Examination of Witnesses (Questions 20-34)|
TUESDAY 6 MAY
20. I would like to go to a slightly more general
point, really following up from something the Chairman said earlier
on. I wonder whether you feel, as I am beginning to, that both
the performance and the perception of the performance of the ECB
results to some extent from a paradox of it being both more dependent
and more independent than both the Bank of England and the Fed.
More dependent in the sense that it does represent these national
interests through the competition of the Counciland this
of course has the inhibitory factors that we have discussed on
the publication of minutes and that sort of thingand more
independent in the sense that it lacks a real economic management
partner in the form of any sort of government. Its main overall
partner, I suppose, is the Commission with the Stability Pact,
which we have seen already has severe constraints in actually
judging the economic situation at the time. This inevitably is
going to make any assessment of the ECB a difficult one to make,
unless there is some change in either the overt responsibilities
given to it or perhaps some extension of the Commission's role
in overall economic management.
(Mr Weale) Could I say that in terms of the issue
of setting monetary policy I do not see that there is a real problem.
The fact that the European Central Bank chooses its own target,
whereas in the United Kingdom it is set by Parliament, I must
say I do not think that matters very much. After all, everyone
can learn from experience. We have been arguing that the ECB should
change their target slightly, or the way in which it is specified,
but we have not been arguing that it should be thrown away completely
and that the European Parliament should set something or would
want to set something completely different. Indeed, if it did
set a target of ten per cent plus or minus 5 per cent, I think
I would feel I prefer the existing arrangements. I think where
there is a weakness is in the coordination of monetary and fiscal
policy. People have always known that this is a problem which
can arise with European Central Banks. I think it is something
of a relief that, at least so far, it does not seem to have arisen
in the United Kingdom; but there does not seem to be (and certainly
not an explicit mechanism) any implicit mechanism of the full
European Central Bank to coordinate its interest rate changes
with the fiscal plans of the national authorities. If they do
it is kept well under wraps. They do not seem to be saying to
the French, "If you do comply with the Stability and Growth
Pact then it will be much easier for us to cut interest rates".
That mechanism does not seem to be there. In those circumstances
you can get into a situation, particularly if the Stability and
Growth Pact is ignored, where the fiscal authorities are pulling
in one direction and the monetary authority is pulling in a different
direction, and the outcome is rather unpleasant.
21. That is not quite right, is it? If you read
the reports of the ECB they do take account and they do pay attention
to public sector deficits in countries, and they are always advising
countries to get the thing right.
(Mr Weale) No, they pay attention to it, but I suspect
the capacity to strike a bargain, given the structure of it, is
different from the informal and unspoken way in which it is possible
to sound out (and I do not know whether it happens) the Governor
of the Bank of England as to his attitude to fiscal changes in
this country. It may be that the French Government does, but it
is harder to do that sort of thing, that is my point.
(Mr Walton) Just to add to Martin's point, the ECB
every month criticises governments for fiscal policy being too
lax and for not making enough progress on structural policies;
but that has not stopped it from cutting interest rates, particularly
in the past few months. It is one thing to have this criticism,
and it is another thing to know whether or not that actually changes
the way they behave. At the end of the day, they have to take
account of fiscal changes to the extent that they will have an
impact on the real economy and ultimately on inflation. The way
I would characterise the problem, and I like the characterisation
Lord Marlesford makes, is that you have this collection of 12
countries which do have different economic structures and, through
time, those structures will probably converge, as they will be
forced to converge; but you do have situations where the economic
environment in one country can be quite different from another,
and that does create a few tensions potentially for policy and
I think you can see that at the moment with Germany versus the
rest. Germany is clearly weaker than the rest of Euroland. German
inflation has actually fallen below 1 per cent on a core basis;
whereas underlying inflation in the rest of Euroland is still
running at around 2½-2¾ per cent, and that does create
a dilemma. The ECB itself has said that if inflation in the euro
zone drops below 1 per cent that would be a cause for concern.
By implication, arguably, if inflation in Germany drops below
1 per cent then that also ought to be something of concern. I
think that has created some tensions. I think that is why in the
end the ECB has become a bit more tolerant of inflation above
2 per cent, because it has realised that to get inflation sustainably
below 2 per cent in the whole euro area could quite possibly mean
that in Germany you would forcing inflation down towards zero,
which may be okay for a short period but is probably not something
you would want to see as a permanent feature. I would say it is
the different economic structures that still exist within these
individual countries which, in some sense, create the perception
of national interest, even though I do not think there is any
particular evidence that ECB Board members themselves act in a
particularly partisan way. As far as I can judge, they do look
at the whole euro area but that in itself is not always that easy
when you have got different performers in different parts of the
(Mr Smith) I was just wondering if you were also getting
at the issue of voting?
22. In a sense, yes.
(Mr Smith) It seems to me at the moment it is quite
likely you do not have a national versus European interest problem,
because you have got the Executive with six votes and only need
another three voting in the European interest as a whole, and
basically the other three are quite likely to have been voting
in the national interest and are likely to be aligned with European
interests anyway. I do not think it is an issue now, but I think
it might be an issue with expansion whether you do end up in a
position where smaller countries could group together and outweigh
the votes of the majority in terms of GDP. On the issue of coordination
of monetary and fiscal policy, I think there is quite a difference
in attitude in that the MPC basically takes into account what
the government does in arriving at its forecasts and, therefore,
its interest rates decision. Whereas the ECB tends to be rather
more proactive in making comments about how it thinks fiscal policy
ought to develop. I am not sure this has any real significance
for the ECB but, given that it has to deal with a large number
of governments rather than one, maybe it is the only way it feels
it can make some sort of point about what is going on. The MPC
does not have that problem. There is one government and you know
what the situation is.
23. Incidentally, on the point David Walton
made about the German economy, it just so happens that we had
the President of the Bundesbank here and he reminded us that the
interest rates in Germany are real interest rates but lower than
they have been for 50 yearsquite an interesting point.
(Mr Walton) I actually think he is wrong to say that.
I guess it depends how you measure it, but certainly if you look
at real short-term interest rates in Germany they have been lower
on a number of occasions. Maybe if you look at the real long term
situation it might have been what he was referring to.
Lord Hannay of Chiswick
24. Could I ask the three of you a little about
exchange rate policy or its absence. The European Central Bank
statutes and the European Central Bank has been very determinedly
of the view that it is not its job to conduct an exchange rate
policy for the euro and it has not indeed done so. That is probably
something which is, on the whole, welcome. The structure of the
European Union as it is currently organised, and the lack of any
institution that really conducts economic governance as a single
unit, does that not mean, a combination of that and the complexity
of the institution, that in fact the EMU would actually been incapable
of conducting an exchange rate policy, even if somebody was unwise
enough to think that it should have one; and that actually we
are in a position now in which benign neglect of the exchange
rate of the euro is almost imposed by the nature of the structure
of the institutions?
(Mr Weale) I think the answer to that depends to some
extent upon what one means by an "exchange rate policy".
If you told the European Central Bank that its job was to maintain
an exchange rate of, say, one euro equals one dollarin
other words, to deliver a fixed exchange rate against the United
Statesthen with appropriate reserves and a suitable interest
rate policy I am sure it could do that. It and others might not
like the consequences but that could happen. If you mean something
more nebulous, then I suppose one really has to ask, "Why
have it? What is it for?" If they were told or persuaded
that the exchange rate should be the first pillar instead of money
GDP or, as it is at the moment, the money stock, then I think
they would be able to pursue interest rate-setting taking that
in mind. I think the European Central Bank would, rightly, take
the view that it would be an odd interpretation of their role
to essentially pin themselves on to United States monetary policy;
and that if there were to be a formal exchange rate policy, rather
than the exchange rate simply being another indicator, the appropriate
thing would be that that should be determined by bilateral negotiation
between the European Union and the United States. I think the
answer is that they would probably find it difficult to define
and justify an explicit exchange rate policy as opposed to treating
it as another indicator. That seems to me the circumstances one
would expect to be in and circumstances that we should welcome.
(Mr Walton) I do not see how you could have a formal
exchange rate policy. At the end of the day, the ECB has got a
mandate of price stability, and it only has one instrument to
achieve that. That one instrument of interest rates, if it were
directed, say, to stabilising the euro against the dollarsupposing
the US were pursing a very inflationary policythen you
would presumably have inflation in the euro area. I do not think
you could have some kind of formal mechanism. Clearly if you get
into a position where a currency appears to have overshot substantially
in either direction then you could have a temporary period in
which central banks get together and intervene or try to talk
the currency back to a more sensible level, that could always
happen. I do not think you could ever go down the route of having
a formal objective. In that sense it is very different, say, from
the UK. The Chancellor one day could say, "The mandate for
the Bank of England is no longer an inflation target of 2½
per cent, it is pursuit of a stable exchange rate versus the euro"
That cannot happen in the euro zone area.
Lord Lea of Crondall
25. Could I just follow up the point about the
exchange rate policy. In a sense there is a contraction, is there
not, in that of course the reason why the "markets"
watch this like a hawk is that it affects the markets. Certainly
the ECB would be marked down if it did not worry about the markets
and the markets start to take a view. In the City of London there
is this implicit idea, "Why can't we all be more like the
Anglo Saxons?" You could set it to music. Is it not a fact
that the name of the game is somehow relating to the markets?
I do not know which markets you are talking aboutbond markets,
foreign exchange marketsbut this is the name of the game,
is it not, to some extent in what you are looking for? The absence
of an exchange rate does not mean that the ECB is not as worried
as hell sometimes about the effect of what it does on the markets
in terms of the euro/dollar relationship or the movement of the
bond markets or the movements of any other market?
(Mr Walton) I think at the end of the day the ECB
is concerned about achieving its objective of price stability,
however you define that. If you have big swings in asset prices
that could compromise your ability as a central bank to achieve
that target. Clearly you do not want to see big unjustified swings
in asset prices. It is one thing to observe those swings and then
to conduct policy but it is another to say that the markets are
actually dictating what your policy is going to be. I genuinely
think that all central banks at the end of the day do not have
much control over asset markets; I do not think the markets have
much control over asset prices; but they have to observe what
is going on as best they can to reach a judgement as to what that
means for their ultimate objectives and, if necessary, modify
their policy in order to attain those objectives.
(Mr Smith) I think theoretically you either have to
have a very strong exchange rate policy if you are going to have
one or you do not have one at all because anything in the middle
normally leads to some sort of disaster. My comments about transparency
I limit to the banks' interest rate policy. I think one area where
I would exempt central banks from being open about what they are
doing is in terms of currencies, for those reasons. It is an issue,
to me, which you might have talked about five or ten years ago,
but it is actually quite difficult to make it relevant given the
way countries are set up at the moment.
Lord Armstrong of Ilminster
26. I wondered if we could turn the discussion
towards what you might call the "governance of the ECB"
and particularly when the European Union is enlarged. It is clearly
more difficult to structure the governance of the ECB than it
would be of a national central bank. Do you think the arrangements
that were created when it was set up were sound? Do you think
that the changes now proposed are going to work; or do you think
we should be looking for some more fundamental change in the way
that the ECB is managed, and the way that the basic decision-making
(Mr Walton) The key thing is, can you reach decisions
as a committee? As Martin pointed out at the beginning, the ECB
has managed to change interest rates as often as the UK; so it
is not that they cannot reach decisions. To my mind, 18 people
seems a little bit unwieldy. Indeed, that could go up to 21 under
the new arrangements. I think if you were just an economist speaking
you would probably prefer to halve that number rather than see
the number increase. At the end of the day I think the issue of
democratic accountability is an important one. The European Central
Bank is there representing all of these nations. To say that you
cannot have most national central banks being represented and
actually voting that is a big decision to make. It seems to me
in the end that the compromise the ECB itself has reached is probably
a reasonable compromise in the circumstances. They have prevented
a situation in which you would get 30-odd people having to vote
each month. They have capped it at 21. That is probably a bit
larger than ideally one would like but it does at least preserve
some notion of democratic accountability and gets away from a
situation where any individual country has got a guaranteed right
to vote every month in perpetuity. I would say they have struck
a reasonable balance.
27. Would you like the ECB to have an MPC of
(Mr Walton) I am less keen on that, to be honest,
from this point of view of accountability. I think national central
bank governors are very well qualified to take decisions about
interest rates. To delegate that to nine or so supposed experts,
I am not sure that that is the route I would go down personallyrelative
to saying that these people who run these national central banks,
who have been observing and participating in monetary policy for
a very long time, are very well qualified to reach these judgments,
it seems to me.
28. Do you think there is a case for the big
countries having a vote all the time?
(Mr Walton) No, because I think the big countries
will get a greater representation on the Executive Board anyway.
When you are looking at Euroland, you clearly need to take account
of the fact that Germany is one third of Euroland and it will
still be 30 per cent of the enlarged euro area. If you are looking
at Euroland as a whole, Germany is clearly going to figure in
the considerations of everybody. Whether that is the Bundesbank
President or whether that is the Governor of the Central Bank
of Ireland looking at Euroland, Germany is going to get adequately
Lord Hannay of Chiswick
29. I think what you are saying is what I would
agree with, that you have to get away from each of the constitute
states of the euro zone having a vote, partly because it becomes
unwieldy with enlargement, but partly also because it is contrary
to the whole ethos under which the ECB was set up; but you do
not want to go too far away from it; but that in order to show
you had gone away from it for everyone (and treating the small
and large in a reasonably equitable way) you had to break this
link between the large Member States always having a vote. Having
said that, and broadly the analysis is one I would share, do you
actually think that the structure of the ECB is well suited to
deal with the ten new Member States which have very different
economic tracks on which they are sethigh growth rate,
probably a bit higher inflation and so on, very big inputs of
European money going into them for a number of years? Do you think
that the European Central Bank will be able to cope adequately
with that? What do you think their attitude will be towards attempts
by the new Member States to join the euro zone very quickly?
(Mr Weale) I think your last question was actually
the answer I was going to give on your first question. Are or
at what stage will the new members be fit and ready to join the
euro area? When they are fit and ready to join the euro area,
in other words they are happy with exchange rate stability, with
inflation rates slightly faster than those in the existing part
of the euro area (probably because countries that are catching
up tend to have faster inflation), then I cannot see why it should
be a problem for them in the euro area; and I cannot see why the
ECB should have a problem coping with them. We hear a lot of this
in another context. The issue will be whether and when they are
ready to join and, provided that is assessed sensibly, there should
not be a problem for the European Central Bank because they are
(Mr Walton) One thing I should just add is, it is
not out of the question that when some of these countries do join
that in equilibrium they will tend to have slightly faster inflation.
Referring to Balassa-Samuelson, countries with higher productivity
growth tend to have on average higher inflation. At the moment
these countries only represent about five per cent of Euroland
GDP, so they are not going to have an enormous distortion on the
overall aggregate inflation figure. As those countries get a bit
bigger and if they have a bit higher inflation there will be a
case at that point for thinking, "Is the inflation target
that the ECB has appropriate, or should they reconsider whether
or not they should nudge it up by half a per cent or so"?
In other words, just to keep inflation at an acceptable level,
say, in Germany you do not want inflation in Germany to be going
down to negative territory, just because you have got inflation
in the rest of Central Europe running at five or six per cent?
That would be another plea I would make at the end of the day,
that the ECB should not regard this review of monetary strategy
as the only review it ever conducts into its monetary strategy.
This is something which they have done after the first four or
five years of EMU; this is something, arguably, they should do
every five years or maybe every time another Member State actually
joins the European area. There is certainly precedent for this.
New Zealand I think is the best example. New Zealand was the country
which was the first to have an inflation target, and it has these
periodic reviews every time you get a new governor, or every time
the governor is going to be re-appointed. That has meant that
through time their inflation target has actually changed. It was
zero to two per cent when it started in 1990, that reflected a
desire to bring inflation down into a region that was low. Once
they had achieved that they loosened that target a bit through
time. It went from zero to three, and then last September it went
from one to three per cent. These things should never be fixed
in stone. There are always going to be advancements in economic
thinking and there are always going to be changed circumstances.
The ECB should never think that this is a one-off shot at trying
to get the system right.
Lord Lea of Crondall
30. In the catch-up process, like Portugal and
Greece in the past and now, hopefully, Hungary and Poland will
catch up, the interest rate is the same for everybody. Let us
assume in three or four years' time they are part of EMU, they
still have to catch-up more from that point on. They will still
have higher GDP growth rates which means, within the trend track,
they will have higher money supply growth rates. This is not incompatible
with your interpretation of a twin track governing the ECB?
(Mr Walton) No, my point is slightly different. Clearly,
any country can have a different growth rate. Germany happens
to have a trend growth rate of around 1½ per cent a year
versus the rest of Euroland, which is about a percentage point
or so higher. Just bringing in Poland or Hungary, which has a
trend growth rate which is even higher, that does not change the
inflation situation particularly. What does change though is that
you happen to have very high productivity growth in many of these
Central European countries, particularly in the traded goods sector,
and what that means is you can have a situation where wage inflation
in the manufacturing sector in some of these succession countries
can be quite high but fully paid for out of productivity, so those
industries are able to compete.
31. You mean real wages?
(Mr Walton) Exactly, yes.
32. You said "wage inflation".
(Mr Walton) Yes, and that translates into higher real
wages. Then the important point about this is that you will tend
to see those same sorts of wage increases pass through to the
more sheltered bits of the economy which do not have to compete
with other European countries. What you will end up with is higher
inflation on average in those countries, even though in the traded
sectors inflation will have been much the same as in other European
countries. The net effect of that will mean that Euroland inflation
on average will tend to be a bit higher.
33. How can you have different inflation rates
when the rate at which the euro is inflating is somehow measured
by the European Consumer Price Index? My point simply was, in
your twin track, am I not right, one of the points of the twin
track is inflation and the other one is money supply growth?
(Mr Weale) Could I try and summarise David's point.
Because the economies of Poland, Hungary and the Czech Republic
are catching up they have inflation of, say, 5 or 6 per cent.
If the ECB wants to keep inflation at, say, 2 per cent for the
wide euro area that means in the existing euro area, depending
on the arithmetic, they might have to be put up to 1½ per
cent. In some of the extreme cases that could take it below a
level that it felt desirable. Whereas if it raises the target
for the euro area as a whole by half a percentage point then inflation
in the more prosperous areas will not be depressed below levels
that the European Central Bank feels comfortable with.
34. Do you feel it is likely or desirable for
the Commission perhaps through ECOFIN, inside and outside countries,
to have a greater role vis-a-vis the ECB? I am not sure what role,
but perhaps in guiding them?
(Mr Weale) Yes, going back to the point I made earlier
in terms of coordinating monetary and fiscal policy (they have
their own problem with the national governments in those respects)
so that we do have the sort of situation we are in at the moment
where national governments are saying, "We don't care. We're
doing this because monetary policy is what it is", some sort
of coordination is desirable. Britain, rather to my surprise,
has managed without any formal arrangements, at least so far;
but given the more disparate nature of the euro area, the fact
that it has 12 national governments at the moment, I think that
would be a job ECOFIN should be trying to do.
(Mr Smith) I find it quite difficult given that the
ECB's mandate is effectively just a single thing to control inflation.
I find bringing anything else into that pretty difficult. While
the ECB can change its own numerical inflation target, getting
anything else changed probably requires treaty change. I agree
with David that the ECB, hopefully going forward, will continue
to adapt to circumstances, but I do think there are limits as
to exactly how it can adapt.
Lord Marlesford: They do. The fact is they actually
take into account things beyond their mandate, partly fulfilling
their mandate but basically how they operate de facto.
The Bank of England has views on employment and growth rates,
and I wonder whether we are moving to a situation where maybe
you like changing the mandate for the ECB and there needs to be
some greater conduit for responsiveness of the real world which
has, after all, been a criticism of the ECB in terms of
its interest rate policy?
Lord Hannay of Chiswick: Surely that argument
if it is pursued, which it may very well be, can only lead to
the euro group, the euro zone countries conducting the dialogue
with the ECB and not ECOFIN; because this is the way in which
greater formality will be given to the meetings of the euro group
because of the need, you say, for economic governance input into
the overall dialogue, which is a worrying one for this country
if we stay outside of that?
Chairman: I am not going to allow at this late
stage a debate between two members of the Committee, although
it is a very interesting one! If there are no further points,
may I thank you for the exceptionally intelligent way in which
you have answered our questions, and say how useful you have been
to us. It has been a very, very good beginning to our inquiry.
Thank you very much.