Examination of Witnesses (Questions 36-39)
RT HON SIR EDWARD GEORGE, MR MERVYN KING, MR CHRISTOPHER ALLSOPP, MR CHARLES BEAN AND PROFESSOR STEPHEN NICKELL
THURSDAY 28 FEBRUARY 2002
36. Sir, Edward, good morning to you and your colleagues and welcome to our Committee. Can I start by asking you what are the main issues for you in the coming months? Would you describe the period following 11 September as one of the most difficult for the Bank in terms of projecting growth and inflation?
(Sir Edward George) Thank you, Chairman. The main issues are what is happening in the global economy and what the implications of that will be for the UK, because the problems that we have been facing really have their origins abroad. That is partly the weakness of the euro, the strength of sterling, which has persisted for some time, but it is also, of course, the synchronised slowdown in the global economy. We have been having to try to stimulate domestic demand to offset the impact of that in order to keep total demand growing, on the basis essentially that unbalanced growth is better than no growth at all. We do now anticipate that the global economy will begin to recovery, probably slowly, but building up as we move through the course of the year. Then there is the question of what is going to happen to domestic demand growth. Our expectation, reflected in the projections in the Inflation Report, is that there will be a spontaneous moderation of the rate of growth of domestic demand, and that would obviously be in many ways the best possible outcome, that the two things happen to coincide. There is a real possibility that that will happen, but there are risks on the other side, and trying to make our best guess of what is going to happen I think will be the challenge as we go forward. September 11 created difficulties of its own. I think the sense was that 11 September itself was an added factor in what was already a complicated situation, because exactly the kind of issues I have just described pre-existed, preceded 11 September, and actually, after 11 September the data that came from the global economy which referred to the period before 11 September suggested that the slowdown was more pronounced than we had expected and would, without 11 September, have lasted for longer, but of course, it did pose new challenges. The issue was just how severe would the shock to business confidence and to consumer confidence be around the world, including in this country. That was a new issue that we had to contemplate. By and large, one hopes that we are largely through the impact of 11 September, so that although there is no question that it did deepen and prolong the slowdown that was in train, I do not think it has changed the world in a fundamental way, but of course, it is another uncertainty that we have to take into account.
37. Looking at your Inflation Report for February and your two key forecasts, it seems to state that the risks for inflation are on the upside, yet the risks for growth are on the downside. How do you reconcile the contrasting risks?
(Sir Edward George) The risks to growth are twofold. One is uncertainty about the global economy, with perhaps a risk compared with our central expectation that the global economy may not be quite as strong. We had that risk in before. The risk that we put in this time was rather less than in November, but there is also a risk that consumer spending could moderate more sharply than in the central forecast because of the imbalance in the household sector, the extent of debt in the household sector, and in an environment where we are projecting a modest upturn in unemployment, confidence in the consumer sector could weaken rather more sharply than we had in the central projection. So they were the downside risks to demand and output. The upside risk to inflation is the risk to the exchange rate essentially. We have really been puzzled, and I do not think many of us would pretend to understand why the euro has been so weak or the pound so strong for some considerable period of time. At some stage most of us would expect that there is liable to be a correction, which I think desirable. It could take the form of a strengthening of the euro against currencies generally, but we felt we needed to put into the forecast an upside risk for the possibility of the exchange rate falling, and that would have an inflationary impact, and that could be combined with a sharper slowdown on the consumer spending side. So you could get those two things together. I would make one point in relation to that. It illustrates rather well the reason why we try to emphasize that, although the forecast is a tremendously important tool in our policy process, there is no automatic linkage between the forecast and the policy decision. If you take the question of the exchange rate, for example, that upside risk, its effect over the forecast period would depend very much on when it happened and how it happened. It does not mean that you can anticipate either the size of the change or the timing of the change in your policy judgment. You may have more time to respond to that in the light of what actually happens rather than in the light of the forecast. We nevertheless think that we should put into the forecast the possibility of that happening as a risk rather than as the central expectation.
38. You will have noticed in the Financial Times this morning that Alan Greenspan has indicated his opinion that the recession in the United States is over, and although it will be a gradual recovery, the turning point has been achieved. We had the opportunity to visit the United States a few weeks ago, as you know, and met Mr Greenspan. He pinpointed the recession date starting in March last year, and indicated to us that it will be a gradual recovery with no double dip. Do you agree with that view?
(Sir Edward George) I do agree with Alan Greenspan. What exactly did he say? Basically, I think we have included in our projection a picture very similar to the one that Alan Greenspan described yesterday. We do think we are around the bottom. We anticipate the US economy picking up gradually through the year, but picking up quite strongly by the end of the year to something around trend growth, and that continuing into the year 2003, and that will have an impact on the whole of the world economy, which is rather positive. The downside risk that I have described is that it might be a bit less strong pick-up through the year than we had factored into our central expectation.
39. My last question refers back to the inflation projection that you made in November. There is a similarity between what you made in November and now. Roger Bootle in written evidence to us stated that he felt it was surprising that inflation forecast was left largely unchanged, because certain assumptions had been changed. Global growth was revised down by 0.25 per cent to 0.5 per cent in 2002; UK GDP growth was revised down significantly this year; oil prices were $1 lower than expected in November; and the pound was 1 per cent higher in trade weighted terms. Given those shifts, you still have consistency in your inflation forecast. Can you explain that?
(Sir Edward George) Yes. In general I would have described both the November forecast and the current forecast in terms of close to trend growth looking forward, and sustained low inflation near the target. I think the focus on small changes in numbers is actually misleading. The uncertainty of the forecast is such that it is not a tremendously constructive thing to do to focus on the last decimal place. I confirm that the forecast that we make in that sense is broadly similar to the forecast that we made in November. Some of the changes are really to do with the past rather than the future, but of course, they influence the forecast by altering the starting point. I do not know if any of my colleagues would like to comment. They are more closely associated with the forecasting process than I am.
(Mr Bean) In terms of the details of the forecast, it is a bit weaker in the very short term, and that reflects the latest outturns to the UK data and revisions to date over the last couple of years. But, as the Governor stressed, the big picture here is very similar to what we had in November. Average growth over the two years is very similar. So essentially we have a slightly sharper downturn in the short term and a stronger recovery a bit further out. As far as the world picture goes, it is a little weaker because outturns in the euro zone were a little bit weaker than we expected, although as far as the US is concerned, we have not changed our estimates very much. Really, the changes are actually very small in the context of the usual changes in forecasting.