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UNCORRECTED TRANSCRIPT OF ORAL EVIDENCE
To be published as HC 313

House of commons

oral EVIDENCE

TAKEN BEFORE THE

Treasury Committee

Re-appointment of Dr Martin Weale to the Monetary Policy Committee

TUESDAY 15 October 2013

Dr Martin Weale cbe

Evidence heard in Public Questions 1 - 38

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Oral Evidence

Taken before the Treasury Committee

on Tuesday 15 October 2013

Members present:

Mr Andrew Tyrie (Chair)

Mark Garnier

John Mann

John Thurso

________________

Examination of Witness

Witness: Dr Martin Weale CBE, external member of the Monetary Policy Committee, Bank of England, gave evidence.

Q1 Chair: Thank you very much for coming in to give evidence. Can I start by pointing out that you were, as I understand it, the sole dissenter on forward guidance-you wanted a shorter time horizon than the 18 to 24 months ahead for the first inflation knockout? Why?

Dr Weale: The policy of forward guidance, if not carefully designed, can have the effect of raising inflation expectations and obviously we were all concerned that that should not happen in the British economy, particularly given the recent history of inflation. I was worried that, with the knockout defined as 2.5% inflation averaged over 18 to 24 months, people would know that in the past the committee had talked about bringing inflation back to the target of 2% over a two to three year horizon-24 months is of course two years-so they might conclude that we were less concerned about the inflation target than we had been in the past. There seemed to me a risk that could, itself, lead to a rise in inflationary expectations.

Q2 Chair: Your concerns are not allayed on that front by the sound of it?

Dr Weale: No, my concerns remain. I think probably the most likely outcome is that inflation gradually falls back to target but, were there a new inflationary shock, of course the issue would become of greater prominence.

Q3 Chair: Despite that vote, you basically came together in the interests of solidarity on the grounds that your concerns had to be offset against the risk of the Committee appearing dysfunctional if you used one framework to explain your decision while the other eight members used a different framework. Given that the MPC operates on the basis of individual responsibility, what was this dysfunction?

Dr Weale: Let me explain. Having voted against the policy I was then left, I think, with three possibilities. One was to say that forward guidance was what other people had voted for but I was having nothing to do with it, I was going to describe my voting and so on in the way that I had done in the past. That would have meant that the minutes each time would have said that eight people were following the framework of forward guidance, one member hadn’t supported it and this was how he described his decision. So that was one possibility. The second possibility was that I was going to follow the form of guidance that I would have supported, which was the 2.5% inflation knockout at 18 months rather than 18 to 24 months. That could also have been rather complicated. The third possibility was that I took the view that, since eight people had supported it, I would adopt the same language as them for the obvious reason that, should there be disagreements while speaking the same language, it makes the issue clearer than if people disagree while speaking different languages.

In practice, the individual members of the committee have to decide what is happening to inflationary expectations. What defined the sort of movement that we ought to be concerned about is not precise-I have not discussed this with other members of the committee-but possibly I will pay rather more attention to the sorts of forward indicators of inflation that we have and be more sensitive to short-term movements than some of my colleagues.

Q4 Chair: But the fact you felt that the committee might be dysfunctional if you did not all rally around this new idea does suggest, does it not, that there is something amiss with the transparency arrangements?

Dr Weale: No, I don’t think so. I said I thought it might appear dysfunctional, not that it would be dysfunctional. Had I adopted, say, the first of the three possibilities that I described, then for quite a long period that would have been a major feature of the public reporting of the committee’s decision making and so on, when actually what is important is what we think is happening to the economy. Different members have different views on that as you would expect. Those are the sort of things that I think are important, and those are the sort of things I would like the focus to be on.

Q5 Chair: Was there any pressure on you to adopt the same framework for decision making?

Dr Weale: Well, obviously the people who supported the framework were explaining why they supported it. All I can say in response to that is that, while they made persuasive arguments, I was not persuaded by them.

Q6 Chair: Maybe I will ask the same question again in a different way. Did you feel that you were getting a better sense of what the new Governor meant when he said he was going to operate by consensus?

Dr Weale: No, I must say I still don’t quite understand what he means by that.

Q7 Chair: We are still exploring this, bearing in mind that the MPC operates on the basis of individual responsibility for decisions and explanations of them.

Dr Weale: Yes.

Chair: Do you think that is how the MPC should operate?

Dr Weale: My understanding is that that is how Parliament expects it to operate and the way it should operate-

Q8 Chair: But do you think that is an operationally efficient way to go about your business?

Dr Weale: I think it has proven to be very effective over quite a long period now.

Q9 Chair: Moving beyond the process to the policy, it is to true to say, isn’t it, that you have a few reservations about this forward guidance, to put it mildly? In fact, you probably would not have done this, would you, if it had been left to you?

Dr Weale: The reservation, as I say, I have is about the precise inflation knockout, not about the general principle of forward guidance. If I look at the forward guidance more generally, it explains that the committee sees unemployment as a very important-perhaps the dominant-determinant of medium-term inflationary pressures. Now, that is something that I have thought to be the case for nearly 30 years. I described that in a speech I gave in Manchester late last year. So the general principles of forward guidance, as opposed to the actual policies that we adopted, were something I felt comfortable about supporting.

Q10 Chair: When you were discussing this in closed session, did you think this was a loosening or a tightening of policy?

Dr Weale: I thought it was an easing of policy.

Chair: The markets concluded the opposite.

Dr Weale: The markets, I think, concluded that the economy was improving fairly rapidly and that, therefore, by following the rules as we described them, the first interest rate increase might come sooner than had earlier been expected.

Q11 Chair: I was not having a go at your judgment; I was having a go at anyone’s capacity to work out what this signalling really means. We had a good look at this with the Governor and concluded that this was not going to be easily understood down at the Dog and Duck.

Dr Weale: Could I say why I think it was an easing of policy? I think it was an easing of policy for precisely the reasons that I voted against it: that there was a substantial risk that some people would see it as the Monetary Policy Committee being less concerned about doing our primary job, i.e. keeping inflation close to target.

Q12 Mark Garnier: Can I continue on forward guidance? What do you think it is trying to achieve?

Dr Weale: I think that forward guidance is trying to explain how the Monetary Policy Committee reaches its decisions.

Q13 Mark Garnier: Do you think anybody believes that?

Dr Weale: As I say, I hope they believe that, because from my point of view, the general framework of the policy is in a large part describing the way I have been making my decisions over the previous three years. I had explained, for example, the role of unemployment in a speech I made late last year.

Q14 Mark Garnier: First, it is an interesting measure to pick on, so picking on the unemployment threshold is number one, but number two is, why 7%?

Dr Weale: No, the 7% is not meant to be an unemployment target, it is not meant to be our view of the level of unemployment consistent with inflation falling back to its target. I mentioned the importance of unemployment but, at the same time, we have to remember that unemployment is not a perfect indicator of inflationary pressures. We all remember the period in the 1980s when unemployment was much higher and inflation was much higher so I-and, I think, the whole committee-was aware that unemployment was not a perfect indicator. That is why we set what I probably see as a fairly cautious threshold. But we have not committed ourselves to raising the interest rate if or when unemployment falls back to that threshold; all we have said is that we will review things.

Q15 Mark Garnier: The sense I get, and I may be completely wrong, is that the unemployment threshold was picked almost because everybody agreed that was the least disagreeable solution. That may be completely wrong and if I am wrong, please say. The other point about it is that the bank staff have to make the medium-term equitable rate for unemployment around 6.5% and this number of 7% has been picked, even then not as a set threshold but as a loose target. It seems for the man at the Dog and Duck-getting back to the point-and more importantly for the market, quite difficult to understand quite what is trying to be achieved out of this.

Dr Weale: First, I should repeat that the 7% is not a target.

Mark Garnier: No.

Dr Weale: I can only say what I think I am trying to achieve by it. There is considerable slack in the labour market at the moment and that is exerting downward pressure on inflation but, as is always the case with economic relationships, we can never be completely sure about them. The bank’s view is that there is room for unemployment to fall further than that before inflationary pressures start to build up. Of course we can’t be sure, so it seemed to me sensible to think of a cautious threshold rather than one where we would run a significant risk of inflationary pressures picking up, to which we would then have to respond.

Q16 Mark Garnier: I approach the world on the basis of, "How is it going to affect my constituents?" So, in very simplistic terms, the biggest problem that could possibly face my constituents-and the constituents of others around this table-is household debt; household vulnerability in terms of rising interest rates. We know there is a big problem with household debt out there, and this could be a big problem for people. Certainly, when I first heard this idea of forward guidance, I thought this was a bit of genius, this was a good idea in terms of the fact that now you have a framework, whereby the commentators can look at what is going on, and we here can get a much better idea of what is happening. Therefore this message could be transmitted to those people in the wider population who have collectively £1.47 trillion worth of debt-more than the Government has-and they can start planning their household income and their household expenditure based on the fact that, at some point in the future, interest rates will start going up. That I thought was fantastic. This is a work of genius by a new, incoming Governor.

The problem is, within days, the market stopped believing it and when you scratch the surface you come up with a threshold-I completely understand what you are saying and forgive me if I use slightly wrong language-set at 7%, and I understand why, but then you three of these caveats, the knockouts, and by the time you add all this together, all you are doing is coming back to the same set of unfathomable problems, as I see it, that the MPC would have been looking at anyway. It is just that what you have done is opened up the bonnet to discover you have quite an ugly engine underneath it and nobody quite understands how the engine is going to work and how the crankshaft connects to the con rods and the valves.

So what I am trying to get from you is how this is better than what we had before.

Dr Weale: One could think of other forms of forward guidance, for example, time-based forward guidance. As I said, I did not support the policy as it was spelt out, but I would have felt even more uncomfortable with a promise to keep interest rates at their current level for a further period, because the way the Monetary Policy Committee has always worked, and I think the right way for it to work, is to look at what has happening in the economy at the moment and to decide what is right in the light of that. Obviously if you make a promise to hold interest rates low, it may turn out nicely, but you run a substantial risk of either having to break that promise or you run the risk of generating an economic situation that you wish you hadn’t walked into.

So time-based forward guidance, a pure time-based forward guidance, would probably be attractive to people who would like greater certainty, but the reality of course is that the MPC no more than politicians can deliver certainty about the future. We have tried to explain in more detail the way in which we reach policy decisions, but for me the use of unemployment as a very important indicator isn’t new; it is the sort of thing I have been looking at, and trying to explain to people that I was looking at it, for the previous three years.

Q17 Mark Garnier: Just one last question on this. You talk about the interest rates and the fact that you can’t give a timing on this, and there are lots of variable factors that can affect interest rates. I just want to pick up on that one particular point because presumably, to a certain extent, relative interest rates among currencies are also quite important. Is it not the case that-reinforcing your position on this-if we say that we will keep interest rates low for a long time and other interest rates around the world go up, that could precipitate a slump in sterling against other currencies, thereby starting to import inflation? In which case you then come back to one of these knockouts anyway. It seems that the economic modelling is so complex that ultimately with this forward guidance and with these knockouts it becomes a random set of measures that, ultimately, are pretty meaningless one way or the other because what you are trying to achieve is so difficult that the forward guidance becomes pointless.

Dr Weale: I would not describe it as a random set of measures. I think what we are doing is explaining more clearly than we have done in the past about the way in which we reach our decisions. I hope that people find that helpful, but we can’t create a certainty that just doesn’t exist, because the future is uncertain. All we can do is say how we respond to the economy as it evolves.

Q18 John Thurso: Can I explore with you the definitions of the knockouts and how they might operate? I come first to the one about medium-term inflation expectations no longer remaining sufficiently well anchored. What will determine your view about whether medium-term inflation expectations are no longer anchored?

Dr Weale: There are a number of indicators of medium-term inflation expectations. One obvious one, which I certainly pay attention to, is given by the Market for Government Debt, the differentials between the yields on indexed stock and the yields on conventional stock. That, of course, is not a perfect indicator. One of the problems that it has is that indexed stock is indexed to the retail price index not the consumer price index. There is a wedge between the two and that has grown recently. What we have to do when looking at the time profile of inflation expectations that that implies is try and unpick the effects of this wedge. We also have to try and unpick the pressures that pension funds may have felt to hedge and invest in index debt. It is possible that pushed up the price of index debt. So it is an indicator to be looked at, but not a perfect indicator.

Other indicators we have are surveys of people’s expectations of inflation. In the short term, those are typically fairly sensitive to the actual rate of inflation. Some of those have been reporting above target inflation for quite a period, but we need to pay attention to those. A third factor to look at is what is happening in the labour market, not only wage settlement and actual wage growth, but wage demand. I am encouraging work at the bank to look at statistical techniques for consolidating these so that we can try and get a clearer signal from disparate indicators.

Q19 John Thurso: That prompts two questions. The first is how great a departure do you look for? The point is, what is the measure? Because the actual knockout is that expectations become de-anchored. What is that? If the world at large is 0.5% away from the consensus, is that de-anchoring or is it 1% or 2% or 3%? So the question is what is the measure?

Much of your answer refers to what one might call professionals, i.e. the markets or people in banking, the City, whatever. To what extent are you looking at the members of the ordinary public and their expectations? Is there a difference between the two or is it all one?

Dr Weale: No. Sorry, I talked first about the Market for Government Debt. We do also conduct surveys of inflation expectations-those are published, for example, in the inflation report. We certainly have done but I will be paying increased attention to those as a consequence of the framework.

If I could return to your point, what is a significant movement? I would regard a clear movement of even half a percentage point as highly significant. For me it is important that people expect the Monetary Policy Committee to deliver its target of 2% inflation. If it became clear that a general view was, "Well, actually, they are not going to do that, they are going to deliver 2.5%" I would become extremely concerned and, of course, if we got to that point, in some sense, the committee would be reacting a bit too late because what you want to do is prevent that from happening rather than treat a movement. I think what is intended to prevent that from happening is the first knockout, the knockout in terms of the committee’s view of inflation over 18 to 24 months. As I have said, I would have been much more comfortable with that if it had been 18 months because then, I think, the risk of a second happening would be lower.

Q20 John Thurso: The picture you paint, it seems to me, is of a very significant but relatively small movement triggering a knockout-which, again, then prompts the question of, if that knockout is applied at that point, does it not diminish the strength of forward guidance? It is quite a big "if".

Dr Weale: Yes. First, I should say that there are nine members of the committee and, going back to the Chairman’s point earlier, there will be nine different views about what significant is and what matters.

John Thurso: We have a very helpful benchmark now against which to ask the others their views.

Dr Weale: Yes. As I explained, given my substantial reservations about the framework that we adopted, I could imagine that I will be rather more sensitive to that issue than to others, but it comes back to the point that the world is uncertain. We can’t prevent that from being the case. All our historical experience has suggested that, when in the past inflationary expectations have become de-anchored, it has been very expensive to try and bring them back. I think, despite the fact that, in some sense, it is an extra variable that people have to take into account, it is right that we give that very considerable importance.

Q21 John Thurso: Can I turn to the third knockout, which is the FPC’s knockout if I can put it like that? This seems to me possibly the most difficult to deal with. Would you just accept the analysis of the FPC or would you take what they say to you as something for debate?

Dr Weale: No. Obviously the FPC is the body that is supposed to be expert in this, which is the reason we have asked them to fulfil that function. I suppose I have found it difficult to imagine circumstances where the FPC could say something that would be public and I, for example, would then feel able to say, "Well, you are only the FPC, thank you for your advice. This is what we are doing". As I say, I can’t imagine the circumstances in which I wouldn’t respond to-

Q22 John Thurso: So it is very much the FPC having their finger on the trigger on that one, as far as you are concerned?

Dr Weale: As far as I am concerned, yes.

Q23 John Thurso: I just wanted to ask one last question on that, which is, what would you expect the FPC to be looking at in order to decide that the time had come to pull the trigger?

Dr Weale: The FPC would have to be concerned about financial stability and it would have to take the view that it did not have the appropriate tools and by asking the Treasury it could not create the appropriate tools for dealing with that. In other words, the only means of dealing with it would be a general increase in bank rate.

Q24 John Thurso: What I can’t quite get my head around is: the main risk to financial stability would be that inflation would take off? If it is not that, which is the MPC’s job, what other set of events could one look at that would require the FPC to say that there was something about financial stability, which was not affecting inflation, that meant a knockout had to be brought in. I just have difficulty in seeing what it is that you would be looking for.

Dr Weale: Well, FPC could say, "There is a major credit boom under way, despite that, for some reason or other, inflation doesn’t seem to be taking off, but we think this is a major threat to financial stability and presumably therefore something that would imperil the Government objectives for growth and employment and you need to act."

Q25 John Thurso: It would probably be around a credit bubble?

Dr Weale: That is the sort of circumstance that I could imagine, but I should stress that is something on which the FPC is the expert.

Q26 John Mann: Dr Weale, are you better able to contribute to the MPC in what will be your second term vis-à-vis your first term?

Dr Weale: Sorry, am I better able to?

John Mann: Yes.

Dr Weale: I think I am. Inevitably, when one starts on a new job, there is quite a learning process under way. In the second term, I feel I understand the processes that the bank is following. I find it much easier to understand where the analysis that we get is coming from than I did when I joined the MPC, so I think that does leave me in a position to make a more effective contribution than certainly at the start of the first term.

Q27 John Mann: Do you think intrinsically in the second term you are more likely to speak out when you are in a minority because of that additional experience?

Dr Weale: In my first term I had no difficulty in voting in a minority in the first part of 2011 and explaining why I was doing that. So, no, I would not like to say more likely or less likely, I will continue to do what I have tried to do throughout my term, which is come to the decisions that I think of as appropriate and, particularly where they are minority views, to explain publicly why I am coming to those decisions and why I think the facts justify the decision I am reaching.

Q28 John Mann: Do you have a view on what is the optimal length of service that an external should have on the MPC?

Dr Weale: I am sure different members are in different circumstances. I think the current framework, where there is a maximum of two terms, is a very good framework.

Q29 John Mann: Do you think there needs to be more consideration of scenario planning for major shocks to the system? I am thinking of political shocks as well. For example, we know that there will be a Scottish referendum. If that was to be for independence, it would be perceived to have some implications. There could be a decision to hold a euro referendum in 2017. That, too, could be perceived as having a significant impact.

Dr Weale: Well, to the extent that either of those events start to affect people’s market perception of things, market perception of risk, those will appear in the asset prices that we take into account. Obviously we do what we can to explain uncertainty and risks and I think the bank has certainly gone a very long way down that road, but there have been some issues, perhaps the most notable one was when we thought there was more than a trivial concern about the breakup of the euro area. Although one can identify that as a concern, it is rather difficult to think of a remotely scientific way of saying what its consequences were likely to be.

Q30 John Mann: Final question. One of the factors of labour market inflationary pressures is seen by some to have been the influence of European, particularly southern and eastern European, labour. Is there a sufficient statistical base to properly analyse what is happening in the current labour market and how these pressures are working in terms of potential deflation of wage inflation, or building up expectations of future increases?

Dr Weale: No, the labour market statistics that we have are generally of high quality, and it is not an issue for the Bank of England, but obviously there has been a substantial public discussion about how well we measure migration and indeed the problems of measuring migration, particularly in a country that does not maintain a population register, or doesn’t try to maintain a population register. No, what you have drawn attention to are some of the uncertainties surrounding the use of unemployment as an indicator of future inflation. We know that over quite a long period real wages have been falling. As the economy returns to normal, will that lead to catch-up pressures or not?

In 2011/2012 I had been expecting catch-up pressures. They have not materialised so far but of course it is perfectly possible that, as the economy returns to a more normal state of affairs, employees will think now their employer can afford to pay them more and, of course, a very good number of employers will think, "Well, my employees have helped me out through a difficult period, now I can afford to pay a bit more so I should".

Q31 Mark Garnier: Just a couple of very quick questions, if I may, about the housing market. The first is, how would you personally assess whether or not a house price bubble was forming?

Dr Weale: House price bubbles or any sort of bubbles are much clearer after the event. I was not going to give the answer, "Wait 10 years and then you will find out". How do I define a house price bubble? People buying houses because of the expectation that house prices will rise and continue to rise at a rapid rate. We don’t have a good sense of what motivates people’s house price buying or people’s desire to buy houses for themselves but, for example, the volume of turnover in the buy to let market could be an indicator of speculative buying-that people were buying because they expected house prices to rise fairly rapidly. I think it is something where we can be well aware of the risks, but it is not clear until after the event. I must say I am concerned about the recent buoyancy of house prices, although, relative to incomes and so on, they are lower than they were during the peak. You would hope they were lower during the peak.

Q32 Chair: But that was a bubble so that doesn’t give us much comfort. Can you give us some better comfort than that?

Dr Weale: In my view, house prices are elevated. Now, of course, what will happen if or when interest rates return to more normal levels, we do not know. To some extent the elevation of house prices is something you would expect with very low interest rates.

Q33 Chair: You mean above the long-term sustainable trend? Let’s just talk more substance-that is what you are saying, isn’t it?

Dr Weale: Quite what the long-term sustainable trend is, is itself uncertain, but you would expect low interest rates to push house prices above the long-term sustainable trend. I think the key issue is that that was raised by the Governor a few weeks ago: that people who are taking on mortgage debt need to be sure that they can afford to look after it even if interest rates eventually return to what we regard as normal levels.

Q34 Mark Garnier: Just one final question on this. One of the FPC’s roles is that the organisation as a body has been charged with making a commentary on whether things like the Help to Buy scheme is causing a problem or not. Do you think the MPC should have a role in making commentary on government policy if government policy is causing a problem for the work that you on the MPC have to do?

Dr Weale: The FPC is absolutely the right body to be looking at and talking about the Help to Buy scheme. MPC, rightly, does not have a role in commenting on government policy, but it has a role in commenting on the balance of the economy and the factors that may lead to imbalances in the economy. Given our recent history, I regard unbalanced growth as a surging consumption at a time when domestic investment is low and net exports are weak when there is a substantial external deficit.

Q35 Chair: Can I end by asking you about some of the recommendations that both this Committee and the Banking Commission-three of the people in this room at the moment are on the Banking Commission-decided upon with respect to the governance of the Bank of England? You have now been in there a while, had a chance to have a look. This afternoon in the House of Lords, consideration will be given to a number of amendments in order to implement the Banking Commission’s proposals, which are opposed by the Government. One of them is that the court should be reformed into something more akin to a proper board; that we should go further than has been proposed with the sub-committee that has been created. Have you had a chance to look at those proposals and do you agree with them?

Dr Weale: I am afraid I haven’t had a chance to look at exactly what is being considered in the House of Lords this afternoon. One of the things that the court still has to work out is the role of the external members of both committees in the oversight process. On many boards, you have non-executive members whose function is to be the first group of people that looks at the way the operation of the organisation is carried out.

Q36 Chair: Do you think that a proposal of this Committee that we have five external members on the policy making committees rather than four-we reverse the balance from four five to five four the other way-has merit?

Dr Weale: I have been perfectly comfortable with the balance of the MPC as it is now. That is, of course, not to say that other arrangements could not work.

Q37 Chair: You are a brilliant politician, Dr Weale. You should be in another trade altogether. Do you want another go at that? Which would you prefer?

Dr Weale: I can’t say I have thought about it a great deal but what I will say is that, having been on the committee for three years, I have never felt there was a problem with the way the committee was doing its work.

Q38 Chair: Thank you very much for giving evidence to us this morning. We are extremely grateful to you and for the evidence that you have given to us over the past few years. I think a long time ago you were a specialist adviser to this very Committee, am I not right?

Dr Weale: No, I don’t think I was ever an adviser. I have certainly given evidence to the Committee from the National Institute.

Chair: Thank you very much, Dr Weale.

Dr Weale: Thank you.

Prepared 21st October 2013