Select Committee on Treasury Minutes of Evidence

Examination of Witness (Questions 20-39)


24 MAY 2006

  Q20  Mr Fallon: You said the Bank was picking up the cost of your flights; are they also picking up the cost of your hotels when you are here?

  Professor Blanchflower: They are, but that is taxable and obviously I am paying tax on that.

  Q21  Mr Fallon: I understand that. My question is, if you are not a home-owner here and you are not renting a property here, is it right that you are setting mortgage rates, effectively, for my constituents, not bearing those housing costs yourself?

  Professor Blanchflower: I think the question the Chairman raised was that the nature of this appointment has to do with competence and independence and I hope to be able to persuade you that I have a strong background, am highly competent in the fields in which I work and that I am independent. I think your constituents would want to have the best person, if you like, someone capable, to do that job.

  Q22  Mr Fallon: Obviously you have followed interest rate decisions here recently, from the MPC; there was a three-way split last time. Which way would you have voted?

  Professor Blanchflower: Actually I attended the pre-MPC for that meeting. I heard some of the discussions. I think the way that I would say it is, to make these decisions you need to look down the microscope. I have not done that, I was there for only two hours, for the first meeting, so at this point I do not think I could say where I would go. I am a very strong data reader and I think it is a judgment call, so I think you need to look at the data, and I saw some of it, and I think you need to hear the discussion from other members. I heard none of those so I am going to keep an open mind on it. You could see arguments in all directions, I could say that, but I think it would be foolish of me to say what I would have done, as I had not heard the discussion.

  Q23  Mr Fallon: Fair enough, but the current debate seems to be about the size of the output gap, seems to be the argument. What is your view of the size of the current output gap in the United Kingdom?

  Professor Blanchflower: I guess there is one way to think of things, as an output gap; as a labour economist, you might think an alternative is the unemployment gap. I tend to think more like that, they sit reasonably together. There does not seem to be large evidence that there are substantial gaps. My view is that at the moment there are some series which point in a direction of change. For an empirical person like me, it is really the question is this cycle or is this trend, and I think the answer is it is too early to tell, I have not had the full discussion with the Bank. There are some worrying things going on, but a blip or a couple of data points do not make a trend, and the question is, is it going to. Obviously, some of the issues have to do with oil prices and we are going to have to see how this feeds through, but at the moment I think we have to wait and see, with the data; that is my position.

  Q24  Mr Fallon: You are replacing Professor Nickell, who was also a labour market specialist, and it was his belief that the rise in unemployment had created the extra slack which would dampen down inflation. Do you agree with that?

  Professor Blanchflower: At this moment, I am not persuaded one way or the other. I know Steve has taken that position. Steve is very eminent. I have spent 25 years as a colleague of his and heard his discussions. I am going to wait and see, at this moment. I think, again, there are still some more arguments that I need to hear. There is some evidence in that direction but there is counter evidence as well; so I think you would say, yes, there is some evidence of spare capacity, but David Walton has made the point that there are other pieces of evidence too. I think it is a time really to be cautious, look at the data, be briefed by the Bank and try to make an independent decision, and not prejudge the question.

  Q25  Mr Fallon: Fair enough; but your position at the moment, therefore, is that you are not convinced there is sufficient extra slack in the economy to dampen down inflation. Would that be a summary?

  Professor Blanchflower: No, I did not say that. I said that there are moves in a number of directions. I do not think I have been briefed sufficiently to know the right response to that. The trends have been flat and expectations seem to have been nice and constant, but now there are some fluctuations going on, we need to understand the source of them and quite what is going on. I do not understand that yet, but I think I am going to have to and I want to.

  Q26  Peter Viggers: When the concept of a single European currency was first mooted, later known as the euro, what was your view of the concept and how has your view evolved, if it has?

  Professor Blanchflower: It is a very good question. Obviously, there was a strong debate about whether one should join the euro. I was not really party to that debate. I am not an expert on those kinds of areas. I do not have a strong view really. Maybe I should have had one. I am not an expert there; really I have not had a strong view about it, I am afraid.

  Q27  Peter Viggers: It is one of the biggest single decisions in the field of economic activity.

  Professor Blanchflower: My expertise has been broad-ranging; it has not been in that area, I am afraid.

  Q28  Peter Viggers: How do you view the differences in interest rates between the UK, the European Central Bank, the dollar, the yen; how does the UK fit into the international pattern of interest rates, how much do they interrelate?

  Professor Blanchflower: Obviously, living in America, I have been watching the changes in interest rates. First of all, I experienced for quite a while quite a significant difference between the interest rates in the US and those in the UK. Obviously I am intrigued and interested in how these two things impact together. The piece of evidence that you see, I think, in the US has been very strong—evidence of significant changes and also, at the same time, a change in the Chairman of the Fed—so I think you have seen some degree of instability in the markets and some concern about what is going on, more instability in the US than you see in the UK. How those two things impact together obviously is complicated, but I think we have seen quite a lot of instability in world markets, partly because of what is happening in the US. I get the sense, from living in the US, that the markets are less clear about what the Fed is going to do. The latest inflation numbers in the last few days seem a little worrying and it appears that interest rates now are going to rise in the US, but it appeared perhaps a month or so ago that they were not going to. The question of how the two sets of things interact together is an open question which I am going to think more about.

  Q29  Peter Viggers: Which are the areas where you sense the greatest stress? You have mentioned that   the United States possibly has market-led difficulties; would you identify the United States economy as being one of the greatest worry areas for you?

  Professor Blanchflower: Certainly the current account deficit in the US of 7%, or so, appears to be unsustainable. There have been concerns obviously about the budget deficits that are being run, and certainly the latest numbers on changes in the CPI seem to be particularly destabilising. My experience is that, though obviously there are other issues in the world, but it seems to me that what was going on in the US in the last three months or so is worrying, in some ways.

  Q30  Peter Viggers: What are the factors which concern you most about stability in the UK economy?

  Professor Blanchflower: The best evidence we have had so far is that this mechanism has worked very well, this great stability that has gone on, certainly since 2000. I think the question is how well the economy and the mechanisms are set up to sustain large shocks which potentially will come. We have seen one oil shock, and it seems to have sustained itself pretty well; the question is how well are the mechanisms set up to sustain shocks. Sitting in the   US, seeing hurricanes Katrina and Rita, unpredictable, uncertain events, these things are going to happen, and events like this are going to happen on my watch. The stuff I want to think about, what potential shocks might come and what we might do about them, I am mindful of that and have started to think about that already.

  Q31  Angela Eagle: Your particular expertise is in the labour market and you say in your application that the labour market here is historically tight. Do you want to say just a bit about how you have come to that view?

  Professor Blanchflower: I would say, probably, I am an applied economist with a specialism in labour markets, because I have written on various areas, you might think on the edges of labour economics but that is really my particular expertise. Unemployment has actually trended down significantly, I think really since about the mid nineties we have seen a strong trend down. Ex ante I do not think we would have expected that. Ex post I think we could say probably it has been driven by changes in productivity; but ex ante I do not think really we would have known that was going to come. I think we have seen permanent changes in the equilibrium unemployment levels and they have remained in the UK, unlike most other places, they appear to have remained, unemployment remains relatively constant since 2000 and inflation has remained relatively constant. It does not look to me that we are very far away from the NAIRU or the equilibrium rate.

  Q32  Angela Eagle: That has actually gone down over the years, that we have a fuller level of involvement in the labour market?

  Professor Blanchflower: Yes, I think that is right.

  Q33  Angela Eagle: Was that supply side changes?

  Professor Blanchflower: My judgment is that it has to do with changes in productivity, potentially brought by technology. In many senses, it is hard, until it is finished, actually to realise that has happened. I see it being quite close to the equilibrium rate. When a series runs along steady for five years and remains relatively flat and pressures do not seem to be coming from it, it suggests you are pretty close to the equilibrium rate. There are lots of ways of calculating it, but given that they all come out pretty much with the same answer then you have a flat trend.

  Q34  Angela Eagle: Professor Blanchflower, you have done some interesting work on the wage curve with Andrew Oswald, which comes up with a conclusion which is opposite to what the free market, neo-classical approach actually would suggest. It is very intriguing that the higher the wages the lower the local unemployment and the lower the wages the higher the local unemployment. That is an interesting finding, an empirical finding that you have done, with good, hard, microeconomic analysis, across 12 different countries. What implications do you think that has for approaches to wages policy here, and particularly can you say something in terms of skills and upskilling?

  Professor Blanchflower: There are lots of parts to the question; let me try to take them through, and I will try not to forget this skill part. The work we have done on the wage curve, which has gone back now for nearly 15 years, started out in the UK, went eventually to the US and we have done work on a dozen or so countries. The wage curve now appears to exist in over 40 countries and, what is interesting, there is not a single country, where it has been tested, that it does not appear. Some people think of it as a piece of evidence in search of an explanation; its constancy is something that we have remarked on and it does not seem to be reasonably explainable by market competitive models. It has implications I   think for the transmission mechanism from unemployment to wage inflation and we argue that some of the transmission mechanisms are less than other people think; so this is obviously testable. In some sense, our specifications say a tightening of the labour market feeds through less to inflation than perhaps other people in the past had thought. This is obviously directly relevant to the kinds of things that happen here; some of it we do not understand but I am working on that.

  Q35  Angela Eagle: It is interesting, because the caricature of the American labour market is that because there is virtually no regulation there is mass creation of jobs at very low wages. The wage curve would tend to suggest, at least in one segment of the labour market, that is not true?

  Professor Blanchflower: The surprise, first of all, that I would have predicted when I started this work, because we started out to get a wage flexibility index, was that you would get something very different in the US than you get in the UK; you do not. However, in the disaggregated sense, you do get some differences. I think the implications of it are hard to draw, but this is ongoing work, I think important work, that we have documented. It does appear that the wage curve is that there is more flexibility, more responses to wages for least-skilled workers than there are for higher-skilled workers. In some sense, our idea is to try to think about wage flexibility of countries, wage flexibility of areas, but in some sense this is filling in the pieces of how the labour market works. We do not have the answers but many people think this is a significant step forward.

  Q36  Angela Eagle: And the implications for skills?

  Professor Blanchflower: I think, potentially, there are.

  Chairman: Forgive me, but we are moving on from that.

  Q37  Mr Todd: To what extent does migration play a part in this analysis as well? You will be aware that the UK has, by European standards, a relatively free market in labour, with migration relatively easy to achieve, and of course you work in a country where, to a greater or lesser extent, there is a similar approach. To what extent does that affect the inflationary expectations and wage patterns?

  Professor Blanchflower: It is a very good question, in fact, exactly something that I am working on at the moment. Some of the issues that we are dealing with obviously have to do with flexibility of labour markets, the interaction between migration, housing markets and labour markets, so we are working on exactly these kinds of pressures, and particularly to what extent do the housing markets make labour markets less flexible. Also we are working on the mobility of workers, how the mobility of workers impacts on how an economy works, on wage inflation, and so on. Part of that has to do with migration of workers within a country, because that is particularly relevant in the US, people argue that it has to do with, much of the benefit of the US is, if you like, migration across areas, and part of the work has to do with migration into a country from abroad, so I am actually working on the implications of migration into the UK. Part of the work that we have done as well has to do with immigrants into the US and particularly the movement of illegal immigrants into the US. It sounds a strange connection but a lot of the work I have done on   Chicago relates to immigrants and illegal immigrants, because in the early years the immigrants came into the US and went to California and to Arizona and to New Mexico, but in recent times we have seen them spreading out. Since 1990, a million Mexicans arrived in Chicago, so some of the work that I have been doing there relates to how migrants come in, the mobility of labour, how that impacts on wage pressures, and so on. I have been working on these; these are very big questions but the Bank is interested in them and I have been working on them both in the UK and in the US and it is a huge area.

  Q38  Mr Todd: Our questioning of both MPC members and Bank officials revealed a perhaps surprising level of ignorance about the impacts of inward migration into the UK and the UK economy as a whole, and that included obviously `on demand' patterns because that is a function of "Well, these people arrive and they don't just provide labour they  buy things too." You have a substantial contribution to make in that particular area perhaps?

  Professor Blanchflower: I think I do, actually. Part of it is to do with the work that I have been doing in some of the places in the United States, as I say, particularly in Chicago. I am aware of and have been involved in a lot in the discussions about the impact of immigration into the US, things like the Mariel boat lift, what did that do to particular labour markets. Actually I have been well-versed in those kinds of issues in the US and I am starting to work now, I have talked to the Governor, I want to work on those issues here and that is one of the things I am going to work on.

  Q39  Mr Todd: You did touch on, in the previous line of questioning, to Angela, the issue of skills but then did not actually return to it, the importance of that dimension within the labour markets and the meaning of that in terms of inflationary impacts and wage expectations. What research have you done in that area?

  Professor Blanchflower: The area of skills shortage is an important one. I think it goes back to some of the earlier questions about regional considerations. If 250,000 migrants went to a particular place where there was a shortage of labour, that was going to have a rather different impact than if they went to a place where there were fewer shortages. I think the question of how these migrants have moved, how they impact particular groups and how the labour market impacts different groups is the benefit of someone like me; that is what I do. My expertise at the micro level has to do with, instead of thinking about the aggregate issues, going to the lower level and thinking about skilled groups and less-skilled groups.

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