Select Committee on Treasury Minutes of Evidence

Examination of Witnesses (Questions 1 - 19)




  1. Good morning, gentlemen. For the sake of the record, could you identify yourselves, please.
  (Mr Bootle) Roger Bootle, Capital Economics.
  (Professor Pissarides) Christopher Pissarides, Professor of Economics at the London School of Economics.
  (Professor Miles) David Miles, Professor at Imperial College.
  (Mr Walton) David Walton, Goldman Sachs.

  2. Thank you very much. There is no need for everyone to answer every single question; whoever feels it is their area, we would be happy to receive that. Could I start by reminding you of the events of September 11 and asking, how big an impact do you think these events have had on the world and, in particular, on the UK economy? Do you think the MPC have reacted in the correct manner to these events? Lastly, do you feel that interest rates have reached their lowest point?

  (Mr Bootle) The first thing to say is, it is of course impossible to have a clear and certain answer to this question because we will never have what we like to call the "counter-factual"; that is to say the other story that would have played out had the events of September 11 not happened. We are reduced to some form of guesswork. Opinions on this will differ. My own view is that eventually it will be seen that the events of September 11 did not actually have that big an impact; and that already there were in train powerful recessionary forces throughout the world. In the United States the macro numbers were already looking decidedly weak; and there was, I think, a very telling confidence survey published by the University of Michigan just after September 11 but showing observations taken before that date, and it revealed a huge plunge in consumer confidence. Japan was already in a very weak state. The European Union, or most of it certainly in the euro area, looked to be slowing very considerably. What I think has particularly happened since September 11 is that a lot of people have seized on September 11, and its immediate aftermath, as the reason for very weak performance. Both companies have seized on this; commentators have seized on it; and governments have seized on it. There is obviously an element in truth; clearly it has contributed something; but I think there is a general tendency to under-estimate the weakness that was in train anyway. On the subject of the MPC's reactions, my own view is they have pretty much got it right. Whether or not the impact of September 11 ultimately will prove to have been that great essentially is not the point; because the evidence was clearly before them of declining international demand, very weak inflation pressures and falling confidence. I do not think they really need to debate the question as to what proportion of that was due to September 11 and what was due to happen anyway; their job is simply to react and anticipate developments along these lines whatever their ultimate causes. On your last question—with regard to whether interest rates have hit bottom—I am sure there will be a number of different views on this around the table. My own view is that they have not hit bottom; and, in particular, there is a danger I think of both commentators and members of the public being misled by what is seen to be very low nominal rates of interest: whereas in fact inflation is already very low; it is set to fall a good deal further; and, by international comparisons, UK rates are still pretty high, so I think there is a fair way still to go.
  (Professor Pissarides) The view expressed largely reflects my view. There were clear signs of slowdown in the world economy before September 11, both in the United States and Europe—especially in the United States, which has been the driving force of world expansion in the 1990s. There were clear signs of slowdown; the Federal Reserve was reacting well in reducing interest rates; and I was hoping and expecting that there would be more reductions in interest rates both in Europe and in the United Kingdom. The MPC were rather slow to cut interest rates in September. In some ways the events of September 11 helped the MPC to see the world recession in a clear light and respond in the way they should have done before then. The MPC had a meeting just before September 11 and they did not reduce interest rates, when I thought the economic signs were that they should have reduced interest rates. Then they had another meeting on September 18 when they did reduce them and did make a difference. The meeting they had before was ten days earlier. Since then I think their response to events has been the right way in cutting rates, by a cumulative two points since the beginning of the year. I should say though that I think September 11 did push the world economy further in the direction of recession. I can single out three ways in which it did that. Firstly, to introduce more uncertainty in the financial markets than existed before September 11; in fact there had been more volatility in asset prices since September 11; secondly, some services, some industries—for example, the airline industry and tourism—have been affected adversely, a lot more than they would have been affected had there not been the events of September 11. Although that was more of a sectoral shock to tourism and the airline industry, an economy does need to adjust to that change that has taken place, and that always brings about some job losses, in some sectors, and other sectors are rather slow to pick up. That will show up in a deeper recession than we would have had. Finally, both September 11 and the war that followed have affected trade adversely. Statistics are not out yet, but I would be surprised if we do not see an adverse reaction to world trade to the uncertainties and the events, which I expect to contribute to the slowdown which started before September 11. The question of have we reached bottom in interest rates, no, I do not think we have; although it is obviously feasible to reduce interest rates more. If we look at the way Japan has gone, there is no reason why we could not do the same. I also hope there would be further reductions, because there are not any signs that the economy is picking up. The signs we are seeing now, and the statistics coming out for August, September and October, are showing more weakness in the economy than the data showed the last time the MPC met. I do expect further reductions in interest rates and do think this would the right policy as well.
  (Professor Miles) After what happened during the course of September, in the US but also in the UK indicators of confidence have fallen dramatically, particularly amongst companies, and investment intentions have been cut back a lot and there have been lots of announcements of redundancies. I agree with what Roger Bootle said, it is difficult to know how much of that might have happened even without September 11. It happened in the course of September but some of it was probably beginning to happen anyway. What clearly has happened as a result of September 11 is greater uncertainty and volatility. That has certainly happened in financial markets, although the UK Stock Market is now rather substantially higher than it was on September 10. One could imagine there being many different possible outcomes over the next few quarters. It is conceivable, and maybe it has already happened—I have not seen indicators of consumer confidence in the US or UK since the fall of Kabul—but it is possible those indicators have already begun to turn round. If Bin Laden were to be captured or killed that might have powerful impacts, particularly in the United States. There is a great deal of uncertainty here. What is surprising to me about the Inflation Report the Bank has just come out with is that, in spite of what you might think is an obvious example of an event that generates much more uncertainty, the assessed spread of possible forecast outcomes, particularly for output, is virtually the same now as it was in August. In fact, the explicit statement in the Inflation Report about the probability of a real dramatic fall in output is very surprising. If I could just mention a table on page 56.[1] What this table shows is the MPC's probability assessment for different possible outcomes on inflation and output—and the output numbers in particular, the lower panel in that table. The MPC's stated probability that there should be a decline in output in the UK at some point over the next couple of years, a year on year fall in output, which you might think is an event that is not likely but not out of the question, their perceived probability is 1 per cent; a one in a hundred chance of a recession in the UK. That strikes me as rather strange, given what you would imagine to be a huge amount of uncertainty. There are some other slightly puzzling things with their projections it might be worth asking the MPC about. One is that the distribution of outcomes for output is perceived to be pretty much where it was in August, and pretty much symmetric. Their perception is that the outturn that output might grow a lot faster than average is equally probable to the outturn that it will fall a long way short of it. Output growing at, say, 1 per cent over the next few years, which would be very slow, is perceived as being no more likely than output actually growing at 3 per cent or so. This seems to me to be a rather strange set of projections given much more uncertainty. In terms of what the Bank has actually done—clearly they have cut interest rates rather significantly—that seems to me to be a very sensible response to what happened. But there is one question where I would be interested to hear what the MPC has to say, which is about the decision to have a special meeting on September 18 and, particularly, how they described the decision to cut interest rates on that day. If I could just quote something from the Inflation Report: "Most members favoured a reduction of 25 basis points. This would signal the Committee's responsiveness to the change in economic conditions". I think in some ways it is rather a strange statement. What exactly does it mean to "signal the Committee's responsiveness"? The role of the MPC is always to be responsive to economic decisions. They did not particularly need to signal that on that day. I am not saying that cutting interest rates was a bad thing to have done at that time; I am more questioning why they should hold a special meeting; and what exactly did that signal? It was two weeks away from the next scheduled meeting, and the conventional wisdom on the impact of monetary policy is that it takes something like a year or 18 months to have a major impact on the economy. To decide to hold a meeting two weeks before when the next one was scheduled is something it might be interesting to ask why the MPC chose to do. In some senses it is a rather dangerous precedent to set, to deviate from the timetable.

  (Mr Walton) I think it is clear that, since the August Inflation Report, the world economy has deteriorated significantly. In part, there was a much greater loss of momentum going into the events of September 11 than most economists were expecting. Then the events of September 11 themselves clearly had a very big impact on business and consumer sentiment. That, I think, was probably enough to knock all of the major economies into recession in the fourth quarter and probably into the early part of next year. If you look at consensus forecasts, they have come down significantly since the summer. For instance, in the United States "Consensus Economics" were showing that people were expecting the US economy to grow by 2.7 per cent next year in their September collection of forecasts. Their latest figures from brokers for November is a forecast of just 0.7 per cent; and the forecast of my US colleagues is actually for the US economy to decline by 0.2 per cent between 2001 and 2002. Forecasts everywhere in the world have been revised down significantly since the summer. In that environment I think central banks have acted entirely appropriately and sensibly by cutting interest rates aggressively. I think the UK Monetary Policy Committee has had a great deal of flexibility, essentially because of the symmetric inflation targets and the fact that inflation has been running slightly below target for the last two or three years. So the Monetary Policy Committee has not been in a position where it has been constrained at all by inflation, and has been able to act very aggressively and sensibly. As far as the Inflation Report itself is concerned, like David, I was a bit surprised at just how relatively upbeat the MPC was about economic prospects. It says that its own forecasts for the world economy have been revised down by between 0.5 and 1.0 percentage point for this year and next. If I could just put that in context: our own forecasts at Goldman Sachs have been revised down by half a percentage point for this year, but by two percentage points for 2002. I think the risk of economic activity for next year is going to be weaker than the MPC expects. If you infer what the MPC is saying for growth over the next few quarters from its fan charts, it essentially expects a small dip in growth in the fourth quarter with an annualised rate of 1 per cent; and then you can infer from the fan chart their central expectation is for growth to pick back up to around the 2-2.5 per cent rate as we go through the first half of 2002. That, to my mind, looks to be on the rosy side of expectations. I thought it was quite curious at the press conference when Mervyn King introduced the Inflation Report that he said the risk of recession in the UK was significantly lower now than at the time of 1998-99, when we had the Asian crisis: but just keep in mind, in 1998-99, the US economy never slowed below a 2.5 per cent annualised rate at that time; whereas at the present time the US economy is declining; the Japanese economy is declining; and it looks at though the continental European economy is also declining. For the risk of recession in the UK to be so much lower than the situation three years ago just seems to me very difficult actually to rationalise. As for whether interest rates have reached a trough, I think they have not because I think growth is going to disappoint, at least in the next couple of quarters. I think the Monetary Policy Committee historically has been very sensitive to any shortfalls in economic activity. Again, with inflation running below target, there is very little cost to them from continuing to ease policy quite aggressively, particularly since (if it turns out the economy does recover more strongly) they can very quickly reverse those policy easings. I would expect to see at least another half a percentage point in interest rates in three to six months.

  3. How reliable are confidence surveys as a guide to the future performance of the economy? A number of the papers I have been reading in the past few weeks have indicated that the bounce-back, when it comes, will be earlier than people predicted. From what I can gather, from your comments this morning, you do not share that view?
  (Mr Bootle) I think there is some evidence that confidence surveys have become more unreliable over recent years. In the UK the CBI survey, which deals with manufacturers, until 1998 had a very good record in predicting turning points and, indeed, the extent of movements in GDP as a whole—despite the fact that manufacturing is only a small part of the economy and decline. It set the alarm bells ringing in a major way in 1998, and proved to be profoundly wrong. The readings then suggested a recession of the size that occurred in 1979-81 and was completely wrong. The CBI survey has recently been extremely weak as well. It is very difficult to interpret quite what that means. Some of the other surveys have somewhat blotted their copybook as well. The GFK survey of consumer confidence is extremely interesting in this regard. It asks consumers what they think of their own financial prospects and what they think of the economy as a whole. The recent readings of the GFK survey are particularly interesting in this regard. Consumers have replied with a very pessimistic reading indeed of the economy. They continue to be really pretty upbeat about their own finances. A gap has opened up between what consumers see for their own circumstances and what they think about the economy as a whole—the biggest gap in the whole history of that survey. There was something similar in 1998; that is to say, they again picked up a mood of gloom and doom about the economy, but when they look at their own circumstances they do not seem to be quite as bad. Without wishing to sound at all sure about this, because I do not think one can be, I think one could imagine a series of events happening such that consumers eventually realise that the outside world was not quite as grim as perhaps they imagined a few weeks ago in reply to these surveys; and we could, therefore, go through another period as we did in 1998 when, looking back, we saw the surveys as being really unreliable.
  (Professor Pissarides) It is rather difficult to see where a quick recovery might come from. That is a problem I have when I see and think, when will this slowdown be reversed? It is clear that the slowdown has come because of world events—mainly slowdown in the United States and Europe. Taking Europe first—there are no clear signs that the ECB reacts more aggressively to events and cuts interest rates. There are no clear signs that Germany, in particular, and the rest of Europe will turn around in the next 12 months or even within 2002. The most recent report on the German economy adjusted down the expectation of growth for Germany that they had. Looking at the United States again—confidence in the United States has been affected worse than elsewhere by the September 11 events. The financial markets are not showing any signs that they will go back to the boom years. It would be very surprising if they went back to what we had two or three years ago, because the boom then was so exceptional, as the Federal Reserve warned many times. I do not really see any reason why this slowdown should be any different from previous ones. It is partly our ignorance as to why economies go into regular swings; but we do know there is a certain kind of regularity to them. Looking at this particular one here, I do not see any reason why it should be shorter than others. If I had to guess, and it would not be more than an informed guess, I would say the end of 2002, the beginning of 2003, so 1½-2 years. I would expect recovery to come from services driven mainly by consumer spending. I should say one thing that reflects partly what Roger Bootle said , that consumer liquidity is higher in this recession than it has been before, especially compared with confidence and compared with what the rest of the economy is doing. That might partly be explained by the uncertainty in financial markets; consumers have done a portfolio shift rather than accumulating money to spend—moving out of the stock market, in other words, and into cash or deposits in banks, where at least rates are guaranteed. That might be the reason why you are seeing high consumer liquidity. It is not surprising to see both an increase in the measure of consumer liquidity and an increase in the uncertainly and, therefore, a fall in consumer confidence.
  (Professor Miles) I think that these confidence indicators are likely to be enormously volatile at the moment. As I said a little while back, it is conceivable if you took the consumer confidence index measure in the UK and US this morning it would be very dramatically different from what it was even a week ago. I can see a possible outcome for the UK where growth and demand pick up quite strongly; I am slightly more optimistic than Christopher. It is not that I think this is the most likely outcome, but it is not an implausible outcome, that we get a sharp pick-up in consumer confidence this side of Christmas. People may think the war is now going to end, and go out and spend at Christmas in a way we really weren't expecting even a couple of weeks ago. We have had substantial cuts in interest rates, and we have got Government expenditure probably set to rise quite strongly over the next year or so. I think there is a possible strong demand outcome. I think this is something the Bank is right to point out. Not all the risks are on one side. I think where the Bank may have got it wrong is under-estimating the probability of very bad outcomes. I mentioned earlier—they have this ludicrously low probability that output might fall as being only one in 100. Where I think they are right though is to say there are certainly possible outcomes where demand and output actually pick up quite strongly.
  (Mr Walton) In an environment where we do not really know what is going on, I think confidence measures tend to be very volatile. We had a big drop in business confidence, as Roger said, in 1998, and then a big drop in confidence when Britain left the Exchange Rate Mechanism. That was actually the start of a pretty strong recovery in the UK. So these measures can be a bit volatile and, therefore, can be misleading. The thing that is quite striking is that confidence has fallen so sharply in every part of the developed world, and that I think is just something that at least policymakers should be taking note of. Obviously we would hope that it rebounds, but if confidence has fallen so far, at a time when economies were clearly weakening, it just raises the risk of a downward momentum building in economies and the expectations become self-fulfilling.

Dr Palmer

  4. My question was really to Roger Bootle. Experience suggests that confidence in the economy as a whole is more volatile than personal consumer confidence, so that might bear out what you were saying, or are they both very volatile?
  (Mr Bootle) They are both pretty volatile. I am trying to imagine a chart, which I have not got before me, the GFK series which asks these two questions directly. The two answers strike each other very well—apart from a couple of periods, the ones I have mentioned, only recently in 1998 when the view about the economy plunged, whereas the view about personal finances was more stable. On that very, very limited bit of evidence, yes.
  (Mr Walton) My experience of that particular survey is, one of the reasons why the overall consumer confidence measure is an aggregate (it is an average of five questions) is that these individual components can actually be very volatile; and if you actually smooth out some of the volatility in the individual questions you actually get a better reading. That is what the European Commission does when it takes consumer confidence of different countries. If you take that composite measure you tend to get a better relationship with consumer spend than taking any one individual component.
  (Professor Pissarides) I might be wrong but I think we might be overreacting to the fact that consumer confidence has failed to do what we were expecting it to do last time when we had a problem. Before then there was pretty good regularity between consumer confidence, spending and liquidity. Maybe Roger knows more about that. We might be overreacting to the fact they give mixed signals because they have been like this most recently. It might well turn out to be that the most recent event is the exception rather than the rule.
  (Mr Bootle) I think that is fair enough, but there is something quite striking about the 1998 events which does have something in common with recent events. That is to say, what occurred in 1998, something came out of the blue from the outside world and was all over the television screens and the newspapers and made people very worried about the environment, and there was the East Asian crisis and so on. These were outside people's ken but alarmed them with thoughts of meltdown, and there were similarities with what has happened recently. That is, I think, quite different from the marked swings that have occurred in the UK economy with regard to people's confidence and spending in the past. If unemployment is going up very sharply or tax has just gone up, there is a reason which people can understand for their own finances and can purely relate to and is not necessarily being manipulated by media coverage. Although I accept your point, I think there is more to the comparison in 1998 than perhaps you have suggested. There is reason to wonder if the answer to the question about the state of the economy as a whole might be giving a distorted picture.

  5. Thank you for that clarification. On the broader issue, how concerned should we be that current policy could be accentuating imbalances in the UK economy? We are thinking particularly of the classic debate about where services and manufacturing are out of step and whether it matters?
  (Mr Walton) If you are a policymaker with one instrument and one target then there are inevitably going to be other things happening which you may not like but there is not that much you can do about it. If the target given to the Monetary Policy Committee is to keep inflation stable at 2.5 per cent then that implies a need essentially to keep the economy overall growing at close to a trend rate. The MPC really has very little control over whether or not all sectors of the economy grow at much the same pace or whether, as we have seen, you can have very rapid growth in business and financial services in recent years and you can have very pronounced weakness in manufacturing. That is not really something the Monetary Policy Committee can do much about. I am not even sure policymakers generally can do much about it.
  (Mr Bootle) The word "imbalance" of course is used in a number of different contexts. You mentioned services and manufacturing and those are all valid and interesting in one regard; but it seems to me the most important imbalance, and one on which the MPC needs to be pressed very strongly, is the imbalance between domestic demand on the one hand and overseas demand for British output on the other. This does relate to the key interest rate questions. Indeed, over the summer Mervyn King, and some other people, made public remarks along the lines that it is impossible to keep the economy going simply by stoking up domestic demand. We cannot stoke domestic demand forever oblivious of what is going on in the rest of the world. I think this question needs to be nobbled. Why not? What are the limits? For how long can you go on doing it? What exactly are the downsides? That seems to be the principal imbalance. The UK could be set on the path of growing reasonably strongly in the context of very weak international demand. That does automatically create one imbalance which shows in the balance of payments. What is wrong with it? Can we carry on? I think these are the questions I would like to pose.

  6. What would your answer be?
  (Mr Bootle) My answer, I guess, would be fundamentally, yes. There is some point at which the deteriorating balance of payments stokes up some very serious problems for the future, and that the markets may take some time to adjust to that. There could be a situation where you could stimulate domestic demand so much that, for various reasons, the market still sustained the pound at that level but you were stoking demand up in such a way that the pound was at some stage or other bound to fall very substantially in reaction to the imbalances you created. You could be buying, as it were, a reasonable output performance now at the expense of what could be a really sharp inflation shock later on, which could be very destabilising. Also I think there something in the argument that it would be artificial to stimulate the domestic economy. There are costs to over-stimulating the domestic economy when the overseas sector is very weak. What you are trying to do, obviously, is to draw resources out of where they would naturally be, ie in supplying overseas demand, into where they would not naturally be. That involves all sorts of frictions and distortions which then have costs to undo. Those two things apart, I would say that the MPC should precisely be aiming to keep domestic demand going in the face of weak international demand, as indeed we did in the 1930s. There is no necessary reason to believe that our growth rate has to be constrained to the international growth rate.

Mr Laws

  7. Could I just ask two questions about recent developments. First, just to pick up on points made in David Walton's paper to the Committee about the present views of the MPC on the outlook for inflation. I was just having a look at the introduction to the November Inflation Report this morning at page iv. I was a bit baffled by two paragraphs sitting alongside each other—this is the last page of the overview of the November Inflation Report. The end of the second main paragraph says: "In the Committee's judgment, the overall risks to growth are roughly balanced, although the overall risks to inflation are on the upside". Then you look at the paragraph below which talks about the November meeting. "Without further action, there was a risk that inflation would significantly undershoot the target over the next two years and that activity would be lower than necessary". On the previous page you actually have the reference to the forecast, which is for inflation drifting up back towards the target but not reaching it. There seems to be a tension here, even in the November Inflation Report, as to whether or not the risks are generally to the upside or whether they are actually to the downside. That is brought out then by your note. Can I ask you specifically on that issue whether you think there is a tension here between what the MPC has been saying recently and what its forecasts show?
  (Mr Walton) I guess we will get further evidence on this when we see the minutes of the meeting that come out tomorrow. I found the language in the Report really quite strange, for precisely the reasons you have just said. You have the Committee saying they think the overall risks for growth are roughly balanced but risks to inflation are on the upside. Yet in the paragraph before it says: "Some members prefer alternative assumptions . . . that generate an inflation profile that is either slightly higher or up to 0.5 per cent lower at the forecast horizon". So the dissenters to the published forecast seem to be on the downside.

  8. Am I being a little bit dim, or can you reconcile paragraphs one and two on that page, where the first one says: "In the Committee's judgment . . . the overall risks to inflation are on the upside"; and then it reports its conclusions to the November meeting saying: "Without further action, there was a risk that inflation would significantly undershoot . . ."?
  (Mr Walton) I think you can rationalise the two in the sense that, if they had not cut interest rates by 50 basis points, they would have had to have published an inflation forecast which showed inflation quite a bit lower than they actually published. Having cut rates by 50 basis points they now have a central forecast and think the risk is slightly on the upside. Again, that is a bit odd. For the MPC suddenly to step up the pace of rate cuts, to be cutting at 25 basis points and then suddenly to do 50, it is a bit surprising for them suddenly to conclude, "Now the risks of inflation are on the upside". The language does not seem to fit very well with the actions. If you just look at their assessment of probabilities—there is a table, next the one David Miles talked about earlier, which just shows the probability of inflation being below 2.5 per cent in two years' time, and the probability of it being above 2.5 per cent. The probability that it comes in above is 51 per cent; and the probability that it comes in below is 49 per cent. To characterise that as saying the risks are on the upside seems a strong use of language. This is only a very small point but it is quite unusual in the Inflation Report forecasts to have a situation where you can perceptibly see that inflation in two years' time is below the 2.5 per cent target. It is only just below target in their fan charts; but there have only been three occasions since 1997, when the Bank gained independence, when they have actually shown a forecast where the central estimate was slightly below 2.5 per cent. To talk about the risks being on the upside just does not fit that comfortably with the actual graphs they have shown. I think the reason they say it is because they worry there is the chance that the exchange rate will fall faster than they assume in their central forecast. Whether that is inflation or not will depend on the circumstances. As the Bank of England has frequently pointed out in the past, you can certainly envisage circumstances in which the exchange rate can fall where that will not lead to higher inflation, particularly in a situation where the economy is very weak. You only have to look at the post-ERM experience to find a very clear example of that.

  9. What I am wondering is whether some of these tensions between what the MPC are saying reflects fundamental differences between the outlook of different members. I wanted you and Roger in particular, as market watchers, to comment on this. It is already clear from this particular page that certain members take somewhat differing views on the likelihood of these various risks crystallising. If we look on page 41 of the Inflation Report it reports the meeting of the 5-6 September, in other words before the terrorist atrocities had been committed, so we do not have the unifying element of the international crisis which was aligned interest rate news. That page basically reports three different camps: there is a middle camp; there is a camp reported in the first paragraph, which I take to be Mervyn King (and you are obviously aware we are seeing a variety of members of the MPC next week). That is why it is striking, because this individual (whoever it is holding this view) is not only concerned about imbalances in the economy given no signs of slower consumption, but actually says they would fundamentally prefer to reverse the cut in interest rates that had taken place in the previous month. I wonder if that is Mervyn King because he opposed that—he opposed the Government's decision on this. Then you have the bottom of the page view which I take to be Sushil Wadhwani's view, which is basically that things are fundamentally much weaker. Could you comment on whether you think there is a big gap, leaving aside the events of September 11, between the way in which various prominent members of the Committee see the outlook? Is it that gap which is creating these tensions in what the MPC are doing and what they are saying about the inflation risks?
  (Mr Bootle) I think the signs are pretty clear that there is a big gap. Indeed, on page 56 we have got that table showing possible effects on RPIX inflation and GDP growth of the alternative assumptions. Although the alternative assumptions on GDP growth do not really add to very much at all—as regards inflation they add to quite a lot. 0.5 per cent at the end of 2003 that I suppose is Wadhwani's view. I think it is quite striking that there is not a table, or part of that table, putting the opposing risks. It is seems almost as though the central view (central both in terms of the most likely and central in terms of the weight of opinion on the committee) leaves to one side a view that has a much lower inflation prospect, but there does not seem to be one on the other side, so I find that rather strange. Having said all that, if there were not to have been disagreements on the Committee in terms of fundamental views, I still think one could produce enormous variations of possible inflation outturns because the future is markedly uncertain. In that regard, David raised earlier on what seems to be a very idiosyncratic judgment that the chances of a recession shown on that table are only 1 per cent. If you look at the table above, the chances of inflation falling below 1.5 per cent I think that is also similarly idiosyncratic, that is rated as 9 per cent in the next couple of years. Obviously it would not be by Sushil Wadhwani; but that seems to me to be extremely odd given what we know is happening in world prices and commodity prices.
  (Mr Walton) There have been differences of opinion on the Committee; you can see that in the voting track record throughout the past year. I am not sure there has actually been a meeting where they are all agreed; the one immediately after the terrorist attacks, they are in agreement there. There has been a range of opinions on the Committee, and I think that is good. Given the uncertainties which exist, it would be very surprising if nine independent members all shared the same view—it would probably be pretty unhealthy if that were the case. One of the criticisms you might have about the European Central Bank is that they do tend sometimes to present this very much as black and white—the policy is what it is until it changes. Whereas at least in the minutes of the Monetary Policy Committee you do get this range of opinion, which I actually think is very helpful.

  10. I was not meaning to criticise the Committee for having different views which, as you say, is entirely healthy. I just think it is useful to understand these differences, firstly, so that we can flush them out and one can see the different members. Secondly, I wondered whether the presentation that Mervyn King gave the other day with the November Inflation Report—and to some extent the contents of the Inflation Report and what the Bank of England is officially saying—is representing a segment of opinion which is more towards Mervyn King's view than perhaps the centre of gravity of the Committee and the way in which they are running monetary policy and, therefore, emphasising more the inflationary risks, whereas the Committee seems recently to be more concerned with growth risks?
  (Mr Walton) I would say that the Inflation Report always tries to present as consensus a view as possible; and you then look at the minutes to see the real variations in opinion. I think the Inflation Report struggles a bit because it tries to build this consensus view. As to whether Mervyn King was presenting a biassed view, I think Mervyn King, as he always does, was really just presenting the view that was expressed in the Inflation Report. If there was any bias it was because the Inflation Report was biassed and not because Mervyn King was putting his own spin on it.

  11. Could the Inflation Report be slightly different in its outlook and tone to the Monetary Policy Committee's conclusions, outlook and attitude?
  (Mr Walton) I think that is a question you should put to the Committee when you see them.
  (Professor Miles) Clearly people do disagree on the Committee. I think you are right, it would be interesting to know why they disagree. I do not know if this is true, but I suspect that a substantial amount of disagreement about risks to inflation stems from different views about the probability that the exchange rate will move substantially. It may be there are some members of the Committee who continue to be puzzled by the strength of sterling, particularly against the euro, and think a really major realignment is possible at any point, perhaps of the order of a 20 per cent depreciation against the euro over a short period of time. If that were to happen, that clearly could give you significant inflation problems.

Mr Fallon

  12. Professor Pissarides, the evidence is that the labour market may be at a turning point. Is that right?
  (Professor Pissarides) Yes. The evidence is the labour market is reacting to events that started back at the beginning of the summer, July/August. The slowdown in economic activity we were seeing then is only just beginning to show up in Labour Force Survey measures of employment and unemployment; and the claimant count is only just beginning to show, even with a further lag than the labour market surveys are showing. There are clear signs that labour shortages and skill shortages are down, and job creation is down. You would expect it to be by small firms. There is still no data, as far as I am aware, to show that is indeed where it was, but I would be surprised if it was not job creation by small companies that has been affected in more recent times. There is also evidence that bonus payments are down substantially, and usually that is the first component of earnings that reacts to outside events, to events in the economy as a whole. Basic pay has not been affected, especially in the public sector, as the Inflation Report emphasises. Again, other costs have come down, and that is why companies can afford to maintain the basic pay levels they were paying before. I do expect it to show signs of decline given everything else that has been happening in the labour market.

  13. In your note[2] you draw attention, and so does the Bank in chapter 3, to the fact that the public sector pay is running well ahead of the private sector. You say that wage growth has to slow down if the inflation target is to be met. You say in your note you expect that slowdown to come from falling bonus payments which of course really apply in the private sector?

  (Professor Pissarides) Yes.

  14. Is the implication of that that the increases we are now seeing in public spending are going to widen this gap between public and private, and we may well have something we have not had for a few years which is a public sector pay problem?
  (Professor Pissarides) It will widen in the near future. It will widen awards almost certainly. Looking at levels of pay, just to say it will widen levels of pay between the pubic and private sector would be incorrect—because the private sector stormed ahead in the previous five years with a higher increase than in the public sector and the public sector have more to catch up—in a way it is unfortunate for nurses, teachers and public sector workers, when the time arrived for them to catch up it also coincided with a slowdown in the economy. So it is more difficult to afford to maintain those rates of pay. In rates of pay, the public sector will have to adjust down, as well as private sector pay, if we are to avoid massive unemployment.

  15. Is there going to be a problem in this winter's pay round in the public sector, or not?
  (Professor Pissarides) You say, "Is there going to be a problem . . ."?

  16. You say: ". . . wage growth has to slow down if the inflation target is to be met"?
  (Professor Pissarides) Yes, I think it has to slow down. If it does not and is maintained at the same 5.7 levels, yes, I would be concerned if I saw public sector pay going at that rate.

  17. Finally, if unemployment does turn up, what are the implications for the inflation rate?
  (Professor Pissarides) If unemployment turns up it will be mainly short-term unemployment and newly unemployed and that usually is quite effective in restraining inflation, so it would push inflation down if unemployment were to rise sharply. It will act as a strong anti-inflation measure if it were to rise sharply. Because the MPC are not expecting unemployment to go up it may be why they are saying the risk is on the upside rather than on the downside. Had they expected unemployment to rise I think they would have said there was a downside risk. I am not expecting unemployment to rise; but if it were to rise then inflation would react and come down.

Mr Ruffley

  18. Can I pass to the ONS revisions to the National Accounts announced in September. I wonder what your assessment is of the significance of these revisions for the work of the MPC? Are they material?
  (Professor Miles) One of the revisions that is mentioned at some length in the Inflation Report, which I think is potentially very important, is the changes to the estimate of the size of the capital stock. I do not think in the Inflation Report there was a figure to how much larger the capital stock was now estimated to be relative to what the MPC members thought in August or earlier in the summer; but the implication of the tone is that it is quite substantial. I think that is very important, because it is a stock, unlike output and consumer expenditure. If you think the capital stock is now 5, 6, 7 per cent higher than you thought before, that is where it is gong to be now for a long time—it only depreciates slowly. Having a much higher capital stock is very useful because it gives you more capacity; it changes one's view of potential economic growth, about how much spare capacity there is in the economy; it may also have an implication for perceptions of what might happen to productivity. They do not spell out in the Inflation Report the magnitude of the difference this has made for perceptions of where growth can go; but I think it would be very interesting to find out from the MPC. They will have had an estimate from their own economists as to what difference this makes.

  19. Essentially in relation to capital stock, that is the most interesting revision?
  (Professor Miles) To my mind, yes.
  (Mr Walton) I think the revisions to output should not be a surprise. Output always gets revised up, so you just need to be aware of that when addressing the forecast. Whenever you see the first estimate of GDP growth there is always a likelihood that within two or three years it will be somewhat higher. To the extent that these revisions are largely in the past, they are in the past so the effect of inflation has probably largely been seen from the impact of a higher output already. It should not really contain too much information about the outlook for inflation going forward. If actual output was higher in the past then so too was potential output for any given inflation.

1   November Inflation Report. Back

2   See p. 3. Back

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