how much we needed
to do, we assumed that that pretty much would happen. But it may
well be that at some stage the banks may well start using the
extra reserves they hold to go out and buy other assets, and that
would add an extra kick to the process that is already working.
Q22 Mr Fallon: David Miles, if we
cannot be absolutely sure of the current impact of quantitative
easing on final demand, how can we be sure we need more of it?
Professor Miles: I think the honest
answer is that one cannot be sure, but one has to make a judgment
on what is most likely to be the right quantity. My own judgment
in the August meeting was that, given the downside risks to demand
and output in the UK, given the amount of spare capacity, then
in order to keep inflation on average, on balance, near to the
target, it was probably warranted to carry on buying assets at
the same pace—on the same trajectory as we had before. But
there is an awful amount of uncertainty about whether that is
exactly the right strategy or not. I think it is important though
that any decision that you make is not a final irrevocable decision.
One can revisit the decision; and obviously there will be a period
some way down the line at which the process will be reversed.
Q23 Mr Fallon: Governor, what are
the milestones that you want to see in place before you should
start to reverse the process, and start selling assets and raising
rates again?
Mr King: Finally it is the judgment
on the inflation outlook; that is the cornerstone of our framework
and it is the criterion by which we make our judgments; it was
the criterion which I used when deciding to vote for the level
of asset purchases I voted for in August. I think that many things
go into that, but one of them is that we felt that the benefit
of asset purchases would be that it would help to offset what
would otherwise have been a very sharp monetary squeeze with the
growth rate of the supply of broad money falling rapidly. We did
manage to offset some of that, I think; so I feel that my judgment
is (although one can never prove it because you cannot ever prove
what the counterfactual would have been) that the growth rate
of the supply of broad money would have fallen very sharply had
we not engaged in our policy of buying £147 billion (it is
now) of assets. I think it is very hard to believe that that scale
of purchase has not actually fed through to broad money in one
way or another. I think we are beginning now, after six months,
to see some signs that perhaps the growth of broad money is picking
up. I shall look at that, as well as what is happening to nominal
spending, and put that together with all the other judgments we
make about what is happening to demand and output and the supply
potential of the economy to form a judgment about the outlook
for inflation and the risks to that.
Q24 Mr Fallon: Is there a level of
supply of broad money that you are looking at looking to reach?
Mr King: There is no indicator,
because if there were that would mean that we would have a broad
money target; but I think the growth rates of broad money that
were consistent in the past 15 years with broadly steady growth
and low inflation were in the 6-9% range. Now that is not a magic
number, but I think I would be looking for a further pick up in
the growth of broad money. That may well happen as a lagged response,
as Charlie said, to the actions we have taken. These are the difficult
judgments we have to make, as to whether what we have done already
will come through to providing a stimulus to broad money and spending
growth in the future, or whether in fact we need to do more. These
are difficult judgments; they are not easy. To those people who
are deeply concerned about the policy of asset purchases I would
say to them, "Look, I understand why in an abstract sense
you may be worried, but the mechanism by which that worry should
appear would be if we started to see excessively rapid growth
of money and spending in the economy and we are a long way from
that at present; and if we did see signs of that we would rapidly
take action in order to slow that down". I would hope that
the framework and our clear intentions would give people comfort
that we are a very long way away from being in a situation where
this is going to create dramatically high inflation. We have got
a symmetric inflation target of 2%. It is a symmetric target.
When the judgment is (which is perhaps not very often) that we
think the risk is that inflation will be below the target, then
it is our duty to bring it back to the target; and that is what
the policy of asset purchases is designed to achieve.
Q25 Mr Fallon: Is not the framework
complicated by the uncertainty on the fiscal side? Would not your
task be easier if the markets were clearer about how the structural
deficit is to be reduced, as well as when?
Mr King: Yes, I think it is clear
any monetary policy is going to face difficulties when there is
a fiscal position such as the present one where, because of the
shock to the financial sector, we have now got at present a very
large deficit, which everyone accepts needs to come down. The
timing of the measures needed to bring it down I think must depend
on the state of the economy, but clearly we need a very credible
overall plan to ensure that the public finances are put on a sound
footing; and that is part and parcel of macroeconomic policy,
for which we are not responsible. But a failure to have a fiscal
framework which gives comfort to everyone, that the public finances
will be on a sound footing, does make life more difficult and
it can push up inflation expectations, and in that way require
us to take action. I think everyone accepts that. I am pleased
there is now a consensus on that issue. As I said, now we have
a long hard road over the next few years to put every aspect of
our framework, macroeconomic and regulatory, in the right place.
It is important we do not do it all at once. We do need to phase
this in as the economy recovers; but we have got to be very clear
where we want to get to at the end of that period.
Q26 Mr Fallon: You are still waiting
for a credible fiscal plan?
Mr King: I am sure there is plenty
of time for that to be announced. I gather there is quite an active
debate amongst those of you who are responsible for it in Parliament
about what fiscal policy will look like, and I look forward to
seeing the outcome of that.
Mr Fallon: So do I!
Q27 Mr Todd: Could I just briefly
turn back to the article by Danny Blanchflower. I think you are
right in not engaging in a debate, but there was one process issue
which struck me when he referred to a criticism that he made of
one of the decisions; there is a reference to you calling him
in to "admonish" him. That would not seem to me an appropriate
relationship between the Chair of the MPC and an independent member.
I assume that is one of the inaccuracies you were thinking of?
Mr King: He participated in the
discussions on the August Inflation Report and signed up
to the Report; and I think I was asked by other members
of the Committee to explain that it did not seem very sensible,
having agreed privately and gone along with a view that was discussed
and signed up to the process, then publicly to dissent from it.
I think it was reasonable for me to point out that this was a
view which other members of the Committee had been upset by—by
his speaking out in public and describing a Report which
he had signed up to as "wishful thinking". It was not
wise behaviour; I was asked to make that clear to him by other
members of the Committee; and as Chairman I think it is reasonable
to do that.
Q28 Mr Todd: But there is a balance
to be struck, is there not, between the role of members of the
MPC to make public—
Mr King: Absolutely. I think at
every point, as he says in his article, that the discussions we
had were always polite and good mannered, even where people had
different views about the state of the economy—
Q29 Mr Todd: I appreciate that.
Mr King: —and people have
never been shy of speaking out—that is one thing you could
not say about the Monetary Policy Committee!
Q30 Mr Todd: I am making a slightly
different point. There is a balance between the concept of collective
responsibility which one has some obligation to if you take part
in any decision-making process, and the freedom to comment?
Mr King: And that is particularly
true of the Inflation Report which is a collective document.
Q31 Mr Todd: Yes, but also there
is a responsibility to members of the public outside to hear the
broader views?
Mr King: Absolutely, and that
has always been made quite clear to the members of the Committee.
Q32 Mr Todd: Are there some tools
that could be used to accelerate the effects of quantitative easing
through to the real economy? All of you have actually commented
on the lags that are inevitably there. It has been certainly pointed
out that one of the effects has been a very substantial increase
in reserves help with the Bank of England by banks. Are there
tools that you could use to accelerate the use of resources that
have been pumped in for the purposes that they are intended for?
Mr King: I think the big picture
is that we have engaged in asset purchases: that does feed through
directly to broad money held by the non-banking sector; and in
various ways that will feed through into the transmission mechanism
of higher nominal spending, and ultimately higher inflation to
bring inflation closer to the 2% target. It is always tempting
to try and speed up the transmission mechanism of policy actions
that we take; and of course the same is true of interest rate
changes, where again there is a lot of uncertainty surrounding
interest rate changes. I think it is very important not to see
asset purchases as in some sense completely different from the
normal way we set policy. We describe the action we take in terms
of Bank Rate normally, but the transmission mechanism through
to the economy is very much the same transmission mechanism as
follows from asset purchases. In terms of the reserves of the
banking system, I think the most important thing to remember is
that as we engage in asset purchases that automatically will increase
the reserves of the banking system and you cannot stop that and
you would not want to: the whole point is that asset purchases
are going to have the impact of raising reserves of the banking
system. What is true is that we do not want reserves to be unnecessarily
high; and we have withdrawn other ways of injecting reserves that
we would normally engage in through out short-term repo operations
in the market in order to bring down the level of reserves. But
I think there is a limit to how far we can go because of the scale
of asset purchases; but we have reduced the other actions that
were boosting reserves. Of course, people have talked about, and
I was asked a question at the August Inflation Report press
conference, whether it would be sensible to reduce the rate at
which those reserves are remunerated, and it is something we are
looking at, and we will reflect on it.
Q33 Mr Todd: Or have a differential
rate applied to those above a certain level?
Mr King: Yes, exactly. I think
you certainly would not want to reduce the rate of remuneration
on a certain level of reserves—that is part of the framework;
but above some normal level you could have a lower rate at which
they are remunerated. But that would not change the overall level
of reserves in the banking sector; that is determined by our asset
purchases. What it would do is perhaps make the banks work a little
bit harder to try individually to convert some of those reserves
into other assets. If you reduced a bit the rate at which you
remunerate reserves that will not convert it into lending to businesses,
but it might mean that they would purchase more short-term gilts,
for example, which would be adding to the effective size of the
asset purchase scheme and so boost money growth a bit further;
and that is something we will reflect on. But I do not think you
should see this as a major change, a major instrument. In Sweden,
for example, it has a tiny effect because they do draining of
their reserves daily so that the scale of reserves on which the
lower rate is charged is actually extremely small. This may be
a useful supplement; we will think about it but it is not going
to be a major change.
Q34 Mr Todd: Part of the difficulty
is that the speed with which quantitative easing has its effects
depends on decision-making within institutions, with which the
public do not have a huge amount of confidence at the moment.
Therefore, the mechanisms you have described can be characterised
in other ways, as banks quite deliberately rebuilding their balance
sheets, holding in reserve resources that should be distributed
back into the economy to generate growth. Does it trouble you
that the fairly academic response that we have had—which
has been to say "This is how it works. There are a variety
of lags here, if you wait long enough it'll happen"—does
not necessarily satisfy the person outside?
Mr King: No, I can see that but
I think the answer is I do not think this is so much a question
of timing as of magnitude. One of the reasons we have engaged
in the scale of asset purchases we have is the recognition that
because of the state the banking sector is in, some of the increase
in money that we have created has been used to pay down bank debt.
In the long run that is also part of the recuperation process
of banks, so that in a sense is also helping the economy but over
a longer time period; but in the shorter run that would affect
the judgment about the scale of asset purchasing.
Q35 Mr Todd: Can I turn to the empirical
data as to how quickly this is flowing through. What are your
agents telling you about the difficulties firms have in borrowing
money at the moment? Which categories of companies are struggling;
or indeed you may be hearing that those with good plans are finding
no difficulty in raising money at all?
Mr King: No, I would not agree
with the latter. I will make one broad comment and then perhaps
ask Spencer Dale to comment because it is his area that produces
the credit conditions survey. I think the big picture is the good
news (and I think it is not entirely unrelated to some of the
activities that we have engaged in through our asset purchases)
is that the conditions for big companies to raise equity finance
and bond finance have improved significantly. There is quite a
significant amount of finance being raised in that form. Of course,
that does not really help the small and medium-sized companies,
and they are still finding difficulties.
Mr Dale: I think that is exactly
right. The message we get from our agents, and it is also the
message one can see from reading the business surveys, is that
some of the larger companies are finding less difficulty accessing
funds. As their ability to go to capital markets improves, so
the competitiveness within the bank lending market is also improving.
Where there are more difficulties is for the smaller and medium-sized
companies, where we hear from the agents and we can see from the
business surveys the difficulty of obtaining funds is still a
pressing concern
Q36 Mr Todd: What should be done
to ease that? Are there any differences in the sorts of activity
of businesses? For example, you mentioned small, but start-ups
may have particular problems. What evidence is there of that?
What measures would seem reasonable to improve that situation?
Mr Dale: The focus of our asset
purchases is to try to increase, as the Governor said, the flow
of money in the economy and improve the functioning of corporate
credit markets. I think, as the Governor was saying, one sees
quite a degree of success in terms of what is happening to corporate
bond markets—where corporate bond spreads have declined
very dramatically—and corporate bond issuance is at record
levels. Large companies are going out to access that. It is very
difficult for us with a single instrument to try to start directing
funds to particular sectors of the economy—be it particular
sectors or small companies versus large companies.
Q37 Mr Todd: I did not suggest the
Bank should do that. I think I said what measures should be taken?
Mr Dale: One would have to try
and think about alternative measures which could try and encourage
banks to direct their resources to small and medium-size companies.
As you are well aware, there are some policies in place whose
aim is trying to do that; but, as I said, from both our agents
and from the business surveys, there seems to be further to go.
Professor Miles: I think it is
important to see that the effect of quantitative easing is not
completely dependent on what the banks do. One of the reasons
I view it as the right policy and an effective tool is that it
can help credit conditions in the economy, even if the banks simply
see reserves accumulate there and do not take second-round actions.
One of the mechanisms is that those who sell gilts to the Bank
of England—pension funds and life insurance companies—would
then naturally look to buy other assets that might be close substitutes
for gilts. A close substitute for longer dated gilts may well
be corporate bonds, rather than simply seeing the money accumulate
in a bank deposit. I think it is no accident that during a period
when the Bank has been purchasing, on a very large scale, gilts,
the issuance of corporate debt by non-financial companies has
increased very sharply.
Q38 Sir Peter Viggers: May I ask
Spencer Dale to comment on the inflation projections which are
shown on page 40 of the Inflation Report. The fan charts
on page 40 show the comparative effect of quantitative easing
of £125 and £175 billion, a difference of £50 billion.
The central projection now sees inflation rise to target within
a year. How much of that is due to the extra £50 billion,
and how much via the change in the economic situation?
Mr Dale: Comparing the two charts
on page 40, there are a number of differences between Chart 5.4
and Chart 5.5, because they were taken at different points in
time: one was from the May forecast and one was from the August
forecast. In addition to the additional monetary stimulus underlying
the August forecast, there is also a completely different set
of other financial prices going on, and also differences in the
economic judgment and the data which changed between May and August.
You cannot read the differences between those fan charts purely
in terms of representing the impact of the £50 billion. The
more general question is clearly the decision to increase the
scale of monetary purchases to raise the inflation projection,
but the precise amount by which it did depended on all the other
factors which were used to make up the economic forecast in August.
Q39 Sir Peter Viggers: There has
been seemingly limited impact on inflation further out than the
charts project. Why is that?
Mr Dale: In what ways "seemingly
limited"? A number of factors were affecting the forecast
for inflation further out between May and August. To one extent
we had the additional monetary stimulus; and the other factor
to bear in mind is that between May and August our view about
the level of output in the past had been revised down quite substantially.
We were starting our forecasts with a lower level of output and
a greater degree of economic slack in August than we had thought
was the case in May, and that acted to pull down on the inflation
projection relative to that in May.
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