Select Committee on Treasury Minutes of Evidence


Examination of Witnesses (Questions 160-172)

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

  160. How much do you feel the pound is over-valued against the euro?
  (Sir Edward George) Trying to make that calculation is an extremely imprecise kind of science. The only guide I have is the sort of numbers that manufacturers who are trying to compete in Europe give me, and that can go down to—we are around 3.15 in Deutschemark terms now—2.80, 2.70.

  161. So you think that 2.80, 2.70 against the mark would be a fairer valuation?
  (Sir Edward George) I honestly do not give you a considered judgment, it is what people say to me.

  162. Presumably within the Bank, in order to make a sensible judgment about the risk of decline in the exchange rate setting off inflation, the Bank economists must have had some look at how much they feel the pound is over-valued against the euro in order to get a judgment of how much the pound could fall?
  (Sir Edward George) It depends on the circumstances in which it occurs, and it depends whether the depreciation is against the euro alone or against currencies in general. No, there is not a "take off the shelf, here is the answer" kind of thing.

  163. Could I tempt Mr King to be a bit more risque«?
  (Mr King) I am afraid you will not, for the simple reason we really do not know. The evidence I would use to come to the conclusion that the exchange rate is not sustainable against the euro indefinitely is what has happened to profitability in manufacturing, which has been very substantially eroded over the past three years. Although the growth of world trade has helped to maintain export volumes, and manufacturing output has continued overall to grow until the last 12 months, the concern now is that profitability has been hit by the higher exchange rates, and this has been taken on at margins which have eroded the profitability, and now world trade has also slowed down. That is the problem facing manufacturing and why it is very difficult to believe this current exchange rate is sustainable, because of the evidence of what has happened to profitability. That, unfortunately, does not tell me what would a sustainable exchange rate be, and I simply do not know that.

  164. My last question is to seek clarification on the answer which Kali Mountford had earlier on about the prospects for unemployment. I notice in the minutes of the committee meeting on 7 and 8 November, you do say there, Governor, or the paper says, "Overall there are some signs therefore that labour market conditions had at least plateau-ed and were perhaps easing slightly." Do I draw the conclusion from that, that your comments to Kali Mountford earlier were that the Bank thinks the best outlook or most likely outlook for unemployment over the next few months is for it to move gently upwards?
  (Sir Edward George) Yes.

Dr Palmer

  165. Governor, if it became clear from political sources around the Treasury or wherever that Britain was planning to hold a referendum on joining the single currency and that would be at a lower level than the current rate, do you expect that this would in fact impact market sentiments significantly and that would in itself tend to lower the exchange rate?
  (Sir Edward George) It is absolutely clear that every time the speculation builds up this is imminent, then you do see a weakening of the exchange rate. It does not persist very long because it is not confirmed, so it is quite possible that if we said, "Yes, we are going to go in tomorrow", you would actually see the thing sell off, because nobody I know thinks that going in at the current rate against the euro would make any kind of sense; there are all sorts of questions about how you decide and negotiate and all that, but leaving that on one side. That is just a comment, an observation. The interesting thing for us is what the implications of that would be. As I say, if it drove the effective exchange rate down very sharply, that would have implications for the inflation target, so we would respond by having to tighten monetary policy. So you would get the kind of discrepancy effected in another form in effect.

  166. Should the referendum campaign come to pass, all members of the MPC and in particular you, Governor, are likely to come under constant pressure from the media to make statements on whether you think a yes or a no would be beneficial to the economy. I am sure you would be very careful in how you respond to that. Do you feel there is a danger that because your specific role in determining interest rates would change as a result of us joining the single currency, this might influence your judgment a bit, that you are all a bit reluctant to give up the specific role you might have?
  (Sir Edward George) I very much hope not. We are public servants and that is our role. We all feel that very strongly. So if that were the political judgment we should do this, that would be what we would do, and we would do that to the best of our ability.

  Dr Palmer: Thank you.

Chairman

  167. If none of my colleagues have any further questions, I will sweep up with two areas. One is the issue of productivity. In your November inflation report you mentioned one result of 11 September would tend to lower the level of aggregate productivity. I was at a seminar in Downing Street a couple of weeks ago and one distinguished economist said the productivity gap between the UK and the USA was 41 per cent, between the UK and France was 11 per cent, between the UK and Germany was 7 per cent. Lo and behold a couple of minutes later another very distinguished economist said, "Don't believe them. The productivity figures are not worth their weight at all." Given this range of eminent economists in front of us this morning, what is your view on the productivity figures?
  (Sir Edward George) Whether they are worth anything?

  168. Yes.
  (Sir Edward George) I think international comparisons are extremely difficult. Monitoring changes in productivity probably is more meaningful but I think others will have a better view of that than me.
  (Ms Barker) I have spent a lot of time looking at international comparisons and it is certainly true there is a very wide range of uncertainty. The ones you quoted sounded to me like output per person, and when you do output per hour you get a relatively more favourable comparator with the US and a less favourable comparator with France and Germany. The figures all seem to indicate there is some gap between the UK and key competitors but I think to be very precise about the size is foolish.

  169. So you would not put your life on the productivity figures and their reliability?
  (Ms Barker) I would be prepared to stake that I think there is a productivity gap between the UK and France, Germany and the US, but I certainly would not stake very much, not even as much as a fiver, on whether it was 20 per cent or 30 per cent.

  170. Would any members of the committee stake more?
  (Dr Wadhwani) Speaking personally, I even have trouble using these numbers with any great confidence in monitoring developments over time. I still find the UK productivity numbers through the 1990s, especially the 1994-98 period, quite puzzling, because the official numbers suggest virtually no productivity growth in manufacturing, yet all the anecdotal evidence and the CBI's own numbers of what happened to manufacturing productivity were quite different. Certainly the observation that inflation came in somewhat lower than expected for much of the latter half of that decade I think would be consistent with the productivity growth having been faster than we measured it.

  171. On the issue of public finance projections, referring to the MPC minutes of March this year and also your evidence, Governor, to our predecessor Committee, the Treasury produces forecasts based on deliberately cautious assumptions of receipts and expenditure, which you use as the MPC. After the last Budget, some on the MPC questioned the appropriateness of using these forecasts, and I have referred to your March document. What issues arise for the MPC's forecasting process from the adoption of the Treasury's fiscal forecasts, given they are based on deliberately cautious assumptions? Secondly, what difference would it make if the Treasury's forecasts were based on central rather than cautious assumptions?
  (Sir Edward George) Mervyn, I will pass that to you.
  (Mr King) The two key inputs to our forecast from the public finance area are the stated plans for spending, public expenditure, and the effective tax rates which are implied by the Treasury's forecasts, so we do not use the Treasury's cautious growth numbers to project revenues, we use our own. So in terms of trying to think about the consequences for the outlook for output and inflation, the key numbers we use are, if you like, the structural numbers underlying the Treasury's projections for both taxes and spending, and they are not in any sense biased. So I do not think we are affected by the cautious approach which is put into the fiscal projections by the Treasury. I think they would say what they want to do is to try to make sure when they produce a central projection for revenues to judge against their fiscal goals. They want to say, "We have built in a margin so we should be fairly confident", and they do some sensitivity analysis in their published documents to enable you to see how robust their conclusions are. I do not think that is directly relevant to the way we make use of the numbers for the purposes of our projections.
  (Dr Wadhwani) Could I enter one qualification. My memory of March is a little hazy but from what little I can remember the issue on the table was whether or not we should go along with the Treasury's cautious assumption there would not be any under-spending even though there had been under-spending in the recent past, and that could clearly have some impact on our growth and inflation projections. I think that is what the debate was about.
  (Mr King) The committee has at various points suggested and discussed explicitly in the forecasts and the inflation report whether it wanted to make a judgment that, relative to the stated plans, we would expect expenditure to be either greater or less than the figure actually put in there. By and large, we have been perfectly content to take the stated public spending plans.

  172. Do any of my colleagues have any final questions? Governor, do you or your colleagues have any final questions? This morning we expected doves and hawks to fly in here, and there are none at all, the hawks have flown before you came, so that was a surprise to us. Thank you for your time this morning and we look forward to continuing the sessions.

  (Sir Edward George) Thank you very much indeed, Chairman. You said, did I have any more questions, I had not realised we were allowed to ask questions! We will remember that next time!

  Chairman: Thank you.





 
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