Examination of Witnesses (Questions 40-59)
MR MERVYN
KING, MR
CHARLIE BEAN,
MR SPENCER
DALE, MS
KATE BARKER
AND PROFESSOR
DAVID MILES
15 SEPTEMBER 2009
Q40 Sir Peter Viggers: Turning back
to the Governor, eventually the steps that you have been taking
will need to be unwound. Will unwinding quantitative easing impact
on the cost of Government borrowing in a different way from raising
interest rates? One commentator has said that: "An eventual
withdrawal of monetary stimulus is likely to take the form of
a rise in Bank Rate rather than a reversal of quantitative easing",
because of the effect on Government borrowing.
Mr King: Since one of the ways
in which asset purchases have helped to stimulate spending and
demand in the economy is to reduce the yield curve for interest
rates further out than the immediate one month horizon, and since
our decisions on Bank Rate also affect the yield curve beyond
the one month for which we set Bank Rate, I think these are very
much the same type of instruments: they affect not just the immediate
level of Bank Rate over the next month but the expected path of
interest rates over a longer period. There is no doubt, when we
come to reverse our asset purchases and to sell assets, that one
of the objectives would be to push up the yield curve in order
to slow down the path of nominal spending to keep inflation close
to the target so that it will not rise above. Just as in the last
six months one of the benefits of asset purchases has been to
bring down the yield curve, lower interest rates than people expect—not
just in the next month but over the next few years—then
that will go into reverse when we start to unwind asset purchases.
That is part and parcel of the transmission mechanism.
Q41 Sir Peter Viggers: Turning back
to the point that was raised by Mark Todd about availability of
funding to companies large and small, there was quite a gloomy
projection by Moody's reported this morning about a further £130
billion required by UK banks. Did that cause you surprise or concern?
Mr King: I think there are two
facts which are important in thinking about the banking sector
and certainly should help to modify the sense of "return
to normal" or "we can forget about what happened last
year". The first is that the depth of the recession is great
and it will continue. Even if we get small positive growth rates
over the next few quarters, for ordinary people the recession
won't have ended because unemployment will either continue to
rise or remain high. It will take time before unemployment falls
back to where it was. For businesses the level of output and demand
for their products will remain well below the levels that they
were experiencing. It is very important not to lose sight of the
fact that growth rates do not tell the story; it is the levels
that really matter. For most businesses and households the recession
will continue for some while, in the sense that they will be experiencing
levels of demand and output, including employment, well below
the levels that we have got used to. That means that the banking
sector will be announcing in years to come losses on loans that
have gone bad that have not yet been revealed. That is a natural
consequence of a recession—that the revelation of losses
lags behind the actual time path of the growth of output. We certainly
know that there will be more losses to be revealed as a result
of the depth of the recession. If you add to that the fact that
as I mentioned earlier banks will, not now but over the next five
years, be required to put aside much larger amounts of capital
and build up buffers of liquidity relative to the capital and
liquidity that they were holding before the crisis hit, that means
that the banking sector as a whole will need to find very substantial
amounts of capital both to deal with the losses that have yet
to be announced and to build their buffers up to the new required
levels. That ought to be the major dampening impact on compensation,
both to shareholders in the form of dividends and employees in
the form of salaries and bonuses. The banking sector as a whole
needs to have a five-year programme now where it is going to be
building up very substantial amounts of capital to be put aside
as a buffer to insure themselves against future crises. So I am
not remotely surprised, and I think this is a very important aspect
of the challenge facing the banking sector over the next few years.
Q42 Mr Breed: Perhaps we could just
turn to the markets. You must be as surprised as many other people
when we look at where the stock market is today and perhaps where
it was six months ago. Are you at all concerned that the markets
have again got it wrong, and that the improvements we are seeing
are actually just overshooting the real macroeconomic outlook?
Mr King: The stock market now
is about 40-45% above its trough in the spring, and that is clearly
a substantial rebound. The fact that there has been a rebound
is not particularly surprising. We know that financial markets
lead movements in the real economy. I do not think the qualitative
shape is particularly surprising. It is still well below—about
a quarter below—the levels of the stock market when the
crisis hit in 2007. I think what this demonstrates is the extraordinary
difficulty of anyone who is being intellectually honest in saying,
"I think this market has overshot or undershot". I just
do not know, and I do not really know the basis on which I have
information that would enable me to second-guess the market as
saying this level is or is not sustainable. But maybe my colleagues
can do better?
Q43 Mr Breed: It is more sentiment
than it is actuality of forecasting?
Mr Bean: No. I think the one thing
I would want to inject beyond what the Governor has already said
is that a large part of the driver of the recovery in equity markets
is down to a perception that some of the worst downside risks
have dissipated, partly as a result of aggressive policy action
around the world. There are basically two things which are relevant
to the discounting of future profits in making up the equity price:
one is the discount rate and the other is the risk premium. The
discount rate is at very low levels at the moment. Relatively
modest variations in risk premiums can thus have quite big effects
on equity prices. I think what we are really seeing is a retreat
from the extreme pessimism that people had about the possible
crystallisation of those downside risks in the first part of this
year. Whether in some sense this is the right level or not, who
knows. Frankly, if I could do that I would not be at the Bank;
I would be making lots of money in the City.
Q44 Mr Breed: We can always say that,
of course, but to a certain extent the volatility in itself ought
to be of some concern in what we have already said is a very uncertain
scenario almost everywhere else?
Mr Bean: The key thing is that
the volatility reflects genuine uncertainty about the economic
outlook and how that uncertainty has evolved over the past nine
months since the collapse of Lehmans. This is a once in a century
event that we are going through, so it is perfectly reasonable
that people in the markets should be uncertain about how it is
going to unfold. If you remember, at the back end of last year
people were talking about a re-run of the Great Depression and
all these sorts of things. Now, quite reasonably, they are saying,
"Well, it doesn't look that bad". So you would expect
some recovery in equity prices under those circumstances.
Q45 Mr Breed: Professor Miles, could
you perhaps respond to the question: how much more sensitive to
movements by central banks does the current rather lax monetary
policy make the stock market?
Professor Miles: I think when
you are at extremely low levels of interest rates small changes
in interest rates can then have a much bigger impact on things
like stock prices than they would at a much higher level of interest
rates. It sort of comes out of the idea that the stock price should
reflect future earnings of companies discounted at some rate;
and if the rate you are doing the discounting at is very low then
even small changes in that have a much bigger impact than would
be the case at high interest rates. I think that is part of the
answer to the question: why might stock prices have increased
so dramatically in the last few months? It is the perception that
central banks will probably keep monetary policy easier for longer
than people might have thought six, or certainly 12, months ago.
More generally on the issue of stock prices, I think personally
I would be more worried about a rally building up a head of steam
and taking us into something that looked like a bubble if simple
measures like stock prices relative to corporate earnings had
moved to very high levels. I think my reading is slightly different
from that. It is that if you go back four or five months, say
to March, in the UK the level of stock prices relative to corporate
earnings had fallen to an extraordinarily low level, reflecting
a degree of pessimism that is now much lower. We have gone now
to a situation where stock prices, relative to corporate earnings,
look sort of average; but we have not moved into a situation where
stock prices have really pushed way ahead of what looks justifiable
given corporate earnings.
Q46 Mr Breed: It is more to do with
the fact that we have undershot—that the market was massively
pessimistic—rather than currently tremendously optimistic?
Professor Miles: Yes. As regards
the degree of pessimism that was around at the turn of the year—I
am not suggesting it was unwarranted; there was a very, very worrying
period around the turn of the year. I think the situation is now
fortunately less worrisome than it was then.
Q47 Mr Breed: Could I just go to
Kate Barker to talk about housing. There has been a lot of discussion
in recent times about modest increases we have seen in house prices
and in the number of housing transactions. Is there any cause
there to be optimistic in the slightly more long-term?
Ms Barker: There have been periods
where we have not necessarily thought of high house prices as
a good thing. I take some encouragement from the fact that we
have seen more confidence coming back into the market; as indeed
I take some reassurance of the fact we have seen confidence coming
back into the stock market. I think these are all helpful and
suggest, as David was just saying, that the big downturn risks
that we were all very concerned about earlier in the year have
receded a little bit; that seems to me a part of the big backdrop
to policy. Whether or not you want to attach too much significance
to some of the movements we have seen over the summer in the housing
market, I find it difficult to say. There has been a relatively
low level of transactions. There is some evidence, of course,
that people were reluctant to put houses on the market and they
were renting them out. That has not quite come to an end, but
demand has picked up a little bit. Whether that will survive into
the autumn period where unemployment is likely still to be rising
and there will be other pressures on people's incomes is harder
to say. It may very well be that we then start to see more of
a response in supply, more people putting their houses on the
market and we do not see this continued. I am reluctant to say
that just because we have seen a few months of rises that it is
going to carry on. We have been talking about the volatility of
inflation over the next two quarters generally. I think the outlook
for the economy remains, as I think we said at the last session,
rather bumpy; and I expect the housing market may well reflect
that. I take a little comfort since from the fact that we have
seen house building itself pick up a little bit; and that does
suggest that the developers have a bit more confidence in the
market; so that is somewhat encouraging.
Q48 Mr Breed: In the past, the housing
market has been a great driver of the economy and such; but the
fact that more people now are repaying their loans and perhaps
using the opportunity of low interest rates to overpay and get
their overall borrowing down, is it likely that sentiments are
going to change dramatically in the early part, to start to move
house prices up and, therefore, actually add real potential to
the growth in the economy?
Ms Barker: I think we have to
be very careful in saying house prices are a driver of the economy.
I would personally tend to think that house prices reflect what
is going on in the economy. They can of course be a driver to
the sense that they enable people to borrow a little bit more
money; that they have got collateral effects because high house
prices enable borrowing: but more generally I would think of the
rising level of house prices reflecting the fact that people feel
confident about the future. I do not think it works the other
way round—that house prices go up and then people feel confident
about the future. I think the real issue in housing is the ability
to some extent of first-time buyers to access credit; and that
is still quite difficult. The age of first-time buyers who do
not have access to finance from their families has been rising
quite sharply. I would expect that to continue and to have a bit
of a drag effect on the market going forward.
Q49 Mr Brady: Governor, on 12 August
you said that you do not think it is helpful to talk about a "double-dip";
you prefer to talk about the pace of the recovery; and today you
talked about the sustainability of the recovery. What do you think
are the biggest threats at the moment and looking ahead to that
sustainable recovery?
Mr King: I think there are three
headwinds which will mean that the recovery might be somewhat
slower and more protracted than we might otherwise have thought.
One is the state of the banking system; which means that clearly
the willingness to extend credit is less than normal. Second is
the state of the balance sheets of the non-financial sector, where
companies and households may be conscious of the amount of debt
that they have at present, and therefore will be using incomes
to repay debt rather than spend. The third headwind I think is
what is happening in the rest of the world. We have actually had
more encouraging news on that over the last couple of months,
and particularly in Asia. I think there are signs that activity
and the growth of activity is returning to pretty buoyant levels.
But of course that may feed through to commodity prices: their
growth is more energy-intensive than other parts of the world,
so that may mean that we see a pick up in commodity prices. I
think there are some headwinds there. Forming judgments about
that is very difficult, and I think myself that it is far too
precise to speculate about double-dips or any letter of the alphabet
as a way of describing the shape. The big picture is that we know
there has been a very sharp fall in the level of output and activity.
That has come to an end: we are now seeing signs around the world
of a recovery—some signs of growth likely in the second
half of this year in the UK. But how quick that will be and how
long it will take to bring the level of output back to where it
would otherwise have been I think is very hard to say. I think
the big picture is that it is likely to be slow and protracted.
Q50 Mr Brady: Your second point was
about companies and households rebuilding their balance sheets.
You commented earlier that you were pleased there is now a consensus
on getting the public finances back into order; but in your opening
statement you had also commented on money spending falling and
the drag on demand from the banking sector not lending. Are you
concerned at all about the effect of public expenditure being
cut and what that might do in terms of demand in the economy,
or not?
Mr King: I think if there was
an immediate large cut today then that would obviously impose
a downward impetus to spending in the short run. But now we are
starting to see signs of growth coming back into the economy,
it is reasonable to ask what is the right pace at which some of
the very large fiscal deficits should be reduced. That is a judgment
that has to be made in successive Budgets. It does depend on the
state of the economy, but it is very important that it is credible
that we are going to bring the deficit down.
Q51 Mr Brady: It depends on the state
of the economy what the right pace is, but obviously that also
will interplay with some of the other things that can go on in
the economy and some of the decisions the Bank has to take. What
would be the interplay between the future path of Bank Rates and
that steady reduction over time in public expenditure?
Mr King: It depends what is happening
to the rest of the economy. What will determine Bank Rate is the
outlook as we judge it for the path of inflation in the medium
term, looking through the short-term volatility, as base effects
and other changes work through, but looking ahead to the picture
two to three years ahead. It is that judgment that will affect
the path of Bank Rate. Of course the path of public spending is
relevant to that, just as the path of private spending is relevant
to it; but everything will go into our judgment as to the path
of inflation; and it is that that will drive Bank Rate.
Q52 Mr Brady: All other things being
equal, which of course they never are, public expenditure being
lower you would expect to see lower Bank Rates sustained for a
longer period?
Mr King: Depending on the expectations
about future actions to deal with the fiscal deficit.
Q53 Mr Brady: Can I also ask how
the level of public expenditure interacts with your decisions,
or your likely decisions, in terms of the timetable of unwinding
the asset purchases?
Mr King: I must stress, it is
not public spending as such; it is the deficits. Again, the path
of unwinding our asset purchases will be determined by the outlook
for inflation. In that sense I want to stress again, I do not
see Bank Rate and asset purchases as living in separate worlds;
they are really the other side of the same coin. The fact that
we cannot at present impose a negative Bank Rate, we are achieving
the effects of that by engaging in our asset purchases. And the
transmission mechanism, the way that David described it—we
are injecting money into the economy, that affects the decisions
about portfolios of those from whom we have bought the gilts,
like pension funds and others—that is also very much the
same transmission mechanism that works when interest rates are
positive and we change interest rates then. I think of Bank Rate
and asset purchases as very much the same kind of monetary policy
action, to affect the amount of money and spending in the economy;
and for both of those the criterion that will determine the path
for those actions is the outlook for inflation.
Q54 Mr Brady: If action is taken
more quickly to bring the public finances back into order it would
be likely that your unwinding of quantitative easing would be
slower?
Mr King: That is a hypothetical
question which presumes an awful lot about other things in the
economy, and I do not want to answer a hypothetical question because
I fear whatever was done in practice it would not be in an environment
where other things were equal. I do not want whatever I say today
to be brought back at some future date, "You said if we did
this that would happen". That is not the kind of promise
anyone can make. Monetary policy will take account of all the
actions that are being taken, including fiscal policy, when making
judgments about the path of Bank Rate in order to keep inflation
on track to meet the target.
Q55 John Mann: Governor, your headwinds—the
third one, international—would it be unhelpful if the European
Union for a protracted period was unable to reappoint its commissioners?
Mr King: There are many dimensions
to the headwinds that I have reflected on, and that is not one
of them! I am sure if there is a process of appointing commissioners
and for some reason that is not met, then that could hardly be
helpful; but I am not sure that this would be a major factor.
It is the policies that will be followed in Europe that would
matter a great deal.
Q56 John Mann: A small point, you
raised earlier about visits of your committee outside London,
is it possible to get a list of where those visits have been to?
Mr King: Yes. Indeed, in the reports
that each member of the Committee makes to this Committee we do
list the regions and areas where we have been. We will not list
the names of individual companies, for obvious reasons. The pattern
of a visit is fairly typical, which is that breakfasts, lunches
and dinners are speaking events, where members of the Committee
will be talking to a group of people brought together to not only
hear from a member of the Committee but put questions to them,
and then we meet various groups of business people, trade unions
and other people in between time and visit factories and learn
about what is going on in individual businesses. These happen
on a regular basis. Certainly we report through you, individually,
but we can pull them together if that would be helpful. In our
Annual Report we list the number in total.
Q57 John Mann: It would be useful
to see the balance of the real economy that has been visited.
Mr King: Yes.
Q58 John Mann: The external members,
Ms Barker and Professor Miles, could you identify any socially
useless elements of the City's activities?
Professor Miles: I have a lot
of sympathy with what Adair Turner said, and I think he used the
phrase recently in an interview about some aspects of activity
in the financial markets being socially useless. I think what
he meant, and I agree with this, is that with some trading activities
in the wholesale financial market it is hard to view them as adding
much to the efficiency of the economy or the sum total of human
happiness (if that is not too pompous). If you look at complicated
derivatives on derivatives—CDO-squared and CDO-cubed—these
are products that were very difficult to understand and where
it turns out there were real problems generated by them because
they were difficult to understand. These are products where it
was quite hard, really, to see how they helped, ultimately, households
or companies finance spending, I would put them in the category,
as Lord Turner did, of dubious, if not socially useless. I suspect
there will be many fewer of them in the future. I think there
is a big distinction between that and most of the operations of
banks which, particularly on the retail side, involve providing
credit to households and companies to finance spending, and I
think nobody would put those in the category of socially useless.
Ms Barker: I would draw a slight
distinction, perhaps. I think the issue was not whether they were
socially useless—one does not like to examine one's conscience
too much or we will start to decide whether anything anybody does
is socially useful; what I think was difficult about some of the
things that the banks did was not just that they did not add liquidity
to the system, but that because they were not well understood
they actually turned out to be harmful. For me that is much more
the issue.
Q59 John Mann: Not everyone in the
City and in industry agrees. The Director General of the CBI says
that there are only two questions: credit flowing to the private
sector (which I am sure everyone would agree with) and getting
back to the competitive and open marketplace. Is he not rather
missing the point about the crisis of the last 12 months; that
it was having purely a focus on the open marketplace that got
us into problems?
Ms Barker: In general, the two
questions that are identified there must be correct, and I would
agree with the implication of your question that regulatory activity
has rather more to answer than just getting back to an open and
competitive marketplace in some areas. However, there are other
areas—David talked about the retail activities of banks—where
an open and competitive marketplace is what we want.
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