Select Committee on Treasury Minutes of Evidence



  The current stance of policy is becoming increasingly restrictive. Although the February meeting reduced the repo rate by 0.25 per cent, when this is set against world conditions, it looks increasingly out of line. The argument remains that conditions in the UK show relatively strong growth, but it is hard to see any indicators that are actually strengthening, while inflation is below target.

  Household spending is fairly good, but rising more slowly than in 1999; the labour market shows low unemployment, combined with evidence of skill shortages, but earnings are only increasing by 4.25 per cent. Financial markets are flat, and investment growth has also peaked. Nothing has changed the view taken last quarter that the economy is slowing. If it is the case that it takes 2 years for interest rate cuts to feed through, now is the time for such cuts to be made.

  The only caveat is that the government may come galloping to the rescue with an expansionary Budget next month, though this is not factored into the Bank's outlook overtly.


  Moreover, the risks to economic performance are heavily weighted to the down side. In particular the US economy is still very vulnerable. The indebtedness of both consumers and businesses means that even a return to more stable behaviour, without rebuilding balances, is likely to reduce the growth rate substantially. The US is a huge and flexible economy—this is a benefit in the upturn but equally applies in a downturn.

  It is my judgement that the US downturn is likely to be short lived—but it is also likely to be sharp. This will impact financial markets and confidence which will need counteracting monetary policy. The apparent stand off in the Monetary Policy Committee between hawks and doves runs the risk that this reaction will be too little too late.


  The central forecast for inflation in this month's Inflation Report requires that inflation rise by nearly one point during 2002 in order to bring the target back on track. The range around this is from 1 per cent to 3.75 per cent. It is hard to see what justifies this range or how the risks have been assessed. On p67, we are told that "certain Committee members prefer to make different judgements from those incorporated in the fan charts", as a result of which the profile could be up to 0.5 per cent lower than in the central projection.

  These paragraphs remain obscure on several re-readings. It is hard to see what purpose the fan charts are fulfilling when we could in fact have a multiplicity of such charts—one for each member of the Committee. If the charts represent "general uncertainty" this could reflect previous forecast errors, rather than any particular judgements. The quantification of judgement calls is however central to the policy process about which we know essentially very little, except from the statements made by members outside the Committee process.


  It can be argued that the reliance on general uncertainty rather than judgement calls means that there is still over reliance on historical relationships, of the kind that are encapsulated in standard models. On this basis the strength of the economy should already have led to much higher inflation than we are seeing. In one sense, the whole discussion in the Report is about the meaning of current indicators and whether something different is happening than what history implies. Therefore the challenge is to locate the current situation in the evolution of the economy. The Report fails to do this.

  The reliance on history is the fundamental reason why the inflation rate continues to overshoot and to surprise by its weakness—and also why it is always expected to return to its target rate in two years time.

  The alternative "stories" by which this may not happen should be more clearly spelled out, otherwise the description of the economic situation which comprises the bulk of the Report is not very helpful as an elucidation of the decision making process.

20 February 2001

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