Examination of Witnesses (Questions 1-82)|
24 NOVEMBER 2009
Q1 Chairman: Governor, we welcome you
and your colleagues to the Committee's inquiry into the November
inflation report. Perhaps you would introduce yourselves for the
Mr King: On my right is Mr Paul
Fisher, executive director for markets; on his right is Dr Andrew
Sentance, one of the external members of the MPC; on my left is
Mr Paul Tucker, deputy governor for financial stability; and on
his left is Dr Adam Posen, again one of the external members of
Q2 Chairman: You have an opening
statement to make.
Mr King: I do. When we appeared
before you a year ago I described how a remarkable set of events
had transformed the outlook for the UK and global economies. At
that time in the wake of the financial crisis output was plummeting
and inflation was beginning to fall from its peak of 5.2%. A year
on, the sharp falls in output appear to have come to an end and
we are encouraged by signs that a recovery will soon be under
way, but the recession means that the level of spending is now
markedly lower than it was in the first half of 2008 and, looking
ahead, the economy continues to face profound challenges. That
lower level of spending has opened up a significant margin of
spare capacity in the economy which is evident both in surveys
of companies reporting that they are working below capacity and
in the labour market. Unemployment although relatively stable
over the past few months is now close to 8%, markedly higher than
the levels to which we had grown accustomed. That margin of spare
capacity will act to pull down on inflation in the medium term.
Notwithstanding this effect, inflation is likely to rise sharply
in the coming months from its current level of 1.5% to above the
target, reflecting an increase in petrol price inflation and the
prospective reversal of last year's cut in VAT. But these are
price level effects. It is not sensible for monetary policy to
respond to those types of effect as they will influence measured
inflation for only a year when policy does not have much traction
on inflation over such a short time horizon. In the medium term
when policy has its most significant impact it is the level of
money spending relative to the supply capacity of the economy
that determines inflation. Powerful forces continue to restrain
spending in the economy. Banks are actively trying to reduce their
leverage. There is a long way to go in that process and while
it continues the availability of credit to households and companies
will be impaired. That combined with uncertainty about future
incomes and profits will make households and companies reluctant
to spend. The need for a credible plan to consolidate the public
finances is clear to everyone and will mean that a lower share
of national income is devoted to consumptioneither private
or publicin the future. Although there are encouraging
signs of a recovery overseas the level of world demand and hence
demand for our exports is well below its level before the crisis.
These forces will act to restrain spending for a considerable
period. It is to counteract those forces that the MPC has taken
unprecedented monetary policy actions over the past year. Bank
rate is almost at zero and the MPC has now extended its programme
of asset purchases to £200bn. That programme is injecting
additional money directly into the economy. Investors are using
some of this money to diversify into assets that have a higher
return and that in turn boosts the prices of those assets, reduces
yields and the cost to companies of raising funds in financial
markets. Ultimately, that will help to restore the level of spending
to a path consistent with eliminating spare capacity and ensure
that inflation is on track to meet the target in the medium term.
The events of the past year or so in financial markets and the
bank's responses have been extraordinary. I have sent a letter
to the Committee to explain more fully one aspect of the bank's
operations that was prompted by those events: lending facilities
that we put in place at the height of the crisis for two individual
institutions that we are now able to disclose. Having experienced
the wider economic consequences of the financial crisis it is
right that households and companies expect fundamental reform
of the structure and regulation of our whole financial system.
As part of that process, last week the Bank of England published
a discussion paper setting out its initial views on how so-called
macroprudential policy might be designed. We hope this will spur
a debate and bring us closer to the point at which we can implement
lasting and effective reform. I am grateful for the opportunity
to make those opening remarks and I and other members of the Monetary
Policy Committee here today stand ready to answer your questions.
Q3 Chairman: A number of commentators
have commented on the bank's optimistic growth figures for 2010
and 2011 and said that when you announced your inflation report
your comments seemed to be at odds with the MPC's written proposals,
in that you seemed to be more downbeat. What is the situation?
Mr King: I think they are completely
consistent. This is a point where we need to look not just at
growth rates but also levels of output and spending. That is why
on pages 6 and 7 of the report you see charts that show exactly
the same outlook, one representing the growth rate of GDP over
the forecast horizon and the other showing the level of output.
In terms of growth the most likely outcome is for rates above
the long run average growth rate of the economy. Taking into account
the downside risks, the average growth rate for calendar year
2010 in chart 1 on page 6 of the inflation report is around 1.5
percent and for 2011 it is around three percent. Therefore, over
those two years the average growth rate expected by the committee
is slightly lower than the long-run average growth rate of the
economy. Given that we have been in a period when there is a great
deal of spare capacity from which the economy can recover and
expand without putting any upward pressure on inflation that is
not a particularly strong recovery. That is shown very vividly
in chart 2 which indicates the level of GDP. That shows that for
the foreseeable future the level of total GDP is well belowthat
is, about 10%the level we would have expected it to reach
had we continued to grow along the trend before the crisis hit
in 2007. In terms of the experiences of businesses and households
and what is happening to companies in the labour market the chart
will illustrate the experience that they will have. One should
expect fairly buoyant growth rates in the short run having come
back from such a deep recession. I do not believe there is any
inconsistency between the two. Charts 1 and 2 represent exactly
the same outlook for the economy but from different angles. I
think it is important for people to think in terms of levels,
not just growth rates.
Q4 Chairman: You have always said
that. Thank you for the information on the two banks, the RBS
and HBOS. You said that the Bank of England extended emergency
liquidity assistance to these two institutions. We note that you
have afforded them £61.6bn. When I and my colleagues received
this note we had a little intake of breath and thought about how
many universities, colleagues and jobs could be supported with
that money. It lends credence to the view that we need to fix
this situation; otherwise, we will go back to what we had before
and accept the status quo. Can you tell us whether all those moneys
have been repaid to the bank? Given the view of Professor Miles
that the banks are still on life support, for what are they depending
on you at the moment?
Mr King: As spelt out in the letter
I sent to you, the loans to RBS and HBOS extended in October 2008
were fully repaid, one in December 2008 and the other in January
2009. Those loans were short-term liquidity support of a "conventional
lender of last resort" kind that the central bank is there
to provide. It bridged to the recapitalisation of the banks that
took place in October and again in January, but those liquidity
facilities were fully repaid no later than January 2009.
Q5 Chairman: At the moment for what
are they dependent upon you?
Mr King: Obviously, we will not
comment on individual banks, but the total scale of dependency
of the banking sector on the public sector through access to central
bank facilities, the special liquidity scheme and the credit guarantee
scheme is enormous and runs into many hundreds of billions of
pounds. There is still dependence by the banking sector on the
public sector for funding.
Q6 Chairman: You recognise that the
banks need to restructure their balance sheets and tighter capital
controls are required. However, you also recognise that lending
will drive a private sector-led recovery. Would you prefer banks
to lend more or repair their balance sheets while we have a public
Mr King: It is not for me to say
what banks should do and it is quite clear that the incentives
presented to banks at present are to run down the extent of their
leverage and get their balance sheets back into order. That is
what drives the restrictive supply of credit that we see not just
in the United Kingdom but also in other countries. That is the
overwhelming driving force behind the movement of credit at present;
it is depressed by the actions of banks in trying to restore their
Q7 Chairman: Dr Posen, you made an
interesting speech a couple of weeks ago in which you said that
the UK lacked a spare tyre for lending to non-financial companies.
I was at a CBI conference yesterday where I was told that apart
from financial institutions 50% of lending went to commercial
real estate and 5% to manufacturing. We really need to do something
to have a channel there. What is your advice to us?
Dr Posen: I am glad to have the
opportunity to respond to you on that, but clearly I do not speak
for the bank but for myself. There are many ways to skin this
cat. Part of it is to try to build up in a structural sense the
ability of small and medium enterprises to access capital markets.
Large British firms can but the bond market, as I cited in the
speech which you kindly mention, is very underdeveloped as a share
of GDP. Apparatus and encouragement can be provided. Government
lending facilities can be put in place. There has been some discussion
in the past about whether these have been effective. I admit they
are not my first choice. There are efforts to use moral suasion
on the banks currently in public ownership; there is restructuring
of the banking system to create more competition; there is the
use of moral suasion on banks such as foreign banks that used
to lend in the UK but understandably, like everyone else in the
world, have returned to their home markets in the past year. They
can be encouraged to come back. There are also efforts to try
to broker deals with the existing banking system to try not directly
to mediate loans but make it easier for small businesses to make
applications and get them properly processed. There are a number
of things that this Committee and Parliament can consider which
essentially come back to two sets of measures. First, there are
those things you can do in the very short term to try to facilitate
lending, because we know that small and medium enterprises are
hit worse during a recession. I am worried that right now they
are being particularly badly hit. Second, one can think about
the structure of the banking and financial system in the UK over
the longer term given that manufacturing and domestic non-financial
companies are not as well served as they should have been.
Q8 Chairman: Is it right that we
need three or four years to think about restructuring of the financial
Mr King: Yes. I share Dr Posen's
view that the most optimistic outlook here is the longer and not
shorter term. I do not think it is easy to come up with remedies
in the short term, but in the long term to have a more diversified
pattern of funding the corporate sector would be an attractive
route to go down. That is often easier said than done, but it
is worth exploring to find out because we have seen how susceptible
the small and medium enterprise sector has been to problems that
none of us anticipated would occur on this scale in the banking
Q9 Chairman: It appears that you
and John Kay are in the minority regarding separating retail banks
from more risky activities. Bankers tell us that this will lead
to the mortgage market being controlled by a cartel. Previously,
Lord Turner saidhe has expanded on his viewsthat
it could outlaw perfectly acceptable business activity. Have you
been persuaded by the arguments of the bankers on this?
Mr King: No. I think the debate
has moved on. The most important point I made was that if we are
to think of restructuring the banking sector in the future it
does not really matter if we think that what banks do is socially
useless or useful; it does not matter whether banks are doing
god's work. Let us just think of something practical in the middle
ground, which is that banks must be subject to the same market
discipline as all other industries. That is a simple, obvious
point. If banks screw it up and make bad decisions they should
be allowed to fail. In my view, there is no way you can run a
system on any basis other than that. Therefore, the real task
of devising a regulatory structure in future as well as the structure
of the banking system is to think through what you would need
to do in order to get to the point where we accept that a bank
which made serious mistakes was allowed to fail and a regulator
that allowed that bank to fail would be able to do so safely and
would not be criticised for doing so. It would have got itself
into a position where it said that if the bank's management made
bad mistakes that was just too bad; the bank would fail and the
creditors and the people who supplied funds must recognise that
they put their money at risk. That is the point which we must
reach one way or another. There are different ways of doing it.
It will not be easy to get there without further measures of separation.
It is absolutely clear that from now on all governments will want
100% deposit insurance for ordinary retail depositors up to, say,
the present limit of £50,000. If that is the case it cannot
make sense to allow banks to use that funding to go off and engage
in very risky activities in which they get to keep the upside
and the taxpayer must come up with the downside. Having restrictions
on what kinds of deposits are used to fund seems to me a very
sensible change in the long run and in essence that is what narrow
banking is about. We need to have a much wider debate about all
the other ranges of banking activity and how that would be funded.
There is a three-legged stool on which it makes sense to try to
rest our approach; we should not rest it on just any one approach.
One is structure and it is important not to lose sight of that.
You can already see one example of that. In the debate about banks
crossing borders many countries, including emerging markets, now
realise that it would be sensible for them to have separate subsidiaries
in their own countries of these global banks because they need
to have separate capital and liquidity requirements for those
banks operating in their territories. That is one example of structure
but there are many others. The second is capital. I am sure that
capital and liquidity requirements will change and be higher in
future, but we at the Bank place a great deal of weight on the
potential contribution of so-called contingent capital; that is,
forms of funding banks that automatically convert to equity when
there is a call on them. Therefore, if the bank gets into deep
trouble that money counts as equity. Ultimately, that is the extreme
case in which one can ensure that no bank can fund itself by promising
to make a guaranteed rate of return and in the end is unable to
deliver and the government feels that it must step in to bail
out the banking system. Therefore, capital is the second leg of
the stool. The third is resolution. In my Mansion House speech
I referred to wills. We have to do that. It will be difficult
to push it far enough, but regulators must be tough enough on
banks to say they do not believe their structure is simple or
small enough for them to be able to allow them to fail and therefore
they must change the way they organise their activities. We cannot
end up in a situation where any regulator or government feels
that an institution is just too important or big to fail. That
must now be the single most important objective of the whole reform
programme. There are different ways to get there. I believe that
to place weight on the three different legs makes sense, but we
cannot end up in a situationthere is still a way to go
in persuading some of our international colleagues of thiswhere
we tacitly accept that some financial institutions are just too
big to fail.
Q10 Chairman: That is a core issue.
You referred to a wider debate. This Committee visited Japan in
October 2007 and had access to the central bank and policymakers.
They said that two issues affected Japan: one was recapitalisation
and there should not be prevarication, which we have done; the
other was public anger and resentment and there had to be a strategy
to deal with it. Do you believe there is here a need for a more
civic engagement to understand what the future of banking is,
what its purpose is and how it best serves the economy?
Mr King: Whether it is called
"civil" or "political" I leave to you, but
there must be wider involvement. What strikes me most forcefully
as I travel round the country is that for a generation people
adopted the view that market discipline was the best route to
prosperity. They accepted that if their companies could not find
customers they would fail and that if they worked for such companies
they would lose their jobs and perhaps they would have to get
other jobs perhaps on less attractive terms elsewhere in the economy.
That applied to every part of the economy until the bail-out of
the financial sector. That is wholly unacceptable not only from
an economic point of view; it will simply undermine people's commitment
to the merits of a market economy. That would be tragic. One of
the great achievements of the market economy has been greater
prosperity not just to the citizens of this country but also billions
of people around the world who have been dragged out of poverty.
We must not lose sight of the merits of a market economy but we
must apply its discipline to the banking sector. That is why I
place so much weight on dealing with the issue of "too important
Q11 Chairman: The Committee is very
much taken with that. The concept of "too big to fail"
and macroprudential tools are the two big issues in future. You
have said that a credible path to the reduction of government
debt is necessary. What is your view of the ideal of debt reduction
given the current conjecture? For example, is it better to reduce
debt in three years rather than six?
Mr King: It is difficult to say
what that number is; it needs to be contingent on the state of
the economy and no one can be precisely sure. But it needs a credible
plan over the lifetime of a parliament to bring down very significantly
the deficit contingent on the state of the economy. It must depend
upon that, but it must be a plan of action that would explain
what would be done in order to achieve that objective.
Q12 Mr Plaskitt: On page 43 of your
report you talk about some permanent changes in the outlook for
government revenues as a result of the recession. For example,
you talk about the path of lower output and refer to lower tax
revenues from particular sectors of the economy. I assume that
you mean the financial sector. Would you expand on the extent
of the permanent changes you see and the scale of the impact on
the outlook for government revenues?
Mr King: I think it is implied
by chart 2 which shows the level of GDP. You can see that for
quite a long period that is expected to be well below the level
we might reasonably have expected had the economy not hit the
financial crisis in 2007-08. That is a pretty large figure of
anywhere between 5% and 10%. On top of that is the fact that those
sectors that generated significant revenues in the UK, particularly
the financial sector, and other transactions taxes could not credibly
continue to generate such large taxes; it was likely to be the
case that the turnover in the housing market, for example, would
fall back to more normal levels at a certain point and that the
rate of increase of profits in the financial sector would not
continue indefinitely. Obviously, that turned out to be true.
Therefore, there are effects from both the impact of the crisis
on particular sectors that contributed heavily to revenues and
the impact on the total level of GDP. That means the amount of
revenue will not be of the order it would have been reasonable
Q13 Mr Plaskitt: You are saying that
even if there is a return to overall GDP growth somewhere along
the track that you project in this report it will not have the
same revenue buoyancy effect as growth has in the past?
Mr King: Certainly, the level
of revenue for the next five to 10 years is likely to be well
below that which would have expected in the middle of 2007 when
we were unaware that the financial crisis was about to hit.
Q14 Mr Plaskitt: Given what you said
in your opening statement about the need for a credible plan to
consolidate the public finances, what are the ingredients of that
credibility? What boxes must be ticked for you to believe that
the plan is credible?
Mr King: There must be elimination
in large part of the structural deficit over, say, the lifetime
of a parliament which is the period for which a government is
elected. Anything beyond that is a statement of intent or hope
rather than a plan to which someone can be held accountable, but
it will depend on the recovery of the economy. If the world economy
fell back and we found ourselves in another period of downturn
it would not be sensible to expect the deficit to be eliminated
that quickly. The path must be dependent on the state of the economy.
Nevertheless, it must be capable of being implemented over a period
for which an administration can be held accountable.
Q15 Mr Plaskitt: Is it sensible to
argue that if government tries to consolidate the public finances
too aggressively it may be counterproductive in terms of support
for the economy and may help to trigger a second dip?
Mr King: It is certainly true
that if you eliminate the deficit too aggressively it will have
an adverse consequence. It is equally true that if you implement
it insufficiently aggressively it will also have an adverse consequence.
As to the debate about whether we should remove the stimulus too
soon or too late we should do it at the right time. That makes
clear that it must be a credible plan based on actions so people
can see what would be done in order to bring about the reduction
in the deficit, but it needs to be contingent on the state of
Q16 Mr Plaskitt: Does not that qualification
make it really difficult to determine whether or not it is credible?
You keep saying that it is contingent on the state of the economy,
which is an obvious factor, but as it is not known you really
cannot plan for it?
Mr King: To set out exactly what
would be done each year for the next five or six years is an extremely
difficult thing to do, but contingent upon a particular central
path of the economy you can say that if that path did emerge you
could expect to achieve a certain scale of fiscal consolidation
and set out the actions to take to bring that about. It can be
done but it is important to recognise that subtlety in saying
that the precise timing of measures should depend on the state
of the economy. Equally, the plan needs to be credible, not just
a broad-based statement of intent.
Q17 Mr Plaskitt: Do you believe that
at the moment there is any risk to the UK's credit rating as a
result of the public finances?
Mr King: I do not believe there
is any immediate risk, but the longer there is not a credible
plan that sets out what actions will be taken the more that is
a risk. I do not believe there is any impediment to the UK putting
in place a credible plan which will convince financial markets.
The risks arise more from possible concerns in financial markets
that might arise if other countries got into serious fiscal difficulty
and it created a more generalised concern about fiscal deficits
around the world. That includes the United States which also has
a large deficit. I do not believe this is a UK-specific issue.
It is true that our deficit is large but by putting in place a
credible plan and following it through it is quite possible over
a period of time to bring down that deficit and it is important
that we are seen to do that.
Q18 Mr Plaskitt: Is it more important
to watch the rate of reduction of the deficit than its absolute
Mr King: I think it is both. You
have to take action to bring down the deficit of the size we haveit
is a very large structural deficitbut to do so at a rate
that is consistent with the restoration of growth in the economy.
Q19 Mr Fallon: The permanent secretary
to the treasury told this Committee a fortnight ago that quantitative
easing was a journey into the unknown and we did not understand
every aspect of it. At its last meeting the MPC split three ways:
some wanted to extend the programme by £40bn, others by £25bn
and others to leave it unchanged. Do you really know what you
Mr King: Yes. I do not accept
that this is a journey into the unknown. There are uncertainties
but there always are in monetary policy. We have had three-way
splits before when dealing with the level of bank rate. You can
certainly say there are different views about the likely future
path of the economy. We have the Monetary Policy Committee precisely
because no one person has a monopoly of wisdom and it is a good
idea to try to aggregate together the views and judgments of a
diverse range of individuals. It is not surprising that when one
is at a turning point in the economy there are different judgments
about what are after all relatively small differences. No one
advocated that we immediately launch and sell back the assets.
The range of views about the additional asset purchases was between
zero and £40bn.
Q20 Mr Fallon: The sum of £25bn
represents quite a difference. At your press conference you described
worrying about asset prices as "peculiar". Can you elucidate?
Mr King: In present circumstances
what I worry about is that it has become very fashionable to think
of almost any upward movement in any asset price as a bubble and
any downward movement as the bursting of the bubble. I do not
believe that is particularly helpful. It is not surprising that
there have been sharp movements in asset prices over the past
six to nine months. At the beginning of the year we had experienced
two quarters when the world economy, in the words people around
the world have used, fell off a cliff. This was true not just
of one economy but every economy. This was wholly unprecedented.
World trade was falling at a rate even faster than during the
great depression and there was enormous concern and uncertainty
about what that might mean. Since then those falls in output have
come to an end and many countries start to see positive growth
rates; all countries have seen the end of those sharp falls in
output. Because asset prices are forward looking I would have
expected them to respond to that by sharp upwards movements, and
they did. In addition the whole purpose of our asset purchases
was to try to raise asset prices, so I believe it is not surprising
we have seen an increase in asset prices. Of course if we maintained
our policy and bought assets month in month out indefinitely we
would end up injecting so much money into the economy that we
would generate not only asset price inflation but consumer price
inflation and fail to meet our target. We take the target very
seriously. There are differences of view and judgment on the committee,
but it is there openly to express those differences about the
precise scale of what we need to do, but everyone is committed
to ensuring that the path we follow for asset purchases and bank
rate is one that is consistent with meeting the inflation target.
Q21 Mr Fallon: Dr Posen, when quantitative
easing was first authorised you were told by the treasury that
you should spend up to £50bn on private sector assets. You
have spent only £2bn on such assets and all the rest has
gone on gilts. Should you not all along have been buying a wider
range of assets?
Dr Posen: One hopes the question
is moot because we are coming to the end of a large-scale quantitative
easing exercise. There are clear advantages and disadvantages
in buying gilts or private assets. If we have done enough and
the forecast as we have it in the inflation report, as the governor
described, comes out the way we hope then what we should or should
not have done in the past is irrelevant; we will have moved the
economy enough to have made things happen. There is genuine uncertainty
about the impact of quantitative easing. As my colleague Dr Sentance
said in his written report to you today, the impacts of quantitative
easing are however highly uncertain particularly given that the
operation of the banking system is impaired by the financial crisis.
The MPC's forecast is based on the assumption that quantitative
easing is highly effective and its effects are lasting in the
same way that a cut in bank rate would be. I believe that is the
right guess but we do not have a guarantee. Were we to get into
a situation where quantitative easing turned out to be less effective
or long-lasting in its impact than we think it has been there
would be a case for buying non-gilt private sector assets because
we would be back in the situation where we had a serious problem
related to the financial system that impacted on the credit markets.
My expectation as well as my hope is that this is moot and we
are passed that point, but it behoves the treasury and the bank
to prepare a contingency plan for the kinds private assets one
would buy and how in case such a bad outcome did occur. That contingency
plan would be locked into a drawer and, god willing, we would
never have to look at it.
Q22 Mr Fallon: Governor, in your
opening statement you talked about restoring the level of spending
to a path consistent with eliminating spare capacity. What is
your current view of the amount of spare capacity in the economy?
Mr King: There are various charts
in the inflation report that spell out the view that within the
labour market there is clearly spare capacity. Unemployment is
above the level which we had become used to and which seemed to
me to be sustainable. Surveys of companies also suggest that within
firms there is spare capacity. I will not put a number on it but
clearly there is a large margin of spare capacity and that is
true whether you look at the labour market or companies' own perceptions
of the amount by which they could increase output if demand was
there and they could find the credit supply to finance it. There
is a large margin of spare capacity and that is simply the other
side of the coin of the extraordinary fall in output we saw which
clearly is the largest in the post-war period. As we discuss in
the report, it has accompanied a reduction in potential supply
because of contraction of the financial sector and its ability
to supply credit, so it is not easy to know how much spare capacity
there is. One of the difficult judgments which the committee will
have to make going forward is that even though output may appear
to be well below its previous level how much spare capacity is
there? At present there is clearly a large margin.
Q23 Mr Fallon: Do you want to eliminate
what you cannot wholly measure? How much of the GDP we have lost
since 2007 will we not recover?
Mr King: That is very hard to
judge, but the figures of the IMF and those on which our report
is based suggest that for some considerable periodthe indefinite
futuresomewhere between 5% and 10% of output will be lost
relative to where we might reasonably have expected it to be had
we continued along the growth path we had been on for many years.
Q24 Mr Fallon: Lost for ever?
Mr King: Lost for an indefinite
period. I suspect that eventually we will claw it back and return
to that level, but it will take many years, so for a considerable
period there will be output well below the level that we would
otherwise have attained. That is the magnitude of the cost of
a financial crisis of the kind we have experienced and why it
is worth putting a great deal of effort into designing an appropriate
structure and regulatory framework for the financial sector to
avoid getting into this set of problems again.
Q25 Mr Brady: How do you see the
effects differing between reversing quantitative easing and increasing
Mr King: Do you mean increasing
bank rate versus selling the assets we have purchased?
Q26 Mr Brady: Yes.
Mr King: I do not think there
is an enormous difference. Both of them are designed to subtract
money from the economy and they have similar types of transmission
mechanism, in that the effects spill over to many other asset
markets. That will reduce asset prices and raise yields, making
it more expensive to obtain finance. Therefore, it will tighten
monetary policy. They are very similar. We would want to co-ordinate
with the Debt Management Office so as not to get in the way of
the auctions that it holds. When it comes to asset purchases and
bank rate the committee will simply make its decision, but it
will have to look at both of those and decide where it feels most
confident in making the initial adjustments. That is something
we will do when we get there, but certainly over a period of two
to three years we would engage in both forms of action.
Q27 Mr Brady: You say that the transmission
mechanisms are similar. Would you expect one to have a more immediate
effect than the other?
Mr King: No. To go back to what
Dr Posen said, one of the problems at present in using either
asset purchases or bank rate is that the transmission mechanism
has been impaired because of the way the banking sector is de-leveraging.
That has made our life more difficult in terms of both dampening
the potency of monetary policy but also creating a degree of uncertainty
about it. I do not believe that is specific to asset purchases;
that is true also of changes in bank rate. These are things we
shall have to face as and when we feel the time is right to make
that judgment, but I do not think there is any technical impediment
to our engaging in what many call an exit strategy. We know what
we would do; it is technically straightforward. The difficult
judgment which is far and away the overwhelming problem is to
know precisely when and by how much to do it. The timing of that
decision is very difficult and it is something we will look at
carefully month by month.
Q28 Mr Brady: Given that you do not
see any real difference between the two mechanisms, it would be
reasonable to assume that the two would begin broadly at the same
Mr King: They might or might not.
It may be easier to explain the movement of one instrument rather
than the other. I do not think there is anything terribly significant
about moving one rather than another. I am sure that over a period
of two to three years we will operate both but whether we want
to do both each time we make a change is something to be seen.
Q29 Mr Brady: Dr Posen, I want to
return to the question of the split between the assets that have
been purchased. Would it have made a difference to the exit strategy
had different assets been purchased?
Dr Posen: That is a very fair
question. This is the place where one is lucky if one did not
buy private sector assets. Our counterparts in the Federal Reserve,
for example, have a very large portfolio of private sector assets
to offload. When it has to withdraw and unwind that position it
has a lot of market distortions and risk. As to selling it to
the gilt markets, our colleagues Mr Fisher and Mr Tucker have
the technical task of figuring out with the Debt Management Office
how best to do it, but when you are selling it to the deepest
and most liquid and transparent market in the United Kingdom,
and in the world, you do not have all these extra headaches as
well as balance sheet risk you would have if you had bought lots
of private sector assets. That is not to say that that was a
priori the right choice, but now we are at this point we definitely
reap the advantages of having on the bank's balance sheet only
or primarily gilts.
Q30 Mr Love: Is there any sign that
the rebalancing of the UK economy towards net exports is taking
Mr King: There are some signs.
Indeed, the company visits I make and the people to whom I speak
suggest that those involved in either exporting or competing with
import industries have found that the conditions in which they
operate, although difficult because of the collapse in world demand
and trade, are better than they might have feared. In part the
fall in the sterling exchange rate is helping from that point
of view, but there is a long way to go.
Q31 Mr Love: But has there not been
a surprisingly slow fall in imports considering the large depreciation
of sterling and the recession? Similarly, as far as exports are
concerned we see a global economic recovery. There has been a
significant depreciation but again our export performance does
not appear to have improved to match that.
Mr King: The point that really
troubles me is the speed at which the imbalances in the world
economy are likely to adjust.
Q32 Mr Love: It will be slower?
Mr King: We have a short-run reduction
in the imbalances because of the world depression, but as the
level of output in the world starts to expand again my concern
is that those imbalances will simply re-emerge and as before we
will be on one side of them again. This is a major problem facing
the world economy. We should put at the top of the agenda two
major difficulties: one is the structure of the banking sector
and its regulationthe "too important to fail"
issueand the other is the world imbalances and the need
for a world monetary system that prevents these imbalances emerging.
If we go back to where we were I have no doubt that as those imbalances
become large again the pressure for protectionism will build up
to an almost irresistible level because there will be nowhere
to go; it will be the only policy solution that seems to be left,
which would be a tragedy. The G20 are now committed to a framework
in which they will challenge each other and talk about the frameworks
of their macroeconomic policy. We discussed this at St Andrews
two or three weeks ago. This is a big step forward. People recognise
the problemperhaps it was not fully recognised beforebut
the proof of the pudding will be in the eating. The real test
over the next year or so will be whether the G20 are willing to
confront the question of what mechanisms can be put in place to
prevent the build-up of imbalances on the scale we witnessed because
that was one of the major contributory factors of the problems
we have experienced.
Q33 Mr Love: That is a very interesting
question which I am sure someone else will pursue, but I want
to stick to demand in the UK economy. I want to press you about
the outlook for business investment considering the uncertainties
you have talked about in relation to access to finance and demand
in the economy. Will we see a recovery in business investment,
and what will be the long-term impact if we do not?
Mr King: I am sure we will see
a recovery at some point.
Q34 Mr Love: But again it will be
Mr King: Business investment is
volatile and has fallen sharply. We have been surprised and concerned
about the pace at which business investment has fallen; it is
sharper than anything we have seen in the post-war period, and
in part it reflects the adverse impact on the supply of credit
of problems in the banking sector. At some point you will see
that reversed and there will be a pick-up in business investment,
but there is a long way to go. If you look at certain components
of investment commercial property prices are 45% below their peak.
That certainly puts the movement in house prices into perspective.
There are small signs. We have seen a couple of small pick-ups
in commercial property prices and maybe this is the turning point,
but you can see why it will be difficult for people to be confident
to invest in projects like that; and it will be just as difficult,
if not very difficult, to persuade banks to lend on that when
they will still be realising large losses over the next couple
of years on past investments in commercial property.
Q35 Mr Love: I move to consumption.
We have seen a shift back towards savings. There is great uncertainty
out there in relation to these issues. We talk about debt consolidation.
What are the prospects for a recovery in consumption over the
coming period? Will that come to our rescue?
Mr King: I do not think we should
keep looking at consumption to rescue us. We did so in the past.
I do not think consumption got to an unsustainable level from
which it must fall back, but savings ratios are likely to be higher
in future as part of the rebalancing of the UK economy. In all
of these factors what we ought to expect is a gradual recovery
in business investment at some point and a switch in demand away
from consumption, both public and private, towards net exports.
That is the sort of rebalancing we will need. I have been talking
about rebalancing for 15 years. I do not know whether I was ahead
of my time or completely out of date. These rebalancings are hard
to predict. It is very difficult to ensure that when one component
of spending contracts another picks up at the right time to replace
it. That is the challenge we face. That is what makes the particular
shape of the recovery very hard to predict. I suspect that at
this point the most important thing is to try to stick to two
or three very clear principles. We are providing a great deal
of stimulus from the monetary side to ensure that inflation does
not fall too far below the target. That gives us a clear anchor
for our policy and we will withdraw that stimulus when we think
it appropriate to do that.
Q36 Mr Love: As you have correctly
indicated, consumption will not be a rescue; business investment
does not look as if it will recover for some time; and rebalancing
towards net exports may take much longer than perhaps we had thought
originally considering depreciation. What does all of that mean
for the stimulus that is currently being put into the economy?
Does it mean we will have to maintain the stimulus longer than
perhaps we had originally expected?
Mr King: If private demand remains
extremely weak we shall have to maintain a substantial degree
of monetary stimulus, but I do not want to anticipate that. The
great virtue of monetary policy is that it can be flexible month
by month and we shall watch the data very carefully, as I am sure
this Committee will, and see what happens.
Q37 Mr Love: What you are really
saying is that we should not adopt ideological positions about
what to do with stimulus measures or the fiscal deficit but look
at how the economy is tracking and take decisions based on the
best estimates of where we are going?
Mr King: The Monetary Policy Committee
has never been ideological. We hope it never withdraws stimulus
too soon or too late. It tries to do it at the right time but
these are difficult judgments and we are bound to make mistakes.
But the great virtue of our inflation target is that we, you and
everyone else know the framework in which we are operating which
is that, if we can, we want a broad balance between demand and
supply in the economy to keep inflation close to our 2% target.
In our last report our judgment was that inflation would rise
in the short run, not because it had been pushed up by asset purchases
or quantitative easing but because of the bounce back in VAT and
the enormous turn-round in petrol price inflation, but once those
effects have come through at the beginning of next year we will
expect the margin of spare capacity to bear down on inflation
again. That was why we felt the most likely outcome for inflation
for much of the next two to three years, once we got through the
short-term impact of petrol and VAT increases, was that it would
be below the target. That is why we have maintained the stimulus.
There will come a point when we feel private sector demand is
recovering sufficiently rapidly that we need to withdraw the stimulus
and at that point we shall withdraw it. We will explain that in
the report to you. We may get it right; we may get it wrong, but
I believe the framework is pretty clear.
Q38 John Thurso: I turn to the question
put by the Chairman about narrow banking. I was much taken with
your speech in Edinburgh. You discussed the differences between
John Kay and Paul Volcker and said that the common element was
the aim to restrict government guarantees to utility banking.
I take you to the other end of the spectrum which is the merchant
investing banking side. You also said that the sheer creative
imagination of the financial sector to think up new ways of taking
risk would in the end force us to confront the "too important
to fail" question. Is it not a fact that in addition to protecting
utility banking we need to liberate the investment merchant banking
side and realign the risk it takes with its ownership so it is
not protected by the utility banks?
Mr King: Absolutely, and that
was very much what I meant by that statement. One of the big mistakes
we could make in the regulatory debate is focus attention on measures
that will stop banks taking too much risk. There is no way we
will be able to guarantee that. If the managers of banks make
mistakes from time to time, as they will, and take on too much
risk which with the benefit of hindsight goes wrong the rules
of the market economy are that the institution is allowed to fail.
People need to know that in advance when they are providing capital
to that bank either as equity or in the form of loans. They will
then have an incentive to monitor the risks that the bank is taking.
If the bank is felt to have an implicit guarantee from elsewhere
there is no incentive for people who supply the money to monitor
the risks and those risks will expand. It may be said that a regulator
can say something is too risky and stop it. With the best will
in the world, if regulators are that clever why not let them run
the banks? By definition, it is a way of saying that they must
be better at running risks than the present incumbents. That cannot
be true in the real world. People make mistakes; risks will be
taken and things will go wrong. The important thing is to allow
the institutions that have taken those risks and the people who
have supplied the money to those institutions to lose; that is
what a market economy means. We do not want that to happen to
retail depositors up to a certain level and that is why we need
to protect those activities and give guarantees because that is
part of the utility aspect of banking we want to protect. I believe
that that needs to be ring-fenced from other kinds of banking.
Q39 John Thurso: Where does that
leave the FSA's intensive supervision?
Mr King: In itself I do not think
it is a direct comment on it, or certainly it is not meant to
be. It is a statement that supervision should try to lay down
rather simple, clear and robust rules which you want banks to
follow to prevent them doing things that are not in the public
interest. We care enormously about the utility element of banking.
Therefore, we want rules to prevent that and ring-fence it from
risks that are being taken elsewhere. In other parts of it it
does not make sense to believe that by having a sufficiently intensive
regime of regulation we will stop banks making mistakes. That
is not true of any industry. The real value of John Kay's contribution
is to ask: why not try to learn from the regulation of other industries?
In other industries we have said we have an absolute care about
the continuity of service. It is important to have continuity
of service in networks, whether it is energy or telecommunications,
just as it is in the payment system, but that does not mean continuity
in terms of the individual provider. The provider may fail and
disappear but the service continues. We have to devise a form
of regulation that is robust with respect to the mistakes we know
people will make. There is no reason why people should not be
allowed to make mistakes. One of the most interesting aspects
is that two years ago many of our colleagues in Europe talked
about the dangers posed by hedge funds. We have heard nothing
about this for 12 months. Why? Because over 2,000 hedge funds
have failed during this crisis. Some did well; many failed. The
great virtue of hedge funds is that they can fail without the
government feeling it has to step in to protect them. If people
want to take risks let them take them but not in a way that will
involve the government feeling it must step in to bail them out.
Q40 John Thurso: To pick up that
point and return to the merchant investment banking end, most
of these started off as partnerships where there was an obvious
link between high risk and high reward. Would it not be helpful
to see a return to that model? Has not incorporation smudged the
Mr King: It is well worth debating.
The application of the principle of limited liability to institutions
that have borrowed a lot of money from elsewhere and then engaged
in risky transactions has undoubtedly made this problem much worse.
If you talk to people who work in the most highly regarded investment
banks given their ability to control risk they will say openly
that one of the reasons they feel they can do that is that over
many years a culture of risk management has grown up because they
are a partnership and they are managing each other's money. That
is a pretty powerful incentive to ensure you do not run excessive
risks. It does not prevent you making mistakes and it is still
important to ensure that if people do so they understand that
market discipline applies to finance just as it does to any manufacturing
Q41 John Thurso: How concerned are
you that the banks are going back to business as usual regarding
leveraging up because of the supply of relatively low-cost money?
There has been a tremendous rebound in the debt derivatives market.
Is that connected to QE?
Mr King: I do not think it is
directly connected to it. Any increase in asset prices across
the board would be likely to have the impact of raising bank profits
where those arose from mark-to-market instruments on the trading
book. That is not a reflection of activities undertaken by investment
banking but in part the consequence of a rise in asset prices.
In one or two instances I have been concerned that banks, particularly
those in receipt of government support, felt it was more attractive
to go down the road of re-establishing an investment banking operation
as opposed to what I thought was their original intention which
was to go back to some good old-fashioned commercial banking.
Q42 John Thurso: Mr Tucker, in a
recent speech you referred to avoiding perverse incentives on
which liquidity insurance was provided. You discussed two pricing
options: an ex ante fee or a premium interest rate. What are the
pros and cons of those?
Mr Tucker: The approach we have
adopted so far is to charge a premium rate at the point at which
the bank draws on the liquidity insurance facility. The advantage
of that is you can make a judgment at the time about whether or
not you will permit an institution to draw on the facility, on
whether it has fundamental problems of solvency and viability,
whereas if it pays a commitment fee upfront through an annual
premium it will be harder to say no at that point. That is quite
an important distinction. The ex post approach we have adopted
is much easier to tailor to the amount it borrows from us, the
type of collateral and the particular circumstances. I think that
is the best approach for now, but I would not want to rule out
switching the approach over the next 10 to 20 years. That was
why I said I thought that was something for our community to debate.
I do not think that it is a great priority just now.
Q43 Chairman: On the question of
narrow banking, you gave a speech at Barclays which the press
interpreted as being different from the view of the governor.
What is your view of this issue, in particular the "too big
to fail" aspect?
Mr Tucker: I said in that speech
and in a number of others that the "too big to fail"
problem is massive. We must solve this problem. The great difficulty
with "too big to fail" is that for a generation no-one
talked about it in case it created more hazard. Guess what? It
was there in the background all the time, so our generation, in
Parliament as well as officials, has the opportunity to put this
right. This is not just a UK issue; it is being debated actively
in the House of Representatives, and it goes absolutely to the
question of whether our society wants a market economy. If we
do, we had better have market discipline in all parts of the economy,
including banking. That is to do with allowing banks, as well
as dealers, to fail in an orderly way. What we must not do in
the period ahead is kid ourselves on either side of the table
that we have reached a nice position where after all banks can
fail in an orderly way. We must not find ourselves in the position
we were in five or 10 years ago when we were blinding ourselves
to an awkward truth. That is where contingent capital comes in.
At root this debate is about ensuring that not only equity holders
can take losses, as they have, though perhaps not as much as they
might have done in some cases. It is to do not only with protecting
retail depositors, but ensuring that unsecured wholesale creditors
take losses. That is where market discipline can come from. There
are two routes to that: we can put these banks and dealers into
some form of liquidation when they are in distress or, essentially,
we can switch their debt holdings into equity holdings at the
point of incipient distress. A lot of people believe that the
latter approach is much the better and will provide for a more
orderly path for our financial system and economy. Contingent
capital is one way to do that. The Lloyds issue is encouraging
in that respect. There is quite a lot of commentary to the effect
that not too much can be drawn from it because people were swapping
one type of debt for contingent capital and they really had no
choice. And there is some truth in that, but it means that in
a month or so from now institutions around the world, not only
in this country, will be holding contingent capital so it will
begin to be a debate not just in the official and academic worlds
but among real world investors. That is a modest but potentially
significant step forward.
Q44 Chairman: The benefit of bringing
you here is we can get your unvarnished views that are not filtered
through the press. I am sorry that we have not so far brought
in Dr Sentance and Mr Fisher. Given this is a big issue, what
are your views?
Dr Sentance: I agree with the
governor and Mr Tucker; it is their main areas of expertise on
financial stability. The Monetary Policy Committee focuses mainly
on the monetary aspect of the bank's role, but there are big issues
in terms of the structure and regulation of the banking system.
These will not be resolved quickly because they raise profound
issues about the way banks operate. I also believe that the globalisation
of the world economy creates pressure on businesses in all sectors
to try to become bigger and more international. Part of the tension
we see in the banking sector is to do with how we manage that
pressure, which was undoubtedly a factor in the build up to this
crisis where banks extended their international reach and became
much more internationally active. The possibility of creating
subsidiaries rather than branches is one way to deal with that.
To my mind, that is a very relevant tension that somehow must
be managed, because we will not take away the pressures of globalisation
on business to become more international and the financial sector
is not exempt from that.
Mr Fisher: I am not sure I can
add very much to what has already been said. In discussions with
banks they are themselves very focused at the moment on all these
issues: the regulatory agenda, the funding markets and the particular
structure. There is a great deal of interest in the Lloyds issue,
for example whether or not that might develop into more widespread
use of contingent capital.
Q45 Chairman: Dr Posen?
Dr Posen: The two key points were
the governor's reference to simple, broad, robust rules and Mr
Tucker's comment about wholesale creditors coming under fire.
My concern is that as good as contingent capital, deposit insurance
and all these things are if we leave too much discretion to the
supervisors and regulators it will go against hammering the wholesale
credits when push comes to shove. Therefore, I tend to argue for
dumber and even more robust, broader and strict rules that may
preclude some activities. Thus, I am spiritually on the side of
the John Kay/Paul Volcker arguments. I am also more of the simple-minded
view that "too big to fail" means we should be taking
another look at the size of institutions in the system. The governor
and others at the table have correctly used the term "too
important to fail". While obviously you can think of institutions
that are systemically important even if small, nonetheless I do
not believe we should lose sight of the fact that there seems
to have been real governance and information problems as well
as political and economic problems from the outside when you have
institutions that are too large.
Chairman: I do not think that at the
moment the banking community is willing to look at the issue of
size. That is a big issue. There is an element of blinding oneself
to an awkward truth. There is a huge debate still to be had and
we are grateful for all the views that have been put forward.
Q46 Sir Peter Viggers: I am reluctant
to leave the issue of banking, but the main thrust today is the
inflation report. I should like to turn to the consumer price
index and inflation. There are a number of differences between
the projections and fan charts in August and those in the latest
edition. One significant difference is that the quantitative easing
limit has been increased. Can you recalibrate for us what you
regard as the main differences between the two fan charts?
Mr King: The set of differences
between the August and November projections in this inflation
report reflects a number or factors that have changed between
the two. First, the yield curve on which the projection is conditioned
is significantly lower in November than in August, so there is
more monetary stimulus implied by that. Second, the volume of
asset purchases is higher, so for those two reasons the projections
are conditioned on a more stimulatory policy than was assumed
in August. Third, the exchange rate is lower than it was in August,
so that is another factor which increases both the outlook for
activity in the short run and also the outlook for inflation in
the first year or so as higher import prices pass through. Fourth,
in our view the world economy is stronger in November than in
August. All those reasons mean that the outlook for inflation
and activity is somewhat stronger than was the case in August.
Q47 Sir Peter Viggers: Turning specifically
to the spike in inflation, which is much lower than in the August
inflation report, you pick out one item as being the end of the
VAT cut. Would you please calibrate for us the reasons for the
change in the spike?
Mr King: In part it is the movement
in petrol prices. It is also the fact that oil and commodity prices
in general have moved in such a way as to change our view about
some of the movements in energy prices that might otherwise have
occurred in the first half of 2010. But each time we do it we
sit down and form the best judgment we can about the very short
run movements of energy and petrol price inflation, plus other
stated government plans for taxes and duties. The view we came
to in November was the judgment you see in the chart.
Q48 Sir Peter Viggers: If GDP growth
were lower than expected in your analysissome commentators
said that it was a little optimistichow would it affect
the inflation projections?
Mr King: I do not think it would
have much impact on the short-run projections, but looking further
ahead it would mean that inflation would be more likely to be
below target and less likely to return to the 2% target at the
end of the forecast horizon. Obviously, that is conditional on
the assumptions for monetary policy on which the charts are based.
If activity turned out to be weaker you would expect us to reflect
that in our own actions.
Q49 Sir Peter Viggers: Some siren
voices, notably from the United States, urge that a measure of
inflation and control would be helpful to the economy generally.
Looking at your central inflation projections, after an inflation
spike you estimate inflation to be below target. Are you content
that the expectation is that you will undershoot the target whereas
a tiny measure of inflation would be quite helpful because of
the effects on lower real interest rates?
Mr King: There are two senses
in which your description of "a tiny measure of inflation
would be quite helpful" can be interpreted. One is in terms
of the impact on the real interest rate; the other is that in
some generalised sense inflation will be helpful to deal with
debt problems, for example. I do not think it is sensible to change
our target; indeed, one of the messages from the inflation report
is that the 2% target is one which, if activity is weaker than
we think, will be difficult for us to achieve from underneath,
not on top. Therefore, we will have difficulty keeping inflation
up to the 2% target in the medium term if activity is weaker than
in our central projection. It would be nice if we had instruments
that enabled us to hit the inflation target exactly month by month
all the way through, but we do not; it takes time for monetary
policy action to take effect. We start with the consequences of
the extraordinarily sharp fall in output which has created a big
margin of spare capacity. Even if we wanted to I do not think
it would be possible to eliminate that margin of spare capacity
quickly. There are reasons for not trying to do it too quickly.
For those reasons we have a very stimulatory monetary policy and
it is quite hard to see how it can be more so, yet we will face
this prospect of inflation. But if we feel that the outlook for
inflation is even more on the downside than we anticipate we will
return to the question and ask ourselves whether we should carry
out more asset purchases. Equally, if the outlook for inflation
appears to be moving up we will return to the question of at what
point we should start to withdraw the stimulus.
Q50 Jim Cousins: This morning the
Committee found some very interesting information on the table
in front of it. Perhaps I may ask Mr Tucker to help me understand
it. The Committee has been told that the liquidity support for
RBS and HBOS peaked at just over £60bn on 17 October and
the bank required collateral of £100bn plus to cover it,
which is a pretty substantial imposition. RBS and HBOS paid a
considerable premium for that support. In turn the treasury charged
the bank 1.7% over two months for an indemnity to cover the costs
of the liquidity support. If I have understood that correctly,
is that really countercyclical support?
Mr Tucker: If we had not done
it the cycle would have been a lot worse than otherwise, so looking
at the big picture the answer is most certainly yes, whether one
likes the expression "lender of last resort" or "emergency
Q51 Jim Cousins: If RBS and HBOS
had been able to get an American Express credit card they would
have been better off, would they not?
Mr Tucker: But American Express
may not have been.
Q52 Jim Cousins: This is tough stuff.
Mr Tucker: It was tough stuff;
it was an absolutely classic lender of last resort operation where
the only point of doing it was whether it bridged to something.
This applies to every single lender of last resort operation that
has ever been carried out. Either you bridge through some panic
that will pass and the organisation can resume its life or you
bridge to some private sector purchase of it, which was not remotely
available to RBS in these circumstances, or some state equity
support which was where we ended up. Can lender of last resort
buy time? Yes, it can. It was very effective in buying time. It
would have been a great mistake not to buy time. Can lender of
last resort make all the problems of the world go away? No, it
cannot. What should the price be?
Q53 Jim Cousins: Do you agree that
this is a heavy price?
Mr Tucker: Perhaps I may come
to the price in a moment. First, the collateral is there to protect
the bank and the state from risk. The price is therethis
goes back to the earlier conversation about "too big to fail"
and incentivesso everybody knows that if a bank gets itself
into such a mess that it cannot rely on publicly-available liquidity
insurance facilities provided by Paul Fisher's Markets area, then
when it is in deep distress there is a high cost to that. It is
not a new thing which has been invented by the Governor and me
or by the Governor's predecessor and the Bank team; these are
principles that have applied in central banking for more than
a century. It would be a great mistake not to apply them. It would
also be a mistake to think that lender of last resort in those
particular cases or in others was waving away all of the problems.
It has to bridge to some more fundamental solution. I am afraid
that in these particular cases the fundamental solution was state
Q54 Jim Cousins: The Bank asked for
£100bn worth of assets to cover £60bn of liquidity.
That implies a very large risk of impairment. Over the next few
years the banking system in Britain faces an enormous risk of
impairment and needs to refinance a very large scale of commercial
property debt and an even bigger sum of money to refinance private
equity. Does that not suggest we will need genuine countercyclical
support from the bank and the government, not the kinds of impositions
made last October?
Mr Tucker: You have to make a
distinction when considering how to handle an emergency. You ask
about the scale of the collateral that we took. Within months
the government had massive equity stakes. Effectively, that is
saying that these institutions were bust which means that the
assets on their balance sheet were significantly impaired. We
had to take a big margin of surplus collateral; otherwise, we
would be sitting in front of you being asked why we had lent recklessly
or on terms that could endanger the state's fiscal position. Those
are not judgments for us but for the fiscal authority, the government,
and those are represented in the equity stakes that the government
took during that month. We are in complete agreement with you
on the broader issue of whether or not the authorities can develop
and apply instruments that would be countercyclical in the way
you describe and that is what the discussion paper on macroprudential
instruments released on Friday and Saturday is about. But one
must distinguish the use of countercyclical instruments in that
sense from handling a dire emergency, which this was.
Q55 Jim Cousins: In the inflation
report there is a reference to the scale of the maturing funding
problem faced by the British banking system. If we cannot succeed
in dealing with the impairments in the existing loan book or the
requirement to refinance the enormous scale of maturing funding
will not the consequence for employment in this country be very
Mr Tucker: But if the banks set
out now to think through a credible plan for their funding over
the next two to three years, there is no reason why they cannot
do it. What they cannot do is simply take no action and then throw
up their hands two or three years down the road and say that the
taxpayer must come in to support them. It is very important that
they are made to put together a coherent funding plan that may
well mean raising funding at longer maturities and reducing profits
to the banks' shareholders below where they might otherwise have
been in order to make sure they have access to funding.
Q56 Jim Cousins: Are you not in some
danger of adopting a scorched earth policy when you want to keep
the market economy going, so you say?
Mr Tucker: No, not at all.
Mr King: I am astonished to hear
you defend the banks. It appears that you want the taxpayer to
Q57 Jim Cousins: Someone has to do
Mr King: Do you think that the
taxpayer should just hand over money at no cost to support the
banks? I am astonished that you of all people would suggest that.
Q58 Jim Cousins: This exercise of
moral hazard that you and Ben Bernanke have been conducting has
already put a lot of parts of the British economy at risk. I indicate
to you that the problem of maturing funding and the level of impairment
implied by requiring £100bn of assets to cover £60bn
of liquidity suggests that we will have to nurse the banking system
very much through the next few years.
Mr King: I am afraid you have
completely confused two separate things, as Mr Tucker pointed
out. The facilities extended to the Royal Bank of Scotland and
Lloyds were repaid, one in December 2008 and the other in January
2009, and the collateral was returned to them. There is no question
of our hanging on to this collateral at all; it has been returned
and the loans repaid. I fail to understand why you think this
is remotely relevant to the funding challenge of the banking sector
over the next three years.
Q59 Jim Cousins: It is the scale
of cover for the impairments that you required and its implications
for the future.
Mr King: But that is now over
and done with. Why on earth do you think that for something which
was put in place for a couple of months when we had to take raw
mortgages and no means of investigating their merits given the
speed with which the operation had to be mounted we should put
taxpayer's money at risk? The operation was successful: we made
the loans, they were repaid and the collateral was returned to
the two banks. That was over and done with almost a year ago.
That has no relevance to the funding challenge over the next two
to three years.
Q60 Nick Ainger: At the press conference
when you launched this inflation report you were asked a question
about rising asset prices and said that it would be peculiar to
worry about asset prices now. In response to Mr Fallon you also
said it was not surprising asset prices had risen, but you have
also told us that output fell off a cliff and it will be a long
time before we get back to the levels of output we saw before
the financial crash. Is it not peculiar that we see such high
rises in asset prices? Should we not be worried now with the price
of oil at $80 a barrel and the doubling of gas prices in future?
Mr King: You should look at each
individual asset price and ask the question separately. I do not
believe there is a common answer to all asset prices. We have
seen quite a remarkable turn round in the growth in the emerging
market economies of the world which in part has played into the
level of commodity prices including oil. I think the resilience
in those parts of the world is partly responsible for the strength
in the oil price. The same factors do not play into understanding
what has happened to financial asset prices where I believe that
part of the reason for the dramatic fall in price was the concern
that we might be about to revisit the great depression. It now
looks as if we will not and that itself may explain why there
has been a rebound of asset prices. I do not think it is ever
easy to say that you would have expected prices to rise by 37%
or some precise number; you cannot because these are very difficult
judgments, but most asset prices are still well below the levels
they were at when the crisis began. It is not the case that they
have rebounded to levels one might have thought were unsustainable
at that point. There is however one immense issue here which is
very hard to judge, namely that world long-term real interest
rates are still very low. That was so in the build up to the crisis
and that was partly why asset prices were rising. They remain
very low in large part because people believe that the large amount
of savings coming out of Asia will carry on. If that is to be
a permanent feature of the world economy we will have to get used
to low levels of long-term real interest rates and higher levels
of asset prices, but if it turns out to be the case, which obviously
financial markets at present do not anticipate, that real world
interest rates rise as the Asian economies save less and we save
more and there is a better balance in the world economy maybe
we will see an adjustment of all asset prices across the world
at some point in the future as real interest rates pick up. But
that is not a factor to do with financial policy or central bank
liquidity provision; it is to do with the functioning of the world
real economy. It is conceivable that people may have made a misjudgement
there, but it is not at all easy to be sure or to know what to
do about it if they have.
Q61 Nick Ainger: Earlier this year
the Prime Minister and President Sarkozy jointly authored an article
in the Wall Street Journal on their concerns about prices
on the oil exchanges in particular. That indicated to me that
they were extremely concerned about this issue. Are you aware
of any further development to try to address this issue? One commentator
has said that a new western carry trade has developed whereby
because of extremely low interest rates people borrow and put
money into assets which then forces up the price of those assets,
although the fundamentals that should dictate the price of those
assets indicate they should be far lower than the current price.
Mr King: I would distinguish between
a so-called world carry trade on the one hand and the concerns
that the Prime Minister and President Sarkozy expressed about
the oil market on the other. Perhaps we can take them in turn.
As to the oil market it would certainly be valuable if the G20
now, not G7, were to discuss the possibility of creating a deeper
futures market for oil. We had a G7 discussion about this some
years ago and the outcome of it was a genuine recognition that
it was difficult to know what to do about it but the fact that
potential producers could not sell forward their oil made it harder
for new entrants into the market, for example Canadian tar sands,
to be entirely confident that if they were to invest heavily in
the production of new sources of oil the price would still be
high 10 years down the road when their production came onto the
market. A deeper and more extensive futures market might help
in that respect. There are some good reasons why it is difficult
to create that kind of futures market and it may be that government
has a role to play. It would be valuable for the G20 to talk that
through. All countries in the G20 recognise that this problem
affects everyone. This is not a zero sum game; there are real
benefits in reducing some of the volatility in the oil market.
In terms of a world carry trade the argument for thinking that
there could be a carry trade must rely on the fact that some countries
do not allow exchange rates to move in a way they would otherwise
do. The idea that countries have different levels of interest
rates is a very natural one and that is why we have different
national central banks. You set monetary policy to suit your own
conditions which naturally means that interest rates will sometimes
be high in one country and low in another. That does not generate
a carry trade in the normal sense of the word because exchange
rates are flexible and if there are unexpected movements in relative
interest rates, the exchange rate will respond to it, thus eliminating
an arbitrage profit. But where governments prevent exchange rates
from moving it is possible for a period for a carry trade to appear
to be profitable while people are basically speculating against
future decisions by governments about moving exchange rate pegs
or changing exchange rate regimes. That is the problem which lies
behind the generalised question of world imbalances if we do not
have macroeconomic frameworks in the G20 that are compatible with
each other. It is not a question of the individual policies being
pursued now, but if the framework for macroeconomic policies within
the G20 means it is possible for a carry trade to develop within
it, with borrowing in the currency of one country and lending
in the currency of another, there is an inconsistency in those
domestic policy frameworks which will eventually create difficulty
at international level. The G20 has now committed itselfit
was explicit at St Andrewsto invite the IMF to work with
it to examine the domestic monetary and macroeconomic policy frameworks
of each G20 member country to see whether when the IMF puts the
results on the table there are any apparent inconsistencies and
to talk to each other about steps that need to be taken to remove
them. One would have to be an optimist to think this process will
necessarily work but the G20 has committed to it and thinks it
is important to recognise that if this process leads to failure
it will be a big blow to the G20 as a group. The G20 has now put
its reputation on the line to make progress on this front. That
is beneficial because it means there is something to lose if these
talks go nowhere.
Q62 Nick Ainger: If there is no immediate
solution to this apparent asset price bubble, or certainly a substantial
increase in asset prices, oil being among them, is there not a
serious risk that the recovery will be delayed, damped down and
so on with unrealistically high energy levels?
Mr King: I do not think it is
an immediate threat to recovery. If you go back to energy prices
I do not think the current level prevents a recovery. What we
do not know is what will happen to oil prices if, say, there is
a fairly rapid recovery. It may be that oil prices start to rise
again to past levels of well over $100 a barrel. In itself that
would undoubtedly have a dampening effect on recovery. We shall
see this as matters evolve. To my mind the bigger problem rather
than that is that recovery takes place but the imbalances in the
world economy start to re-emerge and the fundamental issues about
incompatibility and policy frameworks among the major economies
of the world are seen not to have been resolved at that point.
Unless they are resolved the tensions and underlying causes of
the financial crisis will take place all over again. The crisis
will be different next time; I cannot work out in what way, but
we shall return to tensions and sharp breaks in financial prices.
Q63 Ms Keeble: I want to ask about
the growth forecast again. Your projection of 4% in 2011 has been
described by some commentators as optimistic. Have you included
factors in particular QE which have not been so strongly factored
into the other models?
Mr King: We believe our asset
purchases will have an impact and will stimulate the economy.
To the extent that other people have not taken any of that into
account that is one reason to explain the differences. You quoted
4% for 2011. That is a rough figure for the most likely outcome
but it is not the expected growth rate. We have significant downside
risk resulting from the state of the banking sector and a drag
on the supply of credit, which means that 3% is a better guess
for what we expect to be the growth rate in 2011 over 2010 and
only 1.5% in 2010 over 2009. They are closer to the consensus
forecast although they are still a little on the high side, but
given the scale of the existing spare capacity I do not regard
this as excessively optimistic. There is scope for recovery. The
world economy is beginning to recover. We see signs of recovery
in our own economy and from business surveys. I think it is not
unreasonable. Who knows what the precise number will be? There
does not seem to me to be much value in putting weight on any
given number rather than the general picture we have described.
I stress that even if we see growth rates of that order of magnitude
we will be left with levels of activity and employment well below
the levels we would otherwise have expected to see.
Q64 Ms Keeble: I appreciate that
the fine-tuning will depend considerably on circumstances. However,
if you downgrade your growth assumptions from 4% to 3% that brings
them in lower than the treasury forecast which then has a significant
impact on projections for the structural deficit and fiscal squeeze.
Can you comment on that? The treasury assumptions for 2011 are
3% to 3.5% which have also been regarded as quite optimistic.
Mr King: It is a big mistake to
place all one's weight on one number. The whole point about our
forecast and the fan chart is that we say we believe the single
most likely modal outcome is higher in the range, but taking into
account the downside risks the average growth rate embodied in
our fan chart in 2011 is closer to 3%. Who knows what the number
will be? It is very unlikely to be any of those numbers. The key
point is to have an appreciation of the balance of risks, what
the general picture of recovery or failure of recovery looks like
and why that is the case. We have to recognise that if things
turn out to be different from our central view, as it almost certainly
will be, we shall adapt the policy accordingly. The only point
I make about fiscal policy is that whatever precise measures are
implemented will need to take into account the state of the economy
at the time. We just do not know that in advance.
Q65 Ms Keeble: I appreciate all of
that. However, the knock-on effect of all of this in terms of
the public perception, public services and so on is profound and
some percentage differences can have a big impact. You said that
you would expect the deficit to be dealt with over the lifetime
of a parliament. Therefore, it is quite helpful to know what shape
it will be. You expect growth to be between 2% and 3% or so and
the deficit to be dealt with on the basis of those kinds of growth
Mr King: There must be a plan
saying what will happen to the deficit over the lifetime of a
parliament for which any government elected at the next election
will be in power, so that is five years from next spring/summer.
I think it is sensible to have a plan over that period which says
what actions we will take in the eventuality that the economy
performs in a certain way, that if it grows faster other actions
will be taken and if it grows less rapidly there are things that
at that point will not be put into effect because the economy
will be unable to sustain them. My point is that to have a plan
which says we will genuinely try to get rid of the deficit if
the economy really does recover makes some sense, but it must
be contingent on the state of the economy and a credible plan
that spells out what will actually be done.
Q66 Ms Keeble: That sounds far too
calm and measured perhaps for the debate we are having at present.
Mr King: I am sure you could lead
a calm and measured debate now.
Q67 Ms Keeble: Dealing with the 5%
to 10% loss of output referred to by the IMF, about which Mr Fallon
asked you, there have been some sharp comments about what happens
to unemployment. Increases in employment rates are likely to lag
behind growth and therefore unemployment can remain higher than
we have been used to. You said that 8% was higher than we had
been used to. How real a threat do you think that is?
Mr King: It is very hard to judge.
Given the scale of the fall in output it is quite striking that
unemployment has not risen more than it has. Given past relationships
between changes in output and unemployment one might have expected
unemployment to have risen by more than it has.
Q68 Ms Keeble: You have referred
to part-time employment, people taking pay cuts and such like.
Mr King: Indeed. The puzzle in
all this is that you can point to pay as being extraordinarily
flexible at present, much more so than perhaps we saw in recessions
in the past. That is one explanation of why unemployment may not
have risen as much as it might have done in the past. However,
in the United States which we think of as being very flexible
in terms of pay and the labour market unemployment has risen by
much more than expected. I do not believe we have an explanation
for that. There are real puzzles in the behaviour of the labour
market in looking across Europe, the United Kingdom and the United
States. That is what makes it particularly difficult at this juncture
to know whether the fact that so far unemployment has not risen
by as much as it might have done is either encouraging in the
sense that greater flexibility means unemployment will not rise
to the levels we might have feared or there are further rises
in unemployment to come next year as companies catch up with the
need to reduce their costs. I honestly do not know which of those
two paths we will follow, in part because we do not have a story
to explain differences in labour markets across the US, UK and
Europe, but it is something we should watch very closely over
the next few months.
Q69 Ms Keeble: You have probably
seen the discussion on the Committee's inquiry into women in the
City. What is your view of any risks to the banks generally, given
comments by Professor Goodhart for example, because of lack of
diversity? How do you believe it is best tackled?
Mr King: I do not think it is
for me to comment on what the banks should be doing. I can say
what we are doing. From our point of view, obviously we do not
pay well relative to the private sector. We need therefore to
attract the very best people we can get and in order to attract
not only the best women but also the best men we need to create
an environment in which there are men and women in reasonable
proportions. It is a joint career; this is not a male environment.
We have gone to great lengths to see how far it is possible to
make our careers more attractive to women as they move through
career paths. In studying it we have found that the best way to
do it is to put enormous weight on programmes of flexible working
not just for women but every member of staff. The bank adopts
the principle that no woman should be promoted to a job because
she is a woman. We take no account of that; it is purely based
on merit, but we need to ensure that everyone in the bank has
the opportunity to find a pattern of working that best suits them.
We have put a lot of weight and effort into devising and building
up patterns of flexible working. I hope it will work. We will
see. Recently seven appointments were made at head of division
level. Four of those appointees were women. They are still under-represented
at senior level, less so at junior level. I do not think that
time will solve that problem on its own. In the past the belief
that time will deal with the problem did not work. There is a
lot of self-selection going on in choice of career. We have to
create careers that all kinds of people in the bank want to pursue
and flexibility has been the mechanism chosen to do that. Whether
that is for other people to follow I leave to them.
Q70 Ms Keeble: The view of the Equality
and Human Rights Commission is that the FSA as regulator has a
role in monitoring, championing, leading or however one wants
to describe it. Do you agree with that? If the bank was to be
the regulator should the bank play a more active role rather than
dealing with just its own internal measures?
Mr King: My belief is that this
is a matter of good management. A good management team will want
to ensure that it has a work environment that is attractive to
women. It is in their commercial interest to recruit and retain
better women and men. Therefore, one needs to think deeply about
the way to do it. I just do not believe a regulator can say it
will raise a bank's capital requirement unless more women are
Q71 Ms Keeble: That was why I said
"leading" rather than "regulating".
Mr King: Certainly we would be
supportive of the direction in which you would like to go, but
I am not sure regulation is the means to achieve it.
Q72 Chairman: Mr Fisher, from your
contacts how has the loss of several competitors changed the way
markets are operating?
Mr Fisher: I am not sure they
see it quite that way. At the moment each of them has its own
very distinct pressures which it is trying to deal with. If anything,
they see a great deal of competitive pressure at the moment. One
of the big debates going on out there is about competition coming
from those firms that have government support. I do not speak
specifically about the UK but across the international spectrum.
I do not believe they see a reduction in competition. What these
sorts of circumstances do is open up competition to a range of
new entrants, so there are quite a lot of people out there who
are busy building up their business models and trying to get into
Q73 Chairman: Do you agree with Dr
Posen that half a dozen big banks is not helping competition and
at the end of the day we need to restructure so we increase competition
with an alternative channel?
Mr Fisher: That relates specifically
to UK retail banking. I agree that we need a wider group of banks.
Some of the smaller banks may need to come together to provide
competition for the larger banks. One of the big problems we have
particularly with small business lending is the very high degree
of concentration with Lloyds and RBS in particular. That needs
to be looked at.
Q74 Chairman: Dr Sentance, given
your business experience do you agree with Dr Posen that we need
to reform the financial systems so that business is less reliant
on the banking system? If so, what reforms would you like to see?
Is there a case for government intervention to stimulate new sources
of business funds?
Dr Sentance: This is a long-standing
question. You can trace the issues around access to finance by
small and medium size firms back to the Macmillan Committee in
1931. When I was in the CBI in the 1980s and early 1990s this
kept coming back. I believe that it returns at times of recession.
It has been very heavily spotlighted by the difficulties in the
banking system. It appears that larger companies are able to find
their way round the banking system by accessing the corporate
bond markets. Dr Posen gave quite a long menu of options. If we
could find mechanisms to extend that access to corporate bond
markets to smaller companiesthere are various ideas about
how that might be donecertainly it is a direction I would
favour. I agree with Dr Posen that it is not necessarily just
one approach. At the moment when we talk to companies given their
caution about the state of demand and the impact of the recession
many of them do not want to borrow; they rein back on their investments.
Q75 Chairman: They tell us that the
big issue is the cost of credit.
Dr Sentance: In some cases that
is not helped by the cost of credit. In the fall in lending at
the moment we see a combination of supply and demand factors.
There are constraints on the supply side but also uncertainty
about demand and clearly the unwillingness to make big investments
at the moment contributes to that. I am not sure that in the next
year or two we will find a magic bullet to solve the issue facing
small and medium size companies which has been around for quite
a long time, but I would encourage the Committee to continue its
inquiries in this area and come up with positive suggestions.
Q76 Chairman: Governor, about a year
ago you said that lending was the big issue in the British economy.
We are still at it.
Mr King: We are still at it.
Q77 Chairman: You talked about a
move by banks to operate as subsidiaries when they are away from
their home countries. How does that fit in with the European single
Mr King: There are two aspects:
the intra-European one and international one. The point I made
earlier was that a number of significant emerging market economies
had made the judgment that it would be sensible for them to require
subsidiarisation of overseas banks in their territories because
they felt it would be safer for them to apply to those banks separate
capital and liquidity requirements rather than be left exposed
to the operations of a branch which they could not regulate. One
has enormous sympathy for that. We saw that in part with Lehmans
in this country. That is likely to be a development which will
gain greater traction. The difficulty in the European context
is that, as Lord Turner has said, you tend to be drawn towards
either more centralised European regulation in order to be able
to regulate banks as if they belonged to a single entity or recognition
of the fact that national supervisors need the ability to impose
capital and liquidity requirements on institutions that operate
in their territory because they are responsible for what happens
in that territory. That is something we will have to confront.
Mr Tucker: On the narrow question
of Europe, it is not possible; there are passporting rights for
authorised banks. The broader debate internationally is about
developing recovery and resolution plans. There is an exercise
involving about 25 of the world's largest banks and dealers which
will be undertaken over the next six to nine months. That will
throw up lots of issues, but we and everybody else will truly
learn from it. One of the most important things is not to have
too many a priori thoughts now about whether subsidiarisation
would be much better than branch banking or cross-border lending.
As it happens I am inclined to that view, too, but we ought to
hold that in suspense until we have gone through the 25 exercises
and seen what issues they throw up.
Q78 Chairman: Governor, when you
appeared before us in June you expressed concern that the European
Systemic Risk Board could turn out to be "a mere talking
shop". We have looked at the issue in the report on macroprudential
and microprudential regulation. From your point of view has the
commission's publication of more detailed proposals allayed your
Mr King: I said in June that it
could be a mere talking shop on the one hand or a useful talking
shop on the other. We were not in a position to know, and still
are not; it has not been set up yet and we are many months away
Q79 Chairman: We are talking about
a body of 61 members. If it is to deal with emergencies do you
believe that to be a big number?
Mr King: It will not be able to
deal with emergencies, and I do not think it is seen in that context.
I would think of it as a good forum in which to raise the "too
important to fail" question and to start a proper debate
on that question right across Europe. That would be a rather good
forum in which to do it. Therefore, it might be useful for dealing
with the longer-term questions, but in all these things the proof
of the pudding will be in the eating.
Q80 Chairman: Maybe you can give
us a list of the useful talking shops that you attend round the
Mr King: That will be a very short
Q81 Chairman: Are you concerned that
given ESRB's focus on market conditions across Europe it could
end up making recommendations or advocating policies that are
inappropriate given specific circumstances in individual Member
Mr King: It is possible. It will
be able to issue recommendations only on a "comply or explain"
basis, so it will not have any authority to impose those recommendations
on individual countries. If a country felt that the recommendations
were inappropriate to its circumstances not only would it be perfectly
entitled to but it would find it rather straightforward to explain
why they were not appropriate in the case of country x
and therefore they had no intention of adopting them.
Q82 Chairman: This Committee awaits
a reply from the Treasury on the potential reforms to the international
monetary system. Is this a time to be bold? Do we need a Bretton
Woods mark II?
Mr King: We certainly need something
because of the fear that the imbalances will re-emerge and my
two big concerns about how we got into this and why we might end
up with another crisis in future. We need radical reform of the
international monetary system. In large part this goes to politics
at least as much as to economics, so this is probably more in
your domain than in mine. I shall continue to argue for reform
of the international monetary system, as I have for many years
in speeches. It is very important. If we ignore it and fail to
tackle it I fear that some of the concerns we thought we were
about to experience at the beginning of this year but fortunately
did not will come back to haunt us.
Chairman: On that sober note, I thank
you and your colleagues. This session has been very helpful and