Select Committee on Treasury Minutes of Evidence


Examination of Witnesses (Questions 80-99)

THE RT HON SIR EDWARD GEORGE, MR MERVYN KING, MR IAN PLENDERLEITH, MR CHRISTOPHER ALLSOPP, MS KATE BARKER AND DR SUSHIL WADHWANI

TUESDAY 27 NOVEMBER 2001

  80. Given your background, what do you consider when you come to vote in decisions?
  (Ms Barker) We all consider the same evidence. As you all know, we are given on the previous Friday very long and detailed discussion of all the different aspects of the economy and we all look at all of them. What I think we all as individuals bring to the Committee is perhaps different knowledge about some of them in the way that Professor Nickell is a labour market economist, so he would be expected to comment on that data within the committee meetings and I will often comment on business surveys, what I think is going on in the business community, but we have to weigh all the evidence together. We do not all just vote because we know about the labour market or the business community.

Mr Beard

  81. Mr Plenderleith, in the MPC minutes for November, paragraph 32 says,"Various possible arguments . . . were identified which might favour an immediate cut of only 25 basis points. First, the assessment of deteriorating outlook placed considerable weight on surveys. But surveys tended to be volatile and might be influenced by temporary factors . . . Second, a 50 basis point cut might incorrectly signal that conditions in the United Kingdom were as difficult as in the euro area, and as in the United States . . . Third, a sequence of small cuts might have a more potent effect on confidence than a larger cut if the fact of cutting, and the attendant media coverage, were important." Which of those arguments were you considering when you voted for a cut of only 25 basis points?
  (Mr Plenderleith) All of those, Chairman. That paragraph reflects very much the considerations that were in my mind. They are partly related to the situation, as best I could judge it, in the economy, so to speak fundamental factors; whilst there was clear evidence of the world environment slowing and of the damaging impact of the terrorist attacks on confidence and whilst I shared the general view of the Committee that we should be cutting rates, it did seem to me that the evidence for the impact in the UK over and beyond the cuts that we had already made in previous months was much more in terms of anecdotal evidence, surveys and expectations than in the actual data we could see. That is not conclusive of course; actual data is always in degree backwards looking and the surveys give you hopefully a more forward looking view. Nonetheless I was nervous on those grounds of moving as much as 50 basis points in one step and felt it would be more sensible to move perhaps that month 25 basis points and then see how things went. But my view was also partly based on grounds of timing which is really the second, third and fourth factors indicated there, that there seemed to be some benefit in moving in a series of graduated steps rather than necessarily moving sharply. Therefore, on balance, I favoured moving in 25 basis points. As always, it is a very fine judgment but basically based on all four of those factors.

  82. Do you feel any of them have been justified by events since then?
  (Mr Plenderleith) I think it is too early to tell. The implication of my view was that, if the situation continued to look weak, particularly in relation to the world environment, that there would be a good case for considering a 0.25 per cent cut in December. That was done in November with the 50 basis point cut. I think the evidence we have seen since then is still very hard to interpret because there is clearly a slowing in the world situation broadly in line with the view in our inflation report which I subscribe to. There is clearly deterioration in confidence but not a huge deterioration, and it is hard to distinguish the instant impact of the terrorist attacks and the damage that causes to confidence from the more persistent effects once people have got over the initial shock, and that is truly what I was waiting to see in my vote earlier this month.

  83. Mr Allsopp, the Bank's press release on 18 September said it was too early to make an informed judgment about the scale of the impact of events in the United States, but you went on nevertheless to vote for a 0.50 percentage point increase on 18 September when the majority of the Committee voted for 0.25. Why did you feel that there was sufficient indication to justify that?
  (Mr Allsopp) At the time, I think I was pretty impressed by the uncertainties and—indeed—the deteriorating world prospect, if you like, before 11 September. I had been holding off a little; I thought the world was pretty bad and some of the things Sushil has said are things I would, so to speak, have agreed with. I thought that the position domestically, in terms particularly of consumer demand and so on, was a timing reason really for being rather cautious about the timing of reducing interest rates. In the face of what I thought of as very large shock, one that was likely to affect expectations, confidence and so on, I could see at that stage no reason for, if you like, half measures and I thought that 0.50 per cent was fully justified and that I would be unlikely to want to immediately reverse it soon afterwards and therefore took the view that, since that was my view, I should vote for 0.50 per cent.

  84. Do you regret that the rest of the Committee did not follow you down that road but waited until November to do so?
  (Mr Allsopp) To be honest, the question of whether you cut within a couple of weeks by 0.25 and then another 0.25 or 0.50 all at once, in terms of the longer run effects on the economy, is relatively small. It could possibly have an effect on expectations and some of what has been called the psychological aspects of it, but, in terms of the underlying economics, that is not a very big change, so of course I do not think it would have made a huge difference one way or the other, in the event, given that we, a couple of weeks later, had cut further by 0.25 per cent.

  Chairman: On the issue of inflation and growth forecasts, I will ask David Ruffley to ask questions.

Mr Ruffley

  85. Governor, could I return to the growth projections at Table 6.A on page 56 following David Laws's point. We had evidence from our specialist advisers last week expressing concern about the rosy expectations contained in those growth projections. One figure given to us was the 39 per cent probability that growth will be more than 3 per cent in 2003 but only a 7 per cent probability that growth will be less than 1 per cent and one specialist adviser said to us that he thought that was daft—those were his words, not mine. Another witness, Roger Bootle, said it was pretty striking. There was a consensus that these growth projections were on the rosy side. Can you explain to the Committee why you appear to have a more optimistic view of growth in the next two years than outside forecasters.
  (Sir Edward George) I would just draw your attention to Table 6.D where the numbers you refer to, which are 39 and 7, the exactly comparable numbers in Table 6.D, which was 24 outside forecasters' average assessment, is 28 and 13. Frankly, I do not see that as being significantly different, so that I think what you are telling me is that the people you interviewed had a particularly strong view in one part or another of the probability distribution.

  86. Could I ask about recession because the Deputy Governor said at the press conference that the odds of recession over the next year were much lower than 1998-99 and yet the economic environment was slightly more benign at least in the sense that the US was 2.5 per cent analysed growth rate, it is nothing like that now. What is the basis for saying that the odds of recession are less than in 1998-99?
  (Sir Edward George) I think this is simply a description of the forecast that we have made. If you ask, "What are the grounds for it?" we have to go through every dimension of the forecast. We think that the global environment, as I have explained to you, is negative now. I agree with Sushil that we have three major currency areas probably all in recession at the same time and we expect that to persist in the next year but we do see a pick-up from the middle of next year onwards. At the same time, we have a domestic demand in the UK driven by consumer spending supported by government spending which is kind of offsetting that negative effect and that is where we come out.

  87. Could I ask Dr Wadhwani what his views are on the probabilities for growth in the next two years because I think you said in response to Mr Laws that it was a less than 50 per cent chance of recession.
  (Dr Wadhwani) I think one wants to avoid spurious precision here but, in broad terms, I still think that the probability of a recession in the UK is significantly less than 50 per cent but it is significantly higher than the projections here.

  88. Could you explain why you take that view. Your view is that recession is more likely than the projections on page 56.
  (Dr Wadhwani) Yes. I think that view is primarily driven by a greater concern about the global economy. Rightly and wrongly, my best guess—and these things can only be a guess—is that the global economy will recover perhaps a little later and more weakly than we have in our projection and that I think will inevitably feed into the UK economy.

  89. Could I just ask why the house view or consensus is that the global economy will perform better than your judgment would suggest?
  (Dr Wadhwani) I think that, as the Governor said, so many different factors go into a forecast, so it would be churlish to just identify one, but I guess that my personal sense is that the investment overhang will last for longer and that therefore the risks to consumption in places like the US are greater coming through the labour market. The profit squeeze that we have in the US will mean that you have more lay-offs than we have in our projection. Added to all that, I think there are significant downside risks from the global equity markets where I think that long term profit expectations are still too high. These are all judgments and it is reasonable for people to disagree on these judgments. In my previous job, I know what it is like to have been wrong several times, so I know to be humble about these sorts of projections.

  Chairman: I think we are getting a feel for Table 6.A to D on page 56.

Mr Fallon

  90. If uncertainty has increased since 11 September, why has the spread of possible outcomes for growth remained virtually unchanged since the August report?
  (Mr King) Because two things have happened, really. One is that the outlook for the world economy, and hence therefore to some extent the UK, has changed. I do think that we should not lose sight of the fact that the outlook for the UK does not depend solely on the outlook for the rest of the world. Also, because we have seen significant revisions to the data and we have seen a much faster than expected growth rate in the third quarter, the 12 month growth rate to the end of Q3 this year was no less than 0.6 percentage points higher than we had expected in August, so there has been a significant revision upwards in the growth that we have seen over the past year. So what the fan chart for growth shows you is the outcome of a picture in which, over the past year, growth has been much faster than we had expected only in August. We do expect quite a slowing of growth in the next two to three quarters, so we do have quite a weak picture over the next two to three quarters but then we see some recovery. The result is that, if you are looking at what happens to the growth rate over each 12 month period as it moves along, that growth rate does not actually change very much and it is that which gives you the relatively low figure for the probability of a fall in output over any 12 month period. We do expect weak growth over the next few quarters. So, I think it is a combination of clearly the big news on 11 September and we have also learned since 11 September that the world economy, not only in the US but also in Europe and Japan, was weaker than we thought, but we have also seen that the UK economy was actually quite a lot stronger than we thought despite that fact.

  91. If you have learned a lot since 11 September, can you tell us why it was necessary to have a special meeting of the Committee on 18 September when you had a normal meeting scheduled a couple of weeks later.
  (Sir Edward George) Clearly, the fact that other central banks had moved again at special meetings was something we needed to consider. I think our instinct was that really we would be better to wait until we had our normal regular overview of the monthly data and we actually would see more what had happened in the financial markets. Given that the United States moved, which we had anticipated, before the opening of the US financial markets and given particularly that the ECB which had not moved on the Thursday before the US moved but did decide to move on the Monday, we thought it was sensible to actually consider whether we should respond to that new factor in the situation and we decided then to have a special meeting and we moved by 0.25 because we actually felt that that was appropriate to our situation.

  92. You describe the 0.25 in the minutes as signalling the Committee's responsiveness to the change in economic conditions, which is presumably what you are supposed to signal anyway at regular meetings.
  (Sir Edward George) One of the changed economic conditions was what had happened elsewhere.

  93. The other banks' decisions?
  (Sir Edward George) Yes.

  94. Dr Wadhwani, in your speech in Edinburgh which we have already picked over today, you said that your personal inflation projection was lower than the best collective projection published in the inflation report. Why do you think it would be up to 0.5 per cent lower in two years' time?
  (Dr Wadhwani) Essentially, there are three reasons for that. The first is that, as I said a little earlier, my central projection for the global economy is somewhat weaker. The second is that I think that the global dis-inflation that we are likely to see has a more important effect on the UK inflation than is reflected in the best collective projection. The third is that, in my personal judgment—and I should add that, in everything I have just said, these things are all necessarily uncertain and we all somehow have to come up with our own personal judgments—the third source of disagreement is about the supply potential of the economy. That is the degree to which I think the economy can grow without triggering inflation. Those are the three principal reasons why my best guess for inflation two years out is about 0.50 per cent lower than the best collective projection.

  95. Would that analysis have justified you voting for more than 0.50 per cent?
  (Dr Wadhwani) If there were a mechanical link between one's projection and the decision, the answer is surely "yes", but there is no mechanical link and I think, as I said in an earlier answer, I did contemplate 75 basis points but, for reasons of psychology, did not think that was a prudent course.

Mr Palmer

  96. Governor, I think you would confirm that, as a result of 11 September events, the Committee has cut interest rates more quickly than they might otherwise have done because of the perceived impact on confidence. If it turns out, as some of the answers have suggested might be the case, that confidence recovers relatively quickly perhaps as result of a successful operation in Afghanistan and perceived diminution of terrorism, could we expect a fairly rapid rebound in interest rates?
  (Sir Edward George) I think the point we have tried to make publicly is that we do have to be extremely vigilant on the upside as well as on the downside and certainly whether it was simply a consequence of stronger confidence, whatever the reason, if we actually see the economy performing and likely to continue to perform more strongly than we have in the forecast, particularly if we see a recovery in external demand, a dying down of some of the dampening external influences, then we will have to be alert to the possibility of actually having to move promptly in order to slow down the growth of consumer demand which we have been seeking to encourage because we are, as I said at the outset, seeking to offset these negative influences from abroad by sustaining domestic demand. The price of that is that we have a very big imbalance within the economy between the internationally exposed sectors and the domestic sectors and it is uncomfortable, acting as we are, to sustain it, but it is actually not ideal though it is better than simply accepting that the economy should experience an unnecessary loss of output and an unnecessary rise in unemployment. So, yes, you are absolutely right but whether it was simply the confidence factor or developments in the economy relative to our present expectation, we certainly do have to be just as sensitive to changes which point to upside risks as we have been to downside risks.

  97. The impact on psychology of an interest rate change is obviously immediate and the impact on longer term investment decisions is much more of a lagging effect and I wonder whether you are concerned that this possible zigzag approach will in fact have a delayed impact on the economy at the wrong moment, that the decision to cut will have led to an inflationary impact perhaps 12-18 months down the line and the decision to increase would perhaps also come at the wrong time.
  (Sir Edward George) As I say, yes, we are conscious about that and we are conscious particularly—and there have been lots of discussions reflected in our minutes—of the imbalance within the economy. Of course there is a concern; we could fall off on either side. If we do not cut, then we could have a weakening of domestic demand which would mean that the economy would be overall weaker than we anticipate. If we over-stimulate and are not sufficiently reactive in the sense of reacting to a change in that perception, then we could get an upside risk which would actually carry with it the danger that we got a sharper correction and unsustainable consumer spending growth sometime in the future. So you are absolutely right that there are risks on either side. What we did reflects the judgment that the risks in the short-run anyway are on the down-side or would have been if we had not responded.

Mr Plaskitt

  98 . Governor, are you entirely confident there is no risk of Britain experiencing deflation?
  (Sir Edward George) It is not our expectation.

  99. How are we going to avoid the Japanese scenario?
  (Sir Edward George) I think we are a very long way away from the Japanese, but I am never confident about anything.


 
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