Examination of
Witnesses (Questions 1-97)
Q1 Chair: Good
morning, Governor, Mr Bean. Thank you very much for coming before
us this morning. I know that you have a very busy schedule at
the moment, and that this was an additional meeting brought in
at short notice in response to the decision to reignite the QE
programme.
Can I begin by asking
you, Governor, how it came to be that the Monetary Policy Committee
moved from having eight out of nine members not wanting any QE
in September to a unanimous decision shortly thereafter, this
month, to go ahead with it?
Sir Mervyn
King: I think if you look at
the minutes of the September meeting, where we basically held
the position we had for a number of months, we came very close
to voting for asset purchases in September.
Chair: You were teetering
on the edge.
Sir Mervyn
King: Absolutely. The reason
we held back—
Chair: You were about
to fall over.
Sir Mervyn
King: No, not fall over. We
did not take the step forward and we did so because, at that September
meeting, we were very conscious that there had been significant
news in August, particularly in financial markets, and it could
have been that that was volatility that might reverse itself over
the next month. I do not think we felt that the underlying position
would improve but there was a possibility that the volatility
would dampen down. Basically, we were in a position in September
where, if nothing else changed over the following month, we would
then implement further asset purchases. The volatility did not
dampen down and we did not see a reversal of the asset price movements
that we had seen, so we followed through and took the unanimous
decision in October to resume the asset purchase programme.
Chair: So if we read really
carefully between the lines that September—
Sir Mervyn King:
Not in between the lines; it was actually in the lines.
Q2 Chair: So in
those September minutes we would have spotted that everybody was
lined up. I would like to move on if I may because we only have
an hour.
Governor, you said
in a speech recently, "The Bank should not take decisions
that discriminate between different sectors". Is that not
exactly what macro-prudential tools might have to accomplish?
Sir Mervyn
King: It depends on which macro-prudential
tools, and that of course is exactly the question that you in
Parliament will have to decide—whether you want to delegate
that power to the Financial Policy Committee.
Chair: But you are saying
that you do not want it.
Sir Mervyn
King: I say that, in principle,
we do not want it. I think the experience of both the European
Central Bank and the Federal Reserve has been quite marked in
that respect that, by being put in a position where the lack of
ability to co-ordinate between the Executive and the independent
central bank, which was very evident in both the United States
and in the euro area, put a lot of pressure on the central bank
to do things that it would have preferred not to do—it would
have preferred the Executive do—and then, subsequently,
they were heavily criticised for doing things which were the prerogative
of the Executive. What is important to us is that you in Parliament
decide what powers you want to give to the central bank. What
we do not want to do is to abrogate to ourselves powers that properly
ought to rest with elected politicians.
Q3 Chair: When
you list—as you did in the minutes of that September FPC
meeting—various categories of macro-prudential tools, one
of which is loan-to-value ratios, although we cannot tell from
reading it, you think some of these categories of macro-prudential
tools are appropriate and some you think are inappropriate.
Sir Mervyn
King: Some certainly go further
in the direction of making decisions that more obviously discriminate
among sectors.
Q4 Chair: As a
macro-prudential tool, do you think the Bank should have loan-to-value
ratios?
Sir Mervyn
King: The Committee has not
made a judgment on that, so I don't want to say what the Committee
would or would not want to have.
Chair: So they have no
view on this issue?
Sir Mervyn
King: They are discussing it,
and they will give a view to you and to the Treasury, in the course
of next year, as to what the Committee feels are the right instruments
that we should have. We have not made a decision on that as yet.
Chair: Why not?
Sir Mervyn
King: Because we are discussing
it. We have been asked to give our views by the spring of next
year and we shall meet that timetable.
Q5 Chair: When
you said the Bank should not discriminate between different sectors,
it may turn out that in the spring you will change your mind and
say we should discriminate between some sectors, and those sectors
may include ones for which a loan-to-value ratio tool is appropriate.
Sir Mervyn
King: There is a spectrum.
I don't think anyone on the Financial Policy Committee would think
it appropriate that we should discriminate among individual companies.
That is a key part of the—
Chair: Yes, but I am not
discussing companies. I know that that—
Sir Mervyn
King: That is the issue that
does arise when it comes to credit easing.
Chair: That was also mentioned
in the speech. It is not the issue I am challenging. I am challenging
the word "sector".
Sir Mervyn
King: Well, "sector"
as in motor cars versus consumer durables; I do not think the
Financial Policy Committee would be well advised to make judgments
that discriminate overtly among those sectors on those grounds.
Q6 Chair: What
about the housing market?
Sir Mervyn
King: The housing market, well,
it is a question there of the total amount of borrowing, much
of which may go to the housing market, but it is not specifically,
exclusively for that. Having a limit on the total amount of borrowing
in the economy does not seem to me, in and of itself, to be something
that blatantly discriminates between sectors.
Q7 Chair: Loan-to-value
ratios are more targeted than just a general restriction on borrowing,
aren't they?
Sir Mervyn
King: They are not discriminating
among individuals. It is a generic application of a restriction.
We will have to decide. I am not particularly enthusiastic about
thinking that we will achieve a great deal by imposing loan-to-value
ratios. I think this also gets fairly close to the supervisory
responsibility where the supervisors will have a view, quite clearly,
as to how many mortgages they want a particular bank to have that
is in a very high loan-to-value ratio.
Chair: It would be very
helpful if you could give us a clearer explanation in writing
over what you meant by "sectors", and if you could tell
us whether you think that this rules out certain types of macro-prudential
tools.
Sir Mervyn
King: The speech to which you
refer was not discussing macro-prudential policy; it was discussing
credit easing and monetary policy.
Chair: But the same point
applies.
Sir Mervyn
King: It does, but I think
that is something—
Chair: The fact that you
may have been discussing something else does not change the relevance.
Sir Mervyn
King: If you change the context,
then I would respectfully suggest that the Financial Policy Committee
should submit its views in writing and the Committee will do so,
but it is not for me to front-run what the FPC will decide.
Q8 Chair: Could
I ask you about the use of high-quality commercial bills? Until
2006, the Bank of England used to buy those or was willing to
buy them. It is often argued that the resumption of such purchases
would ease banks' liquidity problems and credit constraints on
SMEs. What has changed since 2006 that has made these purchases
undesirable?
Sir Mervyn
King: That programme did not
disappear because we decided to stop it. It disappeared because
the demand for it went right down, and the way in which money
market operations were implemented, there was no need for a programme
of that kind. One of the ways in which we can increase the liquidity
of a banking system is by increasing their reserves and asset
purchases have the effect of very significantly increasing the
reserves of a banking system. What really matters, in terms of
trying to improve SME lending, is to alter the incentives that
banks have to lend to SMEs.
Chair: It strikes me that
there too it might be worth having another look.
Sir Mervyn
King: At what exactly?
Chair: Commercial bills.
Sir Mervyn
King: We can certainly send
you a note on that if you would like.
Chair: Yes. I think that
would be helpful.
Q9 Jesse Norman:
When the Bank talks about Asset Purchase Facilities, or has done
in the past, is that the same thing as the commercial bill purchase
facility that the Chairman is referring to?
Sir Mervyn
King: No, the Asset Purchase
Facility was created in 2009.
Q10 Jesse Norman:
How is that working?
Sir Mervyn
King: Extremely well. We have
just started it again. We have purchased already £205 billion
of gilts.
Jesse Norman: Sorry,
you are referring to the quantitative easing?
Sir Mervyn
King: That is what the Asset
Purchase Facility is.
Jesse Norman: Yes.
I am talking about corporate debt.
Sir Mervyn
King: There are two schemes
that we have put in place there. One is the Corporate Bond Facility.
The other is the Commercial Paper Funding Facility.
Q11 Jesse Norman:
What is happening with the Corporate Bond Facility?
Sir Mervyn
King: The total of the two
facilities together, we have purchased £11 billion-worth
of bonds and commercial paper together. The objective of the scheme
was to reinvigorate the market so the market itself would start
functioning. When we began the scheme there were difficulties
in both markets. The spreads between the buy and sell prices were
very wide. There was a high degree of illiquidity. In the Commercial
Paper Funding Facility we bought £9 billion. That has now
run off. The market is working perfectly well, the same with the
corporate bond market. We purchased £2 billion. We have sold
£1 billion. We act there as a market maker of last resort
by setting limits on the spread, which we would then be prepared
to come in and intervene. It is still going and companies can
come to us at any point and either buy or sell, and that happens.
So that is working extremely well, and I think the proof of that
is that the issuance of corporate bonds and corporate equity,
in the period since we started, has been at record levels. We
have managed to achieve the objective, which was to ensure that
the market was functioning properly.
Q12 Jesse Norman:
There is not a parallel between that and the credit easing facilities
that the Government is currently contemplating?
Sir Mervyn
King: No. They are in the same
sort of family, but I think the key question is that for the asset
purchases with gilts the objective is to put money into the economy.
You test the strength of that by how much money you put into the
economy. The other facilities all have particular objectives to
deal with problems in the way the market is functioning. You need
to identify the market failure, work out what that is and identify
how you will overcome it. With our corporate bond and commercial
paper facilities, we identified the failure; we took action and
we corrected the failure. The issues about SME financing are rather
different. There are different failures there.
Q13 Jesse Norman:
Did the Bank ever look at using its corporate bond purchase facility
as a form of credit easing or to extend that to include credit
easing?
Sir Mervyn
King: In a sense, what we were
doing was credit easing because we were improving the functioning
of two of the most important markets for corporate finance, corporate
bonds and commercial paper.
Q14 Jesse Norman:
I suppose I am asking the question, why did you not do a lot more
given that the economy was in the dumps?
Sir Mervyn
King: We did not need to do
a lot more because the market failures we identified were corrected.
To spend a lot of money to no effect seems to me rather pointless.
Q15 Jesse Norman:
Why do you think the Government is now doing credit easing if
there is no point to it?
Sir Mervyn
King: Because it is looking
at SMEs, which is a different issue. I have raised the question
of SMEs with this Committee before and I raised it with the previous
Government.
Q16 Jesse Norman:
Did you contemplate the Bank ever using this kind of facility
to help SMEs before the Government took it up?
Sir Mervyn
King: There was no point doing
it for SMEs because SMEs are too small to find it easy or cost-effective
to issue large amounts of paper. The average employment of a company
that issues a corporate bond is 10,000 people. It is very expensive
to issue corporate bonds. It might be better if it were less expensive,
but the fact is that if you want to help SMEs you need to look
at the source from which they obtain finance normally, and that
is the banks.
Q17 Jesse Norman:
So you could not have adopted a credit easing facility with regard
to the banks in order to help SMEs?
Sir Mervyn
King: No. If you want to help
by using banks you improve the incentives that banks have to lend
to SMEs. I am all in favour of that, but that is for you to decide,
not for us at the Bank, but I can certainly see a case for it.
Q18 Jesse Norman:
Do you think that having a system that explicitly favours large
companies that have bonds and does not help small businesses that
don't have bonds is a form of discrimination?
Sir Mervyn
King: That is a function of
the way the market operates, not the way the Bank of England operates.
Q19 Jesse Norman:
But you said that you don't discriminate between companies and
sectors.
Sir Mervyn
King: And we don't.
Q20 Jesse Norman:
It seems you have a series of systems that are designed to help
large companies without touching small companies.
Sir Mervyn
King: No. I say you have to
identify the market failure. There were different market failures
for big companies and other market failures for small companies.
I drew the attention of both the previous Government and this
Government to the market failure affecting small companies. It
means taking action vis-à-vis the banks.
Q21 Jesse Norman:
It does seem to me that the Bank is very often motivated by a
desire to avoid criticism rather than a desire to address the
issue at hand.
Sir Mervyn
King: You may think that, but
that is completely false. What we believe it is sensible to do
is to identify the problem that exists in the market and correct
it, not just make gestures. What would you suggest we might have
done?
Q22 Jesse Norman:
I would suggest that if you had cared significantly about SME
markets you would be framing papers specifically designed to address
difficulties with SME funding and putting them to Government.
That is what we pay our experts to do for us, to give some good
advice.
Sir Mervyn
King: I did give good advice
to the previous Government and to this Government. You will see
the effects of that in due course on this one. The previous Government
decided that, although it owned two of the biggest banks, it was
not prepared to use that in order to help SMEs.
Q23 Jesse Norman:
Did you conduct any formal studies of the inflationary effect
of a second round of quantitative easing before you undertook
it?
Sir Mervyn
King: We certainly undertook
a study of the effects of asset purchases on both inflation and
activity and we published a paper on that.
Q24 Jesse Norman:
Did you come to the conclusion—you must have done—that
the inflationary effects were sufficiently small to make it worthwhile
doing on balance?
Sir Mervyn
King: It was nothing to do
with being small. Any monetary policy easing is going to have
the effect of expanding demand, spending, output and, ultimately,
inflation. That is what monetary policy easing was designed to
do. When we undertook the next round of asset purchases we did
it because, looking ahead, we thought there were real risks of
inflation falling below the target and we wanted to offset that.
Chair: We are going
to explore that in more detail in further questions.
Jesse Norman: Thank you very much
indeed.
Q25 Mr Mudie:
Governor, once again you take refuge in this business of "if
Parliament asks", but Alistair Darling, when he was Chancellor,
asked you to do a specific thing and gave you £50 billion
of Treasury money. Yes?
Sir Mervyn
King: No.
Q26 Mr Mudie:
Then you extended it in the next Monetary Policy Committee to
£150 billion, then £175 billion and then £200 billion.
But Alistair Darling was quite clear that corporate bonds, commercial
paper, syndicated bonds and a limited range of asset-backed securities
created unviable securitisation structures. The present Chancellor
asked you in his letter of 6 October, in view of the deterioration
in economic conditions described in your letter, to go ahead with
quantitative easing, which would include gilts and eligible private
sector assets, and specifically refers to "my predecessor's
letters of 29 January 2009 and 3 March 2009". I have indicated
what was in those letters. Why do you ignore these two requests
from Chancellors and spend this money on gilts?
Sir Mervyn
King: We did not ignore it.
The Chancellor knew perfectly well, then and now, that the vast
majority of the expenditure would be on gilts. I explained why
to them and I explained in the speech last week. We investigated
a range of other options. We identified some that we thought would
improve the functioning of markets and we implemented those and
we spent £11 billion on those facilities. Others we looked
at, and we tried very hard to persuade the market to work together
to produce a useful securitised instrument that could be used
for asset-backed paper, but in fact it proved very difficult to
do it. The market has not produced one itself. We encouraged them;
we put pressure on them to do it. We found no facility where it
would have been sensible or useful for us to spend money on that,
nor did the Treasury suggest one. We discussed it with them, we
explained what we were doing and there was no complaint at the
time.
Q27 Mr Mudie:
Why does the present Chancellor ask you to do something that you
have not done since 2009?
Sir Mervyn
King: He is asking us to do
what we are doing. The Corporate Bond Facility—
Q28 Mr Mudie:
No, he did not. He said to include gilts and eligible private
sector assets as set out in Alistair Darling's instructions.
Sir Mervyn
King: That is what we are doing.
Q29 Mr Mudie:
No, but your market notice, 6 October, "Asset Purchase Facility:
the MPC has decided on a further £75 billion of gilt purchases".
Gilt purchases. That is not what the Chancellor asked you to do.
Sir Mervyn
King: The existing Corporate
Bond Facility is still operational and the amount of money that
that is used for is over and above the £75 billion extra
limit. That is the difference. So we are able to purchase corporate
bonds without any restriction of that £75 billion.
Q30 Mr Mudie:
Mr Bean's two annual reports on asset purchases demonstrate that
out of £198 billion, something like £197 billion was
spent on gilts.
Sir Mervyn
King: No, it is not that.
Q31 Mr Mudie:
I think commercial papers were £0.1 billion one year.
Sir Mervyn
King: No. That is completely—
Q32 Mr Mudie:
I have the reports in front of me.
Sir Mervyn
King: Well read them carefully
because you might then understand them.
Q33 Mr Mudie:
I do read them carefully.
Sir Mervyn
King: Not well enough, clearly.
We spent £9 billion on commercial paper and eventually that—
Q34 Mr Mudie:
£9 billion out of £200 billion?
Sir Mervyn
King: Yes, because you couldn't
spend £200 billion on commercial paper, Mr Mudie.
Q35 Mr Mudie:
I am less convinced that you have the will, because there were
two instructions from Chancellors and you ignored them.
Sir Mervyn
King: That is completely false,
Mr Mudie.
Q36 Mr Mudie:
No, but the argument is not whether you dismiss Parliament or
Chancellors. The argument is that you are choosing a transmission
method that everybody in this room knows is not working for SMEs.
You are putting this money through gilts, and largely through
the banks, and we know the banks are reluctant to lend to SMEs.
You are continuing this despite, as the Chancellor says, the deterioration
of economic conditions, growing unemployment, growing bankruptcies
among SMEs, and you are sitting with this large amount of money,
approval from the Government, but you are ignoring the Government's
wishes.
Sir Mervyn
King: That is complete nonsense,
Mr Mudie. We are working closely with the Treasury on schemes
that will help SMEs through the existing banking system.
Q37 Mr Mudie:
No. Let us just have a last question on that. Are you denying
that you refused to do that credit facility work when asked by
the present Government?
Sir Mervyn
King: I certainly am, Mr Mudie.
It is absolutely complete nonsense.
Q38 Mr Mudie:
So the information in the Financial Times, detailed information,
is total nonsense.
Sir Mervyn
King: We have not refused to
do anything with regard to—
Mr Mudie: Sorry?
Sir Mervyn
King: I have told you before,
and I will repeat it once more if you will listen this time. We
have not refused to do anything which the Treasury has asked us
to do. I explained to the Treasury, before and after the general
election, what the different asset purchase schemes could achieve,
why we had designed them in the way that we did. We had investigated
some others where there were no appropriate assets that were eligible
for schemes that were sensible for us to undertake, and I explained
it to the then Chancellor and to the Treasury, and they accepted
that.
Q39 Mr Mudie:
There were about four issues.
Chair: Very quickly,
please.
Mr Mudie:
Credit guarantee, you withdrew. You did not tell Jesse Norman
that the commercial paper ends next month.
Sir Mervyn
King: There is a very good
reason why it ends next month.
Q40 Mr Mudie:
Of course there is a very good reason, but the Chancellor asked
you to do that and you are not doing it.
Chair: Let the Governor
reply.
Sir Mervyn
King: The Chancellor did not
ask us to keep it going indefinitely once it had achieved its
objective. The purpose of this scheme—I repeat it again—was
to make sure that a market that had been functioning, that had
become highly illiquid and was not working very effectively, that
we intervened to make it liquid and effective again. You do not
make a successful market by a permanent presence of a public authority
in that market; you undermine it, as happened in the housing market
in the United States. We achieved our objective and then we exited.
Q41 Chair: Governor,
you said a moment ago that you have not refused to do anything
asked of you by the Treasury. So if the Treasury do ask you to
take decisions to discriminate between companies or sectors you
will take them?
Sir Mervyn
King: I will discuss it with
them and the Chancellor has told me very clearly—
Chair: Is that that you
will do it or you will not do it?
Sir Mervyn
King: Well, he won't ask me.
The Chancellor has made it very clear to me that he thinks it
would be inappropriate for the central bank to make that kind
of decision.
Q42 Chair: That
is not the question I asked you. What you have said here is that
the Bank should not—not does not but should not—take
these decisions. But you are saying that, even though you think
they should not, you will change your mind if you are told to
by the Treasury. Is that correct?
Sir Mervyn
King: Well, he would have to
give an explicit direction to do it. But the Chancellor has made
it very clear he doesn't believe this is the function of a central
bank, and nor does the Federal Reserve or the European Central
Bank feel remotely comfortable doing this. I think it is important
to understand why central banks don't want to do it. I find it
very peculiar that it is the same people who are most worried
about the powers of the Bank of England after the financial crisis
becoming bigger and bigger who seem to be determined to push us
into doing things that are properly your responsibility.
Q43 Chair: Central
bankers, of course, like to take decisions and think they are
better at taking decisions than politicians who might be—
Sir Mervyn
King: Certainly not.
Chair: Who might be heavily
influenced by all sorts of short-term considerations, which is
why monetary policy was given to the Bank in the beginning. It
does strike people as surprising that, in another related area
with respect to this crisis, the Bank is deciding to withdraw
from the field entirely.
Sir Mervyn
King: No, it hasn't withdrawn
at all. What I am pointing out is that if you write down very
specifically and if you ask in legislation the Bank to take certain
responsibility, we will do it.
Chair: Right, that's
fair enough.
Sir Mervyn
King: But what I do not want
to do is to be seen to be taking decisions for which we have not
got any authority from Parliament, and then you turn round afterwards
when you don't like the consequences and say, "By what authority
did you take that?" That is the problem that central banks
have got—
Chair: That is very
clear. Thank you, Governor.
Q44 Mark Garnier:
I would like to have some focus on how the money gets into the
system. I think you have spoken a bit earlier about how you have
purchased £205-billion worth of UK Government gilts. What
is the process that you go and buy this? Are you going into the
initial IPO of the bond or are you going to the open market and
buying them like any other consumer of bonds?
Sir Mervyn
King: We organise a series
of auctions. So we announce a programme of auctions, which we
have announced now until the New Year. So everyone knows well
in advance when the auctions will be. We announce, say, two or
three a week. We announce the size of the auction each time and
we announce the gilts that we will take at that auction. So typically,
what would happen is that people who own gilts at present would
sell to a market maker and the market maker would then take part
in the auction. Then we publish the results of the auction immediately
afterwards. That is the process we have used since 2009.
Q45 Mark Garnier:
That will have an effect on the price of bonds because you are
in there?
Sir Mervyn
King: It will have an effect
on the price of bonds, but primarily our view is that the idea
is that the people who sell bonds to us receive money in return.
That money they will then decide to reinvest in others types of
securities.
Q46 Mark Garnier:
This is an important point. That is not necessarily the Government
issuing the bonds. It is you going into the open market?
Sir Mervyn
King: Absolutely, and if we
buy directly from the Government that will be against the European
Treaty.
Q47 Mark Garnier:
Brilliant. That is very clear.
My next question
is can you give us a flavour of what is the maturities of these
bonds, in terms of the range of maturity and what the average
maturity is of your holdings?
Sir Mervyn
King: The entire range, we
divide the maturities into short, medium and long and we divide
the auctions evenly across that. So we stay away from the very
short term, below three, in maturity and we buy evenly pretty
well across the spectrum in the others.
Q48 Mark Garnier:
So you have nothing shorter than 3-year gilts and then it goes
all the way out to 30year?
Sir Mervyn
King: Yes.
Q49 Mark Garnier:
Where I am going with this and what I am trying to get is a flavour
of how you reverse this position, because of course quantitative
easing to be QE and not money printing has to be reversed. What
I am curious about is how you go about selling those bonds back
to the market. Do you wait for them to mature or will you sell
them back into the market when the market condition is right?
Sir Mervyn
King: It depends on when the
Monetary Policy Committee decides that it wishes to tighten monetary
policy.
Mark Garnier: Of course it does.
Sir Mervyn
King: The method we would use
is basically just to reverse what we are doing now—to announce
a programme of auctions, to announce that we would sell evenly
across the spectrum in those auctions. So, just put it into reverse.
Q50 Mark Garnier:
So you would sell. You would not wait for them to mature?
Sir Mervyn
King: No, but if the Monetary
Policy Committee decided not to tighten until the first one had
matured, then obviously, by default, one would have matured. The
first one we own matures in 2013.
Q51 Mark Garnier:
Thank you. That is very interesting. So when it comes to the maturity
of that bond it is not inconceivable you may refresh by taking
the money back in then buying; going back into the marketplace—
Sir Mervyn
King: That is conceivable,
and that is what the Federal Reserve has done with some of their
transactions. It is up to the Monetary Policy Committee at the
time to decide what it wishes to do.
Q52 Mark Garnier:
My final question on this is, and I would like you to discuss
this, but briefly. The Government currently has about £1
trillion-worth of Government debt and is anticipated to raise
it to £1.5 trillion in order to deal with the problems between
now, that is 2016. At some point you have £260 billion to
£270 billion, when you have done this, of Government debt
that you will want to be selling into the market. You are going
to be in quite a lot of competition with the Government, because,
of course, a lot of Government debt is maturing so it has to refresh
it. So it is going to be selling £600 billion of gilts into
the market over the next four or five years and at some point
you are going to be trying to sell £275 billion. First of
all, there is going to be a perception that you are competing
against the Government for the market. The second point is a more
general point, which is that if the market stops believing that
you are going to unwind your quantitative easing book then it
will become the printing of money and is that not an inflationary
problem?
Sir Mervyn
King: That will depend on what
else is happening to the amount of money in the economy at the
time, but there is no doubt that when we come to sell the assets
the consequence will be to push down the price of gilts and force
interest rates up. But that is exactly the objective of the tightening
of monetary policy. So at that point we would only want to do
it if we wanted interest rates to go up, so that tightening would
be the appropriate thing to do. Now the scale and the magnitude
of the sales would obviously depend on whatever else was happening.
But there is no doubt that when we come to sell, other things
being equal, it would be more likely to push up long-term interest
rates. But that is exactly one of the consequences of monetary
tightening.
Q53 Stewart Hosie:
When the Japanese did this in 2001 they had a stated objective—
Sir Mervyn
King: Sorry, I missed the first
part.
Stewart Hosie:
When the Japanese introduced their QE programme in 2001 they had
a stated objective of accelerating credit, encouraging more bank
lending. Bank lending fell throughout the entire period that their
special measures were implemented and expanded. When QE1 happened
here, bank lending fell every single month of the year following
February 2009 when the purchases began. What confidence will we
have that QE2 would do anything else? Will we see an increase
in bank lending as a result of this at all?
Sir Mervyn
King: I think the fall in bank
lending would have been worse had we not conducted our asset purchases
because what we were doing was injecting money into the economy
and what the banking system has been doing is destroying money.
As they reduce the size of their balance sheet and deleverage,
they are reducing not just the size of their assets but the size
of their liabilities. Most of the money in our economy—broad
money—comprises liabilities of banks in the form of bank
deposits. So what we were doing was partially to offset what would
otherwise have been an even bigger contraction.
Q54 Stewart Hosie:
So is this £75 billion the same? Is this simply hiding the
erosion of money through the impact on bank balance sheets you
have just described, in a way?
Sir Mervyn
King: It is certainly limiting
it and it is unclear exactly where the deleveraging process will
stop. The leverage ratio of our banks when we started this programme—when
the crisis hit—was over 40 to 1. That is an astonishing
figure. It is now down to 20 to 1. That is better. I would like
it to go lower in terms of the long run, but I suspect it will
decline a little but much more slowly. Indeed, if you look at
the figures on total lending to the non-financial sector they
are not falling any more; they are flat. So I think we are beginning
to see some slowing of the deleveraging process. But I think you
can see that one of the reasons why we were so keen to resume
the asset purchase programme is that, when we started in 2009,
we had expected then that the banking system would be in much
better health than it is now. The premium that banks are paying
to get funding over and above bank rate has not really narrowed
since the beginning of 2009.
Q55 Stewart Hosie:
That is helpful, but what you are really saying is you are not
confident at all that another £75 billion will result in
any significant or any additional bank lending into the real economy?
Sir Mervyn
King: It depends on your definition
of "additional". I can't guarantee that it means that
bank lending will rise. What I do believe is that it won't fall
as far as it might otherwise have done and it may start to rise
now; we will see. I think the action will make a difference to
the amount of lending, but it certainly does not guarantee that
lending to the real economy is positive.
Q56 Stewart Hosie:
You are a central banker and not a politician, but I will ask
the question none the less. The £200 billion had the impact
of perhaps 1.5% on inflation. The £75 billion will have some
kind of impact. We understand that in the real economy, particularly
the SME sector where they can't get financing but they are seeing
inflationary costs, they might begin to ask, "Why on earth
are we doing this?" Why on earth are you doing this when
there is no discernible positive impact in the real economy, but
it is driving inflationary pressures?
Sir Mervyn
King: I am asked this question
a lot by SMEs when I go round the country talking and I give a
two-part answer to it. One is to say that any action we can take
that will boost demand and spending in the economy will help SMEs.
Anything that will improve the economic position will help SMEs.
The second part of the answer is to deal directly
with the very evident problems that they are facing in terms of
a contraction of the supply of credit, and I have absolutely no
doubt that that has occurred. I think you have to go back to the
proposition that only the banks are in a position to assess credit
risks with SMEs. What we have to do is to find ways of giving
incentives to the existing banks in order to lend more. If we
were to set up a new institution tomorrow it would take 18 months
to two years before it would be in any position to assess credit
risks and start making loans. We need to use the existing banking
system and soon, and I think there are ways of doing that and
we are trying to give some advice to the Treasury on that. Of
course, the Government still does own two of the biggest lenders
in the country.
Q57 Stewart Hosie:
Just one final question, getting away from the banks.
Chair: As quickly
as possible, please.
Stewart Hosie:
Yes. In your quarter 3 Quarterly Bulletin you did say that
the purchases previously were "targeted towards long-term
assets held by non-bank financial institutions, like insurers
and pension funds, who may be encouraged to use those funds to
invest in other riskier assets like corporate bonds and equities."
Is that measurable? Did that work to any significant extent? Did
the non-bank financial institutions invest in those areas in the
way you have anticipated?
Sir Mervyn
King: Yes, I think we can see
that some of the risk premium did narrow. One of the things that
matters most about asset purchases is that once the money gets
into the hands of the private sector, whether it is pension funds,
insurance companies, any other kind of fund, they then choose
what to buy. They have the ability to buy a wide range of "risky"
assets and reduce the premium of the return on those assets over
bank rate. The benefit of that is that many of those riskier assets
follow securities that are issued by companies when trying to
finance themselves. So yes, we do think there is a benefit in
that direction. Of course, any empirical study is bound to be
subject to the difficulty of, "Well, we can't prove what
would have happened if we had not done it." But I think we
feel that the data are sufficiently encouraging, and I think it
makes sense to believe that the circumstances in which these asset
purchases would be most effective are really the circumstances
in which the wedges between the return on Government assets—gilts—and
the returns on risky assets are at their highest because then
there is bigger scope for compressing the risk premium and reducing
the cost of finance for those institutions that issued the securities.
Q58 Mr Love:
Governor, can I come back to the first question that the Chair
asked and amend it slightly to ask you, why did the MPC undertake
quantitative easing now? Why did you not do it months ago?
Sir Mervyn
King: I think we felt that
there was a serious question of the balance of risks, and one
of the things that has been concerning us—and I think many
members of your Committee—over the last year has been whether
the experience of inflation persistently above the target might
lead inflation expectations to move up, and that that would cause
some real problems in trying to bring inflation down later on.
As time has passed, I think what we have seen is that there has
been very little evidence that inflation expectations in the long
term have risen—they seem to be fairly well anchored—and
perhaps most compellingly that wage increases have remained very
subdued. I think the evidence on that, particularly as it came
through in the late spring and through the summer, played a major
factor in people feeling that the balance of risks had shifted,
which is why we were much more inclined to contemplate this once
we got to the end of the summer. But I think the thing that really
made the big difference was a change in the outlook for Europe
and the world economy. There were signs of slowing not just in
Europe but in the US and China, but particularly the outlook for
Europe deteriorated with very sharp falls in business and consumer
confidence, and we felt this would have a material impact on the
outlook for overall demand in the UK economy. As I said, in September
we had pretty much reached that judgment but we just felt that
perhaps things might improve; perhaps there might be some solution,
albeit temporary, to the problems in the euro area that would
lead to a restoration of confidence, but of course we have not
seen that.
Q59 Mr Love:
Isn't one of the criticisms that are now made of the bank that
there were signs of a significant slowing in the domestic economy
well in advance of what has happened in the euro, well in advance
of any indications that the world economy was beginning to slow?
Shouldn't you have taken action knowing that that was happening?
Sir Mervyn
King: As I said, I think the
reason we did not is that we were trying to balance the risks
between the problem that inflation was high and rising, that that
might affect inflation expectations. Normally, when I come to
this Committee one of the first questions is, how can you possibly
contemplate easing policy when inflation is so high and rising?
We have to balance these risks and when we felt the risk change
then we altered our view.
Q60 Mr Love:
It was absolutely clear from all the Chancellor's statements that
not only was he not going to introduce a plan B, he wasn't even
going to introduce a plan A plus, and therefore the only one-club
golfer available to the economy was QE. Didn't you read the signals
from that with the domestic economy slowing and likely an austerity
bearing down on it that, regardless of what was happening internationally,
action had to be taken?
Sir Mervyn
King: The international picture
is highly relevant because going through a rebalancing we are
not looking to domestic consumption to drive a recovery; we are
looking to net exports and the world economy had actually picked
up encouragingly. Then the situation changed, and I think the
great virtue of monetary policy is that you can alter monetary
policy very quickly when the data change and that is what we did.
Q61 Mr Love:
If I may say so, I understand why you are covering yourself at
a time when inflation is at 5.2% and you are predicting that it
will come back to 2% in the two-year time horizon. I understand
why you need to be absolutely certain. But you said at the time
of your interviews, after the latest meeting of the Monetary Policy
Committee, that we are facing the most serious financial crisis
we have seen since the 1930s. Was that an appropriate time to
introduce QE, or should we have been thinking in advance that
maybe this crisis was coming down upon us very quickly?
Sir Mervyn
King: I don't think the scale
and the immediacy of how the problem deteriorated in the euro
area was obvious at the beginning of the summer. Indeed, even
on 21 July there was the package that they held out as being the
solution to it. Now, the underlying problems had not changed at
all and they won't change. The aim of the measures to be introduced
over the next few days is to create a year or possibly two years'
breathing space, but the underlying problems still have to be
resolved. But the deterioration in business and consumer confidence
and in the data in the euro area was very marked during August
and everyone looked at this and said that, whatever view you held
at the beginning of the summer, you should hold a somewhat different
view at the end of the summer.
Q62 Mr Love:
One final question.
Chair: A very quick
question and a very quick response, please, Governor.
Mr Love: Recognising
the deterioration in the economy, accepting some of the criticisms
about the effectiveness of QE, will you be back at the Monetary
Policy Committee with an extra £25 billion, an extra £50
billion, an extra £100 billion, to address the problems in
the economy in the future?
Sir Mervyn
King: We will do what we feel
is appropriate at the time, and if we felt that doing more last
month was the right thing we would have done it. So, we will see.
The whole point is that you make these decisions one month at
a time.
Q63 John Mann:
Governor, this £75 billion figure, is this carefully calculated
or is it plucked out of the air?
Sir Mervyn
King: It is not plucked out
of the air. It is based on the study that we carried out on the
earlier asset purchases, and perhaps Charlie could explain the
basis of the study and the certainty around it.
Charles Bean:
Obviously, the article that we published in the Quarterly Bulletin
tries to draw lessons from the first round of asset purchases.
We think we have a pretty good handle on the immediate impact
on an array of asset prices, gilt yields down about 100 basis
points, corporate bonds, investment grade 75 basis points, high-risk
corporate bonds 150 basis points and so forth. Following that
through, it is the impact on activity and inflation that inevitably
becomes a little bit harder to do, but we have made our best stab
using a variety of methods. They suggest the impact of the earlier
purchases on activity was something like 1.5% to 2% of GDP, and
on inflation—as was mentioned earlier—something like
maybe 1.5%, being the peak impact on inflation.
As regards the second phase that we have just started,
we think it is reasonable to think that it would have a roughly
equivalent effect, prorated of course, as it is only a fraction
of the earlier £200 billion purchase. We are using that as
a guideline for the likely impacts. But we may learn as we go
along that the effects are smaller or larger than the first round
impacts.
Q64 John Mann:
You have had the advantage as being able to analyse for several
years now and you have many clever people analysing. So you are
saying inflation, the cost of this, is going to go up another
1.5%?
Charles Bean: Not
from here and, remember, the 1.5% is for the £200 billion,
so prorated, so—
Q65 John Mann:
How much more inflation will be created and how many jobs will
be created and what will the difference of employment levels from
this £75 billion—
Charles Bean: Well, £75 billion
is, what, about a third of £200 billion, so that is 0.5%
on inflation, relative to what it would otherwise have been, and
somewhat more than 0.5% on GDP, relative to what it would otherwise
have been.
Q66 John Mann:
What will that mean in terms of employment levels?
Charles Bean: Exactly how much
that feeds into employment is one of the uncertainties at the
current juncture. One of the things—
John Mann: No.
You have had the chance to analyse because this is not new, so
you are able to project based on what is happened before, so how
many jobs? What will the impact on employment be from this QE?
Charles Bean: Roughly speaking,
you might expect that if output goes up 0.5% employment will go
up 0.5%, as an approximate rule of thumb. However, in practice
at the current juncture—and there is uncertainty about that—one
of the things that we have not understood particularly well through
this downturn is the behaviour of productivity. Normally, what
happens in downturns is that businesses hoard labour in the downturn
and then when the economy recovers unwind that, so higher output
might not lead to so much employment growth. However, the peculiar
thing in the past 18 months or so is that, although productivity
fell quite sharply during the downturn—and therefore, we
wouldn't have expected much employment growth—over the last
year and a half or so employment has grown surprisingly strongly
and roughly in line with output. If that continues to be the case,
as a result of this QE injection, then there will be a more beneficial
employment impact—
Q67 John Mann:
So, therefore there will be—
Chair: It will have to be the last question,
John.
John Mann: Therefore, there will
be higher employment than you would have projected previously
because of the change in productivity. My point is this can now
be analysed. If those outcomes don't occur, if inflation is higher
than you are saying it will be, say in 18 months time, and if
we don't have these new jobs in the way you are projecting, Mr
Haldane is suggesting today there needs to be a direct link between
bankers' bonuses and performance. Governor, is it not right that
there should not be questions asked about the performance of the
Bank, and what sanctions should there be if we don't get this
performance based on this strategy?
Sir Mervyn King:
That is entirely for you and your Committee. It is not for us
to decide how we are assessed or what sanctions there are on us;
that is for you.
Chair: We will give it some thought,
Governor.
Sir Mervyn King:
Thank you.
Q68 Andrea Leadsom:
I think it is very easy to get into a £275 billion gilt purchase,
as we have done over the last few years, but what about getting
out of it? I would just like to understand: if I was a bank and
I had bought £275 billion-worth of gilts from the market
at market rates, I would have to mark them to market everyday
and I would be showing on a daily basis massive losses, massive
profits, depending on the markets. Is that exactly the same as
it works in the central bank, or how exactly does that work and
where is the liability taken if there is a huge loss or the benefit
if there is a huge profit?
Sir Mervyn King:
We publish accounts regularly and they show the mark to market
profit and loss. I don't think we feel that is terribly relevant
because these are securities issued by one part of the public
sector and held by another. So, if the Government marked to market
its liabilities they would offset each other. But eventually we
will come to sell these and you will see the prices at which we
sell them. There will be a final set of accounts; you will have
all that information. As I explained earlier, the challenge will
be to just reverse what we are doing now, to have a series of
auctions. That is why we said before that when the time comes
to tighten policy we would expect the first move to be a rising
bank rate, and when we were confident that we were in a period
where it was appropriate to tighten policy then we would put in
place a programme of auctions over three to six months, as we
are doing now, and then the process goes into reverse.
Q69 Andrea Leadsom:
So, just to be clear, I completely understand the Government's
liability matches off against the Bank's asset—that is absolutely
clear—but you are not talking about holding them entirely
to maturity.
Sir Mervyn King:
No.
Q70 Andrea Leadsom:
So that you will be taking a market risk in the meantime and it
is entirely conceivable, isn't it, that there could be an enormous
profit or loss if you come to sell them in the open market?
Sir Mervyn King:
Yes, although that of course will be exactly offset by the mark
to market profit or loss that the Government has earned on issuing
those liabilities, because this is not the public sector issuing
a security to the private sector, where there is a gain and loss
between the two sectors. This is entirely within the public sector.
Q71 Andrea Leadsom:
So if you then reach a point where, as you say, you have raised
market rates and then you decide to start selling gilts into the
market, what will be your determining factor? For example, will
you be taking into account that if you raise base rates that hits
mortgage owners, whereas if you simply sell gilts back into the
marketplace that might not hit base rates, so all those who have
mortgages linked to base rates will not suffer as a result? Is
that going to form a part of your thinking or will you simply
be working to an appropriate model that you have pre-agreed?
Sir Mervyn King:
No, I think that will be for the Monetary Policy Committee at
the time, and I don't want to prejudge what it would want to do.
As I have said, the one thing we have said so far to guide the
market is that we would expect that the first tightening move
would be a rise in bank rate but that, thereafter, the Committee
would have to make a judgment and it would announce the programme
of auctions that is has. In either way, whichever instrument we
use, I would expect to see the yield curve as a whole shift up
when we started tightening policy. So, I don't think it would
have much difference between the impact on people taking out loans
of different maturities; I think what you would see is the whole
yield curve would shift up because your—
Q72 Andrea Leadsom:
Except that it is true to say, isn't it, that if people have loans
that are linked to base rate and base rate only moves by a small
amount—even if the yield curve shifts—if their loans
are still linked to base rate that would protect certain loans
in the economy?
Sir Mervyn King:
It would, although I think it is very likely that the Monetary
Policy Committee would think of a programme in which it would
be balancing movements in bank rate with movements in gilt sales.
Of course, as soon as you get away from the immediate very short
overnight maturity you would expect the whole yield curve to start
to shift up, affecting the interest rates at which banks could
borrow and finance mortgages.
Q73 Andrea Leadsom:
To what extent have you speculated forward the speed at which
the day you start selling gilts the markets are going to pre-empt
you and shift the yield curve up and, therefore, it will become
harder to place those gilts in the market? Have you done some
forward thinking about the relative speed with which the market
will be on top of this, once you start selling?
Sir Mervyn King:
I don't think it is a question of being difficult to sell it to
the market; the price will adjust so that we can sell it. I think
this is an important question, but it is a question that always
comes when you start to tighten monetary policy, even if you just
do it by raising interest rates. Indeed, if you look back at episodes
when monetary policy starts to tighten there is always the question
that the first tightening is a pretty big signal that the direction
of policy has reversed and then you see the effects right across
the yield curve. If you are not careful then, that can be too
large to be something that you would like to see in the first
tightening move, but you clearly want to see some impact. I think
that is a question that all central banks worry about and they
think about it in the context of the circumstances when they are
trying to tighten policy, but it will be an important question.
Q74 Andrea Leadsom:
Wouldn't you agree, though, that the facts that we have as a one-off
experience—this £275 billion of assets to sell—it
is going to be a uniquely problematic time when you do decide
to shift monetary policy towards tightening? It will be almost
a uniquely impossible task to try and manage your way out of this.
Sir Mervyn King:
I am not sure, because when the time comes to sell the assets
we will be right back into what we were in in the 1980s; then
it was called overfunding. The consequences of what we would be
doing when we were to sell gilts would be absolutely identical
to what the Government did in the 1980s with overfunding. You
can think of that another way. What we are doing now is underfunding.
So the amount of gilts being sold into the private sector would
be, when we come to sell, more than the Government needs to issue
to finance its borrowing. Now it is less. Therefore, although
people get terribly excited about the words, I just don't think
this is unique. I think this is a long history in monetary economics
and we have done it before, even though the words have been rather
different.
Chair: I think funding is a problem we
probably would not mind having at this juncture, but unfortunately
we are stuck with what we've got.
Sir Mervyn King: No,
indeed; look forward to it.
Q75 Mr Ruffley:
Governor, with inflation at 5.2%—it is the highest since
the early 1990s—do you accept that this is having a crippling
effect on household incomes?
Sir Mervyn King:
It is the same inflation rate as in 2008, technically true, but
I certainly accept that what is happening in the economy now is
a very large squeeze on household incomes. Real take-home pay
has fallen by more in the past two years than any time in living
memory. That is not the result of inflation being high; inflation
is the symptom. The causes of that squeeze on living standards
are real causes. They are a change in world prices of energy and
the utility prices of gas and electricity at home. They are the
consequences of higher Value Added Tax, higher food prices in
the world, and the consequence of a fall in the real exchange
rate, which was necessary to enable us to be able to rebalance
our economy in the way that was vital after quite a long period
of a relatively overvalued exchange rate. All of these things
were inevitable and the only question was, at what inflation rate
should we see the squeeze coming? But that squeeze was the result
of factors that were real factors, which I don't think the UK
could have avoided.
Q76 Mr Ruffley:
You say they could not have been avoided, but the question this
Committee has is, could it have been reasonably forecasted? I
just ask you, as Governor, do you feel any responsibility for
letting inflation get out of control because we have a lack of
price stability now? It is well over 5%, inflation. This is undermining
confidence in the British economy, consumers and households. Do
you accept any responsibility for it spiralling out of control?
Sir Mervyn King:
We certainly accept responsibility for not pushing up interest
rates very sharply earlier this year and last year, in order to
keep inflation closer to the target, yes. We did that because
we were faced with a difficult decision, but we felt it was better,
given that the squeeze on real incomes could not be avoided, that
the only alternative to doing what we did was to push the economy,
quite deliberately, into a deep recession with a high and rising
unemployment. I think that would have made a bigger squeeze on
real incomes and I am absolutely confident—I think this
is the key point for us—that if we had done that and inflation
were a little lower today than at the 5.2%, that come next year
you would be giving us a very hard time for having got inflation
to the point where it suddenly went way below the target once
these temporary factors dropped out of the inflation measure.
I think then I would have been saying to you, "Well, if you
want us to try and keep it as close to 2% as possible all the
time then we are going to have a zigzag strategy," and I
think we avoided the zigzag. Now it is very uncomfortable and
we are not at all happy that inflation is at 5.2%. But as I said
last week, I think we do believe this is very close or at the
peak, that it will come down sharply next year. It is quite hard
to come up with any reasonable argument that would suggest it
would do anything other than that. I think then we will be in
a position where we can say to you, "Well, we didn't push
the economy into a very deep recession and end up with inflation
well below the target."
Q77 Mr Ruffley:
Understood, but we have evidence from you that the first round
of QE pushed up inflation, and there is another round of QE that
you have just announced. Therefore, could you explain to us the
sequence of events, if you would, that will deliver your forecast
of 18 to 24 months from now, inflation back at target, because
you are forecasting a very significant fall to around 2%? What
we would like for you to do is just to explain the sequence of
events from now to then.
Sir Mervyn King:
The first thing that will happen, as we go into the new year,
is that the effect of the increase in VAT last January will disappear
from the 12-month window, which is used to calculate inflation.
So, inflation is the measure of increase in prices over the previous
12 months. As we move forward in time, some of the price increases
that came in this year will drop out of that comparison. We will
see that some of the large energy price increases and food prices
at world level drop out. Commodity prices have started to fall
back. As a whole, energy and commodity prices in the world have
fallen about 10% to 20% over the last couple of months. They had
been rising at 30% to 40% a year. Once those things start to drop
out of the window there will be a further fall back. That will
carry on until the end of the year when towards the end of next
year, 2012, the increase in gas and electricity tariffs, which
came in in the last couple of months, will also drop out. On top
of all that, gradually through the next two years, what seems
to us a pretty large degree of spare capacity in the economies
and still very subdued wage inflation—wage inflation is
running at a rate well below the level that we would normally
consider consistent with a 2% inflation target. So, as Charlie
pointed out earlier, there is a lot of uncertainty as to what
will happen to productivity, but given those factors we would
see, as the window moves forward, a number of the price increases
that have contributed to the 5.2% will be disappearing and they
will not be replaced by equally large increases in prices.
Q78 Mr Ruffley:
Final question, the—
Chair: There are more colleagues who
want to come in and I know that you are pressed for time, so a
very quick question and reply.
Mr Ruffley: Just a short one.
A lot of us are concerned about the forecasting record of the
Bank of England. If you had to score on a scale of 0 to 10, what
would you give yourself for the last three years in terms of your
forecasting record?
Sir Mervyn King:
I am not going to score ourselves. That is for you and the others
to do.
Q79 Mr Ruffley:
Five, six, seven?
Sir Mervyn King:
But I will point out that most of the reasons—
Q80 Mr Ruffley:
Go on, Governor, between 0 and 10, how well do you think you are
doing?
Sir Mervyn King:
No, I am not going to do that. No. It is not my job to examine
myself. It is your job to give us—
Q81 Mr Ruffley:
You don't examine your own decisions?
Chair: We will take that as well as an
invitation to take a look at that at a subsequent time.
Sir Mervyn King:
Thank you very much. We do have to move to the airport pretty
quickly.
Chair: Yes. We have a couple more colleagues
who want to come in quickly. We did start a moment or two late,
but we will get you to your plane on time.
Sir Mervyn King:
Good.
Q82 John Thurso:
Governor, I want to ask you a question about SME lending, but
can I very quickly ask you a question relating to risk? The Greek
situation has shown that sovereign debt is not entirely without
risk. The Bank of England now holds a great deal of British sovereign
debt. What credit assessment do you undertake on that?
Sir Mervyn King:
I think with a credible medium-term fiscal plan, and if you look
at the market's assessment of it, this is the first time that
the credit default swap premium for the UK is well below that
of Germany.
Q83 John Thurso:
I am sure that is something we will come back to in due course.
Can I turn to SME lending? What impact did QE have on SME bank
lending, if any, in the first round?
Sir Mervyn King:
It is very hard to judge because we don't know what would have
happened had we not carried out that, but I think that any action
of a monetary kind that would stimulate demand and spending in
the economy will have helped SMEs. So, it did not tackle directly
the problem of bank finance to SMEs. It wasn't designed to. But
certainly by helping the economy it will have helped SMEs. As
I said many times before and earlier today, if you want to help
SMEs obtain finance you need to go straight to that bank channel
because banks have the infrastructure to assess the credit risk
of SMEs.
Q84 John Thurso:
The problem I am really driving at is that, whereas large corporates
are being helped—and perhaps other people will talk about
that—the SMEs, in particular, have the most difficulty in
accessing credit, in part because they are the least attractive.
QE tends to put money into banks, which it is designed to do,
who then use it in the most effective way to get a return, which
is largely not in SME or corporate lending, but much more in the
capital market side. Would you agree that that is one of the core
problems for policymakers?
Sir Mervyn King:
I think the core problem is that, understandably, the banks have
been under such market pressure that they have been trying to
reduce the size of their balance sheet and they can't lend money
out of thin air; they have to borrow money in order to lend it.
The price they pay to borrow money is significantly higher, relative
to bank rate, than it was before the crisis. As I said before,
we had expected that to improve by now, but it hasn't. So the
banks themselves are under great pressure from the market.
Q85 John Thurso:
When we interviewed the Vickers Commission 10 days ago, the suggestion
was made that SMEs would benefit from a ring-fence because money
that is currently being used elsewhere would be within the retail
and commercial operation. That would lead one to assume that currently
banks are using those funds elsewhere in the market.
Sir Mervyn King:
They are de-leveraging—
Q86 John Thurso:
I am just trying to find out whether QE has an impact on that
or whether other tools are required.
Sir Mervyn King:
I don't think there is any obvious reason to suppose that SMEs
are being treated less fairly by banks. I think all forms of lending
by banks are being contracted and that the balance sheet has shrunk.
As I said, leverage has fallen from around 40% on average for
our biggest banks to 20%. So, that is a big change and that is
the result of market pressure on the banks.
Q87 Michael Fallon:
Can I just return once more to George Mudie's question? You identified
a problem in the corporate bond market and you threw some billions
at it. Then you make a speech a few weeks ago saying there is
a problem in the small business market, a shortage of £5
billion, but that is somebody else's problem.
Sir Mervyn King:
No, no, no—
Q88 Michael Fallon:
That is not your problem, that is Treasury's problem, or you said
it was Parliament's problem.
Sir Mervyn King:
No, I did not say that at all. What I said was that the measures
needed to tackle it have to be measures that are directed particularly
on finding incentives for banks to lend specifically to SMEs and
that is something that is appropriate for the Government to do
and they have instruments to do it that we don't; fiscal incentives
to persuade banks to lend to SMEs, or indeed the direct ownership
of two of the biggest lenders. Those are the obvious instruments
to use.
Q89 Michael Fallon:
But there is a liability for these instruments. In essence, you
are saying you don't want it on the Bank's books. It should be
carried on the public finance books.
Sir Mervyn King:
No, not at all. I am still waiting to hear of a credible scheme
that we could carry out that would change the incentives of banks
to lend to SMEs.
Q90 Michael Fallon:
Let me help you here. Your own colleague, Adam Posen, has put
forward a British Enterprise Investment Agency. Who would have
the liability for that?
Sir Mervyn King:
I have no idea, but it would take a long time to set up. As I
said before, if you want to set up a new bank, a state bank, by
all means do it, but frankly, given the way our bureaucracy operates,
I would be very surprised to see any action of that within 18
months—the other schemes that were started before. I think
one of the lessons from the attempts to help SMEs before was that
many other schemes that were devised ended up putting a lot of
the burden of bureaucratic functioning on to the SMEs themselves.
That doesn't make any sense either and if you want to help SMEs
you need to change the incentives of banks to switch the funding
towards SMEs, marginally in favour of them versus others. That
is how the market works. That would be an intelligent response
and that is the kind of scheme we are discussing with the Treasury.
Q91 Michael Fallon:
But why isn't that Adam Posen's scheme?
Sir Mervyn King:
Sorry?
Michael Fallon: Adam Posen's scheme
is a form of credit easing, is it not? It is bundling up these
loans into single instruments to make them cheaper to process,
isn't it?
Sir Mervyn King:
One of the troubles with bundling up SME loans into a piece of
paper is if I came to you and said, "I've got a bunch of
SME loans here. I'd like to sell it to you," you might wonder
which ones I had chosen to bundle up and sell to you. There is
massive adverse selection in that. That is what undermined the
securitised mortgage market—that people began to realise
they did not know whose mortgages they were and then they realised
it mattered whose mortgages they were. That is precisely why in
the past it has proved very difficult to use capital market instruments
to help SMEs because only the banks, and people close to the individual
SME, know what the credit risk is. SMEs are not homogeneous in
the way that mortgages were thought to be, and if you want to
use a capital market instrument it makes an enormous difference
whether these loans are homogeneous. The whole point of an SME
is that one SME is very different from another; some have good
ideas, some have bad ideas. The bank is supposed to be the vehicle
by which you assess that credit risk, and so that is the vehicle
we should use to try to encourage more SME lending, if that is
indeed what you wish to do, but that has to be a decision for
you, not for us.
Q92 Michael Fallon:
But if we are going to have successful credit easing who should
manage that?
Sir Mervyn King:
As I said, when you say "manage it", the great virtue
of going through the banks is that I think if you want to do anything
effective quickly only the banking infrastructure itself is capable
of assessing credit risk, which SME to lend to and which not.
That is what a bank is for. That is what is unique about a bank.
They have people who can make that kind of judgment. I don't.
You don't. The market doesn't. The banking infrastructure has
been designed to do that. What is lacking at present is the incentive
for banks to do it because they have come under enormous market
pressure, understandably, to reduce the size of their balance
sheet and the people who have suffered most from that have been
those who are uniquely dependent on bank finance.
Q93 Michael Fallon:
So you don't think it should be organised by a separate agency,
as Adam Posen is suggesting, and you don't think it should be
organised by the Treasury? You think it should be organised through
the banks?
Sir Mervyn King:
No, I think the Treasury are perfectly capable of organising a
scheme that provides incentives to banks themselves to decide
which companies to lend to and which not, but in which it is possible
for the Treasury to shift the incentives so that banks choose
to do more of it in total.
Q94 Michael Fallon:
Where would the liability lie?
Sir Mervyn King:
It depends on how it is set up, but it should lie with the Treasury.
It is the taxpayers' money at risk. Surely you are not suggesting
that we start now taking on an extra responsibility of managing
the risk that the taxpayers face? There has to be you. That is
why we elect you.
Q95 Michael Fallon:
I was simply asking where you think the liability should lie.
You think it should lie with the Treasury?
Sir Mervyn King:
With the Treasury, absolutely.
Q96 Michael Fallon:
Not go anywhere near your books?
Sir Mervyn King:
Both the profits and the losses should lie with the Treasury.
Michael Fallon: Okay.
Q97 Chair: Governor and
Charlie Bean, thank you both very much for coming before us today.
There have been a lot of expressions of concern, which you have
heard around the table, and of course this crucial period for
the British economy and for the development of what people perceive
to be the Bank's role in handling the crisis. We are very grateful
to you for coming along at short notice and we will be seeing
you in about a month's time to discuss inflation, among other
things.
Sir Mervyn King:
You will indeed, yes; other things, indeed.
Chair: Thank you very much.
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