33. Imbalances in the economy include, notably,
differences between the service and production sectors in regard
to output and the inflation rate. Comparing the two sectors, it
might be argued that the remit is misplaced in that there is no
single inflation rate in any meaningful sense, but two relevant
inflation rates (see, for example, Chart 4.13 in the Bank of England's
Inflation Report of February 2003). Why should the target relate
to the overall average, with no account taken of its two main
34. As Mr King said, "the central view is
that growth will be close to trend and inflation close to target.
It cannot get nearer to that as an overall outlook and yet all
of us feel there are risks and uncertainties and certain fragilities
in the economy and that is because of the imbalances. We have
spent a lot of time on the [Monetary Policy] Committee trying
to analyse how that imbalance will unwind and whether it is likely
to happen smoothly and steadily or whether there will be a sharper
adjustment at some point and, if so, what that means for our strategy
on interest rates"(Q146).
35. It is interesting that although the MPC considers
sectoral differences and imbalances, its members insist that the
overall inflation rate is what matters, and that that is all they
can target. As fiscal policy is set for at least the medium term,
that cannot directly rectify the imbalance either. The Governor
said that the imbalance "has its origin in the international
environment" (Q146). We find that strange, as the imbalance
continues to exist in a variety of different parts of the world
economy. It seems, therefore, that we have a serious problem,
but that no one is or can be charged with solving it. The answer
may be Panglossian: all is well or will come well of its own accord.
36. Mr Taylor said that imbalances are a matter
for the Government (Q208, Q227). He referred to the Chancellor's
"vast range of economic tools" (Q212). He also emphasised
the importance of the exchange rate (Q227 and following). He did
not tell us what economic tools he had in mind or how he thought
the Chancellor should use them. Obviously, one aspect of his approach
is based on the UK's joining the ERM, a topic on which, for the
time being, we as a Committee do not pronounce. A more obvious
point arising from Mr Taylor's evidence is that it is generally
assumed that the exchange rate is a monetary phenomenon, and,
therefore, a matter for the MPC (which rejects it as a target),
not the Chancellor. Moreover, if monetary policy is directed at
inflation, and fiscal policy is intended to meet medium-term prudential
public financial aims, the exchange rate will otherwise be determined
largely by external market forces. In that sense the Governor
is surely correct.
37. Mr Howard referred to a different set of
imbalances, including the housing market, low saving and high
borrowing (Q254). We do not doubt the importance of expressing
concern about such developments, assuming that the emphasis is
on household behaviour. However, it is difficult to see how they
are caused by government action. We are particularly interested
in Mr Howard's proposition that the Government policies are, at
least in part, responsible for the decline in the stock market,
and have "systematically discouraged saving" (Q255).
We have not heard such a proposition from the MPC.
38. Interestingly, members of The Times
shadow MPC exonerated the MPC of blame for the consequences of
aiming at and getting close to the inflation target. Ms Coyle
reminded us that "manufacturing industry has had problems
for decades in this country" (Q176). She might have said
the same about productivity. Other members of The Times
shadow MPC also offered some policy suggestions. Mr Weale suggested
that a tax on mortgage interest rates might help the housing market
(Q175). Mr Kaletsky mentioned a capital gains tax on housing and
manufacturing subsidies (Q176). Having done so, he did not go
on to advocate the policy as practical. He was sanguine about
the exchange rate, and did not consider it to be the cause of
manufacturing industry's problems. More generally, while recognising
the existence of the imbalances, members of The Times shadow
MPC seemed relaxed about them, although they said that debt will
start to become a burden in the long term (Q186).
39. Some interesting background to the imbalance
question is offered by Professor Wynne Godley of the Financial
Times, who is pessimistic about the imbalances, the current
account deficit and the extent to which consumer spending is financed
by net household borrowing.
He says that "the strategic policy issues raised by the imbalances
are complex and cannot be resolved by the manipulation of short
term interest rates by the Bank of England's monetary policy committee."
Above all, he warns that monetary easing coupled with sterling
depreciation might be ineffective both with respect to the external
position and the mitigation of a domestic recession. We believe
that that warning should be taken seriously, but we are inclined
to emphasise the word "might".
40. Some, but not all, the imbalances in the
economy may result from inflation targeting by the MPC. Some might
be reduced by Government intervention, but precisely how that
should be accomplished was not clearly specified by our witnesses.
A few problems may go away of their own accord. No witness suggested
that the UK economy was heading for a critical state or that immediate
or short term action was called for. Certainly, none of the evidence
we did receive led us to predict that the MPC would cut interest
rates as it did in February 2003. We examine this further in paragraphs
47-51 below. Although it was not part of our remit for this inquiry,
we do not doubt that longer-term policy adjustments aimed at improving
productivity and the way in which markets work are desirable.
We merely add that that has been the stock in trade of all governments
for half a century.
41. It is clear from the evidence that we
have taken that there are substantial imbalances in the economy
at present. Of them, the three which are most concerning are
imbalance between consumer spending and investment;
house prices, and the attendant rise in mortgage equity withdrawal;
trade balance and current account deficit.
We conclude that some of these imbalances may
(like the fiscal position described in paragraphs 26-32 above)
be cyclical. In relation to these imbalances in the economy we
consider that some intervention in the future may be necessary.
Development of Monetary Policy
42. The Governor of the Bank of England told
us that no significant changes had been made in the conduct of
monetary policy, and he saw no reason why they should (Q90). We
find that rather difficult to understand. Apart from anything
else, it means that from the start the MPC knew exactly what it
had to do, and has learned nothing of major significance since.
We stand second to none in our admiration for the MPC, but that
the very first group of members obtained perfection of procedure
immediately, and that none of their successors made any further
progress, is difficult to accept. An obvious change is that the
external members of the MPC now have their own research assistancein
order, presumably, to improve the way they undertook their task.
Are we to infer that no improvement has occurred? We also understand
that the role of regional agents has been enhanced.
43. We would expect that, like any other decision-making
body, the MPC would review everything it does from time to time.
The decision-making process gives rise to such questions as whether
the frequency of interest rates changes is right and whether moves
+/- 0.25% are optimal. They are, of course, interrelated. Changes
have also taken place in what the Governor calls the "environment";
inflation expectations; attitudes to debt; and the housing market.
Although we agree with Mr King (Q90) that "the target is
given to us by the government [and it] would not be right for
us to try and fiddle around with the definition", the vast
research effort of the Bank must from time to time throw light
on whether RPIX is an adequate measure of inflation. Adopting
an uncritical attitude to the way inflation is measured is surely
not a necessary part of the remit of the MPC.
44. This takes us back to the question of MPC
appointments. If the MPC has perfected the conduct of monetary
policy, does it matter much who the members are? As Mr Dicks said,
members of the MPC "are there to exercise their judgement":
they are not automatons. He remarked that "we could replace
the MPC and its shadow with a computer if we just respond to the
inflation forecasts" (Q189). If nothing fundamental has changed
in relation either to the inflation process or to the MPC's approach
to monetary policy, the question arises whether the MPC could
feed its judgement on the environment into an automaton (that
is, a computer programme) in order to determine the policy.
45. We consider that the time is ripe for
some serious research into the operation of monetary policy in
the past five years, and above all whether, and in what ways,
the Bank of England Act 1998 has made a difference. We would be
interested to know whether the MPC shares our concern.
46. It is possible that the Bank itself is conducting
such research. We do not have the resources to undertake the task,
but it would be an interesting research project for one of our
leading academic economics departments. One question on which
such research might focus is that asked by Professor Godley: "Is
it possible that people expect more from the MPC than it could
11 Pre-Budget Report Back
For the path of output, see charts 3.2 and A in the Bank of England's
Inflation Report of February 2003. Back
Financial Times, 28 January 2003. Back
Financial Times, 28 January 2003. Back