Examination of witness (Questions 188-199)|
MONDAY 26 FEBRUARY 2001
188. Mr Kohn, thank you very much for coming.
May I say how grateful we are to you, particularly as we know
you have flown across the Atlantic especially to see us which
I have to say in all my experience on the Treasury Committee certainly
is the first time anyone has shown such enthusiasm. Thank you
very much indeed. It is very kind of you. Of course we know you
anyway from our own visits to the Fed over the years.
(Mr Kohn) It is an honour to be here,
Chairman. It is a long flight but a wonderful place to come in
the end. I think the Bank and the MPC and the non executive directors
are very much to be complimented for asking an outsider in to
examine their processes. It is a very unusual thing to happen.
I was very honoured and complimented that they had the confidence
in me to ask me to do that.
189. Would you like to say just a few words
about your Report, your main areas of concern? We have, of course,
all read it. Could you tell us about it in your own words?
(Mr Kohn) The Report, I hope, speaks for itself.
190. Indeed it does.
(Mr Kohn) What I found was a system that was functioning
very well but in need of some improvements in certain areas. The
areas I addressed were the Inflation Report and the inflation
forecast process, the work of monetary analysis which is the chief
staff support for the Report and the inflation process and the
MPC which I thought was very, very good but there were some issues
there having to do with staff turnover and the relationship of
the staff to the MPC and the input into the monetary policy process.
In general I was quite impressed with what I saw. Any process
can be improved and in particular this one is only basically about
three years old and still evolving from one in which the Governor
was advising the Chancellor to one in which the MPC is making
the policy under the Chancellor's remit of an inflation target.
So, yes, there was room for improvement, I think particularly
in the preparation of the Inflation Report and the inflation forecast,
but it was a very, very good process. I think one reason that
I was glad to undertake the task, and I am glad to come back and
consult with you again, is I think what the Bank is doing is very
important. Increasingly countries are going to an inflation targeting
regime in which the government gives the central bank an inflation
target and the central bank is given independence to carry that
out. People look to the Bank of England, to the MPC, to a considerable
extent for guidance on how to do that best. The extent that I
can be helpful to the MPC, and hopefully to yourself, I think
that has favourable effects potentially on policy making in other
countries as well. I am glad to be able to do that. I would like
to finish perhaps by emphasising that I do speak for myself, not
for the Federal Reserve or any of the Board Members. I am here
as an expert in monetary policy whose expertise has been obtained
by serving the Federal Reserve for 30 years now but I do not represent
their views, I represent my own.
Chairman: Thank you very much. James
191. You have just said that a lot of bodies
around the world are looking to the MPC for guidance, that was
the word you used, in terms of how they operate the system. In
particular, can you just reflect for a moment, first of all, on
the definition used of price stability and the process of setting
the inflation target and in respect of other institutions, looking
around the world, would you say that the European Central Bank
had anything to learn from the MPC process?
(Mr Kohn) I think I would rather not answer the latter
because I do not consider myself an expert on their things. In
terms of setting the target, I think in the context of the United
Kingdom and your system and where you came from, the idea that
the Government would set a target and empower an independent monetary
authority to reach that target and be accountable for reaching
that target, was a very good thing and something that brought
you further along the line towards an independent monetary authority
that would be insulated to a certain extent from short term political
pressures but at the same time subject to the overall guidance
that such an authority needs to have in a democratic society.
I think it was a very good step for the United Kingdom, given
what the United Kingdom was doing, and other countries have found
it to be that way also. As for the exact target, if that was part
of your question, the 2.5 whether that is the right one, I think
that is something the ChancellorI am not sure where the
2.5 came from, I think it is something that obviously will be
reviewed over time but I also agree with the thrust of many comments
that I have heard that it is not something that ought to change
on a year by year basis.
192. You seem to be saying the idea that Parliament
defines a target and the Bank independently delivers that target
is the sort of model to aim for?
(Mr Kohn) It is a model to aim for. I do not
want to say it is the model to aim for because, of course,
we operate under a different model in the United States. I think
different models work for different countries in different circumstances.
Our model has worked very, very well for us, as you know, over
the last 20 years, pretty much over our history since World War
2. It is a different model but I think each model needs to be
adapted to the circumstances of the country depending on the experience
of the country.
193. Can I just move on briefly and ask a couple
of questions about research available within the MPC which is
something you had quite a number of interesting things to say
about. There was, as you know, some public disagreement back in
1999 between the internal and external members in terms of their
access to independent research and changes were made to the arrangements.
Do you think the changes have overcome the problems?
(Mr Kohn) From talking to people at the Bank, and
I have not done a thorough update on thisI certainly talked
to people while I was there quite extensively, obviously, and
I have had a few conversations since thenI think they have
gone a long way. There are two central elements. One is that the
externals have their own resources now so they can be sure that
if they have specific topics that they want to get covered they
do get covered. The other aspect of it is that the externals participate
with the whole MPC in setting the longer run research agenda.
I think it is set at the beginning of the year, the end of the
previous year, and then is reviewed part way through the year.
The whole MPC also sits down after every Inflation Report round,
I believe, and talks about short and intermediate term research
over the next three and six months. There is a lot of interaction
among the members on the MPC to set the research agenda now and,
as I say, the externals have their own resources. My understanding
is that helped to clarify the relationships between the staff
and the MPC members to a considerable extent and things are much,
much better than they were.
194. Do you feel they make good choices about
the subjects to research?
(Mr Kohn) Yes, I do. I attended two what they call
research away-days while I was there in which researchers presented
maybe five or six topics to policy makers and senior staff in
very rapid order. I was very impressed with the breadth of the
research, the way it was focused on the policy problems at hand,
with its use as near as I could tell of very up-to-date research
techniques and topics to research and a clear understanding of
the literature that it was building on. So I think that the research
is well-focused, it is comprehensive and it is responsive to the
needs of the MPC. Everybody at the MPC as well as the Federal
Reserve are puzzling or are researching, let me say, into what
is happening to the supply side of the economy. This is a major
topic. As economists in university we are trained to think about
demand management relative to given supply and one of the things
that has happened in the United States over the last five or six
years, and a big question for the United Kingdom, is whether something
is happening to the supply side of the economy. And the monetary
analysis, along with the independent researchers who work for
the externals, were putting quite a bit of energy into this, and
I think that is entirely appropriate. The other area that I identified
was the model-building area. In the United States the Federal
Reserve, the FOMC, starts its consideration of policy from a staff
forecast that forms a benchmark for policy makers to talk about
at the meeting. To a certain extent the models fulfil some of
that function (because they do not have a staff forecast, they
are building their own forecast) at the Bank of England, so I
thought it was particularly important that they put some more
resources into model building. The MPC would be well-served by
making sure that their models were state-of-the-art, and that
they could be used for policy-related research. Models are always
going to be imperfect, they always need to be improved, but I
think more resources (and as I understand it the Bank is doing
that) would give them some fairly large benefits.
195. Did you observe a relationship between
the research and the month-to-month decision-making on interest
(Mr Kohn) I observed the research that went into the
Inflation Report very closely because I sat in on all the meetings
that led to the Inflation Report and there was quite a bit of
research that went into that and quite a bit of reporting on the
latest findings of the model and the latest analysis of the staff
bearing on the inflation outlook. I also observed that the material
the MPC were getting was from the staff. They were getting a lot
of shorter-term research pieces. "Here is a puzzle in the
data, here are two lines of data that seem to be telling us a
little bit of a different story. Can we differentiate that there
is something different happening now than might have been happening
before? Can we bring some research to bear on that?" There
was quite a bit of that that went into the rate-setting process
and I thought it was good. It was certainly comparable to what
happens at the Federal Reserve where a lot of that short-term
research is given to the policy makers before a meeting to help
them sort through the contradictory evidence.
196. Mr Kohn, the Federal Reserve's equivalent
to the MPC, the Federal Open Market Committee, has got regional
representatives on it whereas the MPC does not, it just has the
report of the Bank's agents. How would you compare the two models
in relation to the regional input?
(Mr Kohn) I think there are quite a few similarities
in the following sense. At each meeting of the FOMC the regional
presidents do give a report on what is happening in their regions.
Those reports are sometimes of a confidential nature. We publish
about two weeks or ten days before a meeting something called
a "beige book" which also has regional reports but the
presidents come to that meeting and they update that material,
they bring confidential material to the table. They were talking
to the chairman of the XYZ Corporation and that chairman said
that something had happened to sales at their stores very recently.
They can bring confidential material to the table. They try to
look at the material in the light of the national issues that
are being raised, so, for example, if the Open Market Committee
is worried about inflation pressures and labour cost pressures
they would often tailor their material to answer the national
questions that the Open Market Committee has. At the end of the
day, however, although this regional material is presented, it
always feeds into a national picture and the presidents do not
vote their regions at all. They know they are voting on national
monetary policy. The regional information is of interest because
it illuminates the national picture. There have been occasions
(they are rare) in which you hear of the various regional presidents
giving their views of what is happening in the regions and you
realise that something is going on in the economy that has not
been captured by the data and that can influence the Committee's
decision because they have some new information if there is a
repeated pattern in a number of regions. But the presidents are
very, very aware that they are making national monetary policy
and many times I have heard presidents come into a meeting and
say, for example, "My region is very depressed; the following
bad things are happening to itreal estate markets are down
and this, that and the other thingbut I think the national
economy is in danger of overheating and I am in favour of taking
action on those grounds." So I think to a considerable extent
the data that the agents bring, the information that the agents
bring is very similar to what our presidents bring. A lot of it
is anecdotal. They do try to regularise it and try and compare
it over time. It is perhaps a bit more systematic in some respects
than the information our reserve banks bring to the Federal Open
Market Committee but like the information the reserve banks bring
it feeds into a national picture. And it is also key to special
questions that the MPC has. I was particularly impressed with
the agents' reports when the MPC had said to the agents, "Here
is something we are puzzled about. Go out and ask your sources
about that," and the MPC of course was very interested in
the kind of answers it was getting, and I think that is particularly
useful. In the end although the agents are not voting on decisions
I think the regional input is comparable and is used in a comparable
197. Do you think that the individual MPC members
get enough of a feel for what is going on in the regions just
by visiting from time to time?
(Mr Kohn) I think that is an important part of what
they do. They get a lot of input on the regions from the agents
so at each pre-MPC meeting there is a lot of written material
on the regions but also as the agents present their reports they
bring anecdotes and stories about the regions to bear on their
reports on how national conditions are developing. In addition,
the MPC members themselves make a systematic effort to get out
into the regions and talk to folks. I think this is a very important
thing. I do not know how many visits they make but my understanding
is it is quite a few. I think it is important for each MPC member
to not only get out and tell the story of what the MPC is trying
to accomplish but to get the feedback from the people on the battle
lines of the economy, on the frontlines of the economy as to how
their policies are affecting them and how these things are developing.
Our reserve banks serve that purpose to a considerable extent
in the Federal Reserve system, and I think it is a strength of
the system, but the MPC members seem to be trying to fill that
198. Your Federal Reserve members from the regions
actually live in the regions they are reporting on.
(Mr Kohn) That is right.
199. All MPC members are based in London.
(Mr Kohn) That is right.