Select Committee on European Union Minutes of Evidence

Examination of Witness (Questions 160-178)



Lord Lamont of Lerwick

  160. Sir, I really want to ask about exactly what you have said. You wrote a very interesting article, as I recall, about two months ago, making the point you have just made to Lord Sheldon, but if I recall rightly you did it more in the context of deflation.

  A. Yes.

  161. I suppose it is the combination of deflation and the failure of the financial institution. Can you just go into a bit more detail about what are the different things you think can be done? Would it be intervening on the euro curve in the foreign market? Is there something that can be done by giving the ECB more powers over banking supervision? What exactly is it that could be done?

  A. I do not think it will be given more powers over banking supervision. Its powers have been negotiated very carefully and any renegotiation would last much longer than any crisis it had to deal with. I did not think we would reach deflation before the coffee, which we are not having, but I will tackle this head on. I am not one of the deflation mongers. I do not think that the 1930s are around the corner, but supposing we reach a situation where the zero interest bound becomes operative, that is the European Central Bank would like to get interest rates below zero but it cannot, there is a deficiency of demand or the threat of a slump in Europe. I am not saying it is likely, but I am just following the Boy Scout motto of "being prepared". Now, the Federal Reserve have had a very open and interesting debate on what it can do if it cannot reduce interest rates any further, and going further along the euro curve is the most orthodox, although I am not even sure whether that would be allowed under the ECB rules, because that might be regarded as supporting the debt of European governments. To take the most extreme case—the most extreme case is the easiest to explain - where ideally one would like a helicopter dropping euro notes. Now, the most realistic way of doing this would be temporarily to allow the governments to have larger deficits, and for these deficits to be financed by the printing and circulation of extra euros; in other words, the governments would borrow the euros from the Central Bank. Now, this would be a chamber of horrors to all these institutions and the Growth and Stability Pact would have to be put on ice. The rules about not supporting government debt would have to be put on ice but, above all, there would have to be agreement with the European Central Bank and 12 individual governments about how to do it. Now, it is going to be difficult enough if it arises in the United States or in the UK. The prospect of dealing with that kind of slump crisis—I hate to use the word "deflationary"—is, frankly, a nightmare; let us hope it never occurs.

  162. On deflation, or moderate negative inflation, it may be unlikely for the eurozone as a whole—that seems happily to be the consensus of opinion—it appears pretty certain for Germany, but are you concerned about the ability of the banking system and the indebtedness of the personal and corporate sectors in the German situation?

  A. I am not an expert on the indebtedness of either the personal, or the corporate sector in Germany, but clearly there is a danger that an inflation rate which might be not too low and not too high for the whole area - might involve very low or negative inflation rates for Germany and that Germany is going to suffer. Would it be unfair to suggest that Helmut Kohl might have thought of these matters before pushing the euro project so fiercely?

  163. Can I just ask one final question? If the interest rate target had been, let us say, one per cent higher, do you think the outcome of the euro project in Germany would have been very much different or not?

  A. Sorry?

  164. If the inflation target had not been subject to this, but supposing it had been one per cent higher, presumably to the extent which one had to depress interest rates in order to get the average for the eurozone it would have been less harsh on Germany. I wonder if you think that would have had any significant difference.

  A. I think it would have been better, to anticipate perhaps some further questions. If the ECB had a central target of two per cent with a range of one per cent on either side, it would have been more satisfactory. The reason why I circulated this preliminary note is I think that one can exaggerate the beneficial effects this would have. Germany has a system for pricing people out of work and it is called the European Social Model. Also, it went in at too high an exchange rate, and neither of these things would have been materially eased by a slightly more expansionary policy of the ECB.

Lord Sheldon

  165. Sir Samuel, just coming back to your arrangements within the note, because I see you give five per cent to fiscal policies and procedures in the ECB. Can I ask you to give us your view on how the two pillar monetary strategy has worked since the start of stage 3 of the EMU and the introduction on 1 January 1999? Am I to take it from that you think it has worked rather well?

  A. They have made the best of a bad job. I can talk about the two pillars in a minute, but I do not think they have made shatteringly wrong decisions and, in fact, they have not moved very differently from the Fed or the Bank of England. They have moved a bit more slowly and a bit more cautiously but, as Mervyn King said this morning, you can expect a new institution, because it has to establish its credibility, to be a bit careful. There is the question of the two pillars. Now, in practice, it was only one pillar that mattered, what they call the economic analysis. Unlike many other people, I would not throw away the first pillar. Remember how much criticism Nigel Lawson got, after the event, when he abandoned the targets for M3. I think, looking back on it, there is something to be said for the Geoffrey Howe method of keeping the monetary pillar there and trying to talk your way out of the situation when it is ignored. Seriously though, as Dr Issing constantly points out, there is some long-term relationship between the money supply and inflation. You can overdo it and it is very difficult to state exactly, and maybe they should not have put this relationship in as a pillar, but I think that they should be very careful before they get rid of it. It is a very useful check to discourage them from responding to a series of specific situations in a way which can create an inflationary threat in the long term. At the moment it is a fact that we do not need to worry about inflation, but these things change and, although it was probably a mistake to use the word "pillar", I would not bring that pillar down, I would keep it there in the background, which is where it is now.

Lord Armstrong of Ilminster

  166. Possibly even put a little less weight on it?

  A. Yes. I do not think, Lord Armstrong, that very much weight has been put on it. If you look at the justifications of the interest rate decisions, they have been nearly all in terms of the European economy and, in fact,—and this will be familiar to you from discussions in this country - most of what has been said about the monetary pillar is why it has been all right to ignore it, or to disregard it for a short period.

Lord Hannay of Chiswick

  167. Yes. If I might be allowed a remark at the beginning to reassure Sir Samuel that I do not think anyone on this inquiry has yet shown any indication to look for a scapegoat at all. So I think that the need to quantify precisely the allocation of blame is probably not necessary. Certainly, as far as this Member of the Committee is concerned, I find it very difficult to believe that the chairman of the French Committee would not be in just as much difficulty now as they are, even if there had not been EMU? What one of our previous witnesses, Paul Volcker, said was that he felt that what was lacking for the President of the Central Bank was something that had been of huge value to him as head of the Fed, which was his weekly dialogue with the secretary of the Treasury, who was responsible for other aspects of economic policy and financial matters than the ones he was, and he felt that the European Union would have to move to some kind of dialogue. You will no doubt be familiar with the proposal Mr Giscard d'Estaing has put forward for strengthening the economic governance aspect of the eurozone countries, not in terms of giving them control over some centralised fiscal policy but in terms of producing someone with whom the President of the Central Bank will be able to have a dialogue. I would like you to comment on whether you think that is a likely way forward, or whether it is a desirable way forward, because I think from the Government's side what we are looking at will be quite important. Also, do you not think that your remark about the Geoffrey Howe approach to the monetary dilemma seems entirely different from the approach that the present Member States of the eurozone are taking to the Growth and Stability Pact, that is to say, they are treating it as something which still needs to be there, even if it needs to be interpreted rather more flexibly than its precise lettering would imply during all the present circumstances?

  A. I will answer the last part of the question first, if I may. I think they are interpreting it a bit more flexibly. The member countries did not carry out the earlier part of the Growth and Stability Pact which was the most important, which was to try to get their budgets in order before they ran into recessionary problems. They now have the dilemma: do they shelve, as it were, or explain away the Growth and Stability Pact and allow the fiscal stabilisers to work, or do they try to adhere to the pact and carry out perverse fiscal policies? I would think that there is enough room for flexibility in the interpretation of the pact if they want it, but it does not help matters when Solbes, the European Commissioner, and the old Bundesbank hand behind himI have forgotten his name for the moment—start issuing broadsides at countries for not seeking to balance their budget in the next year or two. There is still a constituency for the rather literal interpretation of the pact. Your earlier question is more difficult, which is why I have left it until last to answer. In principle, it would be wonderful if just as the heads of government appointed a spokesman, if the finance ministers either appointed an independent spokesman or appointed one of themselves, not for six months at a time though, but for quite a few years. Without Europe moving in a more federal direction, I find this very difficult to envisage. Supposing for a second, we were in the euro, could you imagine Gordon Brown leaving it to the Italian Finance Minister to negotiate on his behalf with the ECB. By all means try in that direction. What Mr Trichet—who has, I think, got a good touch in these matters—will have to do is to have these discussions "behind the Speaker's chair" with the major finance ministers, bringing in the ones from the smaller countries ritually once a year or so. I think that probably will be more important, especially in a crisis of that situation, than trying to find a spokesman for all the finance ministers, which is going to be extremely difficult.

Lord Taverne

  168. I want to come back to your original take. I suppose the question which we are interested in, according to our brief, is the five per cent, namely what has gone wrong with the five per cent? So perhaps you can tell us how you think the five per cent can be explained. Before we come to that, according to your figures, there is not an awful lot the ECB can do because there are fundamental things which are wrong, and the most fundamental thing, according to you, is the social model.

  A. Yes.

  169. It is relevant, therefore, in a way, and I want to ask you about that. Everyone agrees that there is the need for structural reform in Europe, but are you going beyond that? Structural reform seems somewhat easier than the whole remodelling of the social model. If one looks at the 20-year period, or ten-year period, the European social model did rather well compared with the United States. If you look within the last ten years, it did well compared with the United States: growth was better; unemployment was lower, taking the total; and even now productivity per hour is higher in a very considerable number of countries in Europe compared with the United States. If one looks at the Polder model as opposed to the Rhineland model, one finds the Dutch have done extremely well; even in the last five years they have done pretty well. So is it the social model that is to blame, or are you really giving a different name to what most people believe are a number of structural reforms that have to take place?

  A. These labels are all very vague indeed, and "structurally" is one of these weasel words that ministers use in order not to engage in polemics against each other, especially when they come from different political parties in Europe. Frankly, and here I am, I think, quoting Mr Trichet—he was talking about France, but I think this applies more generally - he said that "the cost of labour is too high and this prices people out of work". This is perfectly consistent with productivity having performed reasonably well—according to the study by Goldman Sachs, which I have got here. The productivity performance has been quite good in the last ten years, in fact slightly better than the United States; oddly enough, slightly worse than the UK, but that may be productivity with a ten-year period. Where the American model has been far more successful has been bringing people into employment. It is not only demographic, the big failure of the European social model has been on the employment side. Now, if it was just that people did not like flexible wages and they were prepared for fairly high unemployment, or non-employment levels, that would be their affair. I do not think it is just a matter of individual preferences of European citizens, because they are going to run very quickly into a demographic crisis with a smaller and smaller working population having to support a larger and larger proportion of the population either in retirement, premature or otherwise, or in so-called education which, in the case of Germany, goes very high up into the twenties age group. So the model is going to run into problems. I would be delighted to talk about the five per cent, if you want me to.

  170. I do not want to go into it too far because it is only indirectly relevant. Can I come to the first question, the five per cent. How does the five per cent break down? What constitutes this five per cent?

  A. Yes. This is taxing my arithmetical powers. I will not give the percentages, but I have not too much to add to what many of your other witnesses have said. I do not think the monetary pillar has done any harm. What it really is is just an amber light which says: "Do not forget about the money supply", and I am perfectly relaxed about that. Now, it would help if they made it clear that falling below the inflation target which is now expressed as just below two per cent—which is the same as ours if we allow for the difference in definition of the index—that it is a range, and even now it is not clear that they would be as worried by going well below two per cent as they would be if they went up to three per cent. I think they could have acted a little more quickly, although a detailed examination shows that they have moved at least as often, if not as early, as the Bank of England Monetary Policy Committee. I suppose they could have been slightly more expansionary and slightly more alert to recession dangers. I think 90 per cent of their problem has been presentational and they have been very dogmatic. I am afraid we are talking about the Dutch in a different context, but I think the outgoing president has not been terribly good at presentation; I am a bit surprised, I thought he would have been rather better. I think that they have erred—to put it in one sentence—slightly on the restrictive side. We need to get the ECB working as well as possible, but do not let us assume that this will solve most of Europe's problems.


  171. How do you feel about the presentation? What mistakes have they made in the presentation?

  A. I do not think that they should have published minutes in the British model, with a young multi-national institution that would have been very difficult. What they could have done, which is not too different from what the Fed does—because in the Fed, by convention, only two or three governors express public disagreement even if more actually disagree, and the Fed minutes concentrate on the different points of view, and so even do the MPC minutes probably, although you can usually work out from the minutes who said what—it would be helpful if different points of view were expressed in good central banker language, and then the reason for coming out on one side or the other; that would be very helpful. I suppose too that the President giving evidence before the European Parliament is not quite enough, because there is no real European demos yet. Again, I believe even today's meeting is being televised. I do not think you can see on television—correct me if I am wrong—the cross-examination of Mr Duisenberg by the European Parliament; maybe you can on some European channels, but I do not think that this is top viewing for people here. Somehow or other it would be helpful if the President gave explanations to national parliaments. Now, it is very difficult when there are so many countries involved, but maybe national parliaments, or their committees, could take the initiative; it is difficult for the UK, not being in the system. I do not see why the Bundestag, for instance, or one of its committees should not ask the President to give evidence, and putting the onus on the individual parliaments might reduce the number of appearances compared with a ritual expectation that he talks to all of them.

  Chairman: The problem is if you go to one, you have to go to the lot, and I think that has always been the difficulty.

Lord Marlesford

  172. Can I go on to exchange rates because, frankly, I would have thought one of the big worries for the European economy at the moment is the huge appreciation of the euro at the present time. What is your view on the role, if any, of central banks on exchange rates? I can see they could follow or pick up interventions as sort of bucking the markets down. I suppose one can influence some of the factors which influence exchange rates. Do you think there is anything the ECB should be doing at the moment about exchange rates?

  A. There will be three reasons why they should hesitate a lot. Firstly, it is not their competence. As far as I understand it, the Maastricht Treaty exchange rate policy is a matter for finance ministers. Secondly, any attempt to have an exchange rate policy against the dollar would lead to an almighty row with the United States, as if relations were otherwise very good on other fronts of international policy. Thirdly, I have no idea what the correct exchange rate is. President Duisenberg says that the present exchange rate is simply a recovery to the average of the last 15 or 20 years before the euro depreciated as it did earlier. I think if the ECB were to agitate for an exchange rate policy, it would be a stick for its own back. I think you will find as many economists saying that the European exchange rate is still too low as those saying that it is now too high. It would be much better for it to carry out its present remit and to let the exchange rates come out into the wash. The exchange rate is a very important safety valve, but it is only a safety valve if it is left to operate.

Lord Geddes

  173. Sir Samuel, I really want to come back to the previous question. I am sorry, perhaps I should have just butted in so it would flow more naturally. You were talking about the European Parliament, you were talking about TV broadcast of interviews or analysis. Do you think the European Parliament should have the power to confirm candidates to the Executive Board? Having brought up the subject of the Executive Board, do you think that we should move from unanimity to qualified majority for the appointments to that Executive Board?

  A. Among the group appointing the Executive Board, whether it is the Council of Ministers, or the European Parliament, I would leave qualified majority for the moment, because so far ministers on the Council have managed to agree, and once there is a voting procedure, it becomes much more a matter of national pride and honour to get one's own candidate on. Should the European Parliament appoint the members of the ECB? My initial reaction is "heaven forbid".

  174. No, my question was to confirm rather than to appoint.

  A. To confirm.

  175. You could argue that is the same thing, but one step removed.

  A. Confirming it would be less bad. Supposing we got into a European slump, there would be lots of European politicians who would want a lot of rescue operations for particular industries, and the creation of even more money than would be justified in the circumstances. To unleash these populist measures would not, to my mind, appear to be a very good idea, no. In a curious way, national parliaments restrained themselves in these situations. Where there is an international gathering and European MEPs still have to make a name for themselves, I would put these ideas on ice—not forever—for the moment.

Lord Sheldon

  176. You mentioned that the European Central Bank could have been, in fact, perhaps a little more conscious of the problems of deflation as well as the problems that were arising. Also, you mentioned the way that the Fed has this contact with the Treasury in Washington. We have, of course, here in Britain the relationship between the Monetary Policy Committee and the Chancellor of the Exchequer. Should there not be some sort of relationship between the European Central Bank and some other body?

  A. Well, there is an EU Monetary Policy Committee. I think they actually are representative and I think it is the finance minister who chairs that group, but certainly somebody from the European Monetary Policy Committee, which is a political committee, is allowed to attend but not to vote at the ECB, rather as a Treasury representative comes to the MPC here. There should be discussions at a higher level and obviously contacts between the Governor and Chancellor here are not confined to a Treasury representative attending the MPC—obviously the Governor and Chancellor see each other quite a lot. What do you do if there are 12 and eventually 31 finance ministers? It is a little bit of a nightmare and I can understand the inclination of the ECB to postpone that problem for as long as possible. I think if it came to a situation where that was very important I have no doubt, especially under Mr Trichet, that the ECB would communicate very quickly with the German and French finance ministers and with the others a little more formally and a little later. It would have to be done informally at the moment unless and until, as I think I said in reply to Lord Hannay, there is enough esprit de corps among European finance ministers to appoint and trust a common European interlocutor. This is not so far-fetched. A certain Lord Brittan was given this role in relation to trade policy, but he had to keep on coming back for mandates. I think we are quite a long way from the time at which one person will be able to act for all the European finance ministers. I think it will have to be done fairly informally and I expect Mr Trichet to become rather good at it.

Lord Armstrong of Ilminster

  177. Could I ask one question? The European Council has decided upon changing the arrangements for the governance of the ECB after enlargement, changing the voting modalities and all that. I suppose the IGC gives us another chance to think about that. Do you have any views or comments on the proposals that have been made? Do you think they are optimal or should we try and seek further change?

  A. I would want to seek further change. Having criticised the European Parliament, I must say I have come across a very sensible proposal which is summarised in one of the volumes of the Treasury's five tests; in fact the extract was sent to me by this Committee. The European Parliament has proposed a nine-person Executive Board under enlargement which would carry out operational decisions and the larger group of all 25, or however many it is, would meet only occasionally to give them a steer. I think that is sensible. I think the proposals as they stand at present lead to the danger of too large a body being concerned with interest rate policy, which is not best discussed with 20 or 30 people around the table, and I think on this matter I would follow the suggestion of the European Parliament.

  Lord Armstrong of Ilminster: Thank you very much.


  178. Thank you very much, Sir Samuel Brittan. Professor von Hagen has arrived. If you want to go, please do. If you want to stay, do stay.

  A. I will listen to him for a time, if I might.

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