Examination of Witnesses (Questions 80-99)
RT HON SIR EDWARD GEORGE, MR MERVYN KING, MR CHRISTOPHER ALLSOPP, MR CHARLES BEAN AND PROFESSOR STEPHEN NICKELL
THURSDAY 28 FEBRUARY 2002
80. Mr King, the Governor recently said that if the exchange rate fell, it would cause some increase in inflation but help cure the imbalances in the economy. Is it your opinion that if the imbalances were cured in that way, it would offset the inflationary effects of the reduction in the exchange rate?
(Mr King) That would depend on the circumstances. A change in the imbalances which did not have much impact on the overall path of demand and output would not lead, in itself, to an offsetting change in inflation, no. So the rise in inflation would still come through. But it would all depend on the circumstances in which the exchange rate changed, whether that was accompanied by a change in other exchange rates and changes in the pattern of demand in the world economy, what was happening in the US and in Europe. All of those things would be relevant to an assessment of why it was that we felt the impact of the change in the exchange rate and associated developments on inflation was what we believed at the time. I think it is similar to the question Mr Tyrie asked about why we do not have ready reckoners. The answer is because in practice, every time the exchange rate changes, other things are going on which led to the change in the exchange rate, the fundamental causes, and those things have to be factored into the equation too. I know it is not very helpful, but I do think it is a fundamental reason for thinking that each time there is a significant change in the exchange rate, we have to sit down and think carefully about why and what the consequences are, and I think it is relevant that the countries that did try to use ready reckoners and monetary conditions indicesCanada and New Zealand both used those in recent yearsfound that maybe this ready reckoner represented some sort of average impact of the exchange rate versus interest rates, but each time they saw a change, each meeting they came to to justify their decision, they had to explain why this month a change in the exchange rate could not be examined satisfactorily through the ready reckoner. As a result, they abandoned monetary conditions indices and went back to where we are, which is looking at the change in the exchange rate and trying to judge what its impact will be given everything else, and it is encapsulated in our projection in the inflation rate.
81. After Black Wednesday the inflation that was predicted did not actually emerge. Could it be that we are all being too miserable about prospects of reduction in the exchange rate and that inflationary pressures are being magnified?
(Mr King) It is a very good example of the fact that there the exchange rate change took place when unemployment was high and activity was very depressed. You could still see some impact of the change in the exchange rate on the movement of RPIX inflation, and certainly RPIY inflation, to take out the indirect tax changes that were taking place around that time. Other things were going on, of course. It was not just that the exchange rate changed and nothing else happened. The inflation rate was falling and it would have gone even further I think had it not been for the fall in the exchange rate that then took place, and of course, the consequent adjustment to monetary policy. Again, the exchange rate is not something that one can look at in isolation. That is the trouble. It does need to be looked at together with everything else that is happening.
82. Governor, you told us this morning that unbalanced growth was better than no growth at all. How hard is unbalanced growth to stop?
(Sir Edward George) Again, it depends on the circumstances, but the point that I was trying to make was that the dampening influences, the negative influences on demand in the United Kingdom, basically originate abroad. We cannot directly, in what we do and what the Government does, address those causes. So we are faced with the global slowdown producing weak net trade, weak external demand. But the policy question for us, which is implicit in our mandate to keep inflation at 2.5 per cent, is what can we do. The only thing we can do is to stimulate domestic demand. Public spending was increasing through this period, which was actually very welcome given that this was partly offsetting the weakness of external demand, and lower interest rates to actually encourage, essentially, consumer spending were also part of the process. It is in that sense that to have unbalanced growth, because we could not do anything to achieve a better balance of demand, was better than actually going into recession, which would have been the alternative if we had not tried to offset the weakness emanating from abroad.
83. The revised figures for the last quarter for growth show that in fact growth has stopped.
(Sir Edward George) Absolutely. I do not think I said that we could attempt to insulate the United Kingdom. In fact, many times I have said we could not insulate the United Kingdom from these external pressures. We could seek to compensate for them and compared with many others, we have managed to do that reasonably well so far.
84. The revised quarterly growth figures we have had show the lowest growth for almost ten years. Without doing anything, would you regard that as having resolved the problem of unbalanced growth, or do you think unbalanced growth is still continuing, even though the overall growth figure is at its lowest for ten years?
(Sir Edward George) I suspect that the fourth quarter figure as revised yesterday may well have been affected by 11 September and all that and is probably a low point. You have to be careful about taking one quarter's figures. But certainly in many of the euro zone countries they had negative growth during this period. The United States, on the figures which were revised today, had absolutely marginal growth. I caution you against taking one quarter as the number. What we can try to do is to offset these negative influences by stimulating domestic demand in order to try to cushion the UK economy as a whole, to try to cushion what would as a consequence happen to the rate of inflation from these external influences. I do not know if I am getting the drift of your question.
85. The fact that we have the lowest quarter on quarter growth now for ten years
(Sir Edward George) That is because we have had a synchronised global slow down and we have not been able to offset that 100 per cent by stimulating domestic demand. That is the explanation. The number itself may be exaggerated we know because of the particular events of September.
86. You do not think it means you should try harder?
(Sir Edward George) Well, if this situation is going to persist, which is not what we anticipate in the forecast, then yes, of course, we would need to try harder but there are risks in that. If the picture is as we see it, and we try harder, which we can only do by stimulating domestic demand growthmeaning consumptionand encouraging borrowing, then the risk is that we would over achieve in the sense that, as the external demand improved, we would then run into the opposite problem. We have been trying very hard and actually if you look at what has happened to consumer spending in the fourth quarter even then it has been really very strong.
87. Mr King, you said earlier that compared with movements in prices, some of the things we are talking about here in terms of forecasting effects are trivial compared with movements in prices. Which could act better and faster on prices: changes in policy or changes in taxes? I am asking you here for advice as a legislator.
(Mr King) It is that last bit which makes me uncertain about the nature of your question. If indirect taxes are doubled tomorrow, I would imagine that the impact on prices would come through rather more quickly than if we made a small reduction in interest rates, but I am not quite sure if that is what your question is directed at.
88. You are encouraging me to think as a legislator that there is some scope in dealing with these issues for tax changes being more effective than interest rate changes.
(Mr King) Surely the objective is not to manipulate the month to month inflation rate, is it? In terms of influencing the inflation rate in the medium term then interest rate policy is the appropriate tool to do it. We have seen in the last two years in fact that changes in the Budget did affect short run movements in RPIX, what you do one year comes off the next. You cannot keep on doing it.
89. I am grateful to you for that. Similarly, if one was trying to deal with imbalances in demand across the economy or was concerned about them, the Governor has expressed some concern about that, which would be more effective: changes in interest rate policy or changes in the spending and tax policy?
(Mr King) I think the problem is that neither are terribly helpful and that is why we have the problem with the imbalances because what we have been able to do reasonably successfully is to maintain an overall balance in the economy, that is not a problem. The problem is that a combination of a sharp slow down in the world economy and a very weak euro against sterling has led to imbalances between the tradeable and non tradeable sectors of the economy. I am not sure that we have any domestic policy instruments to affect either the nature of the slow down in the world economy or indeed the weakness of the euro against sterling.
90. In terms of the imbalances in our domestic economy, the only real policy to follow is the policy of Asquith which was to wait for somebody to turn up?
(Mr King) I am not sure if Asquith was the originator of that policy, I think Mr Micawber certainly had some prior claim and I am sure it goes back well before. You say it is waiting for something to turn up. We have one instrument in our policy armoury, we must use that to achieve what we can which is an overall balance and that is what we have done.
91. For the first time in the Minutes of the MPC for some time the Committee considered the possibility in February at the last meeting that unemployment might rise quite sharply. I wonder if I can ask Professor Nickell, whose area this is, how great he considers the risk of unemployment rising quite sharply?
(Professor Nickell) I do not think the risk is very great. There is some possibility of a sharp rise but in my opinion the rise in unemployment which has already started, I think will be a very slow and relatively modest one.
92. Professor Nickell, could I add to that, particularly in the area of regional policy and imbalance.
(Professor Nickell) Yes.
93. As you know the Chancellor's twin objectives in this area in a paper that the Treasury co-produced with the Department of Trade and Industry focuses on productivity and job growth.
(Professor Nickell) Yes.
94. The Inflation Report, in Section 2.4 refers to the developing trends between the manufacturing and service sectors with input declining in the former. We have had a paper from Professor Sheila Dow on the issue of regional imbalances. She says that "The relationship between sectoral composition and regional growth is not a simple one. Nevertheless, the continuation of the decline in manufacturing is adding to regional disparities . . . . we need to consider the effects on the UK as a whole of a widening gap in regional growth experience." Could you give us your views on that?
(Professor Nickell) I agree with that. I think that regional imbalances are extremely important. I should say before I start pontificating further that I do not think monetary policy can do anything about regional imbalances but leaving that aside
95. What can?
(Professor Nickell) What can?
(Mr Bean) Regional policy.
(Professor Nickell) Yes. Charlie says regional policy but I guess you would want something more specific than that.
97. More public spending in the regions?
(Professor Nickell) Yes. Some variation of public expenditure across regions might be helpful but I guess that exists already. Whether the variation in public spending across regions is that closely related to these problems, I am not sure. There are all sorts of possibilities. For example in Norway they have differential payroll taxes across regions.
98. Gosh, you are being a lot more helpful than Mr King was. Do tell us more.
(Sir Edward George) Chairman, I have to say I do think we are going way outside our monetary policy brief.
Mr Cousins: Oh, yes, but it is very interesting.
99. Actually, Governor, I accept that but on our visit to the United States a couple of weeks ago we had the privilege of meeting Bill McDonough, the Chairman of the New York Federal Reserve. He took the Chancellor, Gordon Brown, to a project in Harlem which was focusing on community regeneration. We asked him the direct question "Should the Central Bank have an issue in community regeneration and redevelopment?", to which the answer was an unequivocal "yes" so our interest has been stimulated by that. Many commentators have mentioned to us that the issue of regional disparities is one which the Central Bank should be in. There is a legitimate background to why we are asking that. If the answers are not forthcoming then we could discuss this at a later date. It is one thing the Committee is very interested in.
(Sir Edward George) I am very interested in it too, Chairman, do not misunderstand me but did you ask him what the Central Bank could do about regional disparities because that is the question that we are essentially discussing here? I would be very interested if he said he thought that they could do something because that would be a novel idea.