Select Committee on Treasury Minutes of Evidence


Examination of witnesses (Questions 236-239)

MONDAY 26 FEBRUARY 2001

MR ROGER BOOTLE, MR DAVID MILES, MRS BRIDGET ROSEWELL AND PROFESSOR ANDREW SCOTT

Chairman

  236. Firstly, apologies that we have not got all our Members. A couple have gone down to listen to the Foot and Mouth statement who have a lot of agricultural areas in their constituencies. They may come back, I do not know. Thank you very much for coming. May I start by asking why did the MPC cut rates this month and were they right to do so? Perhaps that is a nice general question which you can all reply to. Who is going to be first?

  (Mr Bootle) Shall I start? I think there are essentially two reasons. The short term and conjunctural reason is I think almost wholly connected with the American slow down in the sense that there was at the time the Bank made the decision very little evidence from the UK economy of any demand weakness and there has not been much since either. That was I think the first reason, as a sort of assurance policy against contagion from the United States and the wider world. The second point is I think at least as important which is that the inflation rate has consistently undershot the target now for 22 months and it looks as though, on current form, it is due to continue doing that for some considerable time. So without the rate cut I think it would have been very difficult for the Bank to have presented in its Inflation Report a picture of the inflation rate going forward consistent with trying to hit the target. I very much agree with that view myself so I would argue that the Bank was absolutely justified in cutting rates, indeed I think the big issue was whether they should have cut by a quarter or by a half.

  237. David Miles?
  (Mr Miles) I agree very much with what Roger has just said. It seems to me the key thing that happened between November and this report, and which happened just before the decision to cut interest rates, was the news coming out of the US that certain forward looking indicators like confidence indicators had fallen very dramatically. The US Fed clearly took them very seriously; they cut interest rates by 100 basis points in the course of January. That is a very big cut. The MPC has taken out a sort of partial insurance policy against the knock on effects of a possible slow down in the US. Like Roger I think the big question is have they done enough? My own view is that the scale of the possible slow down in the US remains extremely uncertain. There are still conflicting signs in the US and it is not even clear whether we are heading towards what you would call a substantial slow down, let alone a recession. Some confidence indicators have fallen very dramatically but some other indicators—retail sales and the employment numbers—still look relatively strong. I think it would have been unwise for the MPC to have cut interest rates very significantly given the great uncertainty about the possible scale of slow down in the US. But I think it was clearly the slow down in the US that triggered what they did.
  (Mrs Rosewell) I agree that it is the slow down in the US. After all, we have had one whole point off the US interest rates during this calendar year, against which a cut of a quarter looks really rather trivial. They could have held on for another month, but the longer they left if it was clear that increasingly the expectation was then going to move downwards. To do a pre-emptive quarter point cut was the smallest cut you could make and the fact it was unanimous in this view, we were just discussing amongst ourselves, is perhaps slightly surprising, and I suspect that it is a combination of those people who thought if we make it a quarter point that might be a minimum amount and those who might like to go further. I think what is much more interesting is the minimalist cut that they have made. If you compare the inflation forecast in this report and the inflation forecast in the last report, and they are compared on pages 66 and 67, the speed with which inflation has to rise back towards 2.5 per cent in order to hit the target by the end of the period gets sharper and sharper, and if that is therefore to be achieved, how are we going to get back to this inflation rate rise? The economy is slowing down. It may not be slowing down very much and some aspects of it are still quite strong but, generally speaking, the growth rate of the economy is slowing here and in the US—how sharply we have yet to see, there is some uncertainty about that—and therefore, if you do not cut interest rates now, when do you cut them? It seems to me that we are running into a situation where real interest rates in this country are more and more out of line with what is happening elsewhere and are likely to become more so given the way that the economy is moving forward. I think it is rather worrying that we have only had this quarter point cut this time.
  (Professor Scott) Rare unanimity amongst economists both in the MPC and here. The reason was very clear from the last Inflation Report. The estimate is that United Kingdom growth is close to trend, inflation has been under-shooting the target for a long period of time. As Bridget commented, the inflation forecast shows a very rare and sharp rise in inflation, almost coincident with their GDP forecast to hit 2.5. Given also the weakening in the US it seemed obvious that the interest rates had to fall. The question is obviously whether by a quarter, half, three-quarters, by how much? Trend growth, low inflation below target; it is inevitable you have to cut interest rates.

  Chairman: Thank you very much. David Kidney?

Mr Kidney

  238. At the press conference Mervyn King said: "There was much discussion in the Committee ... about risks ..." and a bit later on: "And it was this balance of risks which led to a modest pre-emptive reduction in the official rate." Bridget, you have just been talking about how the central forecast seems to dictate whether we should have a cut in interest rates. Are we going to see more and more tension between them weighing their different risks and putting different rates on those risks as against what their central forecast ought to be dictating?
  (Mrs Rosewell) It seems to be one of the tensions in what we know about the Committee between what is the risk round the central forecast and what is, if you like, the interior risk that individual members of the Committee are working with. We have in these discussions before talked about the ways in which the risk is assessed and how you generate the fan charts: the extent to which those are derived from different sorts of assumptions and the extent to which they are derived from different sorts of uncertainty about the way the equation works within a given model, and you can do it both ways. There is some part of both of those processes emerging in the way that the fan charts are put together. We always live in uncertain times and the future is always different from the past, so the way in which those assumptions are being formulated by different members will be changing as we go forward. I am not clear that we can really sensibly ask a question of the MPC to disentangle this. I agree that it would be nice to do so and various people have been commenting that we ought to have more of this kind of clarity. I suspect, however, it is the kind of clarity that is going to be awfully difficult to provide and the answer to the question might be as unclear as what you have started with. There are two particular ways in which it has got more difficult. One is that the uncertainty surrounding the path of the US economy has been there for some time but has increased and now we are actually on a downward path. Secondly, I think there is genuine uncertainty about the extent to which that is likely to affect the United Kingdom economy given the stability that the United Kingdom economy has exhibited over the last year or two. We know that there is structural change going on, particularly structural change going on in the financial markets at the moment. Look at what the banks and building societies are up to. How will that all wrap up together? How do you put that in a fan chart? I think getting a clear answer to that question is going to be very difficult.

  239. Roger, you have said in your paper to us that the status of the central forecast was somewhat unclear. What should we ask to try and clarify the situation?
  (Mr Bootle) What I was struck by and the point I make in the note is that the February Inflation Report says: "Some members prefer alternative assumptions about supply-side developments and about the extent and consequences of the US slowdown which together could reduce inflation for the two-year horizon by up to half a per cent." I do not recall an Inflation Report before where the risks to the central forecast were all one way in the way this seems to describe. Were there any members seeing risks in the other direction, ie above the central forecast, and in what sense is the forecast central? Is it simply that it is viewed as the single most likely outcome or is it something more than that? I have a nasty suspicion that what the central forecast may be is a view promoted quite strongly by certain senior members of the Committee, without much dissent by a few others, and then there is an alternative view which is described as a "down-side risk". If I were looking at that from the outside and wanting to form an impression of what the overall view was I am not sure I would necessarily describe it as a "central view with a risk"; I think I might describe it as "one view versus another view".


 
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