Select Committee on Treasury Minutes of Evidence

Examination of witnesses (Questions 280-292)




  280. We will ask the academics.
  (Mr Miles) This is a speech, as I read here, to the North East Agency Contacts, so does he not have to say that? It is like saying "you people are very important, you are doing a great job, we continue to think you are very important". I think he would have to say that, would he not? Of course I am sure he believes it!
  (Professor Scott) What we know about econometric models is that they are lousy at predicting turning points and that for monetary policy a very sensitive time comes when the economy ceases to grow above trend and starts to grow below trend. Those are two occasions when econometric models will not have the accuracy or the volatility to pick up very precisely. I think he is right in that sense, given that is probably where we are at the moment. He is looking at a raft of indicators to try to find out what is happening and conversations with taxi drivers and bankers may be very informative to get a feel for that. There are big weaknesses in econometric models at those points in time and that is what the Bank is worried about, are we now going below trend rather than above trend?
  (Mrs Rosewell) Even if your model is absolutely wonderful you still do not have any data for what is going on today, or very little data for what is going on today. If you want to forecast you first have to decide what has happened for periods over which you have nothing published and even for periods for which you have some things published, all of which you know are going to be subject to very severe revision. So most of the time that you spend, even with an econometric model, and if you believe the econometric model, is spent trying to sort out that ragged edge problem and get yourself up to the point of today, and for that most forecasters have always stuck their ears in that uncomfortable position close to the ground.
  (Professor Scott) If you are at a turning point the ragged edge problem is pronounced because where you were last quarter may be very discontinuous from where you are today.
  (Mr Bootle) It sounds very uncomfortable keeping one's ear close to a ragged edge on the ground. I think the record of Alan Greenspan is regarded as worthy of some comment, and he is widely regarded as having been a wonderful, brilliant—

  281. God.
  (Mr Bootle) God, yes, and central banker. If one asks, if that has been true, what has enabled him to make those decisions, I think very few people would say it has been a superior econometric model. I should have thought the answer was very much that he is supposed to have kept his ear very close to the ground. By all accounts he looks at a mass of data. Goodness knows how many series he is looking at as well as talking to people and listening to people. At the end of it all he is making a judgment about what all this amounts to. I think it would be quite interesting in the cut he made earlier this year to know what were the official stats on which he made that decision. It is not clear to me that there were any that gave that result. There were a few confidence indicators that came out a few days afterwards that gave that result and presumably he had early access to those, or at least had a pretty strong steer as to what they were going to show. It was not, as far as one can tell, GDP figures or money supply figures or consumption figures or whatever, it was what he judged to have been a change in the mood, in the underlying circumstances, as revealed by these bits and pieces of data.

Mr Cousins

  282. If that is right we have now become inured since the Monetary Policy Committee has been functioning and we stare at these fan charts and we are very much into the numbers and figures, but it becomes very, very difficult once you have educated people into a dependence on fan charts and figures to actually then take a decision that is based on a mood.
  (Professor Scott) There is an iterative process. Everyone knows that econometric models are fallible, they try to recount the average past experience, so what tends to happen is that will come up with a forecast. Everyone will listen to the mood, they will look at the numbers and say "I do not think that is right", but rather than say "throw it away, here are my numbers", the model challenges the Committee members to try to explain why they think their inflation number is different. They say "I think investment is going to be stronger, or consumption is going to be stronger", so there is an iterative process between the models and the members' views, or some members' views, which ends up with a consistent forecast which is produced by the econometric model but where there are lots of add-ons and impulses added here and there to arrive at a forecast which produces in a consistent way the single number the MPC are looking for. It does operate as a framework to try to force consistency on the more a priori intuitive views of the MPC.
  (Mrs Rosewell) It makes sure the numbers add up.


  283. Of course they have the Agents' Report and whatever for the touchy-feely stuff.
  (Professor Scott) That is right.

Mr Beard

  284. The last section of the minutes of the MPC, the immediate policy decision section, summarises the arguments that have been put forward in the course of discussion. Do you think the accountability of individual members would be improved if those arguments were attributable to each individual?
  (Professor Scott) I think it would be unhealthy if you had each individual's views being noted. I think it is difficult enough as it is for people outside the Committee to go on the record. I think it is important, as your previous witness was saying, to have some sense of group accountability. There is a problem, I think, which is particularly apparent in this Inflation Report which is with quite a close vote, 5:4, I am not sure if in the way it was stacked up the external members particularly had a way of recording their views. I think something like a page or two pages where the externals could write their own views of what was happening without actually having to attribute views to each external member of the MPC would be helpful. It would give a sense of freeing oneself from the Bank's editorship of the Inflation Report without going too far down the road of having individual accountability.
  (Mrs Rosewell) I agree that forcing individuals to say what their individual positions are could be very invidious and would undermine independence, I agree with that. I am not sure that you could, however, ask that external members should make a statement separately from the Inflation Report. Apart from anything else, they may violently disagree themselves. There is no necessity that we are going to see the Bank on one hand and the external members on the other, far from it, and I am not even sure that is true at the moment. If it is particularly the case that there are alternative views then those alternative views should certainly be reflected more adequately than they are at present. Just to say "there are alternative views and these result in these numbers" is not very clear, what we want is the story that underlies those views and to have that given some weight if it is particularly a strong minority that are holding it. I am not sure that you can legislate for these things because if it will be a question of "there is a substantial minority who think X" then that ought to be properly described, whatever the view X and the reasoning behind it is.

  285. Are there any different views?
  (Mr Miles) I think you can learn an awful lot from the voting record. I am not sure that having nine detailed personal justifications in each set of minutes would add a whole lot because knowing how people vote tells you a lot.
  (Mr Bootle) I have not got strong views on this really. I think the question was would it increase the accountability of individual members. I think it most certainly would but I am not sure that is the only consideration that one should have. Indeed, there are points in the opposite direction. I think it would inhibit the free flow of argument and discussion and that ought to be an important objective as well. I think I rather take Bridget's line that it would be nice to have the alternative story identified in more detail so one could follow the argument through. I am not sure that I would want names attributed to every little jot and tittle of the way the argument went, I think that would be unnecessary.

  286. How well do you think the MPC has been doing in the four years of its lifetime? What would be the criteria by which you would judge whether it has been a success or not?
  (Professor Scott) I think it has done exceptionally well and you judge it by performance on inflation.

  287. Just that one criterion?
  (Professor Scott) In the end that is all it tries to control, so yes.
  (Mr Miles) I think I would look at more than just what has happened to inflation. I would look at what has happened to inflation and what has happened to the real economy, to unemployment, output, and what has happened to expectations of inflation. Have they built up credibility that they are going to continue to roughly hit the target? I think looking at all those things it has been a pretty good record. If you went back to whenever it was, May 1997, before the Bank was made independent and you had been told "this is what is going to happen to the UK economy over the next four years", you would—


  288. We would settle for that.
  (Mr Miles) You would say "we will definitely settle for that, thank you".
  (Mr Bootle) I think I largely agree with David. I do not think the inflation record is enough, although it is pretty good and obviously it is, as Andrew says, the first thing they are charged with. I am wary of judging them purely on that, or even principally on that, because it seems to me there is an awful lot of sluggishness in the inflation numbers and it is quite possible that there is an environment under which inflation is going to be more or less at the rate it has been regardless of whatever the Bank did. In fact, I think there was a National Institute study that argued that not long ago, that essentially if they had done nothing to interest rates inflation would have wound up to be the same. I think David's point is a key one about expectations in the markets and there there has been a complete transformation of what the markets expect about the inflation rate in Britain compared to other countries. That is partly a comment on them but it is also partly a comment, of course, on the authority which sets the framework, namely the Chancellor, if it is possible for the regime to be altered. I still think they have not had a real test, I have to say. The big questions are the ones we were discussing earlier on, namely what happens when they are way outside the target, they are either well below 1.5 per cent or they are well above 3.5 per cent, let us say, and there are difficult output considerations at that point? The original framework is pretty vague, I think, on precisely how they should behave in those circumstances. That will be the real test, particularly if output is extremely weak and unemployment is rising, that will present them with a real test of their abilities. However, having said that, there is one episode on which I think they did extremely well and that was the 1998 international crisis when they reacted pretty quickly and they managed to give the message at the critical time that they would support demand if necessary and in the end they pulled it off and managed to avoid a recession. I would point to that rather than anything to do with inflation as being most important.

Mr Beard

  289. Do you think that there have been any notable mistakes in the four years?
  (Mr Bootle) I think there have been a couple of occasions when I would have judged the interest rate decision differently. I am trying to remember the exact date. There was one when rates went up it seemed on the back of the average earnings data which turned out to be misleading. There was a sense in which, looking back, that decision was too much based upon that particular indicator. I cannot think of any serious mistakes but then, after all, the movement has not been that big.

  290. It could be mistakes of omission.
  (Mrs Rosewell) Yes. I think the real difficulty is to decide what would have happened had we not had the Monetary Policy Committee and really to judge their performance that is the question you have to answer and that is the question that is most difficult to answer. I think it is perfectly reasonable to conclude that we would have had a period of reasonably strong growth and fairly low inflation whatever had been the outcome. To that extent I think that it is Roger's test that is the most important one, which is what happens in periods when things are difficult. Therefore, there were really only two or three months where you could say they came under pressure. That was in the autumn of 1998 when there was the stock market crash. I think they probably did do the right thing then and did respond to circumstances as they changed in a way which really they have failed to do over the last year where I think they could have cut interest rates at various times, and particularly over the last few months, in a way which they have failed to do.
  (Professor Scott) I think we rightly perhaps over-scrutinise the Bank here. I think we should acknowledge that it has been a tremendous innovation. Inflation has been very low. My students get very upset when I grade them on exams they have not actually sat and the Bank has had this experience. They have made a couple of mistakes. I think the one that focuses us most and that we are talking about today is given we think there is a high likelihood of writing a letter, we think they probably made a mistake in not lowering rates sooner. That aside, it has been a tremendous achievement. I think they have achieved a credibility in the markets backed up by the falls in inflation which is rather hard to quarrel with. There have been some minor problems, minor mistakes and minor things about resources, about internals and externals, but it is the best we could have hoped for.

  291. You say the credibility would not have been there had the monetary policy been a political decision still?
  (Professor Scott) Absolutely. All the evidence that justifies making the Bank independent suggests that you would have got something like what we have seen. Undoubtedly it has been a marvellous environment to run monetary policy under, it is what we hoped and what has been achieved.

  Mr Beard: Thank you very much.

Mr Cousins

  292. Just to go back to 1998. In 1998 there was the US Government very firmly committed to maintaining stability in the world economy and now we have a US Government that may be more and more concerned with issues of "moral hazard". We had a very interesting speech by Mervyn King to a group of oil men—he certainly picks his audience—in which he said "Turkey? Who gives a damn about Turkey, throw Turkey to the wolves", which in light of the statement we have going on behind us is kind of interesting. That does suggest that there is a genuine difference of attitude from 1998. Perhaps there is possibly now a bit of over-confidence that was not present in 1998.
  (Mrs Rosewell) Not on the part of the Federal Reserve however. The reactions in 1998 were largely those of Greenspan which the Monetary Policy Committee on that occasion followed. The reactions now have been monetary policy reactions. I do not think there was really any other more general US Government reaction which was important in 1998.
  (Professor Scott) I think the issue is how do you provide liquidity to a country going through a financial crisis? You either do it through the taxpayer, giving money to the IMF and the World Bank, or you can have it through Alan Greenspan cutting interest rates and saying "borrow as much as you want from me". I think we have seen a shift away from the physical one towards the monetary one, given the Asian experience, which was the IMF bail-outs did not seem to work very well and Greenspan's actions worked brilliantly. In many ways it is a sort of ratification of what happened there. I am not sure it is an over-confidence to change how you are going to do things.

  Chairman: Thank you very much. Just briefly, as this is probably your last appearance while I am still Chairman, may I thank you very much for all you have done over the last four years. Thank you.

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