Examination of Witnesses (Questions 20
MONDAY 22 APRIL 2002
20. On the wider economy and imbalances in the
economy, what has this Budget done to correct imbalances? Or would
you agree with some commentators who have said that the Chancellor
has ducked that, the consumer boom is going to continue and it
will be up to the MPC to correct any imbalances?
(Mr Barr) You can argue it is not up to the Chancellor
to address it at all, that is why there is an independent central
bank and it is their job to address these imbalances and overall
meeting the inflation target and making sure the whole economy
is growing close to its productive potential. That is the first
point. I think to use the word "duck", even though it
is tempting, I may have done it myself immediately after the Budget
speech, is a little bit harsh. It is certainly fair to say that
he did not do anything to slow the consumer really. About the
tax increases that we are seeing directly on the consumer sector,
we should note (a) they are not happening for a year and (b) most
of it is being given back in the form of tax credits. There are
also many people making the argument, as has been said earlier,
that it is a redistributive Budget so, if anything, it might lead
to an expansion in consumer demand. I think the burden is completely
on the MPC to address this issue and to say whether it is a problem
and whether some issue needs to be taken. I think what is interesting
though, and I think this is a point Tim mentioned earlier, is
you now have both sides of policy making, both the monetary side
and fiscal side, saying to us that consumption is going to slow
very aggressively next year, and most of the policy projections
we see have it returning back towards trend without really saying
how that is going to happen. If you look at the Chancellor's trend
growth forecast he is telling us there are going to be further
rises in employment, further rises in population, and that does
not suggest to me an environment in which the consumer slows on
its own. Of course what we do not know is what level of interest
rates the Treasury is using in their growth projections, but I
do think it still remains out there. Should we be slowing the
consumer and, if so, is it going to have to be monetary policy
and when should that process begin? Of course, we heard the Governor
at the weekend telling us he is not overly concerned about it
at this stage.
(Mr Weale) If you look at the employers' national
insurance contribution in the medium term I think it makes very
little difference whether you collect taxes like that from employers
or employees, in the end they are taxes on labour income and where
you take it out of the pay packet does not matter enormously.
I think in the short-term, in effect, it is rather likely to be
paid out of saving, consumers will carry on, it will either be
paid for out of profit or despite the tax advantages on pension
contributions, that you do not pay national insurance on those,
I do think that for employers who are looking at ways of saving
money it will give added impetus to reducing employers' contributions
and that again means that the tax will be paid out of saving.
This will continue a trend that really we have seen since 1997
that as the Budget has moved into surplus so household saving
has fallen and fallen, and I am not sure that that is the appropriate
thrust that policy should have taken.
(Professor Congdon) Could I make a point here. The
big imbalance in the economy in the last six years now, getting
on for seven years, has been domestic demand rising faster than
output with growth in consumption being the most conspicuous feature
of growth in domestic demand and, associated with that, imports
rising faster than exports. I think it is a fair comment that
this Budget does not really do very much to address those imbalances.
It is true, nevertheless, that it does increase taxes in line
with increase in spending and in that case that is responsible,
but it does not actually attack the imbalances in terms of excess
consumer spending. There is an aspect of the forecast which I
think one might raise eyebrows about and that is the volume of
exports. It is expected to fall by about one and a half to two
per cent this year and then to rise by seven and three-quarters
to eight and a quarter per cent next year. It is true that there
have been swings of that sort between years of poor export growth
and then extremely fast export growth in the past, but typically
these have been after a big exchange rate movement and I cannot
believe this Government really wants the pound to fall heavily
in the next six months to a year. I think that some questions
might be raised about these forecasts for exports and they need
to be seen in the broader context of the Budget not really dealing
with the imbalances in the economy with excess consumer demand.
21. What table are you on?
(Professor Congdon) Page 200. I think it is in one
of the other places in the Budget documents as well.
22. Can I throw in a supplementary there? The
Chancellor said in his statement that he expected world trade
to grow by 8½ per cent in 2003, is that not an important
underlying assumption on export volumes?
(Professor Congdon) Yes, that is a fair comment. It
seems a very high figure to me. There have been figures like that
in the past but it seems a very high figure. I would not get too
alarmed about all this but just review it critically.
23. But you seemed to say that you thought he
was working on an assumption of a devaluation in the exchange
rate, but there is also an assumption about the growth in world
(Professor Congdon) Do not forget, it is not just
the growth in world trade, it is the growth of world trade going
from a minus figure in 2002 to plus 7¾ to 8 in 2003.
(Mr Weale) The picture I have is that these figures
are broadly in line with the squeeze in world trade. The difficulty
arises, or at least the complication, because of the difference
between the annual profile and the monthly profile. World trade
fell sharply between January and December of last year, but the
average figure in 2001 was quite a lot above the average in 2000.
Because of the fall from January to December, even if we have
a modest pick-up during the year, the average in 2002 will be
below the average in 2001. I think that is built into the projection.
A greater worry perhaps is that the most recent data do give a
hint that Britain has started to lose its share of world trade
again. It has been stable for about two years and there is a hint
in the latest figures that maybe we are losing export share again.
24. Can I move on to the European question?
The Chancellor said in his statement that he feels he is well
within the Maastricht criteria for the euro. Does anyone dissent
from that statement? You all think it is right? No dissent from
that statement? He also told us, and I would like your comments
on this, he had written to the Governor of the Bank of England
reasserting the symmetrical inflation target of 2½ per cent.
He then went on to describe it as "a target which is not
only pro-stability but also pro-growth". Would anyone like
to interpret that statement and suggest why he said it and whom
he might be addressing?
(Mr Barr) He is obviously reflecting the symmetrical
nature vis-a-vis some other targets. The Government has made it
very clear for a long time that is why they have this range and
prefer that to the ECB target of 2 per cent or less, which is
an asymmetrical target. That is something which Gordon Brown has
been promoting as a policy issue and benefit, if you like.
25. Do you read much significance into the fact
he has said that?
(Mr Barr) Personally not, no. My own belief is that
in years to come we will see significant reform of the ECB anyway
ahead of enlargement, so I would not be surprised if the ECB changed
its target to a more symmetrical one.
26. But does it not suggest to you that the
Chancellor might be minded against sterling entry into the euro
on the current stance of the ECB, and that a change in that stance
which you are forecasting would be a pre-condition in his mind
to ticking the box for entry? Is that what you are saying?
(Mr Barr) No, it is not what I am saying. I am saying
why I think he has said that. He is reaffirming his inflation
target, reaffirming the confidence that the financial system has
in that target and reaffirming the success, to be fair, we have
seen in meeting the inflation target. I think to look deeper for
hidden EMU messages is a mistake. I am not sure that is the signal
he is trying to give.
27. What leads you to think the ECB will reform?
(Mr Barr) I think we will have to see ECB reform ahead
of things like enlargement. The ECB for its first three years
of operation I think was reasonably insecure, reasonably uncertain,
needed to bed down, needed to be seen to be trusted by the financial
markets, and I think after a rather shaky start in terms of perceptions,
in terms of transparency, it has actually come on a long way in
recent years. I think as we go forward we will seeand I
am not talking about next year or the year afterwards but five
or ten years aheadthe ECB, as it expands, as it takes on
more countries, potentially the UK, it will be much more open
to reform in the way it conducts monetary policy, whether that
involves changing the target, whether or not it involves publishing
minutes or whatever. I am very optimistic we will see that gradual
evolution of the European Central Bank.
28. Does anybody else have a comment on that?
Does anyone violently disagree?
(Professor Congdon) I am not sure what the basis for
these statements is, forgive me. I do not see any signs of any
radical change in the way the ECB currently manages its policy
(Mr Barr) We have seen already some significant changes,
for example, the movement away from having a meeting every two
weeks to having a meeting only once a month, and having a press
conference following rate moves. We have seen an increase in transparency
in the ECB. Sitting in the markets, as we both do, I personally
feel we have seen an easier-to-understand Central Bank than we
did, say, in 2000. Whether that continues or not and whether we
see further evolution is of course important.
29. But Professor Congdon does not see any of
(Professor Congdon) It is not very obvious to me.
As they get more members there will be problems about the composition
of the governing council. For example, on the question of the
minutes and the publication of the voting, they have explained
very well why they will not do this, because there are different
nations involved and it is affecting the amour propre of
the different nations. It is not a matter of giving some experts
a technical task, as we have in Britain, and you can publish the
debate and publish the discussion and have the voting records.
The problem with the ECB is that each national governor of the
Central Bank could be taken as representing his constituency and
they do not want the political debate out in the open. They are
very clear, it is understandable, and I do not see any sign of
30. What about the symmetrical versus the asymmetrical
(Professor Congdon) It is pretty clear that the ECB
with 2 per cent or less do not mean a minus figure, so in that
sense it is zero to 2, so 1 per cent is in the middle. This is
31. No, it is not, because that is much more
deflationary than having 2½ per cent as the central target.
(Professor Congdon) It is not, not really. There is
no long-run trade-off between employment and inflation in this
policy area. In this country we had 27 per cent inflation in 1975
and we got it down to 2½ and unemployment is actually lower
now Saying that going from 2½ to 1 is deflationary is nonsense.
(Mr Barr) Can I make two quick points? As regards
the changing of the ECB, to all intents and purposes they have
disregarded their monetary pillar as a policy issue. They may
pay lip service to it but it is very much a targeting inflation
issue. They talk about distortions in the monetary figures. I
think most people in the markets now disregard the monetary pillar
to all intents and purposes. The other issue in terms of changing
the target, whether it makes a difference or not, it is worth
bearing in mind that our 2½ per cent RPIX inflation target
does equate, give or take, to the 2 per cent on the harmonised
target. It is a small point but it does narrow the gap between
the two, if you like.
(Mr Weale) Could I make two points? First of all,
to agree with Professor Congdon, that if the European Central
Bank had a target of 1 with a 1 per cent band either way, we would
then say it was a symmetrical target. If the Chancellor believes
a 2½ per cent target is pro-growth whereas a 1 per cent target
is not, then that raises the obvious question, would a 3½
per cent target be more pro-growth than a 4 per cent. In other
words, where do you stop. I think if he does take the view there
is a trade-off between the inflation target and the growth rate,
he should be able to explain how he has calculated that 2½
is the optimal target. If he does not think that there is, it
is difficult to see why we should be worse off moving to a 1 per
cent target, or an arrangement of having inflation between 0 and
2 per cent.
32. You assume that is what he means when he
says he is pro stability and pro growth?
(Mr Weale) Then there is the question would 3½
per cent be more pro growth.
33. Yes, but it is less pro stability.
(Mr Weale) Not necessarily with a 1 per cent band
Chairman: This is all fascinating but
Mr Plaskitt: I sense you have had enough!
34. One question while we are on the ECB which
will relate to Bank of England policy. Most people argue that
the long-run survivability of the ECB structure will depend on
the extent to which there is growing flexibility for countries
to make labour markets more flexible in the euro areawhether
or not one agrees with that view, that is a commonly-held viewso
that the area can adjust more easily should there be an asymmetrical
shock. Do you think the ECB should engage more actively in the
debate about the kind of structural reforms which are required
to the economies of the participating countries?
(Mr Weale) I suppose looking at the strikes in Italy
recently over the reform of labour markets and all the changes
in the labour market lawwhether "reform" is the
right word, I am not sureif I were an Italian politician,
either for reforms or against them, I suppose I am not sure my
job would be helped if there were noises from Frankfurt saying
how the Italian labour law ought to be changed. I think you could
apply the same argument to pronouncements from Brussels, but at
least pronouncements from Brussels are from people who have connections
with elected governments, whereas the ECB once appointed does
not, so I should have thought a prudent governor would keep quiet
on this issue.
(Professor Congdon) I really do not see it as the
Central Bank's job to comment on things like relations between
governments and trade unions or on trade union law. These are
very political subjects, very much subjects for the time being
for national preferences and national legal systems and cultures,
and it is not the job of the European Central Bank to make comments
on these things. It does in fact make quite a lot of comment on
supply side issues in very broad terms in its Monthly Bulletin.
35. I only ask that question because the Bundesbank
did comment very actively at the time of the unification of Germany
on a whole range of structural reform questions and Alan Greenspan,
unlike his predecessor, also has engaged heavily in this type
of debate. Neither the ECB nor the Bank of England feel they should
participate. Of course the point which has been made against it
is a highly political one, but is it not the case that what we
want perhaps from independent banks is an ability to express a
more pure economic view on these issues?
(Professor Congdon) Let me put it like this, if you
are the Governor of the Bank of England who has just had independence,
and that has obviously given the Bank a bigger respect, would
you then start to criticise the way in which the British Government
relates to the TUC? It does not seem to me this is the job of
a Central Bank Governor. Sure, a Central Bank might be involved
in things like banking supervision, pension arrangements, all
these have structural implications, but there are limits to what
a Central Bank should be commenting on.
Mr Tyrie: You have taken it to an extreme
by talking about the Government and the trade unions. You have
provided a set of examples where the Bank is extremely cautious
about commenting at the moment and I am asking about where it
might have a role.
36. We are actually engaged in a separate investigation
into Europe and we are seeing Mr Duisenberg amongst others and
I think we will ask him those questions and report back to you.
Looking at it politically, can I ask you a political question,
does this Budget make it easier to have euro entry or not? Could
you give us your economist views on that in very simple terms?
Does it make it easier or harder?
(Mr Weale) I think it probably makes it slightly harder.
In the short-term I agree with the view that on its own it is
not doing very much to restore it, to give a better balance to
the economy. In the long-term, the Budget is undoubtedly expansionary.
Both of these issues make it harder for the exchange rate to move
to a level that many people would feel more comfortable with for
(Mr Emmerson) I have no view whether it makes it easier
to join the euro, though if we wanted to strictly adhere to a
balanced budget rule, because the Chancellor is increasing borrowing
and has reduced the proportion of the finances slightly, it makes
strict adherence to the balanced budget rule rather than the golden
(Mr Barr) If we are or are not going to join EMU in
the foreseeable future, the 2002 Budget will not be seen as any
contributing factor for or against. If anything, if you want to
be politically clever you could argue, by not raising household
taxes it might make it slightly easier to win a referendum next
(Professor Congdon) It is difficult to criticise the
fiscal rules that the Government has got in the European context,
because they are plainly consistent with the Maastricht criteriathe
budget deficit is less than 3 per cent of GDP and the debt is
less than 60 per cent of GDP. Just a couple of points. One is
the imbalances have not really been dealt with. I have been saying
this for years but one would expect sooner or later the pound
will have to fall against the euro, maybe it will happen very
quickly, and to some extent the fact that the consumer boom has
not been restrained makes that sterling adjustment more likely.
So there is that question. I am also a little bit worried about
this on the excise duty front. I think it is fair comment for
two years now he has been holding back excise duty increases with
a view to helping the inflation numbers. This is a little bit
artificial and it does raise questions about whether in the medium
term inflation will be in line with the European average as it
needs to be in line.
37. Can I move on somewhat to something else
which you raised in your opening remarks, Professor Congdon, where
you talked about whether it was possible for the housing market
to sustain these low interest rates. Do you think that unless
some action is taken, and I note from your briefing notes you
have often been on the hawkish side, we could be on the edge of
another housing boom and bust?
(Professor Congdon) The normal behaviour of house
prices is that they rise in line with earnings, they rise about
two per cent faster than retail prices. So the increase in house
prices that is consistent with the two and a half per cent inflation
target is four to five per cent a year roughly. In the last year,
the Nationwide House Price Index has gone up by about 14 per cent
and Halifax by about 16 per cent, so effectively house price is
rising by about one per cent a month and, by the way, that continues,
there is no sign it is coming to an end. There are two ways that
the adjustment can take place. One is that the house price inflation
comes back towards the four or five per cent figure, maybe even
house prices may fall for a bit. The other way is that the growth
of earnings and, indeed, inflation generally takes off. One or
the other of these things must happen because we know what the
long run behaviour is. I am worried that the consumer boom is
too strong and that part of the adjustment may be through inflation
increasing towards three or four per cent, not immediately but
perhaps in the next two or three years. I think that is something
to worry about, yes.
38. Have any of the others got comments they
want to make?
(Mr Barr) One thing I will say about house prices
is whether what we are seeing is a reaction to permanently lower
expectations of interest rates whereby because people, if you
like, price in more affordability in terms of a repayment mortgage
in coming years, the level of house prices rises. At some point
that should, as Tim mentioned, level off, the question is where
is that point, have we reached it yet? On some calculations you
can argue prices have another 20 to 30 per cent to go before we
would reach that higher level, if you believe in that kind of
analysis, personally I do. There has to be a risk that things
do overshoot in the short term because consumers are unlikely
to retrench of their own accord. There are all sorts of strange
things going on beneath the surface. For example, it is very well
known and it is very much highlighted in the press that people
are just borrowing and borrowing and borrowing and things like
house lendings are at very, very high levels but what is sometimes
not reported is the fact that on the asset side of the household
accounts they are putting a lot in their bank accounts also. We
are seeing the fastest rise in bank deposits since 1997 when they
had the demutualisation. Perhaps that does represent delayed consumption,
that is going to come down the line, or there could be many other
reasons why we are seeing these portfolio adjustments. Last year,
for example, the household sector was not a net borrower, it was
in an overall balance sheet context a very, very small net lender.
There are also some strange beneath the surface actions going
on, it is not just about one side of the balance sheet that is
rallying significantly, I think there are more complicated issues
going on. My own personal belief is that the consumer will not
slow of its own accord. We felt it would slow because of rising
unemployment but I am not now a believer that is going to be the
39. I think for the last ten minutes or so we
will concentrate on the health issue and the aggregate taxation
and expenditure. The Chancellor, as we know, announced plans to
raise health spending by 7.4 per cent per annum to 2007-08, but
the Treasury have made tax projections to 2006-07. Assuming other
spending plans remain unchanged, do you expect that taxes will
have to increase in the future to meet the NHS commitment in 2007-08?
(Mr Weale) I think the answer is yes, that the situation
generated in the Budget to 2006-07 is, as I said at the beginning,
one which I think will lead to a less satisfactory budgetary situation
and therefore I think probably requires higher taxes. Any faster
growth in spending or growth in spending ahead of national income
beyond that is bound to require further increases in taxes.
(Mr Emmerson) The Chancellor's annual published Spending
Plan is really up to 2005-06. Between there and 2007-08 he wants
to increase NHS spending by 0.7 per cent of GDP. If we want to
spend more on any one thing out of financial income that means
we have to spend less elsewhere. That means either he will have
to spend less on other public services or he will have to increase
borrowing or he will have to increase taxes. That does not mean
he will have to stand up and announce more increases in national
insurance contributions, for example, it might be that other errors
of public spending can grow less quickly or that the tax system
might deliver him the money, the areas that far out are very big,
but I would add that the spending plans for, say, 2006-07 and
2007-08 are yet to be set and will depend on how far the Government
wants to continue progress in delivering world class public services
and doing things like reducing child poverty, which we know are
likely to require real increases in benefits for families with