Select Committee on Treasury Minutes of Evidence

Examination of witnesses (Questions 340-359)



  340. For this meeting you were flying blind then?
  (Sir Edward George) We knew simply what you know about what is going to happen.

  341. Governor, the inflation target is nearly four years old now. It has been re-affirmed in successive Budgets. Do you think an inflation target has a natural kind of shelf life?
  (Sir Edward George) No, I think it is something that should be kept under review, both the precise measure of inflation we should target and, also, the number of the target. However, my own view is that I would not actually have made a change within this period because I think it is terribly important that we actually try to bed down inflationary expectations at the current level. That already seemed to me to be a tremendous task, and we have been making progress on that. I think if the rules are changed, certainly if they were changed too often, that would actually damage that process. So I do not think I would feel it had a sort of natural shelf life, but I think there would come a time when it would be sensible to review it seriously. I am not sure that time is now.

  342. Do I take it then that you or the Bank have not been consulted on any possible changes to the target?
  (Sir Edward George) We had not actually ourselves suggested that there should be a change in the target.

  343. I asked you whether you had been consulted on any possible changes.
  (Sir Edward George) In a general sense we are always open to make suggestions of that kind if we feel we want to.

  344. I asked you whether you had been consulted.
  (Sir Edward George) I am not prepared to tell you whether or not I have been consulted because I think that would imply something about what is in the Chancellor's mind. I do not think I feel I can actually answer that question.

  345. There has been this general speculation that the Bank could be influenced by the time of the Budget and the election. How are you going to reassure the wider public that the timing of the election will play no part at all in your decision making on interest rates?
  (Sir Edward George) I think it would become absolutely apparent. The great advantage of the transparency that we have is that if it were clear that we were being inhibited, that all the discussion was about the need to change rates up or down and we did not move, then people would begin to wonder why. I think that is the securest prediction. In making it absolutely plain that we do not feel inhibited, I think that is part of the process.

Mr Davey

  346. Following on from Mr Fallon's point there, Governor, at the last election the different bodies debated the pros and cons of an independent central bank. Would you like them at this election to be debating the pros and cons of different inflation targets?
  (Sir Edward George) No, I think that is kind of premature.

  347. So you hope all the political parties will go with the 2.5 per cent and, indeed, the current framework of the MPC for that matter?
  (Sir Edward George) Yes, I think, myself, that these arrangements are still bedding down. I think it is best to leave them bedding down, but not inhibiting politicians from doing what they like.

  348. That is very kind of you. Could you remind the Committee how many meetings of the MPC there will be with respect to decisions on interest rates before May 3, and when exactly those meetings will be?
  (Sir Edward George) There will be one on Budget day and there will be one in April. There will not be one before May 3.

  349. So two possible days when interest rates could be changed.
  (Sir Edward George) Yes. We can, in principle, change interest rates between meetings, if we have a special meeting to do so. So you could have very many changes in interest rates.

  350. But it is unlikely. Reading your Inflation Report for February, it does seem that the likelihood of any movement of interest rates between now and May 3 is likely to be down. Is that not how we should read the Inflation Report and the Minutes of the MPC meetings?
  (Sir Edward George) I think you would be ill-advised to draw any conclusions about future movements in interest rates because I have to tell you, speaking for myself, that I am driven by what happens between now and then, and what happens implies looking out over the next couple of years. So that I do not believe that it is sensible to try to anticipate what we will decide at our meetings either in March or in April—or indeed beyond.

  351. If you look at table 6A which has been referred to previously, page 67, there is a 92 per cent chance, according to your Committee, that by the end of Q4 this year inflation will be less than 2.5 per cent and a 63 per cent chance that it will be less than 2.5 per cent by Q4 2002. That is a very clear indicator that the risks are on the down side and that the next move is likely to be down in interest rates.
  (Sir Edward George) If the evidence suggests that those risks are crystallising that would be a logical consequence because you would then have the prospect of inflation on the down side. I do not think that you should read too much into that. The world is changing all the time.

  352. Just to look on the flip side of this issue, about whether there is a possibility of interest rates going up between now and 3 May, one would have to see a concurrence of quite a number of events for that to happen, a large give-away in the Budget coupled with the US economy stabilising, presumably, coupled with perhaps commodity markets improving or becoming tighter with tensions in the Middle East, for example, food prices going up. If that were to happen, if all these events were to come and move the prospects in a completely different way from what we see today, you are assuring the Committee that you would be prepared to put up interest rates, that you personally would persuade colleagues on the Committee that interest rates should go up, even if that were to happen before 3 May?
  (Sir Edward George) If I were persuaded that the risks had shifted in relation to the inflation objective, looking out across the next two years, such that we were unlikely to achieve the inflation target of 2.5 per cent over that period, then certainly I would vote for a rise in interest rates. I can think of lots of other factors which would push me in that direction, like the increase in the tightness of the labour market clearly reviving and that being reflected in rising labour costs; something happening in the oil market. There are lots of factors which could shift the thing in that direction. They would have to be significant factors because one does not pop about from one month to the next typically. I think our behaviour has shown that. If they did point in that direction we would be obliged by the statute as I understand it to take the appropriate action.

  353. I certainly welcome that. Given that your Committee and the whole nature of the monetary framework now in the United Kingdom is based on credibility and the perception of the commitment of the MPC to hit the target, do you feel over the next few months that you are in quite an unenviable, uncomfortable position because of the way that commentators might choose to read any decisions you take? Do you feel that this is quite a testing period for you or are you completely relaxed and happy to write letters, happy to put rates up and down?
  (Sir Edward George) Completely relaxed. I write letters all the time. If the data and the implications of that data from the analysis point in one direction or another I am happy to reflect that in my policy judgments on the day.

Mr Beard

  354. My question is to those members of the Committee who took the view that the slowdown in the US economy is likely to be sharp but short-lived. On what basis is that view held by those members? What is their estimate of the impact of that on the outlook for inflation?
  (Sir Edward George) Shall I speak because I am one of those members of the Committee which took that view? I think some of the reasons have already been explained by Charlie, that there are reasons for being relatively optimistic. What you have to recognise is that in the first half of last year the US economy was growing at a totally unsustainable rate and that was absolutely generally understood within the United States. We were looking for a slowdown in the United States economy, as they were. I think they were tightening policy in order to bring that about. Any slowdown from five or six per cent a year, which was what was happening in the first half of last year, to a sustainable number, which may be between two and three per cent or may be a bit more if you are very optimistic about the productivity improvement, is going to feel like a pretty dramatic event, and clearly this was exaggerated by the movements first of all in financial asset prices in the US equity prices. I think that caused a lot of people to say, "What is the worst thing that might happen?" If you do that you can really scare the pants off yourself and there was quite a lot of that happening. You have to keep it in perspective. Given that we were looking for a slowdown, given that there are reasons, both on the stock side and in terms of the nature of investment in the United States, which would cause that to be relatively short-lived, and given particularly (because I think the Federal Reserve responded very promptly to what was the real worry) that people really would say, "What is the worst thing that is going to happen?", so you see a very abrupt fall, not just in financial markets but in industrial confidence, in consumer confidence, which in turn would drive a further fall in financial markets so that you would get a downward spiral, the very prompt action by the Federal Reserve I found reassuring. They were signalling that they are looking for a slowdown, but not anything worse than the V-shaped thing, but are prepared to act. Given the capacity for fiscal action which I think is now very broadly accepted in the United States, even to the point of saying that it might actually be helpful if we could advance some of that by making it retrospective, it is too soon to panic. There is undoubtedly a risk that all these things will come to pass, that you will get a much more extended period of relatively slow growth. You may even get some period of negative growth in the United States. That is a risk. The central expectation in my view is that it will not be as bad as that. I think it would have aggravated the position here if we had responded to a perception of, "What is the worst thing that could happen?" If we had moved rates early or sharply then I think we would have been signalling to the United Kingdom economy which, as Mervyn says, is in a quite different situation from the American economy, that we feared something of the same kind happening here. I think that would have been calculated to induce a sharper slowdown in the United Kingdom than I think we are heading for.

  355. Is there any one amongst those present who takes the view that the slowdown could be more prolonged or deeper and could explain why they take that view and how that has influenced their position? Nobody?
  (Dr Julius) I think it depends on what you mean. I personally do subscribe as my central case to the view that the Governor has just explained, that is, the soft landing in the United States, but I think there is a very significant risk that that is not the scenario that materialises. However, if I had to put my money just on one view at the moment, I would put it on that view, not the alternative.

  356. Is it the case that the much talked about productivity gain in the United States has probably been falsified by the presidential election in America? Is there any indication that it has not really materialised?
  (Dr Julius) I think that is the $64,000 question, as we used to say. Over the course of the next couple of quarters we will have better evidence on that. It is almost certainly true that, as the US goes into at least sharp cyclical slowdown, productivity gains will also slow, but the underlying view, and it is my view as well, and as I understand it the Fed's view, is that those productivity gains are real; they are based on evidence that has actually taken place, and they are widespread enough in the economy already that they will support continued fairly strong growth momentum once this cyclical slowdown has passed.

  357. Does anyone take the alternative view, that the much talked about productivity gains have effectively been wasted as the whole situation deteriorated?
  (Mr King) Again, I think you are trying to give extremes to which people have to identify. What I would say is that much of the productivity gains in the US has been associated with investment, in particular in information technology. Whether the growth rate of productivity will remain at the levels we have seen in the last five years is hard to judge at this stage and that is, as DeAnne said, what we will find out in the next six to 12 months, and a slowdown in investment may lead to a fallback somewhat in the rate of productivity growth, but it is not going to disappear.
  (Professor Nickell) One of the driving forces behind the improvement in US productivity growth has been the continuous decline in the price of IT equipment. That continuous decline looks like carrying on for some little time. While that continuous decline goes on there is every chance that underlying productivity growth in the United States will be higher than it has been historically.
  (Sir Edward George) I thought one of the most significant comments in the statement that the Federal Reserve put out when it cut interest rates for the first time, between meetings, although subsequently repeated, was its conviction that, leaving aside the cyclical element in productivity, the underlying rate of growth in productivity still had a long way to go in spreading through the United States economy, which is their perception. It is not just the introduction of technology. It is the application of that technology through the whole of the economy. I have to say that that weighs with me a great deal because I think they are very much closer to it. They inevitably have done a great deal more analysis of this thing. It is not as if it is a new thing for them. They have been monitoring this process over a considerable period of time. The reason why I see that as significant is that the implication is that that would put them, in terms of the sustainable rate of growth for some period ahead significantly above 3.5 per cent, and that gives them the room to respond if in fact the US economy looks as if it is going to go substantially below for any length of time. I think that is a tremendously important aspect of the perception about the situation in the United States.

Mr Ruffley

  358. Governor, there was a report on 12 February in the Financial Times which said that the Bank is "developing techniques to assess economic convergence between the UK and the euro zone". Is that true?
  (Sir Edward George) You should not believe everything you read in the Financial Times, is my answer. It is certainly true that we are continuously monitoring the evolution of the euro zone economy as well as our own. That is to put us into a position where we can make judgments about some of these questions, but we are certainly not launching special exercises to develop special techniques to assess the five tests.

  359. But there are techniques that you are using to assess economic convergence between the United Kingdom and the euro zone?
  (Sir Edward George) In the sense that we are monitoring what is happening to the euro zone economy and how that relates to what is happening in our economy, of course. We are doing the same thing with the United States.

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