Examination of Witnesses (Questions 1-61)
MR MERVYN
KING, MR
CHARLES BEAN,
MR SPENCER
DALE, MS
KATE BARKER
AND PROFESSOR
DAVID MILES
23 FEBRUARY 2010
Q1 Chairman: Governor, welcome to you
and your colleagues on this examination of the February Inflation
Report. Can you introduce your colleagues for the shorthand writer,
and I believe you have a short statement afterwards.
Mr King: I do indeed,
Chairman. Good morning to you all. On my right is Spencer Dale,
the Bank's Executive Director for Monetary Policy and Chief Economist.
On his right is Kate Barker, one of our external members and,
sadly, making her last appearance before this Committee; on my
left is Charlie Bean, the Deputy Governor for Monetary Policy,
and on his left is Professor David Miles, another of our external
members. If I may, Chairman, since members of the Monetary Policy
Committee last came before this Committee there have been some
signs of a recovery in demand around the world and also at home.
But this nascent recovery is fragile. The tensions that underlay
the build-up of large world imbalances have not been resolved
and, at home, bank lending to the non-financial sector continues
to fall. So the risks to the Committee's central view of a gradual
recovery of output remain to the downside. Some countries, especially
those whose banking systems were relatively unscathed by the crisis,
have seen strong growth in recent quarters, but recovery in our
largest export market, the euro area, appears to have stalled
and, as I highlighted in my speech in Exeter, to maintain levels
of economic activity around the world, high savings countries
must expand their domestic demand while low savings countries
are reducing their net borrowing from abroad. At present, there
is little evidence that this is taking place. Some countries are
reducing significantly their borrowing from abroad, but without
a compensating pick-up in external demand for their goods and
services, these countries will continue to experience weak recoveries.
The euro area is a microcosm of that broader problem. In contrast,
conditions in financial markets have continued to improve with
the prices of many risky assets rising and risk premia declining
somewhat. Short-term funding markets are almost back to normal
with interbank lending spreads remarkably close to their pre-crisis
levels. That has fed through to some recovery in property markets
where prices have risen by around 10% since their troughs last
spring. Nevertheless, markets in a range of securitised instruments
have not re-opened and are unlikely to do so without fundamental
reforms to their design and transparency, and there is a considerable
challenge for the banking system to refinance the funding it has
obtained with support from the public sector. As the financial
sector repairs its balance sheet other sectors of the economy,
especially the public sector, also need to strengthen their finances.
As a result, there is likely to be a considerable drag on spending.
To offset the effects of these headwinds the Monetary Policy Committee
decided at its February meeting to maintain the unprecedented
level of monetary stimulus by holding Bank Rate at 0.5% and maintaining
the stock of assets purchased over the past year at £200
billion. The effects of the money financed asset purchases will
persist and, together with the low level of Bank Rate, will continue
to provide a substantial boost to money spending for some time
to come. In addition, output in the economy is still benefiting
from the effects of the depreciation in sterling that occurred
in 2007 and 2008. Judging how these various factors will play
out is an extremely difficult challenge. In part that is because
the effects of the stock cycle, the restoration of the standard
rate of VAT to 17.5%, and even the cold weather in January, mean
that data are likely to be volatile over the next few months.
Last week I wrote an open letter to the Chancellor to explain
why inflation had risen to 3.5% in January, more than one percentage
point away from the target. This is the third episode in which
I have written such open letters. As in the previous episodes,
the Committee believes that the current high level of inflation
reflects temporary factors such as the increase in VAT, higher
oil prices, and the effects of the exchange rate depreciation
continuing to feed through. We are conscious that just four months
earlier inflation was only 1.1%, and the Committee believes that
although it is likely to remain high for a few months more, inflation
is more likely than not to fall below the 2% target over the forecast
period, as the influence of spare capacity bears down on inflation.
Chairman, our economy has embarked on a process of healing; that
will take time. The crisis has left us facing many serious challenges.
Among them are how to reform the international financial system,
how to reduce our largest peacetime fiscal deficit, and how to
restructure our banking and financial system to prevent another
more serious crisis in future. The crisis did not originate in
the non-financial sectors of the economy, but that is where most
of the costs are falling. You do not need me to tell you that
its impact is not just economic but also social and political
in nature. Throughout the crisis your Committee has led the way
in putting forward proposals to leave the UK economy better placed
in future to meet those challenges. I thank you for that, and
I look forward to working with the Committee again in a new Parliament,
and, with that, I and the other members of the Monetary Policy
Committee here today stand ready to answer your questions.
Q2 Chairman: Thank you very much,
Governor. In November 2009 you told us that the key risk to the
UK's Triple A credit rating would arise "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". Given the need for
a bail-out of the Greek economy and serious concerns around the
fiscal position in other European economies, such as Spain, Portugal
and Italy, are you now more concerned than was the case in November
last year about the possibility of the UK's credit rating being
downgraded?
Mr King: No, I do not think anything
has changed and I think we are very different from Greece. It
is very clear that we have a political consensus on the need for
fiscal consolidation; we have a very good track record in the
past of meeting our obligations; we have our own currency which
gives us greater freedom of manoeuvre, and we also have a public
debt which has a much longer maturity so that we are not faced
with the same rollover re-financing problems which afflict many
other economies. In fact, in the UK we should be grateful that
we have a maturity of our public debt which is almost twice that
of any other country.
Q3 Chairman: Examining the statistics
on the UK's budget deficit and debt levels compared to other EU
Member States, it appears that debt levels are comparable to those
of countries like Germany, France and Austria. Do you think analysts
and the rating agencies are exaggerating the problems that the
UK faces and "unfairly" focusing on the UK?
Mr King: We do have a very large
fiscal deficit and we have yet to tackle that, and I think the
rating agencies are bound to remain somewhat uncertain until we
see measures clearly announced and defined that will deal with
that fiscal deficit over the lifetime of the next Parliament,
but I do not believe the rating agencies are concerned in the
sense they are not re-rating the UK and I would be immensely surprised
if they were to do so. I think they expect, as we all do, that
either in the next Budget or after the General Election measures
will be announced that will make clear precisely how this deficit
will be tackled.
Q4 Chairman: Good. How exposed is
the UK banking sector to government debt of the so-called PIIGS,
Portugal, Italy, Ireland, Greece and Spain?
Mr King: I think we are very different
from many of those countries and, as I say, what really matters
is a combination of a political consensus to deal with our problems
both in terms of the fiscal deficit and in terms of dealing with
the banking sector, and the fact that we have a track record of
doing that. Clearly, as I said, two of the main domestic challenges
facing us in the future are to deal with the fiscal deficit and
to find a way of restoring the finances of our banking sector.
These are not simple or easy challenges, they have arisen out
of a great world financial crisis, so I do not downplay the significance
of the problems or challenges but I do think there is a broad
consensus in the UK both to understand that we need to deal with
these problems and, I think, a determination to do so.
Q5 Mr Fallon: Governor, you have
just said you want to see measures in the Budget clearly announced
and defined to deal with the deficit and presumably you want the
next Government to start straight away?
Mr King: What matters is that
I am sure that rating agencies and the markets will be looking,
whether it is just before or just after the General Election,
for a more detailed explanation of exactly how the structural
fiscal deficit will be brought down over the lifetime of the next
Parliament.
Q6 Mr Fallon: But you do not want
it postponed?
Mr King: Well, you certainly cannot
eliminate the deficit in one year. There has to be a programme
announced that will start and then continue right through the
lifetime of the next Parliament.
Q7 Mr Fallon: So you have to get
started at the beginning of the Parliament?
Mr King: We need to get started
but I honestly think that much of this debate is being overblown
because even if you announce very clearly a programme either just
before or just after the General Election, to the extent that
a significant part of the fiscal consolidation will come from
measures or adjustments to public spending, it is very difficult
to make those changes start immediately. Anything, for example,
that is done on public sector payroll has to wait until the next
pay round, so it is inevitable that it will take time before these
measures come through. Starting with a very clear and detailed
plan, however, seems to me very important.
Q8 Mr Fallon: Getting started is
the key. Fine. David Miles, if the inflation projections are even
lower than they were in November, and now lower for the whole
of the three-year forecast period, why did you not favour further
asset purchases?
Professor Miles: For me it was
a pretty finely balanced decision. The inflation profile is that,
more likely than not, inflation stays above the target for most
of this year and, in fact, slightly more so than I had thought
a few months ago. It then drops beneath it for most of 2011 and
gradually then comes back towards the 2% level during 2012. By
the end of the forecast horizon the probabilities of being above
or below the 2% level are pretty finely balanced. You could make
a case that with the central projection, the most likely outcome
for inflation, being beneath the target level for much of 2011/2012,
that might suggest that policy should be slightly easier and that
you should continue with the asset purchase facility and buy some
more assets. I felt that keeping the stock of purchases in place,
which is really maintaining an extraordinarily expansionary monetary
policy, was, on balance, the right thing to do this month. It
is a decision that is finely balanced; it is one we will come
back to in future meetings. The next meeting is next week. If
we had had to make a decision to keep the stock in place for many,
many months it would have been an extremely difficult decision,
but this is a decision about what to do at that meeting and, as
I say, for me it was a pretty finely balanced decision.
Q9 Mr Fallon: But what is the evidence
you are looking for that would persuade you finally to vote for
more asset purchases?
Professor Miles: It would depend
very much on the probabilities of inflation falling in different
ranges as we look forward. As I say, at the moment the judgment
is that on balance inflation is probably going to be above target
most of this year, beneath it for most of next year, then coming
back towards target level. Now, if the news is that the economic
outlook seems even weaker, inflationary pressures lower, and that
moves down that inflation profile, there is a strong case, then,
for expanding further the asset purchases. If it goes in the other
direction that would be a case for pushing the lever in the other
direction.
Q10 Mr Fallon: Governor, you have
said it is far too soon to conclude that no more asset purchases
would be needed. Does that not indicate that a continuing weakness
of the economy might well make that further stimulus necessary?
Mr King: It may be; we will have
to see how things pan out. My particular concerns at present derive
from the state of the world economy and our largest trading partner,
the euro area. Within the world economy we are seeing countries
that ran deficits take measures to rein in domestic demand, it
was inevitable that countries would do that, and we are yet to
see evidence in the major surplus countries a sustained expansion
of domestic demand, and that must throw some question mark about
how sustained the expansion of overall demand in the world economy
can be, and that will inevitably have an impact on the UK. You
have already seen that, despite the depreciation of sterling,
we have not so far—though I suspect we will in due course—seen
much evidence of a pick-up in net trade for the UK which is an
important part of our rebalancing. Those are the cautious signs
overall and we need to look very carefully at that but, as David
says, this is a decision we look at month by month.
Q11 Mr Fallon: Spencer Dale, the
Bank says the beneficial effects of quantitative easing have not
been fully felt. Could you explain that? You have spent £200
billion, most of it on gilts. That has helped the Government deal
with its debt, but how has it really helped the economy? How can
we measure that?
Mr Dale: Measuring it precisely
is very difficult because one has to think what would have happened
absent that asset purchase programme and that is clearly unknowable,
but I think one can point to very clear beneficial impacts of
those asset purchase programmes. We have seen a very substantial
rise in asset prices, where equity prices have increased by 50%
since we started our asset purchase programme and corporate bond
yields have fallen by 200 basis points or so. I do not think all
of that can be attributed to our asset purchases but I have no
doubt that some of it can be. At the same time we have also seen
record amounts of issuance of both corporate bonds and equities
by UK companies which again has been helped by our asset purchase
programme and the increased liquidity that has provided.
Q12 Mr Fallon: The Governor spoke
about trade, Charlie Bean. In the Inflation Report the Bank points
to continuing weakness on the export side. The substantial depreciation
of sterling does not seem to have boosted exports as much as one
might have expected. If exports are not going to help us recover
the capacity we have lost, what will the main other drivers of
growth be?
Mr Bean: The key here is to recognise
that it takes time for a depreciation to feed through. Looking
at the lessons of past significant depreciation in, say, the wake
of the 1992 exit from the Exchange Rate Mechanism, it took some
years for the full effect of that substantial depreciation to
work through. What we have seen so far is exporters primarily
taking the benefits of the depreciation in terms of increased
profit margins rather than cutting prices to expand sales, but
one would expect that in due course to lead to an expansion of
supply because it is more profitable than would otherwise be the
case. So I am not altogether surprised that we have not seen a
large effect yet from the depreciation, but I would expect it
to be working through over the course of this year and into next
year. The precise speed at which that happens, though, may well
depend on the strength of the recovery in overseas markets. The
Governor has already referred to the worries about the euro area,
and if the euro area remains relatively sluggish in the rate at
which it recovers, then it may well take that bit longer for the
beneficial effects of the depreciation to work through.
Q13 Mr Plaskitt: Continuing with
quantitative easing for a moment, Governor, in your statement
to us this morning you said that it is providing "a substantial
boost to money spending". How are you measuring that?
Mr King: As Mr Dale said, one
of the difficulties we face is knowing what the counterfactual
is, but we have injected £200 billion of money into the economy
and that, through a wide variety of channels, leads to higher
asset prices, lower spreads, perhaps even a lower exchange rate,
greater issuance spreads the sale of both debt and equity, all
of these things feed through to higher nominal spending in the
UK economy.
Q14 Mr Plaskitt: Should we be looking
at what is happening to M4 as an indicator of the effectiveness
of QE?
Mr King: We influence M4 directly
by injecting the money into the economy and, by and large, that
increase in M4 stays in the economy and that is why you can argue
that looking at the money numbers tells you a good deal of what
would have happened had we not injected this money. Now, there
are some aspects to the recovery in the economy that involve banks
themselves issuing debt and equity or companies repaying bank
debt, which mean that will be part of a downward pressure on broad
money even though they are part of the measures which help recovery,
so I do not think it is a single statistic where you look at one
number and say that that is the answer to our problems. The steps
in this are very clear, however. We inject money into the economy
as the first step, that is the important part, and we did that
in large part because when you look at the monetary squeeze that
was being imposed through the contraction of the balance sheet
of the banking system we were starting to see very sharp falls
in monetary growth, not just in the UK but in the US and euro
area, and in some of those other countries monetary growth is
actually negative now. This is a serious position to find oneself
in, and you need to get back to a position in which monetary growth
is clearly positive, and that is what we are trying to do, so
we inject the money into the economy as the first stage. The way
that works is through a very traditional transmission mechanism,
not dissimilar to the way changes in the Bank Rate work, by leading
to changes in asset prices, in the spreads on particular instruments
in the economy which can lower the cost of finance to companies
and households, and through a range of channels which we have
spelt out in many of our publications, all of which in their different
ways help to influence overall spending in the economy which,
given the supply in the economy, then determines the balance between
demand and supply and hence inflation.
Q15 Mr Plaskitt: M4 growth has been
very small since the start of QE.
Mr King: Indeed.
Q16 Mr Plaskitt: Are you saying that
the significance is there has not been a big fall off in M4?
Mr King: Indeed.
Q17 Mr Plaskitt: So all it has done
is compensated for what would have happened by other means?
Mr King: I think we would have
seen a very serious monetary contraction because the UK's banking
system has been very severely damaged, probably more so than that
of any other advanced country, so we were facing a very tight
monetary squeeze—of a kind we have not seen ever, probably.
Q18 Mr Plaskitt: So it would be better
to describe QE as having filled a hole rather than putting additional
support into the economy?
Mr King: So far it has filled
the hole but, of course, the bulk of the action on quantitative
easing took place only in the last six to nine months and, even
if the lags were as short as they might be with Bank Rate changes,
we would still have yet to see the bulk of the impact of that
come through. So we have seen so far it has filled a hole and
that has been very important, but we have yet to see much of the
impact of the asset purchases we have made come through in terms
of nominal spending in the economy, or even broad money growth,
and we will see that over the next year, I expect.
Q19 Mr Plaskitt: Have you any concerns
about the impact that QE has had on asset prices, in particular
if you look at equities, that it is something of a bubble?
Mr King: Well, I think it is rather
odd to go from one extreme to say it has had so little effect
that monetary growth has been shrinking or close to static, and
then to worry that it is so important that it has pushed up asset
prices. The way in which asset purchases operate is, indeed, to
raise asset prices, that is one of the main vehicles in the transmission
mechanism and that is what we were trying to see, and I think
one of the main factors lying behind the rise in asset prices,
which has been considerable, particularly in equities over the
past year, has been that a year ago financial markets were contemplating
the sort of downturn that we did see in the Great Depression.
After all, we were right in the middle at that point of the fastest
decline in world trade ever seen, and two consecutive quarters
when output was falling in many countries around the world by
5% or 6% or more in just two quarters. There was an unprecedented
rapid collapse of output and confidence. The measures we have
taken and the measures which other central banks have taken around
the world have all contributed to a reversal of that concern that
we would see a re-run of the Great Depression, and those serious
downside risks, I think, have now been eliminated. That is not
to say we do not face enormous problems and challenges but we
have dealt with the short-run problem, and in the light of that
it is not surprising that financial markets have priced in the
disappearance of some of the worst outcomes that could have occurred
which had previously accounted for the sharp falls in asset prices
from the middle of 2008 to early 2009.
Q20 Mr Plaskitt: What sets of circumstances
will be in place that will lead you to think it is appropriate
to begin reversing the process of QE?
Mr King: It will be based on a
judgment about the outlook for inflation. There are many factors
that go into that. We would want to look at what is happening
to world demand and different aspects of domestic demand, and
we would also want to see whether there are more upward shocks
to the price level in the UK through, for example, changes in
world commodity prices or oil prices. We have seen a 70% rise
in oil prices in the past year and that has clearly had an impact
on our domestic inflation rate. We would want to look through,
so far as it seems sensible to do so, some of those short-run
effects but if they continue, or appear to be likely to continue,
then clearly we will have to factor those in. Now, all of these
things go into our normal inflation judgment and it would be natural
for us to wait until we had a chance to think through the outlook
for inflation in its entirety, in the round, before making a judgment,
and if we felt that the main risks to inflation were on the upside
of the target rather than the downside, that would clearly be
a signal for us to start to tighten monetary policy.
Q21 Mr Plaskitt: Do you expect in
due course it will be fully unwound, or do you think it is now
a permanent feature of monetary policy?
Mr King: No. I suspect we will
sell these assets in due course.
Q22 John Thurso: Governor, on page
15 of the report you make it clear that banks will need to replace
the funds that they have under the Special Liquidity and Credit
Guarantee Schemes, and you also note the difficulties that may
arise with sources of funding such as asset-backed securities
which would imply that funding should come more from retail deposits,
but there is gap over the last 10 years between what has come
in in retail deposits and what has been required of something
like £180 billion. The Council of Mortgage Lenders has made
the point that this will cause considerable difficulties for banks
and building societies when the scheme comes to an end. You have
made it clear that there is no way it is going to be extended.
Do you reject their analysis of what is going to happen?
Mr King: I reject the argument
that we should keep it going because they are not prepared to
find alternative sources of funding, and the main reasons for
that are the following. We made very clear that this scheme was
temporary; it was a three-year window where the taxpayer would
help to finance illiquid assets which had become illiquid in the
course of the financial crisis and which it had not been entirely
easy for those banks to anticipate would become illiquid, so this
was a temporary scheme to offer them the chance to finance a very
large stock, almost £200 billion, of assets which they could
not easily otherwise finance. We gave them a three-year window
to do that: there is no scheme in the world that is as generous
as this scheme, and the banks were given full notice that they
had three years to find alternative sources of finance. Many banks
are doing just that and it would be quite wrong to argue that
a taxpayer-subsidised scheme should be extended in order to penalise
those banks that had recognised the need to find other sources
of funding, even though they are clearly more expensive, but some
banks are going out and finding other sources of funding, and
it would be quite wrong to subsidise and reward those banks that
had not bothered to find alternative sources of finance. The bulk
of the SLS is accounted for by a relatively small number of institutions.
We are working with them to make sure there is a proper pattern
of refinancing over the next two to three years, so we do not
suddenly face what is sometimes described as a "cliff"
in which the funding just runs out; we are working with them to
make sure they do look for other sources of funding beforehand.
There may be some institutions that will find it difficult because
of the nature of their business model, but there is nothing coming
out of this financial crisis that will justify the taxpayer subsidising
an existing structure for the financial sector. Some institutions
may well need to accept a smaller balance sheet in future if they
cannot attract new sources of funding. New institutions or other
institutions that can attract new sources of funding will be able
to expand their balance sheet, so there will be a shift, and I
think the most important thing to hang on to in all of this is
there is clearly no shortage of savings in either the UK economy
or the world as a whole. The savings are there, the demand for
borrowers is there, and we will need to find perhaps new ways
to channel those savings to borrowers, so we are working directly
with the banks in order to ensure that the SLS is unwound in an
orderly way, and we are working with Government and the FSA to
think about either new ways of constructing securitised instruments
so that a different type of securitised market could be regenerated,
or, indeed, alternative ways to channel savings to borrowers,
both corporate and household.
Q23 John Thurso: What would be the
characteristics of those securities that would make them more
palatable than those which largely caused the crisis?
Mr King: I think the most important
is that what turned out to be the case when the crisis occurred
was that many of the pieces of paper that represented claims on
mortgages, to take that one example, turn out to be extremely
hard to value when people somehow finally realise that house prices
could go down as well as up, because when house prices go down
as well as up you need to know something about whose mortgages
they are and whether these are the kind of people who will repay
the mortgage, whether they will be affected by unemployment or
not, and it turned out that the pieces of paper contained no information
about these characteristics. It is not impossible to design securities
which contain aggregate information on the pool of mortgages which
is represented by those pieces of paper, and if there is to be
a viable securitised market in mortgages, which I firmly believe
can be recreated, it has to be on the basis that there is greater
transparency and greater information about the liabilities and
the people who are carrying the obligations to repay, otherwise
it is very hard to know how much money you want to pay for that
piece of paper. That is one aspect of it. There are other more
detailed aspects to do with the specifically UK nature of master
trusts in the securitised instruments which, in the case of Northern
Rock, created a very difficult situation in which there was a
tremendous pressure to keep issuing new mortgages to feed the
trust with new mortgages each year. This is a very dangerous outcome
in terms of the macro economy because you do not want to have
instruments which have built into them an incredibly strong pressure
to keep generating more and more mortgages. Mortgages will go
up in the upswing of the cycle and may come down in the downswing
and we need to allow that to happen naturally, so there are ways
in which these instruments can be designed but, in the end, the
market will determine it. What you cannot do is somehow believe
it is sensible to sustain a particular market only on the basis
of taxpayers' subsidy.
Q24 John Thurso: Professor Miles,
both the Governor and Paul Tucker when they were before us recently,
and on other occasions, have welcomed the role that contingent
capital ("cocos") can play in providing an emergency
buffer for a bank when its financial strength falls below a pre-agreed
level. However, since then there has been a concerted howl of
anguish from a lot of senior bankers and top institution investors
who have labelled it amongst other things "death spiral convertibles"
and saying it would be a "red flag" to the market. Do
you have any sympathy for their views, or is that just what you
would expect of them?
Professor Miles: Going back over
a long period there is a view amongst many bankers that holding
more capital is very costly, and that view was very influential
in the whole design of the capital requirement structure and the
Basle agreements. In retrospect it meant that capital requirements
were far lower than they should have been. So in some sense the
response of bankers to this particular recommendation is in keeping
with a general view that having more capital is very costly and
we must be very careful. I must admit I have much less sympathy
for that view than I have ever had—I was always somewhat
sceptical about it. I think the big story here is that, ultimately,
banks right across the world need to hold very much more capital
than we thought might be adequate two or three years ago. I am
pretty open-minded about whether that capital should be in the
form of capital that is always there—ordinary issuance of
equity and the capital sits on the balance sheet—and what
proportion of it might be contingent capital that gets called
when a bank's capital ratio falls beneath a certain level.
Q25 John Thurso: If I may, the argument
is that, whilst the idea of having a buffer is fine, it is the
fact that it gets triggered which causes a run on liquidity.
Professor Miles: Yes.
Q26 John Thurso: Do you think they
have a point there?
Professor Miles: One needs to
be careful in defining what the trigger is and you would need
to make sure the trigger was not perceived as being a sign that
this institution is in very serious trouble. So I would set the
trigger at a level which clearly was well short of a point at
which the bank was clearly in great difficulty.
Q27 Jim Cousins: I wonder if I could
ask you, Kate Barker, if you think that the commercial property
sector might still deliver a very significant aftershock to the
British financial system?
Ms Barker: I am not sure I have
an incredibly strong view on that, but I certainly think it is
true that we are not necessarily out of the woods as far as the
commercial property sector is concerned. We have seen some pickups
in parts of the sector recently, some of the pricing has improved,
particularly in prime property, but it is apparent that some of
the loans that the banks have made to commercial property remain
under water, and it is possible that if we do not see a recovery
taking hold through this year—and there has been a lot of
forbearance so far, so it is difficult to work out whether that
will continue—then we will see an aftershock from some parts
of the commercial property sector. We know that in retail property
many of the decisions on retail property are no longer going ahead,
there are a great number of vacancies in the retail sector and
clearly in some areas perhaps values have further to fall, so
I agree there is some risk still in that sector.
Q28 Jim Cousins: You have obviously
studied mortgage lending very thoroughly and there was a lot of
concern about the fall-off in mortgage lending last month. Do
you think that is just a temporary blip caused by the weather,
or is it something more that should worry us?
Ms Barker: I have to say I am
never quite sure whether things like the weather will affect mortgage
lending. It is often quite difficult to find really good weather
effects in a lot of economic series. However, we also had some
changes in Stamp Duty which may have had a temporary effect, but
I think the most significant question is really how far is mortgage
lending going to be constrained going forward and clearly, given
the difficulties which we have just been talking about with the
banks and bank financing, it seems more likely than not to me
that mortgage lending is not going to be available going forward
on the terms it used to be. That suggests to me that there are
still adjustments in the housing market potentially to come. We
are not really quite sure whether over a three or four-year view
this market is going to settle out. Like others, I was rather
surprised by the strength of prices in the housing market through
last year, it is possible that some people were delaying decisions
to move or put houses on the market and in some sense that cannot
continue, so while I would make no strong prediction on this—the
Governor is always warning us about the dangers of making predictions
on house prices—it is also possible that the housing sector
will continue to be quite weak through this year.
Q29 Jim Cousins: Mr Dale, if we just
go back three or four years, a flow of funds from outside Britain
was supporting a lot of home buying and buying of commercial property
and lending to private companies in Britain. There is absolutely
no sign that foreign money is coming back into the housing market;
there is a slight sign it is coming back into the private company
market. How concerned are you that we will be able to raise money
from outside the country to keep our own financing problems going?
Mr Dale: I think one of the features
of the credit crunch we face both in terms of the residential
market and within the corporate financial market is the withdrawal
particularly of foreign banks. Foreign banks accounted for a significant
component of the increase in corporate bank lending through much
of the middle part of the past decade, and we have seen a very
sharp contraction of that lending by foreign banks most recently,
as you suggest, and I think that is one of the key features about
the risk going forward, the extent to which either new foreign
banks will enter the market or the extent to which UK lenders
will be able to make up that gap. In the most recent few months
there are signs that some foreign banks are starting to come back
into the market for corporate loans, and that is recorded in our
most recent Trends in Lending Reports, but that is still very
early days, so the risk you highlight is a real one.
Q30 Jim Cousins: Governor, in your
opening remarks to us you absolutely correctly drew attention
to the huge refinancing problem that banks and private companies,
and indeed private individuals have, and also to the huge sums
of money that government is going to have to raise, come what
may, about the future of public spending over the next couple
of years. You also said there is likely to be a considerable drag
on spending in the economy as a result. How serious could that
drag be? Could it drag us back into recession?
Mr King: It is very hard to know
what will happen, there is enormous uncertainty, and, as you pointed
out in your question to Spencer, we are going through a period
in which there is significant rebalancing of the UK economy in
addition to no longer being able to borrow from abroad to finance
much of our banking and domestic lending activity. The other side
of that coin is that we will need to increase our net exports
so that we will not be borrowing that much from abroad, and that
is why we would expect to see over the next few years, and it
is hard to put a timescale on it, a considerable change in the
balance between domestic demand, where there will be a drag on
spending, and net exports, which will be the source of growth
that will enable the economy to pick up again. One of the challenges
that faces us, however, and there is no way round this, is that
the timing of these things is very hard to make coincident. We
would very much like to see a recovery in the world economy led
by our biggest trading partner, it would be a big help if the
euro area were to grow more rapidly. That would enable us to expand
our exports and that would be a source of growth and would make
it possible to achieve a better balance in our economy as domestic
demand is held back by the need of all of the domestic sectors
to get to a more sensible financial position. So there is big
challenge, and this is one of the challenges which we on the Committee
face in trying to work out the balance of risks between upside
and downside risk to domestic spending and activity as a whole,
which then feeds directly through to upside and downside risk
to inflation.
Q31 Jim Cousins: But, Governor, given
the fact that we will have to rely on foreign funders doing the
right things in terms of our own homes and jobs here, and foreign
purchasers doing the right things to help us to produce goods
and services here, they may not be as kindly to us as we might
want them to be. Against that background do you not think you
will have to go back to quantitative easing or special schemes
to support the financial sector to avoid a return to recession?
Mr King: I do not know but we
stand ready to do whatever seems appropriate. That is one of the
great virtues of monetary policy. We have already lost a lot of
the overseas financing, and as a result we have seen an improvement
in net trade, in large part a contraction in imports, we hope
to see a better balance in future, but monetary policy can either
be more expansionary or more contractionary as the situation demands,
and we stand ready to do that.
Q32 Sir Peter Viggers: Would I be
wrong in thinking there is a slight change of tone between the
Quarterly Inflation Report and the thoughtful statement you gave
to us at the beginning of our meeting? I read the Inflation Report
as looking forward with expectation, hope, possibly even a hint
of optimism, and I read your statement as being one of caution
and concern. Would I be wrong in thinking there was a slight change
of tone?
Mr King: I do not think there
is a change of tone; the outlook is still the same. I wanted to
draw your attention to the concerns we have about the outlook,
in particular for the Rest of the World. I was struck by the mood
at the G7 meeting that I attended with Charlie in Canada, where
several of the major economies around the world said very openly
that they were relying on external demand growth to generate growth
in their economy. Well, that cannot be true of everybody. That
was a concern about the world economy, which I have, but I think
our central view is still that the most likely set of outcomes
is along paths which involve a gradual recovery, that is the most
likely, but anyone who has lived through the last two years will
surely know there must be enormous uncertainty on either side
of that, and it is only fair to set that out.
Q33 Sir Peter Viggers: In the Inflation
Report, and I am referring specifically to the gross domestic
product projection based on market interest rate expectations,
it says that the assumption is that the issuance of Central Bank
reserves remains at 200 billion throughout the forecast period.
What would the GDP projection be if you made a different assumption,
if you assumed more or less?
Mr King: I do not know because
the Committee would have to meet and form that judgment, so I
cannot answer that. Maybe in future months we will have the opportunity
to tell you.
Q34 Sir Peter Viggers: Fair enough.
The statement in your preliminary statement that lending to the
non financial sector continues to fall came to me as both a surprise
and a disappointment—a surprise because many bankers have
sat in front of us and absolutely sworn that they have increased
their lending to the non financial sector, and a disappointment
because most of us have assumed that quantitative easing is about
encouraging banks to lend to the non financial sector. Would you
comment on that?
Mr King: Yes. I do not think that
asset purchases is about directly affecting the amount of lending
to the non financial private sector. It is, first, about the amount
of money in the economy, not the amount of credit, and that would
expand demand overall. What is happening, which there is very
little we can do about, is that the banking sector itself, given
the enormous problems that have occurred to it in the past couple
of years, is still contracting its balance sheet. Now this is
not unique to the United Kingdom. Bank lending to the non-financial
sector is falling even more rapidly in the United States, despite
the fact that they have seen some signs of recovery. That is because
the measures they have taken and that we are taking in terms of
asset purchases can stimulate money spending even at the same
time as bank lending is contracting. It is not a position we are
comfortable with, we would like to get back to a situation where
the banking sector can expand its lending, but I am not sure if
that is going to happen until we see further consolidation of
the balance sheets of the banking sector, and there is still quite
a way to go on that front.
Q35 Sir Peter Viggers: Looking for
engines of growth, and I am addressing this to Charlie Bean, I
think, the figures for the eurozone were disappointing in the
last quarter, and some commentators have said that is a flat period
and that the eurozone is likely to improve quite soon. Would you
comment on that general point?
Mr Bean: There is a bit of a dichotomy
within the eurozone, in that manufacturing has continued to strengthen,
which reflects the general strengthening of manufacturing around
the world in the recovery phase, but services has remained pretty
flat and, as you correctly note, has eased back, and that is behind
the easing in growth in the fourth quarter there. Obviously the
real issue is how much strength there is as we go through this
year. The eurozone is struggling with the same headwinds as we
are, namely a deleveraging banking system; different countries'
banking systems are in different positions, but in general there
is still that headwind against which they are struggling. As we
have already discussed, there are some countries that are also
struggling with difficult fiscal positions, which are difficult
which puts more weight on the countries that do have some room
for manoeuvre continuing to maintain their policy stimulus on
the fiscal side and on the ECB continuing to maintain an accommodating
monetary stance. But I think we expect the euro area to have a
sluggish recovery in very much the same way as the UK will.
Q36 Sir Peter Viggers: Will there
be a tailwind from the BRICs? The expanding economies?
Mr Bean: Almost certainly the
emerging markets will continue to grow quite robustly. It is possible
that Chinese growth may tail off a little—the Chinese authorities,
being concerned about potential overheating there, have started
to tighten policy a little bit—but the overall picture from
the emerging markets remains one of reasonably strong growth.
Of course, however, they are still a relatively modest market
for the euro area in particular and ourselves. So that provides
some tailwind, but unfortunately not as strong as it might be.
There is a little bit of a quid pro quo for that in that strong
growth in emerging market countries is likely to put upward pressure
on commodity prices which is obviously less good for domestic
growth prospects.
Q37 Nick Ainger: Mr Bean, the Governor
in his letter to the Chancellor and also in his statement this
morning refers to the temporary nature, the temporary deviation
from the target, and he puts it down to three factors—firstly,
the increase in VAT back to 17.5%; secondly, exchange rate issues,
and, thirdly, the 70% increase in the price of oil. Clearly—hopefully—the
VAT increase is a temporary measure and I do not want you to suggest
where exchange rates are going to be, but why do you think, bearing
in mind the huge volatility we have seen in the past in the oil
markets, that, in fact, the effect of oil prices is also temporary?
Mr Bean: It is quite possible
there may be further adverse movements in the oil price and, of
course, my last answer referred to that possibility. As it looks
at the moment, there is certainly some scope for a further expansion
in the world supply of oil without putting upward pressure on
oil prices; there is some spare capacity, and some of the past
investments are gradually starting to come on-stream. However,
I do not rule out the possibility that we may find ourselves subject
to further upward shocks from oil and other commodity prices and,
were that to happen, of course, that would make the inflationary
backdrop less kind. The projections in the Inflation Report are
conditioned on an assumption for oil prices that comes out of
the futures market and which assumes a pretty flat oil price.
But there is a lot of uncertainty about that and within the oil
market itself, if you look at oil options, there is a big spread
of possibilities. So you are absolutely right to flag that as
one of the risks.
Q38 Nick Ainger: Because what we
have seen this year, and the Report refers to this, is the 70%
increase at a time when the two largest markets for oil, North
America and Europe, were contracting, so you would have expected
after the plummet from the peak in the summer of 2008 that oil
prices would have reflected the fundamentals in the market which
was there was not a lot of demand out there and, therefore, they
would have stayed at a low level, not risen by 70%. We have had
this discussion in the past. I met with the Commodities and Futures
Commissioner in Washington recently and there is a strong view
that speculation in the oil market is affecting prices adversely,
not reflecting fundamentals, and that perhaps international action
is needed to try and regulate far more the futures markets, the
over-the-counter trading. What is the Bank's view on trying to
tackle this issue?
Mr Bean: Our view is that speculative
behaviour, while it can have short-run effects on the dynamics
of prices, probably does not have lasting effects on, if you like,
the trend in oil prices, which is driven primarily by supply/demand
imbalances. The nature of the oil market is one where, where we
are at the moment, the supply might be reasonably elastic, as
Saudi Arabia has a certain amount of spare capacity. But when
you get up to hitting those capacity constraints, it is quite
difficult to increase supply much, so the supply curve becomes
pretty inelastic at some point. The demand for oil is also pretty
inelastic with respect to prices. So what that can mean is when
you hit world capacity constraints in oil, then the price becomes
extremely volatile. So our reading, primarily, of what went on
through 2008 when, of course, the oil price continued rising—I
think it was about $80/$90 a barrel at the beginning of the year
up to about $150 a barrel in mid summer—was that was primarily
being driven by underlying fundamentals, particularly robust growth
in emerging markets. That is not inconsistent with speculative
behaviour having some influence on the short-run dynamics. But
our view would be that it is not the prime driver of these previous
swings.
Q39 Nick Ainger: The IMF were concerned
about this issue, because obviously it was not just oil futures
but other commodities as well, including food, and they made the
assumption that it was not fundamentals that were driving certainly
what happened from mid-2007 to mid-2008, it was speculation, and
while there may well have been fundamentals forcing up or causing
change, the way that the commodities markets operated massively
geared up that change. Have you a view on that?
Mr Bean: Well, I think if you
go back and look at what has happened to the prices of a range
of commodities you find that commodities where there are not significant
futures markets and insignificant speculative behaviour were subject
to exactly the same broad movements as we saw in the oil market
during that period, which suggests it is not a story purely about
speculation because you would have expected to see very different
behaviour between markets where there is futures trading and those
where there is not.
Q40 Mr Brady: Spencer Dale, all of
the projections in the Inflation Report are predicated on 200
billion of asset purchases. Do you produce Fan Charts for other
levels of asset purchase?
Mr Dale: No, we do not, and I
should stress in some senses it is forced upon us because of a
lack of a good alternative produced by the market. As you know
for our interest rate assumptions we have two; we have a constant
interest rate assumption and an interest rate path implied by
the market. Unfortunately there is not an analogous path for the
stock of asset purchases produced by the market on which we could
also condition.
Q41 Mr Brady: So you are not able
to say what the implications are of the fact that it is predicated
on 200 billion of asset purchases; it is simply where we are?
Mr Dale: It is a conditional assumption,
yes.
Q42 Mr Brady: So you do not even
have working assumptions within the Bank?
Mr Dale: Not in any precise formal
way, no.
Q43 Mr Brady: Would you care informally
to hazard a guess or give an estimate of what you think the impact
of that 200 billion is?
Mr Dale: It is very hard to come
up with any sort of single point estimate of how much these asset
purchases are affecting the economy. As the Governor said, the
Committee comes together, it takes a view of the impact of the
stimulus, together with all the other factors affecting the economic
outlook when producing its forecast for inflation and growth.
It is very hard to take out one incremental impact of that and
say absent that this is what the economy would look like.
Q44 Mr Brady: You cannot do that
at a single point but presumably you could look at a range of
possibilities.
Mr Dale: You can certainly think
through a set of counterfactuals but, again, when one carries
out those sort of counterfactuals it would beg a number of other
questions about why was the degree of quantitative easing less,
to what extent was that expected by the market, how was that interpreted
in terms of the behaviour of the Monetary Policy Committee and
why would it be behaving in that way. One would need to make judgments
about all of those other factors before you could come up with
a coherent simulation.
Q45 Mr Love: Mr Bean, economists
have referred to the presentation given last week of the February
Inflation Report as "misleading and confusing". This
appears to relate to the change in the CPI inflation rate two
years out which is projected to fall from your Report, which says
1.79% to 1.57%, yet the Monetary Policy Committee appear to have
not ignored the implications of that adjustment in the inflation
rate. Is there a growing sense that the Monetary Policy Committee
is predisposed to hold quantitative easing when, in fact, the
evidence that you produce in your own report would suggest otherwise?
Mr Bean: The numbers that you
are quoting there are falling into the trap of assuming that you
can look at a single measure of central tendency in the forecast,
whether it is the most likely projection—the mode—the
mean or anything like that, and mechanically back out from that
the policy decision. When we make the policy judgment, implicitly
we are looking at the whole distribution, the whole range of possible
outcomes. Some of the risks you may learn something about in the
near term. For instance, at the moment inflation is significantly
above target, and one of the risks might be that that period of
above-target inflation leads to inflation expectations rising.
Once inflation has dropped back that risk would no longer be relevant,
so that is a risk that might resolve itself quite quickly. There
are other risks that we may not know for a great deal longer about,
such as the extent of the headwind from the banking sector and
so forth. So in informing the policy judgment you have to factor
in quite a lot of elements of the outlook—it is not simply
a case of looking at one measure of central tendency, one path,
within the whole range of outcomes. And there are various other
issues that we'll also factor in, like uncertainty about policy
multipliers and so forth.
Q46 Mr Love: What seems to have surprised
the economists, and I am not an economist, let me state straight
away, is this idea of skewness which had not existed in your November
or August reports but has been introduced in the February report—
Mr Bean: No.
Q47 Mr Love: —between the modal
and the mean.
Mr Bean: Quite the opposite. As
far as the growth protection went, in November we had an extremely
large downside skew and that reflected the fact that we thought
there were a lot of downside risks facing the economy. As we have
moved through to this year, the outturns for growth have been
a bit weaker than expected but we think some of those downside
risks now look a bit less threatening. So as far as the growth
protection went, we lowered the modal protection but reduced the
downside risk, roughly offsetting in terms of their effect on
the average across the whole distribution, the mean. Now, what
does that imply for the inflation protection? Well, if you are
just thinking about the modal projection for inflation—what
we sometimes refer to as the central projection, that deep red
line in the middle—if you have a weaker growth profile,
then you would expect a weaker inflation profile to go with that.
So that is why the mode comes down. But because the downside risks
to growth are less, that means less downside risks to the inflation
profile. Back in November we had roughly balanced risks either
side on the inflation profile, but we have now taken some of the
downside risks away, so that leaves you with some net upside risks.
If you want an economic story to explain where those upside risks
come from, it is from the fact we are presently undergoing a period
of elevated inflation which may raise inflation expectations;
then there is the possible risk to commodity prices which we have
just been talking about, that is another upside risk; and there
are probably others that one could enumerate.
Q48 Mr Love: Do you accept that the
case that is being made by a number of economists in introducing
this issue about the short-term spike in inflation being greater
than originally expected and comparing that with the longer term
reduction that is the implication of your February figures is,
to say the least, confusing and there does seem to be some form
of mismatch between the figures that you are producing in your
February Report and the decisions of the Monetary Policy Committee?
Mr Bean: I am not sure it is confusing.
The reality is that we are in the position where inflation is
currently elevated but we think the underlying inflationary pressures
are relatively weak because of the large margin of spare capacity
in the economy, and that will in the medium term push down on
inflation. There has to be a degree of uncertainty about the strength
of that downward pressure. We are uncertain about the margin of
spare capacity, the size of the output gap if you want to call
it that. We are also unsure about the impact of any given output
gap on inflation in these current circumstances, so the extent
of that downward pressure is unclear. We think it is probably
enough to pull inflation below target a year and a half to two
years out, but then as the economy recovers it will be pulling
inflation back up as the margin of spare capacity gradually starts
eroding, so that by the end of the forecast horizon, conditioned
on market interest rates, the risks of inflation being above or
below the target are roughly balanced.
Q49 Mr Love: One last question. Governor,
it has been described by a number of economists as a bit of a
mess. Do you accept that there has been any form of fudging between
the decisions of the Monetary Policy Committee and the figures
that have been placed before them, and do you think there is a
need, perhaps, for greater clarity so that not only the public
but the economists will understand what you are saying?
Mr King: I do not, and the reason
for that is that the policy decision turned out to be one that
everyone had expected and they had access to the same information
about the economy as we did, so there was no disparity between
the information on the economy and our decision. As David said
at the beginning, once we had completed our projections—if
you look at the projection as a whole—there was clearly
a bigger chance in our view that inflation would be below the
target for most of the forecast horizon than above it, so that
naturally posed the question of whether we should conduct some
further asset purchases. We put that question to ourselves and
we decided on balance, no. The factors that loomed very important
in our decision were other aspects of that very same projection:
first of all that inflation is well above target now, it will
stay there for a while, we do not want to run the risk of inflation
expectations moving up and being dislodged from the target. There
are risks that there could be further upward movements, whether
it be commodity prices or other changes in indirect taxes, who
knows. The second reason is that it seemed to us to be a very
good time to take stock of what we had done because, as I said
before, the bulk of the asset purchases we conducted has really
only been in the last six to nine months and much of the effect
of this is still to come through, so to have a period where we
took stock of what we had done, concerned that at this juncture
inflation is above target, seemed to us wholly consistent with
the outlook. There has never been a strictly mechanical link between
someone saying get the slide rule out, this is the mode at 2 years—
Q50 Mr Love: We do not use slide
rules any more.
Mr King: It is a shame we do not.
It is a broader judgment about the outlook in order to meet the
inflation target in the medium term.
Q51 Mark Todd: Governor, can I turn
you to section 3.1 which discusses the ONS's figures on growth.
In the very polite way in which this Report is phrased it might
suggest some variance of opinion from the data that ONS have produced
to date. Are you comfortable with the quality of ONS's data supplied
to the Committee?
Mr King: I am very glad we do
not have the task of actually publishing the data which they do,
but they publish pretty early on their first estimate of GDP and
they do that because we and other people ask them to publish a
first estimate, but they make very clear that this is not their
final estimate and that they will over time have access to better
information as it comes in and, when it comes in, they revise
their estimates. What we have to do is to try and make a guess,
and we do it in our fan chart, of do we think there is a balance
of risks to their final estimate compared with the initial estimate?
On average we think there probably is some very small upward revision
on average more likely to be made than not, we take into account
the other data for the economy and obviously many people were
pointing to the fact that many indicators, business surveys and
others, were giving a somewhat more upbeat picture than the ONS
data. I do not attach great significance to that.
Q52 Mark Todd: Presumably your bank
agents have got access to the information as well.
Mr King: The agents too, absolutely.
Look at chart 3.2 on page 25. You see here our back-cast, our
judgment of the possible range in which the data might finally
turn out to be when the ONS have had all the data, and the big
picture is basically unchanged as to whether you take the ONS
figures or our estimate from the back-cast. The big picture is
a very sharp fall of about 6% in output as the crisis hit and
basically, since then, bumping along the bottom, and then we give
our forecast.
Q53 Mark Todd: But it is fair to
say there is quite a significant variance in the dip, to be honest,
is there not?
Mr King: I do not think it is
massive.
Q54 Mark Todd: The reason I am asking
about this, Governor, is because we have discussed this before.
Mr King: Yes, absolutely.
Q55 Mark Todd: And the concern was
expressed at one stage about whether ONS were as well-resourced
to provide the data that the MPC needed as they should be. That
is the background to my question; I understand the points you
are making.
Mr King: They do a pretty good
job of producing it; they use a very large number of sources to
produce their data. We certainly, when we saw the numbers coming
in—which were weaker than we and others had expected given
some of the survey results—did not react in the Bank by
saying "Oh gosh, the ONS must be wrong", we reacted
by saying "Ah, we must take note of this" and we should
take note of it. The great danger is that outside commentators
have a fixed view and they feel the job of the ONS is to come
into line with their view. That is wrong. We take great note of
what the ONS say and I have no reason at all to suppose that their
estimates are in any way distorted. Of course if they had more
resources I am sure they could do more, but I rather suspect over
the next couple of years you will hear that from every single
component of the public sector, not just the ONS. You will not
hear it from the Bank.
Q56 Mark Todd: Nevertheless, this
data is quite an important tool, not just to yourselves but to
many other people.
Mr King: Yes.
Q57 Mark Todd: And gives an indicator
which prompts policy across quite a wide range of activity. You
touch on the impact of uncertainty on your projections on labour
issues, for example, on the next page, which you hark back to.
Maybe part of the explanation for the relatively resilient paper
market is that growth has not been as negative as the ONS has
projected, so you can see the wider implications if there is a
quality issue.
Mr King: Absolutely, but it is
wrong to criticise the ONS for not producing—
Q58 Mark Todd: I am not criticising,
I am really suggesting that maybe there is a more robust partnership
that can be found if you are looking at some of the issues on
how they produce their data and whether there are gaps. In the
past we have found that they have under-estimated certain parts
of the economy because the economy flexes and changes quite rapidly.
Mr King: Indeed, and we do have
a very good working relationship with them where both the Committee
and also at working level Bank staff talk to the ONS on a regular
basis. We expressed very openly and frankly our concerns about
some aspects of their processes; we were concerned that the process
of producing a revised and balanced set of national accounts was
postponed for some considerable time. That did give us cause for
concern and we made it very clear to them. In terms of the conceptual
methods of how GDP is estimated and whether that should be changed
in the future, we have a very frank and open and productive conversation
on a regular basis with the ONS which helps to improve these things.
Q59 Chairman: Governor, in your opening
statement you mentioned the need to reform the international financial
system and to restructure our banking system. Since your appearance
at our Too big to fail? Inquiry we have seen a concerted fight-back
from the large global banks. Both Barclays and Goldman Sachs,
who have appeared before us, rejected President Obama's proposed
reforms, they rejected the limits on the size of banks, they rejected
the restructuring activities that they engage in. Are you concerned
by the attempts of the banking sector to block structural reform
to the banking sector and that in the absence of such reform the
moral hazard problem will grow even more acute and, as you mentioned
in your opening statement, we could witness another more serious
crisis in future?
Mr King: That is a real concern.
I am not at all surprised that the banks are defending their present
position. They have an implicit subsidy through the "too
big to fail" outcome that we have and it is not surprising
that anyone who receives a public subsidy in effect tries to defend
it and keep it going; it is quite natural that they would try
to do it. That is no reason why we should go along with that.
There are very good reasons for thinking that in future it would
be much better to put at least some weight on putting in place
firebreaks and firewalls in different parts of the financial sector
and not relying on getting regulation absolutely right. There
is plenty of scope for improving regulation and that needs to
be done, but the real lesson from the regulation of other industries
which is a very important thing that we should look at, is that
you cannot get regulation exactly right. None of the banks set
out to destroy themselves in the way that some banks effectively
did; there were regulators all over the banks in some countries
and in some banks they did not spot the risks. Risks will occur
which are very hard to anticipate in advance; the big lesson from
that is not to pretend that we can calibrate a Basel regulatory
system so finely that we can guarantee that these risks do not
materialise, but to ensure that when they do, we have firebreaks
and firewalls so that the entire system does not bring down the
rest of the economy with it.
Q60 Chairman: What advice do you
have for us in terms of the future and the reform of the financial
architecture?
Mr King: I hope the Treasury Committee
will keep looking at this and studying it because I do not think
it is reasonable to expect governments to say, "Ah, we will
definitely adopt this particular policy path or that policy path",
there is a genuine debate to be had about the right way in which
our financial sector should evolve, how it should be restructured,
what kind of regulatory framework we should have, how big the
capital requirements should be. As David said, they could be much
larger than they are now. This is not a question of making marginal
changes. The impact of this crisis has been so large that just
to fiddle at the margins will be a wholly inadequate response
but it is perfectly reasonable to take our time now and to have
a proper debate about where we want to get to in the medium to
long term. I have one area of sympathy with banks which is that
it is not sensible for us to try to impose on them big changes
in structure or capital very quickly. That will make it much more
difficult for them to finance lending to the real economy but,
equally, we must not let the need to have a long transition period
deflect us from the need to keep up the pressure and momentum
on what that debate should result in ultimately.
Q61 Chairman: Governor, can I thank
you very much for that and can I thank Kate Barker for her tenureship
in the Monetary Policy Committee. I believe that you have done
almost nine years with three terms and been the longest-serving
member so the Committee would like to thank you for your appearances
before us and wish you well in the future. Given, Governor, that
this is going to be your last appearance and Inflation Report
before the election can I as Chairman thank you very much for
your co-operation and your ever willingness to come to the Committee
at all times. I know it has been quite demanding on you but we
are grateful for that and we wish you and your fellow committee
members well in the future. Thank you.
Mr King: Chairman, thank you very
much. This is in fact my 17th appearance before the Committee
since the crisis began, my 19th appearance in front of a parliamentary
committee in 29 months. That is almost some sort of record. It
has not been fun, if I am honest, it has not been easy, but it
has ultimately been productive. I would like to thank you and
your Committee for having played a major role in taking forward
the debate, particularly on the restructuring of the financial
sector. I know that you and some of your colleagues may not be
here after the election on the Committee so can we thank you very
much for your help on the Committee. You should at the end, particularly
you, Chairman, take pride in what the Treasury Committee has achieved;
the quality of the reports has been very high and it has actually
resulted in reform in the UK which perhaps has not been seen in
other countries. Thank you very much.
Chairman: Thank you very much, Governor.
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