Appointment of Dr Ben Broadbent to the Monetary Policy Committee of the Bank of England - Treasury Contents


Examination of Witness (Questions 1-52)

Q1 Chair: Good morning, Dr Broadbent, thank you very much for coming to see us this morning. If you had had a vote at the last MPC meeting, which way would you have voted?

Dr Broadbent: I am not entirely sure, to tell you the truth. I wasn't at the meeting or the preceding briefings.

Chair: But you have seen virtually all the relevant material. The Inflation Report is pretty thorough, the minutes are extremely full and you have had the benefit of the—

Dr Broadbent: The minutes are not yet published but I can certainly—

Chair: —cross-examination of the Government.

Dr Broadbent: Yes. No, I am not willing to say exactly what I would have done. The truth is I genuinely don't know what I would have done. I left my last job a couple of months ago and have not followed every number, so I really don't know the answer.

Q2 Chair: Is that partly because you do not have the information in front of you, or partly because you would rather not express a view to us this morning? After all, when you are having a drink after hours, doesn't the conversation turn now and again to what you would be doing if you were on the MPC?

Dr Broadbent: I can tell you that the last two months, certainly, I have studiously avoided talking to anyone about this. It may be a bit of both but the first is sufficient, really. As I say, I genuinely don't know so I think it would be wrong for me to express a view here.

Q3 Chair: Have you taken a look at Andrew Sentance's arguments for raising rates?

Dr Broadbent: Yes, I have.

Q4 Chair: What do you make of those?

Dr Broadbent: Well, you only had to look at the split of the vote across the Committee over the last several months—not to say more than a year—to see that there are strong arguments on both sides. I think we have just had the release of the latest CPI figure, another reading over 4%. You could be forgiven for pursuing Dr Sentance's line of argument and worrying that this so-called higher spot reading might persist into the future, so I think there is clearly a respectable case to be made. On the other hand, I think there are still huge risks in both directions and that is why you have had a split vote for quite a long time.

Q5 Chair: I am not talking about the last couple of months, but in recent years since the crash, when you have been looking at monetary policy have you ended up feeling that you are nearer the doves or the hawks?

Dr Broadbent: Sometimes one; sometimes the other, possibly. I don't think I have always been in the same direction. It has been more of a second order judgment. If I have had any difference with what you might call the middle, it has been about the communication, possibly. On the broad thrust of policy, I think I would have followed pretty much what the Bank has done.

Q6 Chair: You are on the fence, aren't you, this morning?

Dr Broadbent: On this, yes, because I don't see any upside to my pre-committing to a point of view even before I have joined the committee. I think that would be wrong.

Q7 Chair: I am not asking about what you are going to do in the future but about your past thoughts. It gives us information about the way you may conduct yourself on the committee.

Dr Broadbent: I understand that.

Chair: I think that is a reasonable line of inquiry.

Dr Broadbent: I quite understand, and I agree. I only say two things. First of all, up until now my job has not been to express a view about what should happen; it has been to try and say what will happen, and that is an important distinction. Secondly, although as you say, I might well have had an opinion about what should happen at different times, the problem with expressing that strongly here is precisely that I may give an artificial or a misleading steer about what I might do in the future. That is the difficulty.

Q8 Chair: Let me end with one more attempt before I hand you over to Michael. Since the crash and therefore the need to reassess monetary policy, to look at monetary policy in a somewhat different light, is there any significant decision that has been taken by the MPC on interest rates or QE, at any time, which has led you to raise an eyebrow, or have you been happy with all those decisions?

Dr Broadbent: The big decision? Because when you say "all of them" obviously they meet every month.

Chair: There has been a string of decisions.

Dr Broadbent: There has been a string of decisions, but I would characterise the big decision as very aggressively to ease monetary policy in late 2008 and through March 2009, and on that front am very much in agreement.

Q9 Chair: They have done the right amount at the right speed and at the right time?

Dr Broadbent: The right speed, certainly. As quickly as you possibly could was the speed, and I think that was the right speed in the latter part of 2008 and early 2009. The right amount? Quite honestly we have so little experience of how to measure the effects of bond purchases that judging the right amount of QE is difficult, but certainly it was necessary once you ran into that zero band. The disagreements obviously will come later on, given what has happened to inflation, and there, as I said earlier, I think you could see arguments strongly on both sides. The big thing that happened since the crash is that early aggressive easing, and I was very much in agreement with it.

Q10 Michael Fallon: You will be aware of the announcement this morning that CPI inflation is 4.5%.

Dr Broadbent: Yes.

Michael Fallon: Well over twice the target. The MPC has been off target for over two years now. What has gone wrong?

Dr Broadbent: Several things. First, and most importantly, there has been a significant rise in not just the price of oil but the price of oil commodities. I would say that is something that has been happening for much of the last seven or eight years. Often the target has been missed very much for that reason. I might come back to that in a moment because it does raise some important questions about how you forecast inflation, but that has been the primary thing.

Over this past year in particular, you have also had the rise in VAT. If you "strip" both those things out you are a good deal closer to the target. Therefore, I think there is every reason to expect that once those things have dropped out of the annual inflation rate, in 2012 inflation will be much closer to the target.

Q11 Michael Fallon: We have been told this every quarter by the MPC—quarter after quarter—that it is going to be back on target. The MPC is still miles off target. Why do you think the MPC has made so many mistakes?

Dr Broadbent: I don't know if it has made so many. These things are rather slow moving.

Michael Fallon: If it is twice what it is supposed to be it is not a good outcome, is it?

Dr Broadbent: No, I understand that. There is a forecasting error. One thing that has been true of the economy since the crash is that it has become a lot harder to forecast. There is no forecast that has got it right, if I take what people were saying, say, a couple of years ago. That said, there are some important issues that I think the MPC should worry about, particularly in regard to these rising commodity prices. As you are aware, the MPC treats these rises as one-off occurrences. It assumes that whatever the jump in oil price is, or any other commodity price, the price will then stay there from now on for ever. That has been the most important single forecasting error.

Q12 Michael Fallon: So they have misread commodity prices?

Dr Broadbent: They have always, ever since we had inflation targeting, made a forecasting assumption that even though they were volatile, the best guess of the oil price a year from now is where it is today, more or less. There are good reasons for doing that but in a global environment where the strongest growth in the world is coming from the parts of the world that consume the most commodities, perhaps you ought to think about doing something different. It is very difficult to know what to do, but I view that as the single area where the surprise has been biggest.

Q13 Michael Fallon: But you're going to be paid to know what to do, not to tell us how difficult it all is. Are you not concerned that inflation expectations are now becoming completely unanchored when people see the target is missed month after month, with inflation twice what it should be, year after year?

Dr Broadbent: Well, year after year, I don't know. As you say, it has been most marked most recently. Over the history of inflation targeting as a whole, it has been met pretty well, but clearly there is a risk that the longer these things go on, the more likely it is that they get embedded into people's baseline view about what the underlying rate of inflation is. If anything, I have been surprised about how little that has happened. It is hard to measure these things very exactly, but if you look at, say, what are called break-even inflation rates in the bond market, what financial market expectations and inflation are, or you look at the rate of growth of nominal pay, to me, neither of those sends very alarming signals about inflation expectations, and I see no strong evidence that they have become de-anchored.

Q14 Michael Fallon: Dr Sentance gave us evidence of wage settlements beginning to creep up well above 2%.

Dr Broadbent: That is true.

Michael Fallon: Why is he wrong?

Dr Broadbent: I think he is right to point out that they have risen but I don't think they have risen to levels that are alarming yet. The truth is that if everything were "normal", and we were growing normally and productivity were growing normally and inflation expectations were where you want them to be, you might expect wage settlements to be 3% or so, or more.

Q15 Michael Fallon: You are telling us you are not alarmed by inflation at 4.5%. It is supposed to be 2%.

Dr Broadbent: No, I am alarmed by—

Michael Fallon: Why aren't you alarmed?

Dr Broadbent: It is more than twice the target, as you said, and it needs to come down. My best guess is that it will. What I am trying to say is—because you asked a separate question earlier about whether inflation expectations have become de-linked—I don't see strong evidence that they have done yet. In fact, I have been slightly surprised that they haven't done so more. That is not to say that they won't, and clearly you cannot indefinitely have inflation this far above the target without that happening.

Q16 Michael Fallon: So what are you going to do to get it back on track yourself?

Dr Broadbent: As I said, my best guess is that it will come down next year.

Michael Fallon: So you are not going to do anything until next year?

Dr Broadbent: That is a slightly different point because if the policy—

Michael Fallon: You are the new appointment, and what we want to know is what you are going to do to help get inflation back on target.

Dr Broadbent: I will cast my vote as I see fit in order to keep inflation on target over the medium term. What I do now probably doesn't have that much impact over the rate of inflation, say, next January, February or March. Where it really begins to affect inflation, my first vote will not, to the extent it has any bearing at all on inflation, do much before, truthfully, the end of next year or into 2013 given the lags in the system. In the meantime, I have a forecast—an appraisal of the Bank's forecast—which is broadly in agreement with theirs, which is that it will come down. I quite understand how having heard that from lots of people over the last year or two, you might be sceptical but, none the less, that is the best guess.

Q17 Michael Fallon: All the evidence points the other way.

Dr Broadbent: I don't know if that is true. A lot depends, as I said—

Michael Fallon: It has gone up again today.

Dr Broadbent: We know what the effect of VAT is, and we know that that is going to come out. We also know—I don't know what this morning's reading was—that petrol prices are up; they are somewhere between 15% and 20% on the year. A lot depends on what happens to those. In order to maintain that contribution to inflation, you would need the oil price to do again, over the next year, what it has done over the past year. I think it is more likely that it will not rise as much. There is an important question over the medium term about whether you continue, in the face of what might be a trend increase in commodity prices, to always assume they are flat. That is a big question. But to argue that you are going to see inflation come down next year I think is entirely reasonable, whatever the miss is over the past year. The fact that you have missed it on this side this year does not mean necessarily that your forecast is evidently wrong, in one direction or another, over the next year.

Michael Fallon: We hope not. Thank you.

Q18 Chair: You said a moment ago that your vote will have no effect on inflation until 2013.

Dr Broadbent: It was a first order approximation, Chairman.

Chair: Yes. Is that true of inflationary expectations?

Dr Broadbent: No, I think they may feed into inflation sooner than that. If you suddenly saw, for example, a big jump in pay settlements or a big sell-off in the gilts market related to a deterioration—

Chair: You are taking the conventional view, with which I agree, in which case the decisions that you take now may have a much earlier impact than you are suggesting.

Dr Broadbent: To the extent that they affect those expectations, yes, that is quite possible.

Q19 Mark Garnier: I have one last question on this inflation point. For quite a long time we have been hearing the story about VAT. At the end of 2009 we had a VAT increase from 15% to 17.5% and that took a year to work through the system. Obviously, we have now had another VAT increase, from 17.5% to 20%, at the beginning of this year and that now has a year to work through the system. We also have these rising commodity prices. At the end of the day, these are turning into slightly long-term issues. Now that everybody is turning around saying, "Quite a lot of this 4.5% is represented by VAT and commodity prices", is there now not an argument to try and tackle the underlying inflation? Instead of leaving it at 2.5% or 3% once you strip out these things, is there not an argument to drive that down to a far lower level, thereby giving room for VAT and commodity prices to fill the gap to the target inflation rate?

Dr Broadbent: On VAT, I think it would be wrong to factor in anything other than the current rate. On commodity prices, it is tricky, because there is this conventional assumption—which I can quite understand; it makes sense in some ways—to if not hold them constant at least to match forwards in financial markets, to say we are going to take as given the expectation of future commodity prices elsewhere. We have had, basically since 2003, an upward trend and we think we understand the macro-economic causes of that; as I said, we've limited supply. Whatever they are globally, perhaps you might say we should allow something. I would imagine that there is something in the forecast already for that. I imagine part of the upside risk to inflation in the fan charts in the Inflation Report is there precisely to allow for this. It is a big decision then to say, "We are going to assume, as a central case, that oil prices are going to go up, commodity prices, 10%, 20% a year" and therefore policy should be tighter or something else should happen. It seems to me quite a big decision to go down that route.

Q20 Mark Garnier: Part of the commodity price problem is the currency: obviously commodity prices are priced in US dollars and we are in sterling currency; inflation is in sterling. There is an argument that goes that if you raise interest rates you will strengthen sterling to a certain extent and that will mitigate some of the commodity prices.

Dr Broadbent: It is true that the currency, in an open economy like ours, is an important part of the transmission channel of monetary policy. That is true in general. I don't think, as it happens, that the big falls in the currency we saw in 2008—predominantly the latter part of 2007—were driven by monetary policy, for what it is worth. But, yes, that would be the normal part of the transmission mechanism. What you are asking is the same as the questions before, in some sense: should we react to having got things wrong in a particular direction, given the lags in policy? That depends very much on whether or not you project the things that have gone wrong over the last couple of years to keep happening into the future. On some things I think it would not be the right response. I think we can understand that the VAT increases were genuinely one-offs. Another factor we haven't mentioned is—

Q21 Mark Garnier: When you say "one-offs", they were two one-offs?

Dr Broadbent: They were two one-offs.

Mark Garnier: Yes, okay.

Dr Broadbent: What I mean by "one-offs" is that it would be unreasonable to project them as things in perpetuity.

  Mark Garnier: Yes, sure.

Dr Broadbent: There are some other things that we haven't mentioned, like maybe the hit to economic capacity wrought by the financial crisis and a more limited output gap than we had anticipated. That too is something where, over time, we might expect normal productivity growth to resume, but we have to worry about what the implications are for the future and it seems to me the most difficult area is this commodity price. Do we assume— there are good reasons why you might want to do this—that that jump is a one-off, or do we assume it is part of an ongoing trend? That is the crux of the question you are asking.

  Beyond that, I don't think the high readings we have of inflation now necessarily tell you that they are going to be high after now.

Q22 Mark Garnier: Can we stick with interest rates? We are moving to a slightly different area.

Dr Broadbent: Yes.

Mark Garnier: Leaning against the wind, in terms of using interest rates to take the heat or the air out of, let's say, the bubbles, the ECB paper noted that, "Recent empirical and theoretical counterarguments shift the balance in favour of the view that leaning against the wind should not be disregarded on principle, even if the economic science is still divided on the issues". You say, in your answers to the Committee's questionnaire, that you are sceptical, "However the policymakers should aim to do much more than this in terms of the monetary framework, for three reasons", you then go on to it. Do you think the Bank of England should be looking more at how raising interest rates can take the heat out of bubbles? What is your view on this? Do you want to discuss your view?

Dr Broadbent: You will see that I gave a relatively long answer to that question in your questionnaire. Certainly you have to understand how policy works, as best you can, in order to get it right. As I mentioned, interest rates affect exchange rates, there are policy effects—in the short run at least—on a whole range of asset prices, including in the housing market or equity markets or wherever. I don't think that they are the best way to control identifiable bubbles. Even assuming you can identify what a bubble is and when it is occurring, in a small open economy like ours I don't think that domestic interest rates are really the best way to deal with it. I think I mentioned in that answer that much of the growth in the balance sheets of British banks in the last decade related to overseas assets. My own view is that the domestic monetary policy, while not quite powerless to affect it, couldn't have done much—first order—about what happened to those balance sheets, to the credit boom within them and to the subsequent crash.

  The risk would be that in seeking to affect that, you muck up what you are trying to do primarily with the inflation target. Therefore I believe the answer is to introduce a second lever, and we are doing that with the creation of the FPC.

Q23 Mark Garnier: Yes, I would like you to expand on that because obviously you note the FPC is better placed to react to domestic financial risk, but there is quite an interesting dynamic going on between the MPC and the FPC: the MPC has one monetary policy lever, which is interest rates—and I suppose QE—whereas the FPC has a whole load of levers it can pull, some of which, arguably, it can only pull in private because it might have an effect on markets. How do you see the dynamic working between the MPC and the FPC?

Dr Broadbent: I don't know yet which instruments the FPC will be using. It may be a matter of experience and time before it lands on one or two that are most useful, most transparent and so on. Whatever it does end up using, there is no doubt that what the FPC does will probably affect the economic environment in which the MPC operates. If it does something, say, to tighten or reduce the rate of growth of credit, or of banks' balance sheets, that may well affect domestic demand and the setting of monetary policy. The same goes the other way around. Having said that interest rates are not the ideal way to control this, they probably do affect things to some degree. Each affects the other and, therefore, it is important that there is at least communication between the two, and I believe the idea is to have each committee attend the other's briefing before the meetings.

  The fact that there is interaction, given that they have different targets doesn't matter per se. They can each operate independently, each to meet its own target, but given that they probably affect the optimal setting of the other's policy, they should communicate with each other.

Q24 Mark Garnier: One last question, again on the FPC. I am interested in your view on this rather than quizzing you on your ability to be a good member of the MPC. With the FPC there is going to be an element of stepping in to try and stabilise the financial system. Do you think it is possible that markets may factor in a reduction of risk? Because they are almost abrogating the risk element to the FPC to do that for them and, therefore, it will be slightly more risky because the FPC is there to step in and do it on their behalf.

Dr Broadbent: To some degree, I suppose, yes, but the FPC is being brought in at a time when we are also bringing in tighter regulation, better oversight and better practices, in many areas of banking. Maybe at the margin that is true, but I think we should see it in the context in which the regulation is being changed wholesale, in which capital ratios are pushed up by maturities, the funding is being extended, and so on. So I don't think it is terribly important next to what else we are doing.

Q25 Chair: You mentioned the output gap a moment ago. In your judgment, what proportion of the deficit is structural?

Dr Broadbent: If the output gap is 4%—and I say "if"; I choose that number partly because I have seen it a bit and it makes reasonable sense to me—given the sensitivities, it might give you a structural Government deficit of around 6% or 7%, something like that; 7% maybe of GDP, relative to the 9% or 9.5% that we had unadjusted.

Chair: So between two-thirds and three-quarters?

Dr Broadbent: Yes.

Q26 Mr Umunna: You wrote a piece in the Financial Times, I think in February, in which you said that on fiscal policy the Treasury is probably on the right course. Do you still hold that view?

Dr Broadbent: Yes, broadly speaking. There is always room for precisely different paths, but we faced in 2009-2010, as a result of the financial crisis, this monumental deficit. It was unsustainable. Much of that was structural and it had to be reduced. Broadly speaking, I think that is right.

Q27 Mr Umunna: Are you not concerned that the scale of the retrenchment is going to adversely affect overall demand, going forward, and could become self-defeating?

Dr Broadbent: I think it does have an impact. It is interesting; you can probably be quite precise about what it means to be self-defeating, which is "the multiplier". If it is more than 1 or close to 1 then it would be. My own view is that in an open economy like ours it is probably quite a bit less than 1. It is more than zero, so clearly in my view it has an impact on demand. It may be one of the reasons why growth has slowed a bit over the last few months—it may be.

Q28 Mr Umunna: The Chancellor, on the Floor of the House, has been quite clear that he will stick to achieving the fiscal mandate, within the time frame set out, in order to allow maximum flexibility to the MPC to loosen monetary policy in the event that growth slows. Do you envisage it being possible for the MPC to put in place a further rate reduction going forward? Do you see that happening this year or the next? A rate reduction, given that we are already on the floor in that respect?

Dr Broadbent: As you know, if there is a case for easing policy when bank rate is at or pretty close to zero then it is going to be QE that—

Mr Umunna: I was about to come on to that, but I am just working through the logic.

Dr Broadbent: Yes, there is no room for—

Mr Umunna: There is no room for a rate reduction?

Dr Broadbent: No, not from here.

Q29 Mr Umunna: Do you envisage circumstances in the next year where there could be a further round of QE?

Dr Broadbent: If the economy were genuinely to slow a lot. I have to say that is not my central expectation. You can think of certain risks involving another huge round of retrenchment in the banking system or the global economy.

Q30 Mr Umunna: Perhaps I can put it another way. Do you think a further round of QE is feasible and realistic if inflation is as per the Bank's central projection, given that QE is inflationary?

Dr Broadbent: The reason you would want to engage in another round of QE, were that to occur, is because you are concerned that over the medium term inflation would undershoot the target. That is why it would occur. It wouldn't occur for any other reason.

Mr Umunna: A central projection.

Dr Broadbent: Exactly. In other words, at the moment, given the central projection, which is of course one among a huge range on the fan chart, it doesn't look like there is a case for doing that currently.

Q31 Mr Umunna: If growth slows and is anaemic, inflation is as per central projection, and you have said a rate reduction is not on the agenda and QE, in the circumstances where inflation is as per the central projection, is also wrong—off the agenda—then what other things, what other levers, would need to be pulled in order to simulate demand?

Dr Broadbent: You have to be careful here. Suppose that were the case, and you are right to worry about it because I think one of the most surprising things about the recovery—and there has been a recovery—is that nominal growth has been fine and nominal GDP is growing quite strongly, but the split between real growth and inflation has been very disappointing. The supply side has looked very bad and on the face of it productivity growth is appalling, quite honestly; we haven't had any for 18 months if you look at output per hour. Very, very, very unusual. Maybe it is not accurate; maybe the numbers will be revised, maybe they won't be. The reason I begin with that is because the state of affairs in which that continues, in which inflation doesn't come down materially below target and, therefore, we can't ease monetary policy—and we shouldn't—yet growth is weak, can only be one in which underlying productivity growth is also weak, roughly speaking. We don't produce any more output gap. The trend rate of growth in the economy would be weak in that scenario and the normal prescription is to do stuff about productivity, and that is a long-term problem. I am not sure it is the job of cyclical macro-economic policy, whether monetary or fiscal, to do anything about that.

Q32 Mr Umunna: Policy makers, both on the monetary and the fiscal side, should just sit on their hands while my constituents get hammered by low growth?

Dr Broadbent: At the end of the day, our income is determined by our output. That is the function of our productivity. That is inescapably the case. It is also a function, unfortunately at that moment, of what we import; the price of what we import going up faster than the price of what we export. That too has been true. In actual fact, for all these various reasons, we have had weak income growth for years—even before we went into the recession; I think I am right in saying that. If I look at the five years from 2003 to 2008, the five-year period up until the beginning of 2008, average real income per household barely grew.

Mr Umunna: It has been fairly stagnant.

Dr Broadbent: It barely grew. We have been fighting against these trends of rising commodity prices and, more recently, weak productivity growth for quite a long time. Policy may well be able to do something about some of these things but I don't think it is the place of cyclical policy, which is designed mainly to try and keep output close to its potential rather than affecting that potential, to do much about that.

  In time I expect it to change. I am a reasonable optimist. I don't think the rate of growth of productivity, having been 2% for decades, is suddenly going to collapse.

Q33 Mr Umunna: Can I ask you a related question, but slightly moving on a bit, on your view of how the markets behave and react to quality decisions? We took evidence from the chief economists of HSBC, Barclays, the managing director of Capital Economics and a couple of economists from the National Institute of Economic and Social Research, and they said that generally their view was that the markets take a benign view of policy changes if those policy changes are made for economic and not political reasons. What is your view? Do you agree with that?

Dr Broadbent: Yes, markets are sometimes surprised by policy decisions.

Q34 Mr Umunna: Would we be in a situation in this country where if there were drastic changes in policy for economic reasons, the markets would punish us in the way that some have described them as punishing the Portuguese, the Greek and the Irish?

Dr Broadbent: Oh I see. No, not necessarily. In the case of those countries the market—

Mr Umunna: They are quite different from us.

Dr Broadbent: Quite. But the market there is worried, not necessarily about particular decisions but about whether, as a result of all sorts of things, the public finances are sustainable.

Q35 Mr Umunna: So comparison between us and them is quite absurd?

Dr Broadbent: In my own view, the single most important difference between us and them—because you might have said we run a similar structural deficit and a deficit, still do, so does a country like Spain—is that we don't have a fixed exchange rate and that has been an important difference. We have monetary flexibility. That has been an important difference but, as I say, I don't think it is individual decisions so much as—

Q36 Mr Umunna: The argument has been made that the markets take a very dim view of policy changes, regardless of the motivation.

Dr Broadbent: No, what the markets worry about is sustainability.

Mr Umunna: It just seems to me that it is an absurd position to say the markets will take a dim view if you don't change direction, or change your policy decisions, according to economic circumstances.

Dr Broadbent: I agree.

Mr Umunna: Because that would be an argument for never changing policy at all.

Dr Broadbent: No, I agree with that. The important consideration is: are the public finances—if that is what you are talking about—if anything, on a sustainable path and there may be different policies that meet that description.

Mr Umunna: Thank you very much.

Q37 John Thurso: In another article in the Financial Times, in February of this year, which was basically talking about the objectives of various members of the MPC, you are quoted as saying, "Some MPC members place sufficient risks on deleveraging in the banking system, but at the margin they are more concerned that nominal income should grow than on finding the appropriate balance between growth and inflation." Who did you mean and what did you mean?

Dr Broadbent: It is hard to say who, because I was genuinely thinking of some arguments—maybe I was wrong about them—or interpreting some arguments in the minutes or the Inflation Report. I wasn't intending to identify certain people and nor does that matter, really. I was identifying a train of thought that I could identify. I think the perception has been sometimes that because of the weight of this contraction in banks' balance sheets, and because of the potential costs of that in an economy with a large balance sheet, were nominal income to contract, the priority early on, in 2009 say, was just to get nominal income growing. You could make any reasonable assumption about productivity after that, which kind of determines how that nominal income is split between real growth and inflation. You would have said, "Okay, I am going to loosen policy a lot. I am going to get nominal income growing and I will be able to meet the inflation target".

What happened subsequently, as we know—partly because of commodity prices, partly because of VAT, partly because, apparently, our productivity performance was much less good than we had hoped or expected—is that a lot of that nominal income growth turned out to be inflation rather than real. What I was surmising, or trying to suggest, is that even if they hadn't wanted it in advance, some policy makers might think, "These price effects are temporary. A more important consideration, given what is going on with the banks, is just to keep nominal income growing". I don't know if that is still the case or not. I certainly think in 2009 and in early 2010, effectively, that may have been true of some people.

Q38 John Thurso: You would characterise it as an unintended consequence but, with hindsight, reasonably benign.

Dr Broadbent: It is not necessarily hindsight, but in early 2009 we were in an economy in which nominal incomes were declining. I can't remember when that had previously been the case but probably certainly before the Second World War. Both sides of the household balance sheets were big. Some people forget the asset side. That is also very big. If you have large gross debts in the economy and nominal income suddenly starts falling, that is quite dangerous; that sort of debt deflation very dangerous. So at that time, when our nominal GDP was falling, I think it was perfectly reasonable to say, "Well, our first priority is to turn that around".

When you are doing that, you might also think, "We probably will have inflation well below target if not negative as well, so let's do this". Later on, what I was suggesting is that as inflation turned up people may have clung to this additional de facto target to keep nominal demand in the economy going up, even though the split between growth and inflation was not turning out to be very favourable.

Q39 John Thurso: Do you think in that regard that the MPC has been misinterpreting its target?

Dr Broadbent: Let us not forget that the MPC does have some flexibility. This is not a target that is meant to be met at all times. Given the lags in policy, it would be difficult to do that without enormous disruption to other things in the economy. It has given what I think Charlie Bean has called "constrained discretion" in meeting its target. The way I have interpreted that is that in some instances, particularly if you get a nasty supply shock—a big jump in oil, a big drop in productivity—which you interpret as temporary, you might allow yourself a little longer to get back to target. In other words, this is not something where in every instance you should be at 2. It would be undesirable to aim to do that. I guess my answer to your question is that there is a balance between meeting the target over the medium term as you are obliged to but not meeting it in such a way as to cause unnecessary, or undesirable, disruption to the real economy.

Q40 John Thurso: Turning to a different topic. The Inflation Report, May 2011, notes that the corporate sector continues to run a substantial financial surplus. This is looking at the substantial uncertainties. It says there is a wider than usual range of views among committee members but this surplus suggests, "There is scope for higher investment spending, or possibly greater support to consumption if more of the surplus were to be distributed to households." What do you think would be the catalyst for the corporate sector to begin to lower the level of surplus?

Dr Broadbent: The first thing I should say, incidentally, is that if that is an aggregate number it probably hides a lot of variation. Although there are clearly some companies who do not have to borrow from banks, and whose spending is being depressed—if it is at all—just by nervousness or caution rather than by constraints in bank lending, I think there are signs for some companies, and for households, that the supply of credit is the binding constraint, and this Committee has spoken on that in the past. I don't want to take the position of the aggregate balance of the corporate sector as a sign that somehow there is one representative company and this is how it behaves.

Q41 John Thurso: Why was it in the Inflation Report then, in your view? I think you are right. My experience is that there are companies that have done well and have cash on the balance sheet, and they're saying, "Well, we'll sit in that position until we see which way the wind is blowing. We're safe, so why invest?" and there are other companies that are struggling, desperately need credit and can't get it from the banks. It hides myriad different circumstances.

Dr Broadbent: Exactly.

John Thurso: But why would the Inflation Report have put this in a paragraph and drawn attention to it in this way?

Dr Broadbent: Because it is very striking to have had such a large surplus. I have to say, it has been there for a long time. It was there before the crash, and the corporate sector has been in a financial surplus for the best part of the decade, as far as I am aware. I think that is right. But, yes, there must be at least some tranche of companies—one imagines they are the larger companies—who remain cautious about the outlook, are not constrained by the banks but are, none the less, investing less than you might expect them to.

I have always believed that these questions of confidence and caution are themselves reasonably cyclical, and if growth becomes well established then they will and then at some point there will be a question about how you restrain it. I think that is all I can say. If you are not constrained by bank lending, and you are investing less than you might otherwise be expected to because of the—

Q42 John Thurso: When you look at an increase in investment, as a sign you would look for of the economy picking up, what are the underlying views?

Dr Broadbent: It has been. Let us not forget it has been. This was, in fact, an investment-led cycle. We hear a lot about consumption, but consumption didn't do much and didn't grow that strongly before and hasn't fallen that much since. Credit is used to buy durable stuff and when you turned off the credit taps it was investment that took the big hit. It has come back quite a lot and the truth is that, given the pressures household income has been under, if demand is to grow strongly it is, as you say, in investment that we should look for the strongest growth to continue. I think that is a key area of demand, yes.

Q43 Chair: A moment ago, you said that the MPC may exercise constrained discretion in response to a supply shock, and that discretion can enable the MPC to take a decision to take longer to get back to the target than it otherwise would. How much longer?

Dr Broadbent: It is difficult because in the current scenario there have been expectations for that to happen quite quickly. So much of the inflation has been in the commodity-led areas, or indeed in VAT, and given the assumptions we make, at least those effects, reasonably, will dissipate within a year. As I said at the beginning, I think that the forecast for inflation currently is a reasonable one, and that forecast, roughly speaking, has us back at target in 2012.

Q44 Chair: To be clear, should the MPC be exercising constraint discretion now or not?

Dr Broadbent: I think different people on the MPC would have different views about that or the extent to—

Chair: I know, but I am asking your view.

Dr Broadbent: Yes, I understand that. I don't think it has to, quite honestly.

Chair: You don't exercise it if you just feel like it; you exercise it when you have to.

Dr Broadbent: No, I understand that.

Chair: I would like to know whether you think they should be now.

Dr Broadbent: What I mean is that they don't have to. We will be back at 2% next year, almost regardless of what policy does in the next three or four months, on any reasonable expectation, I believe. I don't think the question is material in terms of the current outlook.

Q45 Chair: I'll have a third go. Should the MPC be exercising constrained discretion now? There are two options; one is yes, one is no.

Dr Broadbent: I will try and answer it a bit more clearly. It should always exercise constrained discretion. The policy under which it is—

Q46 Chair: Before you go any further, you've defined "constrained discretion" to mean an observable response from the MPC in a decision to take longer to get back to the target.

Dr Broadbent: You want a definition?

Chair: Well, that is the definition you have given me.

Dr Broadbent: Yes.

Q47 Chair: I am happy with that as a working definition and now I am asking you: are we in that world now or not? That is what I am asking you.

Dr Broadbent: We are always in the world where it is entitled to use this discretion. I am trying to genuinely—

Chair: Are they exercising it?

Dr Broadbent: No, I don't think they are.

Chair: We are always in a world where a policeman may have a gun in his holster, but what we want to know is: is he entitled to use it?

Dr Broadbent: Yes.

Chair: Are we in it or not?

Dr Broadbent: Under certain circumstances, yes, he is entitled to. We are not, in the sense that—put it this way, the policy—

Chair: Should we be using it now?

Dr Broadbent: I am trying to answer. The policy you would follow if you were a rigid inflation targeter, I can't see as identifiably different from the one we are following now. Let me put it that way. Look at the forecast in the Inflation Report. Inflation is at 2%, at least on the market path for interest rates, which has a gentle rise some time out into the future. To me, that is not one where the MPC looks either to be exercising, or in need of exercising, this discretion.

Chair: It has taken a long time to get there but I detected the answer "No".

Dr Broadbent: Yes.

Chair: Is that right?

Dr Broadbent: Yes.

Q48 Chair: When you said, "Yes", you are saying, "Yes, the answer is, 'No'." Is that correct?

Dr Broadbent: I was saying yes, at all times it can, but it doesn't have to. That is what I said at the beginning.

Q49 Chair: Is it now? Should it be now? That was my question?

Dr Broadbent: It doesn't have to, is my answer.

Q50 Chair: In your judgment is the MPC exercising its discretion?

Dr Broadbent: My answer is no.

Q51 Chair: You defined the criterion that the MPC might use in order to assess whether to exercise that discretion, also in an earlier answer, so when you said that it should form a judgment on whether its actions would lead to an unnecessary or undesirable impact on the real economy—that was your phrase—

Dr Broadbent: That is the phrase I think in the remit, or something like that.

Chair: You are telling me that, in your view, the actions of the MPC at the moment, in order to ensure that we get back to the target in a timely fashion, will not lead to an unnecessary or undesirable impact?

Dr Broadbent: No, well that is certainly not the case. If you look at the Inflation Report forecast, it has inflation falling back to target, conditional on a path for interest rates that while not completely flat has an almost imperceptible upward slope. That doesn't seem to me a path for interest rates that is going to cause great disruption to the real economy and, none the less, there you are back at target, so, in that sense, yes.

Q52 Chair: Right. And you are happy with the forecast?

Dr Broadbent: Yes, the forecast is rather like the question earlier about—

Chair: You are in the forecasting business so it is a reasonable question.

Dr Broadbent: Absolutely, and as a forecaster, I know how easy it is to get things wrong. I am happy with that forecast, yes.

Chair: We have noted the very straight bat with which you have attempted to play every question, only scoring runs when you absolutely had to. We will discuss with colleagues whether any inadvertent snicks were taken, but thank you very much for coming before us. It has been a very interesting and revealing exchange.



 
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