Examination of Witnesses (Questions 128-139)
Mr Roger Bootle
10 JULY 2007
Q128Chairman: Good
morning and welcome; thank you very much for agreeing to come
and talk to the Committee. Our Chairman, Baroness Cohen, is not
able to be here today but I am standing in on her behalf. As you
know this is a recorded session and there will be a transcript
of what is said which will be sent to you after the meeting. Is
there anything particular that you would like to start with, or
a general comment on the situation?
Mr Bootle: Yes, I will make a few general remarks,
if I may. First of all, on the whole question of what has gone
well and what has gone badly, as it were, in the euro area, I
feel that both the hopes and the fears with regard to monetary
union were always grossly overdone. In my view the most important
things that happen in economies are real, not monetary, and we
had a period when the advocates of monetary union fondly imagined
that merely bringing currencies together and abolishing exchange
rate fluctuation would unleash a wave of prosperity, which I always
thought was na-ve. Equally, we have had of course a number
of people who thought that forcing currencies together would bring
some sort of disaster; that has also proved to be completely wrong.
The issues are much more nuanced and balanced and, in particular,
I would take issue with those people, both within the eurozone
and outside, who see the weaknesses in European economic performance
recently as stemming largely from the euro; to my mind they stem
from real factors.
Q129 Chairman: At least one thing
that has been achieved is lower inflation. Competitive devaluation
and very high interest rates have been effectively eliminated
by the single currency.
Mr Bootle: On the point about low inflation,
I am not sure you can say that countries of the eurozone have
achieved low inflation because of the advent of the euro; after
all, we have achieved low inflation and we are not in the euro.
Countries all around the world have achieved low inflation without
being in the euro so I see low inflation as being an international
thing to do with a series of forces, but which could in principle
have been achieved by countries who did join the eurozone had
they remained outside it.
Q130 Chairman: Do you think that
the ECB's monetary policy has been too restrictive?
Mr Bootle: The record is very interesting. If
you look at the history of inflation in the eurozone it does not
strike you as evidence that this is a monetary policy regime that
has been much too restrictive; after all, what would you expect
to see? What you would expect to see is inflation, I guess, decidedly
below the target, but in fact that is not what you see, what you
see is inflation pretty much bang on the target, around about
2%, and indeed the average recently is slightly above 2%. If you
want to argue that the monetary policy has been too restrictive
you would have to argue one of two things. The first is that the
target itself was too tight, and I have some sympathy with that;
perhaps it should have been acceptable for the inflation rate
to be slightly higher, and that particularly is so if the eurozone
is expanded to accommodate the fast-growing countries in the former
Eastern Europe. The second thing you might argue is that effectively
there is a horizontal Phillips curve—if you drew a line
linking the rates of unemployment on the one hand with rates of
inflation, rather than the traditional relationship under which
you had some sort of trade-off such that in order to have lower
inflation you had to put up with higher unemployment, if you had
a straight line you could have the same inflation rate with wildly
different rates of unemployment. If you believe that, then the
fact that the inflation rate was pretty much bang on the target
would not necessarily mean that the policy was not restrictive;
that is to say you could argue that the ECB has not given growth
enough of a chance. In the United States, for instance, under
Greenspan for a prolonged period there was a policy of giving
the economy a chance and the result was that the economy grew
quite strongly and carried on growing, with unemployment falling,
without inflation picking up. The root of this is the argument
that there is quite a lot of inertia in the inflation rate, and
if it goes to a certain level it is liable to stay there and it
is liable to stay there if unemployment is 2 to 3% lower. I might
argue something along those lines; the ECB has not given European
growth enough of a chance and is now perhaps tightening policy
too much too fast if it wants to give European growth something
of a chance.
Q131 Chairman: How should that be
remedied? Should the decision be made by the central bank or by
ECOFIN?
Mr Bootle: It is very difficult to come up with
simple answers to this issue and even though I have heard myself
saying what I have just said I am very conscious of the political
dimension in the European Union. There is a great danger for academic
commentators in particular to come up with regime commentaries
and criticisms based on some textbook idea of how a central bank
should operate; the problem is that the institutional structure
in the eurozone is very different and I think quite weak and the
difficulty is that you have a very new, young, institution with
a young currency and the potential for substantial political interference
in the regime, against a backdrop where the new President of France
is making all sorts of difficult noises, shall we say, along those
lines. In a pure sense I would argue that the ECB should not tighten
quite as much as it has, but in the practical circumstances in
which we are living I understand why it is doing it and, what
is more, the idea that somehow or other you should interfere in
the set-up by having ECOFIN taking more of a role is potentially
extremely dangerous. The fault lies with the overall institutional
framework, the fact that the politics of the eurozone are extremely
difficult.
Q132 Lord Inglewood: I would like
to dig a bit deeper if I may. I was going to put the question
originally somewhat differently and say if you had been setting
up a framework for a currency in the eurozone would you use the
Stability and Growth Pact as the box in which you set it?
Mr Bootle: I am tempted to say, like the Irishman
when asked the way to Cork, "I would not be starting from
here".
Q133 Lord Inglewood: I am afraid
you are.
Mr Bootle: Exactly. The Stability and Growth
Pact really does put into a nutshell the institutional difficulties
to which I was referring earlier on. It seems to me that there
has got to be some sort of fiscal restraint, otherwise the free
rider problem is quite significant: that is to say that countries
can run irresponsible fiscal policies confident in the belief
that the costs of these will be borne by the eurozone as a whole
in the shape of higher short term interest rates and probably
higher bond yields, and the country running the irresponsible
fiscal policy will have marginally higher bond yields but not
that much higher compared to the situation outside the currency
union. Some sort of restraint, therefore, is desirable. The particular
system that was originally instituted was very tight and I welcome
its relaxation under the reforms of however long ago it was, but
I still do not think it is an ideal set-up in that it is in principle
too restrictive. Our own fiscal arrangements are in a pure sense
superior, but they have got their problems as well, notably the
leeway granted to the Chancellor in effectively deciding what
is investment and what is not investment, when the cycle begins
and when it ends. That is far from ideal but in principle our
arrangements are better. The difficulty is if you had that sort
of system in a European context how on earth could it work? Would
we allow the French government to decide what was investment and
what was not investment, to decide when the cycle started and
when it ended? I do not see how one can ideally structure that.
My feeling is that the revised system is not too bad given the
circumstances that actually exist.
Q134 Lord Steinberg: This question
concerns the size of the US trade deficit and the Chinese surplus
and the rationale for asking is do you think there is any significance
as far as the eurozone is concerned in relation to these two vastly
different powerhouses of the world now? We know that the United
States has been running a deficit for umpteen years and they are
perfectly comfortable with it; equally well we know that China
is now running this huge surplus and nobody seems to be happy
about it. They are two different aspects; do you think that they
have any relevance in relation to the eurozone and if so what?
Mr Bootle: Yes, they have for a start a major
macro relevance and, secondly, a relevance in particular European
countries. On the macro front the relevance is the danger first
of all of a further substantial appreciation in the euro; there
is a significant risk that at some stage or other the dollar will
fall significantly and unless there is some change in the attitude
of the Chinese authorities to the management of its own currency
it is almost inevitable that the euro is going to rise against
it because there are not that many big currencies to go up instead,
the yen being one. This would pose a significant risk to the European
economy in that you could end up with the euro significantly higher.
The other related macro danger in this situation is that the world
could be driven in a protectionist direction. It is understandable
in many ways the frustration that the Congress in America feels
with the Chinese trade policy, in particular with this apparent
tolerance of an enormous surplus. I do not think it is actually
in China's interests to run such a distorted economy with such
an enormous surplus and there is an issue about quite why they
do seem to think that it is in China's interests. Given that,
one can imagine a situation developing in which America gets really
very fractious, imposes duties and penalties and China responds
and Europe feels it has to respond as well. That is potentially
extremely ugly, not just for Europe but for the world as a whole
so this issue is of key relevance to the eurozone for both those
reasons.
Q135 Chairman: Should the ECB be
putting some pressure on the Chinese authorities to gradually
allow their currency to appreciate?
Mr Bootle: The answer is yes, but it should
be done through the usual international bodies and I do not think
currency appreciation alone is remotely going to be enough, we
have to see this in the round. If you are going to try and reduce
the Chinese trade surplus then, other things equal, that will
of course result in lower demand in China overall and increase
unemployment which, understandably, the Chinese authorities do
not want. The policy of raising the exchange rate in order to
cut down the surplus must be accompanied, therefore, by policies
to boost the level of domestic demand in China, principally consumption.
There does not need to be any increase in investment which is
already absolutely enormous, it is the low level of Chinese consumption
that needs to be boosted.
Q136 Lord Trimble: That presumably
means increasing wages in China.
Mr Bootle: It may mean increasing wages, it
has not necessarily got to mean that but that would be one way
of doing it. In essence it means either a laxer monetary policy
or a laxer fiscal policy and in the circumstances probably in
China it means a laxer fiscal policy. The Chinese have got ample
scope to run a bigger budget deficit.
Q137 Lord Steinberg: Can I just come
back, My Lord Chairman? You are foreseeing a bit of a turbulent
time in relation to this. We have had in the past ten years since
the eurozone was set up fairly stable currency movements throughout
the world. Are you now seeing that just as here in Britain the
newspapers are full of two dollars and one cent to the pound,
that will become even wider and are you seeing as a result of
that the euro will increase substantially so that we are going
to go into a period now of turbulence in the currency markets?
Mr Bootle: "Seeing" is far too strong
a word and I have been doing economics long enough to know that
no economists see anything clearly with regard to exchange rates,
they are not possible to forecast. I am not trying to say that
I can see anything through a crystal ball as it were, but having
said that there is a significant danger that all economists can
see—structural flaws and problems—and I am by no means
alone in worrying about the implications of the huge imbalances
in the world. The dollar has fallen quite a long way and of course
the euro has gone up, so it is not as though things have been
completely stable. To answer your question directly, yes, I am
concerned that although at the moment there seems to be a sort
of Faustian pact between the Chinese and the Americans, where
the Chinese are supplying the goods to America and supplying the
finance to buy the goods, this is a deeply unstable and worrying
situation and, at some point or other, one senses that there could
be some major instability in currency markets and, worse than
that, difficulties facing the open world trading system.
Q138 Chairman: There is diversification
of reserve holdings which is weakening the dollar against the
euro and making our exports to America more difficult.
Mr Bootle: Yes, that is one factor that is going
on and contributing to the strength of the euro. Difficult though
the relationship is between the euro and the dollar, the most
important distortion in the world is the under-valuation not just
of the Chinese currency but more or less of the whole of Asia,
which applies to the yen as well and lots of the smaller currencies.
To redress the imbalances in the world what we need to see is
an up-valuation of just about all the Asian currencies against
both the euro and the dollar.
Q139 Lord Trimble: Going back to
your opening comments, which I found interesting because you were
saying that you were more interested in the real factors affecting
economies rather than purely monetary matters, if I understood
you correctly, looking at the position within the eurozone over
the last number of years it looks rather disappointing in terms
of comparatively low growth. What do you see as the causes of
that? Are they the real economy or are they things that are linked
to the introduction of the euro?
Mr Bootle: They are primarily real with, I guess,
one exception. I do not want to say that monetary things are completely
unimportant, I do not believe that, but you could argue that Germany's
weak performance until recently was partly down to the euro because
she may well have entered monetary union at too high an exchange
rate for the deutschmark, and certainly German trading performance
was initially quite weak after the inception of the euro. You
cannot argue that now, however, because Germany has improved its
competitiveness no end. Paradoxically I would say that now the
euro's restraints and difficulties and problems are most acute
for Italy which, in normal circumstances outside the euro, would
by now have devalued. It would have carried on, presumably, having
its inflationary cost increases, but it would have devalued and
so maintained competitiveness. The roots of the eurozone's lower
growth are the same as people have talked about for ages and ages
and ages: excessive levels of taxation, over-regulation, particularly
with regard to the labour market, insufficient investment in IT
perhaps related to all of those things, lack of an entrepreneurial
culture, all those things which have got next to nothing, frankly,
to do with the euro.
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