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UNCORRECTED TRANSCRIPT OF ORAL EVIDENCE To be published as HC 299-ii House of COMMONS MINUTES OF EVIDENCE TAKEN BEFORE TREASURY COMMITTEE
OF THE BANK OF ENGLAND: TEN YEARS ON
Tuesday 20 March 2007 RT HON LORD GEORGE MS M BELL, CBE, DR D JULIUS, CBE, DR S WADHWANI, CBE and PROFESSOR C GOODHART, CBE Evidence heard in Public Questions 98 - 176
USE OF THE TRANSCRIPT
Oral Evidence Taken before the Treasury Committee on Tuesday 20 March 2007 Members present John McFall, in the Chair Mr Colin Breed Mr David Gauke Ms Sally Keeble Mr Andrew Love Mr Brooks Newmark Mr Mark Todd ________________ Witness: Rt Hon Lord George, a Member of the House of Lords, former Governor of the Bank of England, gave evidence. Q98 Chairman: Lord George, welcome to our inquiry into the Monetary Policy Committee of the Bank of England 10 years on. We are privileged that you have come along this morning since you were very much part of that. We would like to look at the next 10 years and take the lessons from the previous 10 years. I start with 1997. How much of a watershed was the establishment of the MPC? Lord George: It is a great pleasure to be here. I always enjoyed coming before the Treasury Committee. How much of a watershed was it? I saw it very much as the culmination, not necessarily the end point, of changes that had been happening in the approach to the management of the UK economy over very many years. On the supply side we had a shift from a great deal of central control where people told the public at large what it could and could not do. My early years at the bank were involved with exchange and credit controls, rationing of access to capital markets and that kind of thing, but in the wider economy one had prices and incomes policies, public ownership of large parts of productive industry, powerful trade unions that knew they could not lose their jobs because the owner could not go bust, incredible rates of income tax which reached 83% at one time on earned income - it was even more on unearned income - and gradually over time on the supply side there was a movement towards a much more market-based economy. That is important because it is the supply side which determines the rate of growth, level of employment and all the good things in life that we can hope to sustain. I had very little to do with the Bank of England which was very much involved in the demand management side of the economy. As to demand management, equally we saw fundamental changes. We had lived with boom and bust but policy aggravated rather than mitigated that cycle. Fiscal and monetary policy operated together without any real distinction. When the economy was weakening the levers were pushed forward until inflation took off and the balance of payments became a problem. Then both levers were pulled back in conjunction. One had a boom and bust cycle. It was worse than that because it was explosive. Every peak of inflation was higher than the previous one and each trough of unemployment was lower than the previous one. We were really looking over a precipice. On the demand side we learned from the experience that we could not go on down that road. Government identified that fiscal policy was quite a cumbersome instrument to control demand certainly in the short term, and that opened the way to a specific role for monetary policy. We moved gradually not just to recognition of the role of the different elements of demand management but that fiscal policy needed to focus on the medium to longer term and the level of debt in relation to income - it was not a short-term instrument - and that in monetary policy the aim could not be to trade off growth versus inflation in the short run. The mantra of central banks everywhere these days is that stability is a necessary condition of sustainable growth. The target was to keep aggregate demand growing approximately in line with the underlying supply capacity of the economy to meet that demand. I am sorry that you have started me off. As an old man who has retired I reflect on this a great deal. What was terribly important was that they all came together across a broad part of the political spectrum. There was common political and, I think, public support for these directions which happened gradually over time. I believe that the establishment of the MPC and the devolution of operational control over monetary policy to that committee must be seen in that broader context. If all those other things had not happened it could have been a disaster. One would have had the central bank in public conflict with government every five minutes, but it took place in the overall context where it became a technical job to manage monetary policy to keep demand growing in line with supply. That was epitomised in the symmetrical inflation target which had been adopted years before. That target was adopted in 1992, five years before the MPC came into effect in 1997. Q99 Chairman: I must ask this question for the public record. A number of experts have written in to say that the success of the MPC over the past 10 years has been due more to luck than judgment. Lord George: I have heard that. Frankly, I do not care too much whether it was luck or judgment. The great thing has been the result. Surprisingly, in this Committee I was often called an inflation nut as if inflation was the only thing about which I cared. What I found really satisfying and encouraging was the increase in employment to an all-time high, and it is still there. There has been a steady decline in unemployment from double digits and very low rates of unemployment compared with most of the rest of the industrial world and certainly Europe. I do not mind whether people believe that is luck or judgment; it is the outcome that is important. I believe that we had tremendously good luck in that all these things came together at a political level which meant that there was a broadly accepted clear understanding of what the bank and the Government were trying to do. That was certainly fortuitous. I really do not believe it could have been done by just focusing on one little bit of the big picture. On the other side, at the beginning of the MPC we had the Asian crisis which spread around the world and recession in the industrial world. We narrowly avoided it, but most of the rest of the industrial world went into recession at the beginning of the current decade. It was not pure luck. There were quite difficult circumstances to deal with, as there always are. Indeed, we had to take action that on the whole we would have preferred not to, for example stimulating consumer demand because all the other elements of demand had fallen away. We were very conscious of the fact that that could give rise to problems in future. We tried very hard not to do more than we felt we needed to do in order to keep within the inflation target limits, but we knew that later on it would cause problems, which are still with us. Q100 Chairman: Not to mention long-term capital management and the Russian defaults? Lord George: Yes. I put those in the category of the Asian crisis. Q101 Chairman: The appointments process has been described by Stephen Nickell as opaque. Many others have made the same point. Do you think it is necessary to have such secrecy surrounding the appointment process? From your point of view as governor at that time, how did the selection process work? Did you feel fully informed? Would you have liked more influence in the selection of members? Lord George: I was certainly never shut out of it. The bank suggested to the Treasury a list of potential outside appointees. We would discuss it with Treasury officials. An appointment with which I was not comfortable was never made. I was given the opportunity to say that I could not stand a particular bloke or that I thought he was hopeless. I never felt particularly uncomfortable with the appointments process. There were occasions when appointments were made pretty much at the last minute and I believe that as much as anything else that was because the Chancellor had an awful lot of other things to do. It might not have been perfect, but I did not think there was anything fundamentally wrong with it. Q102 Chairman: In terms of the Treasury Committee itself, what role do you think it could have? Could it have an enhanced role? Could it be given the power of veto over appointments? Could there be more prior public discussion as to who should sit on the MPC? Lord George: What you are talking about is the appointment of technicians. One needs people who know about the technical competence of the potential pool of people coming onto the MPC. You will judge whether you believe that the Treasury Committee has that kind of competence. In principle I am all in favour of public debate, but we are talking about something that is essentially technical rather than just democratic in a broader way. I do not know that public debate will be particularly helpful. It could discourage some people from participating because there is newspaper discussion saying this chap is better than that chap or this chap is no good. I do not know that that is terribly helpful in the kind of process with which we are concerned. Q103 Chairman: The changes would be significant and the implications quite profound as a result? Lord George: Absolutely. The last thing we want is to introduce a political element into that decision. Q104 Chairman: You have been coming to the Treasury Select Committee for a number of years and putting forward the views of the MPC. How important are meetings such as this in terms of communicating with Parliament and the public in particular? Lord George: Without flattering, I think they are terribly important. The opportunity for us to explain to the Treasury Committee what we were doing, and for individual MPC members to explain their thinking, was a very positive dimension. To have the technical job that the MPC is doing understood is terrific. When I was at the bank - I imagine it continues today - we had regular meetings with groups of parliamentarians. That occurred probably four or five times a year. Those meetings at the bank were precisely in order to explain to Members of Parliament how the bank worked and open ourselves to questions from parliamentarians in order to try to understand it. We do it publicly through the inflation reports, publication of the minutes and so on, but that is a terrifically important process which creates understanding, and I believe that on the whole it has proceeded fairly well; and it has helped to strengthen the consensus that I described at the beginning. If people feel they can understand it and it seems to be working reasonably well that is helpful. Q105 Mr Todd: Do you think that inflation expectations have been anchored by the actions of the MPC either in the more technical financial community or the public at large? Lord George: I think that "anchored" is a strong word, but there is an understanding - this has been happening to varying degrees from different starting points globally, not just in the UK - that people who manage economic policy now realise that the boom-and-bust approach is a dead end and very damaging. I believe that that has been accepted by the public at large. It implies that they do not expect to see inflation reach 27% in a single year in the United Kingdom. I cannot believe that that was ever true but it was. In that sense inflationary expectations are much lower because people really understand that what government and the bank are trying to do in managing the economy is to produce greater stability. In that sense I agree. As to whether it is precisely 3%, 21/2% or 2%, I do not believe that one will ever succeed in anchoring that, but it is certainly down at that level rather than in double digits. Q106 Mr Todd: Would it surprise you that Citigroup carried out a public opinion survey which showed widespread ignorance of the precise target, or even who set it, whether it had changed recently and so on? That reinforces your point that in broad terms people understand it, but in precise terms they do not. Do you believe that there is more to be done to educate the public on the various components of inflation, for example linking it to concepts of asset price inflation with which people are often quite familiar in terms of the values of their properties? Is there more to be done to explain what these things are and how they relate to, say, one's next wage demand? Lord George: As I hope I made clear, I believe that public explanation is absolutely critical and it is an ongoing process. I do not think we will ever get to a situation where everyone in the country knows about the MPC and the details of the target and all that. It is the broader understanding that we have to keep reinforcing. Q107 Mr Todd: You are aware of the debate about whether the precise inflation measures being used are the right ones and whether they include the correct components and so on. Therefore, there is a public dimension to that process. Lord George: I believe that whilst they are important questions they are second-order compared with the overall understanding of the way macro-economic management is proceeding in a broad sense. The fact is that any technical subject is not widely understood. There is great debate about climate change. If one carried out a survey to find out how many members of the public knew whether it was due to solar energy or was manmade one would find a complete void. I am very keen that there should be greater understanding of that, but the mass of the population will never understand the technical details. I believe that the same is true of macro-economic policy. Q108 Mr Todd: Should one be satisfied that if asked people would think that inflation was around 21/2% or 3% and would not rise dramatically above that level? Lord George: Yes - and that interest rates would be 5% or, at the higher points, at 6% or even 7%, or that at the low point it would be 3% or 4%. I do not believe that the mass of the population will ever understand those things, but I believe that the broad direction, which is the important matter, is fairly well understood. Q109 Mr Todd: The banks sponsored a competition among schools which focused on the inflation target and the various levels that could be applied to achieve it. Do you think that more could be done there? Lord George: I believe that that was a fantastic idea on the part of Mervyn King. That focuses on economics teachers and students of economics at the school level. Part of what they are doing is to study the technicalities of this kind of thing. Q110 Mr Todd: Perhaps there should be more emphasis on lower level awareness? Lord George: It is an ongoing task and we must keep on doing it. I do not believe that there are particular initiatives, but perhaps I do not have the imagination of others. Q111 Mr Todd: It has been suggested from time to time that the MPC should have responsibility for bursting asset bubbles. Do you think it desirable that its brief should enable it to deal with house price inflation and specifically adopt measures to assist with that? I merely pose that question because it is put to us from time to time. Lord George: For years I used to quote the Chinese proverb "man try to juggle with too many balls end up in heap on floor". I believe that that is extremely relevant to that question. The inflation target is really a form, but what it is talking about is aggregate demand in relation to the potential underlying supply capacity of the economy. The inflation target is really the barometer of success or failure in achieving that. Asset prices can be driven by all manner of outside considerations. It is tremendously important that the Monetary Policy Committee monitors, follows and studies what is happening to different asset prices, financial assets, housing and so on, as it does. Those subjects are studied extremely carefully within the bank and are discussed by the MPC. But if one decided to set a target for house prices and equity prices one would end up in "heap on floor". One just cannot focus on more than one objective. To focus on inflation is not a narrow objective; that is the form of it, but it has broader significance than that. Q112 Ms Keeble: Do you believe that the CPI is still a credible target for inflation in the UK or should it be modified? Lord George: Do not misunderstand me when I say I believe that to be a second-order question. I was not particularly keen to modify it from the RPIX which we had for some considerable time. There were pros and cons in that respect given that it was going to be 2% rather than 21/2% which helped possibly to reduce inflationary expectations. I would be fairly reluctant to jump about with it because inevitably people will say that the goal posts are being changed and it is being done for this or that particular reason. I honestly do not believe that it makes a fundamental difference. A 2% target for CPI is a good benchmark for the kind of broad balance and stability that is the big picture here. Q113 Ms Keeble: But do you not think there is an issue about the credibility of the MPC? You say that the general public will never understand it, but I think they do. You said that you were an inflation nut. Inflation is a matter of public debate now whereas it was not for a long time. I think people understand the difference between inflation as they experience it and inflation as the MPC defines it because of the impact of house prices. Do you believe it would be helpful if there was a slightly modified target, or do you think it does not matter if the MPC has a target that is not really credible to the general public? Lord George: I would question the statement that it is not credible to the general public. I believe that the general public knows that the objective is to maintain stability over time and that will be reflected in relatively low inflation on whatever measure over time. As to the precise target that is set I do not believe that you will ever get people at large to agree that this is the right thing as distinct from that. I was amazed the other day to see that the Office for National Statistics was enabling individuals to calculate their own inflation index. The implication is that somehow one can target individual inflation concerns with different sectors or individuals members of the public, which is barmy. It is a broader concept than that and it must be one that is across the board and reflects the balance between demand and supply. Q114 Ms Keeble: Do you not think that in a sense the MPC has been a victim of its own success? People have been used to low inflation - at about the rate of 2% - for a long time but now it is increasing. If you look at the discussion in the area of public sector pay bargaining, the main issue of debate is the fact that public experience of inflation is well above official versions. Do you believe that that matters, or should the MPC perhaps recognise where the public is? Lord George: What you are saying is that they should target house prices, to which I say: absolutely not. They look at what is happening to house prices and take account of the impact of that on wage bargaining and everything else. The increase in household debt was certainly a subject that we focused on in my day job, and that will be and should be continuously focused upon. But if one suddenly says that one must look at this or that there is no end to where it can lead. I am very happy with where we are. Q115 Ms Keeble: How do you explain to the public whose experience is that prices are going up considerably - all of us as MPs hear that - that inflation is at whatever level the MPC thinks it is, which is about 2%? Lord George: It is not what the MPC thinks it is. That measure of inflation is calculated by the Office for National Statistics and that will anchor inflation. It may not do so to the same level but it will fluctuate around that and other measures of inflation, but it will anchor the general level of price increases. One can have endless debate about precisely what one should and should not include. I just think that the overall objective will be undermined if too much attention is paid to particular measures which reflect the expressed opinions of particular groups of people in society. Q116 Mr Newmark: As a supplementary, you are setting the terms of reference. By definition you are saying that inflation is x because you have set those terms of reference by which to measure inflation, but I echo a lot of what Ms Keeble says. Either at the doorstep or in my surgery people say to me that they read in the papers what inflation is but their experience tells them otherwise. It is a big problem particularly for pensioners who say that for them inflation is running at 7%, 8% and 9%, not 2%. That is problematic. We need to do some thinking as to what the terms of reference necessarily are. Lord George: I think you should look at what would be the implications for the economy as a whole if you targeted pensioner inflation Mr Newmark: I understand the point you make about targeting individuals, but if you ask the 645 MPs they will say that when they get onto the doorstep the feedback is that these may well be the facts that people read in the papers, namely that inflation is 2%, but it bears no resemblance to real life experiences. It may be - I am not saying that we should - we need to think about what those terms of reference are for the inputs into whatever inflation index we are using, whether it is CPI, RPI or whatever. Q117 Ms Keeble: What makes it worse is that the one tool that the MPC has is interest rates and that filters through to our constituents in the form of higher mortgages. That makes them complain even more; it becomes cyclical. Lord George: Yes, if house prices are going up. But one has to step back and recognise - I referred to it earlier - that when we were in an environment of global economic weakness at the beginning of the decade it meant that external demand was declining. Related to that, business investment was declining. One had only two alternatives in sustaining demand and keeping the economy moving forward: one was public spending and the other was consumption. It is true that taxation and public spending can influence the demand climate and consumer spending, but confronted with what we saw we knew that we had to stimulate consumer spending. We knew that we had pushed it up to levels that could not possibly be sustained in the medium and longer term, but for the time being if we had not done that the UK economy would have gone into recession, just like the economies of the United States, Germany and other major industrial countries. That pushed up house prices and increased household debt. That problem has been a legacy to my successors; they have to sort it out, but we really did not have much of a choice about what we did unless we accepted that we would yank it back or give up stability altogether. That is the point I am trying to make in answer to Mr Newmark. There are some people - maybe lots - who say that house prices is the biggest problem, that the mortgage rate is going up, housing is not affordable and so on. Q118 Mr Newmark: There is a whole host of other issues including council tax. Lord George: There are always things that one can bring into this kind of pot and within that there would be social judgments which are not for the MPC; they are for government. But my concern is that if it is said inflation or RPIX is so much that is one measure. If one looks at pensions a lot of pensioners will say that inflation is at 8% or 9%. If one really wants to target that measure of inflation, or include it within the inflation target, one will be giving up low inflation and accommodating those people. The only way in which we could bring down inflation would be to clamp down on the economy which would mean rising unemployment and falling output. Of course I understand when employees in the health service and schools say that it is not good for them, but one must look at it over time. If one focuses on that too much at the moment one will either inspire action that causes the economy as a whole to weaken or undermine the commitment to stability in the broad sense which has been so successful for us over the past 15 years. Q119 Mr Newmark: For the past four or five months in a row effectively earnings, excluding bonuses, have not kept pace with inflation. Do you see that as a problematic trend? Is there an issue about which we should be concerned? Lord George: I believe it is something that we should all applaud because if it had kept pace with inflation then underlying inflation would have been higher looking forward. Q120 Mr Newmark: But from the point of view of the public earnings in real terms are declining. Lord George: They have been rising consistently over many years and if there is a setback this year on certain measures that is the price we pay for keeping the thing moving ahead as it has been doing up until now. Q121 Mr Newmark: Interest rates are a powerful but blunt and untargeted tool. Is there more that the bank could do either to influence fiscal policy or request additional powers from the Government to provide a more nuanced response to changing economic circumstances? Lord George: I certainly would not want to put the bank in the position of managing fiscal policy as well because the considerations go way beyond economics. They have to balance social as well as economic concerns and that is the job of elected politicians. It is not a technical job like that of the Bank of England, so one must have much more input into that. There was another dimension to your question which has escaped me. Q122 Mr Newmark: I am just reflecting Professor Wren-Lewis's written evidence to us that perhaps there is room for manoeuvre for some sort of fiscal inputs into decision-making rather than a focus on monetary policy. Lord George: I have absolutely no doubt that tomorrow they will be listening to the Budget and studying the implications over the next period. The Monetary Policy Committee and monetary analysts and other permanent staff at the bank will be taking as much account of all those things as they can. It is not as if we are operating in ignorance of what is happening in the rest of the economy; quite the reverse. Q123 Mr Newmark: As a related question, do you think that the bank must remain on guard against changes in fiscal policy that may be detrimental to the smooth functioning of monetary policy? Lord George: If that sort of thing was happening in a significant way I am quite sure that the bank would draw it to the attention of the Treasury and Chancellor. The reality is that there are many things going on in the world that the bank cannot and does not expect to be able to influence or cause to be different. What the bank must do is take account of all those things that are happening, for example in the United States, China and India. Q124 Mr Newmark: But there is a difference between taking account of something and trying to have influence over it. Is there any thinking as to the bank or MPC having some influence over fiscal policy if needed? Lord George: It can express its views to the Treasury. Q125 Mr Newmark: It is merely a matter of expressing a view rather than getting hands on any levers with respect to fiscal policy? Lord George: I certainly would not want the bank to have levers over decisions about fiscal policy. They go much broader than purely the monetary policy objective, but I think that the kind of advice the bank would give would be, "If you do this it will cause that to happen and interest rates will rocket. Is that really what you want?" But it should certainly not be able to veto decisions or insist that politicians behave in a certain way. I should like to point out that we live in a democracy. Chairman: Professor Wren-Lewis mentioned that in exceptional circumstances the bank should take responsibility for some fiscal policies. We questioned him and asked whether it would include VAT and whatever else. I think I can speak for Members here in saying that the argument was to some extent demolished. We entirely agree with you, Lord George. Q126 Mr Love: Perhaps I may take you back to the earlier discussion about the role of the bank in terms of asset prices and possible bubbles. To go back to your time at the bank, your opposite number in the US Alan Greenspan talked openly about irrational exuberance. We did not say much on this side of the pond in relation to that. What are the limitations on the bank in commenting on what is going on in the marketplace at any time? If you do comment does it make any difference? Lord George: I do not believe there are any constraints on bank officials and members of the MPC expressing concerns about what is happening in financial markets and questioning whether that is justified in terms of the underlying situation. As I have already said, the bank takes account of what is happening because those things can have a powerful influence on demand and inflation. I think that anybody who claims to know with great confidence what is happening in the economy, let alone in financial markets, and what the explanation for that is does not understand the questions. It is an incredibly difficult thing. I would be quite surprised to find somebody saying that the exchange rate against one or other currency is much too high or low. Frankly, it can be said that it raises a question that is being determined by financial markets, but to be able to do anything about what is happening in financial markets is not realistic. Q127 Mr Love: It just so happens that one of the current external members of the bank seems very sure that there is a bubble in terms of house prices. What he cannot comment on is when that bubble is likely to burst, but that is a different issue. Lord George: When I was still in my day job a lot of people forecast a collapse in house prices over the next six to eight months. We are still waiting for it. One must be very cautious about that kind of projection. Q128 Mr Love: That probably answers my next question. The odd comment on what is happening in the marketplace will probably not make any difference. Should the bank take a specific view and should all its members comment regularly on matters in order to try to influence markets more than they are doing at the present time? Lord George: On the whole, I think they do comment fairly regularly on what is happening in financial markets. The side of the bank concerned with financial stability, not the MPC, produces six-monthly assessments of the risks to financial stability which is a different concern, although they are related and interconnected. Like love and marriage, you cannot have one without the other. I am not conscious of any need to do more than they do in terms of commenting on developments in financial markets. Q129 Mr Love: One of the expert witnesses suggested that monetary policy might have been overly-restrictive especially in the early days but that that might have been a temporary phenomenon as the bank was building up its reputation. Do you think there was an element of conscious bias in those early days to establish the reputation of the bank? Lord George: No, I do not. I was very conscious of the fact that it was a symmetrical target. That is terribly important because if it is lopsided it does not reflect the original intention. It is not the broader objective of balancing demand with underlying supply. That it is symmetrical is something that we all understood perfectly well from the beginning. But when we were undershooting fairly consistently and achieved 1.5% when the target was 21/2% we might have written a letter of explanation to the Chancellor. I rather wished I had done so because it would have relieved the pressure on my successor. We did not have to do that, but fairly consistently we were on the down side. The reason for that I impliedly explained earlier. That arose in the period of weak external demand when business investment was weak because of global recession, so we had to stimulate household demand. That was the role that we could play in it. We knew that this was not a sustainable situation, so we were being very careful not to do more than we felt we absolutely had to in order to keep the economy moving forward, which we succeeded in doing. It was that which caused us to be careful on the "stimulus" side; it was not that we wanted to convince people that we would always undershoot the inflation target, because that was not what we were trying to do looking at it over the longer term. Symmetry was accepted by the MPC from the beginning and was a fundamental characteristic. Q130 Mr Love: You think that is a critical part of it? Lord George: I do. Q131 Mr Love: Who should set the inflation target? At the moment, clearly the Chancellor sets it. Should it be set every year or on a different timescale? Lord George: My understanding is that he has changed it only once and that was when he changed the index. If the Chancellor tried to set it every year people would wonder what was going on. I am sure I can imagine a set of circumstances - I cannot think of any immediately - in which it is felt justifiable to say that even 2% inflation is too high given what is happening in the world as a whole and therefore the target will be lowered, or that if we try to deliver the 2% inflation target we will face great weakness and therefore tolerate for a period a higher rate of inflation. I think that would be immensely dangerous and highly exceptional. An elected politician should have the right to take that decision but he would have a hell of a job explaining why he was doing it unless the argument was fairly convincing. Q132 Mr Love: That would be particularly the case if he wanted to raise it rather than lower it. Should there be some form of consultation before he made a change of that nature? Lord George: I am sure that he would consult with all sorts of people because it would be a very big decision. Although the Chancellor sets the inflation target I believe that is justifiable because there is still a perception that there is a short-run trade-off between growth and inflation. I am dubious about whether that is true, but I believe that is the perception, so in that sense it is a political decision. I think that if somebody outside the MPC set the inflation target it would draw the bank into a political process. We are very happy to be outside that political process. Q133 Mr Love: There has been surprise about the lack of real discussion about what the inflation target is. The Chancellor set it 10 years ago and he changed it only once in relation to the change in the index. There has been very little comment. Does that surprise you? Should there be more comment? Should politicians in Parliament and commentators be talking about whether the 2% symmetrical target is the appropriate measure? Lord George: No. I believe that it reflects what I said right at the beginning that there was a broad consensus on what we were trying to do, namely to keep underlying demand growing consistently in line with the supply capacity of the economy. Over the past 15 years we have grown consistently quarter by quarter and I do not think that has ever happened before in recorded history. In those circumstances I believe that the view of the public and across the political spectrum - this is what I mean by "broad consensus" - is that this is a sensible way of carrying on these matters. But that must be low inflation and it must be symmetrical; otherwise, it would just be a doddle. If it was x% or lower one would always guarantee it by driving the economy into the ground which is not a sensible approach and is not consistent with the consensus that has been fundamental to what we have done. Q134 Mr Gauke: I want to ask about the transparency of the MPC. Do you think more should be done to allow the positions of individual MPC members to be made public? Lord George: It depends on what you mean. Some people have said that in the minutes of the meetings the statements of individual MPC members in the debate should be attributed. I would be very sceptical about that, because when I was there the characteristic of the discussion, particularly on Wednesday afternoon before the policy-making session on Thursday morning, was on the one hand and on the other; that is, lots of individual members would say that on the one hand a particular series of data could be interpreted in one way but on the other hand they could mean something else. If one really attributed individual comments it would be on the one hand and on the other and one would get the impression that they did not know what they were doing. I certainly do not go as far as to say that the minutes should be verbatim because it would change the character of the debate, which I thought was fantastic. People could be open-minded. That is the nature of it. If somebody thinks he knows for certain what the answer is frankly he does not understand the questions because it is an art, not a science. Beyond a certain point you know where you are making judgments rather than wrestling with uncertainty. Q135 Mr Gauke: One idea that has been suggested is that individual MPC members should write their own personal reports to this Committee. Is that something for which you would have sympathy? Lord George: They all participate in the discussion and the draft of the minutes is seen by the MPC. There is a meeting to discuss the draft of the minutes. MPC members are quite free to express their view. Q136 Mr Gauke: But would you be sympathetic to the idea of members putting something in their own name as a formal part of the structure? Lord George: They can come here and you can ask them questions and they can answer on their own behalf. There is no constraint on that. They can make public speeches and lectures. I believe that it would alter the character of the meetings if one had attributed minutes or nine different sections where individuals wrote their own thing and it was not a discussion of the meeting and interaction but a discussion of the individual point of view. I do not believe that would be helpful. Q137 Mr Gauke: What about the idea of the votes on a particular interest rate decision being revealed immediately as opposed to a month later? Would you be sympathetic to that, or do you see difficulties? Lord George: That would be great for the newspapers and sensationalism: a hawk voted this way and somebody else voted another way. I do not believe that that would convey very much. I believe that to do it in the context of the minutes is much more informative. Q138 Mr Gauke: To return to the appointments process, to paraphrase your evidence you said that you were broadly satisfied with how it worked in your time, but certainly some indication has come from the Bank of England about more recent concerns in that regard. Do you believe that as far as your relationship with Gordon Brown was concerned there was a spirit of openness throughout your time as governor? Lord George: Yes. It took time for it to build up, and it began before he became Chancellor. I used to have meeting with him. Ken Clarke encouraged me to do that and I thought it was terribly sensible. We discussed the question of the MPC before the decision was announced. It was important because one needed to develop a rapport and understanding. I had to persuade him that I could be trusted. I believe that that kind of relationship is terribly important, and I would encourage both sides to continue it. As far as I know, they do so. Q139 Mr Gauke: This morning we see reports from Lord Turnbull, for example, that Gordon Brown has played denial of information as an instrument of power. Was that ever your experience as Governor of the Bank of England? For example, in relation to the FSA, not specifically the MPC, was that ever your experience of working with the Chancellor? Lord George: I accepted that he had certain decisions to take, but he always gave me the opportunity to express my opinion. The FSA was different. I was very surprised; I thought we were going to talk about it, but it was introduced very soon after the MPC for reasons that you will have to ask him about. Q140 Mr Gauke: But far as concerns denial of information as an instrument of power, do you recognise that as something which the Chancellor ever used? Lord George: I do not think I would, but, as the Chairman said on the radio this morning, you would have to ask Andrew Turnbull about it. Q141 Chairman: He has gone to ground. Lord George, thankfully you have not gone to ground. This session has been hugely helpful and we are privileged that you have come along to give evidence. Thank you very much for presenting it to us. Lord George: It has been a great pleasure. It is quite like old times, Chairman. Memoranda submitted by Ms Marian Bell, CBE, Dr DeAnne Julius, CBE, Dr Sushil Wadhwani, CBE, and Professor Charles Goodhart, CBE
Examination of Witnesses Witnesses: Ms Marian Bell, CBE, Dr DeAnne Julius, CBE, Dr Sushil Wadhwani, CBE, and Professor Charles Goodhart, CBE, former members of the Monetary Policy Committee of the Bank of England, gave evidence. Q142 Chairman: Good morning and welcome to the second session this morning of our inquiry into the MPC 10 years on. As with Lord George, we are privileged to have the benefit of your experience. We hope to finish at about half-past 11. We shall ask crisp questions and I am sure you will give very crisp answers to them. To what extent do you think that the record of the Bank of England and the MPC over the past 10 years has been the result of the institutional reform since 1997? I asked Lord George how much of a watershed it was. Ms Bell: Perhaps less 1997, but the overall inflation targeting framework has been a big contributor. One must remember that lots of developed economies have had similarly favourable experiences, though perhaps not as favourable as ours because there has been a global consensus about the way to run macro-economic policy, in particular monetary policy. We have been part of that. Having said that, I think it would have been quite easy for the MPC to get it wrong at different stages and notably it has not. I think it is quite wrong to think that it has been plain sailing and there have not been any risks. There have been big structural changes in the world economy and the UK economy and also a considerable number of shocks. The MPC has dealt with that extremely well. Dr Julius: I would agree. It has certainly been a mixture of international factors and improvements in policies here and some pretty good judgments by the various people who have been on the committee. Dr Wadhwani: I would certainly endorse that. It has been a mixture, but I would not underestimate the significance of the change in 1997. What it did markedly was to bring down inflation expectations, as one sees in a variety of measures. It also gave one much greater confidence that inflation expectations would stay anchored. I believe that that has made a significant difference to the way in which the economy has responded to shocks. For example, it has made it much easier for the economy to handle the fluctuations in oil and commodity prices that we have seen. I believe that the anchoring has been very important. Q143 Chairman: Professor Goodhart, in your submission to us you mentioned that the stability of inflation since 1992, particularly since 1997, has been extraordinary in comparison with previous eras, but it could be taken for granted by the younger generation and maybe down the line the MPC will be blamed for things which it really should not be blamed for. Professor Goodhart: Absolutely. I believe there is great danger that because the past 15 years have been so incredibly stable people now think that if inflation varies by 0.3% in a month things are going wrong. One used to have variations of 1% or 2% a month quite regularly. The stability has been quite remarkable. I think that now people take it rather too much for granted. There could be occasions when there are greater shocks - other countries get into difficulties and all kinds of things could happen - and it might not be possible in future to repeat the stability of the past 10 to 15 years. Q144 Ms Keeble: How supportive is each of you of the CPI as a measure of inflation, especially in view of the fact that the RIP is used in wage bargaining? What do you think about the current discrepancies in the public debate between the public's perception of inflation and the measures which the MPC is using? Ms Bell: I do not think it matters so much what measure of inflation one takes. I think it matters that it is consistent and credible, and to achieve that it should not change around too much. As long as it is fairly representative of the cost of living - perhaps one can argue about whether or not house prices should be included - I believe that it is fine and for statistical reasons CPI has superior properties. It would be nice if it included house prices. I do not believe that RPI itself is particularly realistic - the previous target was not RPI but RPI excluding mortgage interest payments - because interest rates themselves should not be directly included in a measure of inflation. Dr Julius: Of the measures currently available the CPI is the best one to target. There are advantages in having a geometric mean and various reasons why RPI would be the wrong measure to target because it includes mortgage interest rates. Having said that, one has to look at the practicalities of how one can include the impact on inflation of house prices. It is not a clean-cut exercise and that is part of the reason the European Commission has not so far succeeded in coming up with a way to do that. Unless a good way to do it can be found, I think it is better to leave the clean-cut measure - CPI - as we have it. When we were looking at RPIX, which includes a measure of house price inflation with the owner occupied equivalent of rental costs, it was not a very good element and it destabilised that particular measure. I add that in times like the present when commodity prices are quite volatile it is useful to look at a core measure. The MPC does not currently pay a lot of attention to core measures of CPI, but I think that that can also add knowledge about where inflation is going in future. Q145 Ms Keeble: I can see the point of having a fairly stable measure that is reliable as a statistical tool, but there is an issue about the public perception being completely out of kilter. You may think it does not matter whether or not the public thinks that the Government and MPC use credible measures. Nonetheless, there is a credibility issue especially when the use of interest rates can widen the perception because increases have a knock-on effect on mortgages. Dr Wadhwani: I wonder whether it is a matter of attempting to educate the public, because it is quite dangerous to endorse public views that they deserve wage rises in line with RPI. Ultimately, in an idealised labour market wages should be going up in line with what a competitive business can afford and that need not be RPI. In the specific instance where RPI is boosted by interest rate increases that may not be something that businesses can afford to pay. If in the labour market people insist on getting RPI-style wage increases they may just end up boosting unemployment. Therefore, it seems to me that it is our duty and, with the greatest respect, possibly your duty to help educate the public about this issue. I also strongly suspect that in periods when RPI is running below CPI - that was certainly part of my experience when I was on the committee - there was not much heat from the public about the issue. Q146 Ms Keeble: Do you believe there is any bias, particularly anti-inflationary bias, by the MPC despite the fact that the target is symmetrical? Professor Goodhart: There was certainly no bias of which I was ever aware. I think the reason why inflation came out at a tiny bit below target was essentially that we all expected the exchange rate to come down a bit. It rose enormously in 1997 and the general expectation was that it would decline slightly from then on, but it never happened. Because the exchange rate was always somewhat higher than we expected inflation turned out to be just a tiny bit lower, but the deviations were minute. Q147 Ms Keeble: Do you think that the interest rate should be the only tool used by the MPC, or should it have other tools at its disposal? Professor Goodhart: The bank has other functions as well. It is concerned with financial stability and it has to consider what kinds of instruments it might want to use for that purpose. There is also a question of whether the bank should ever intervene in the foreign exchange markets. You probably are aware of issues in France about what the ECB should do. The question of whether there should ever be intervention in the foreign exchange markets is a very lively one. Q148 Ms Keeble: I do not believe you agree that letter-writing is a form of sanction? Professor Goodhart: Certainly not. Letter-writing is usually an explanation of what has happened. The MPC is always trying to achieve the inflation target. Shocks are bound to occur from time to time and they will drive inflation up or below the limit. At that point the MPC must explain why it has happened and what it intends to do. It is a form of explanation, and it also gives the Chancellor a chance to reply so that if inflation has deviated from what the MPC is trying to achieve the Chancellor can say that it should try to return quicker or more slowly than the bank suggests in its letter. Q149 Ms Keeble: I was interested to hear Lord George say that he wished he had perhaps used it when inflation went too low. Do you believe that it is differently perceived? Professor Goodhart: My belief is that every central bank governor and most members of the MPC are looking forward to the first occasion of letter-writing. Obviously, they do not want a deviation from target to occur, but they are quite looking forward to getting this part of the institutional instrumentation in operation and showing how it ought to work. Q150 Ms Keeble: But it has not been used in 10 years and is seen almost as a tool of last resort. Professor Goodhart: It is not a tool of last resort. When the MPC was founded in 1997 the historical experience and expectations were that there would probably be about two or three letters written per year. The decline in the volatility of inflation over the past 10 years has been quite extraordinary. If one went back to the kind of normal variations in inflation that occurred in all historical experience one would certainly expect letters to be written fairly frequently. Stability has been so great that it is almost unimaginable. It was not imagined that there would be anything like this when the MPC was established in 1997. Q151 Chairman: Are there any other comments on letter-writing to be added to Professor Goodhart's view? Ms Bell: I agree that it is not a sanction and should not be seen as such. It is definitely part of the communication process. I also agree it is disappointing that we have not had a letter yet. I wonder whether perhaps the bounds should be narrowed or the committee should start writing letters when they get towards the end of it just to make use of that communication tool. Dr Wadhwani: It would be dangerous if it was seen as a sanction. If it was seen as a sanction by the committee it would stop it doing the correct thing which is occasionally to allow inflation to stray outside and to bring it back only gradually. Q152 Mr Love: We are all pining for a letter, and maybe we will get it one day. I move on to the characteristics of a good external member. Who better to answer that question than former external members. Perhaps I may start with Professor Goodhart who in his submission wrote a detailed spec as to who should be external members. Perhaps he would elaborate. Professor Goodhart: The MPC is a remarkable institution which is charged by Parliament and the Chancellor with the job of changing interest rates in such a way as to hit an inflation target. That is a technical requirement. Effectively, the specification ought to be that the person involved is capable of achieving within a reasonably short time the ability to make a sensible and informed choice. Q153 Mr Love: Does any of the witnesses believe that in trying to reach a balance of the external members there is a role for non-technical persons? You have had one such person on the committee. Dr Julius: With the current structure, particularly the central role of the forecast in the MPC process, it is quite difficult for a non-technical person to participate fully in that exercise. It depends exactly on how one defines "non-technical". I do not believe it means that one needs a huge amount of econometric model-building in order to be an MPC member. I note that one of the submissions suggests that at least one of the external members should have substantial experience in model creation. Q154 Mr Love: What is your view of that? Dr Julius: My view is that certainly one or more should have real experience in using and interpreting forecasting models of the economy. I am not persuaded that experience of building models is required, but every external and internal member needs to be professionally competent in interpreting models, asking the right questions about them and so forth. Without that the internal functioning of the MPC process and communication of the output is compromised. Q155 Mr Love: Dr Wadhwani, Professor Goodhart says that it can take six months for the non-specialist to become comfortable with the forecasting procedures. The outside expert said to us that in order to keep the bank on its toes at least one member needed to be thoroughly acquainted with it. Do you support that view? Dr Wadhwani: Yes. It certainly takes time to adjust to the model and to be on the committee. That is why I now feel that terms should be longer; instead of three years perhaps the term should be five or six years. Members should be given the option of perhaps serving a somewhat shorter term, but certainly should be encouraged to serve a longer term. Q156 Mr Love: I want to come to that. I hope to seek a consensus among the four of you. First, for how long do you think members should be appointed? Should members be eligible for reappointment? There seems to be a broad consensus developing. Ms Bell: If I may comment on the external member who is a modeller, I am not sure there is a need for somebody who is able to be hands on and run his or her own model, because the external members do not work as a block, or should not do so; they should all be there as individuals. I am not sure one gains anything by having one person who can go through the nuts and bolts of the model. What one needs is that all the members understand the broad properties of the model and how it is put together and can hold the bank to account. There is plenty of technical expertise within the bank. Q157 Mr Love: You appear to suggest in your evidence that four years without reappointment is the correct way to go forward. Ms Bell: I agree that perhaps terms should be a little longer. I also think there should not be reappointment. The suggestion of four years arose because with four external members one would have a very neat roll over. We had a problem a few years ago when there were big internal changes going on at the bank and two external members came to the end of their term at the same time. I think that potentially it causes difficulties. Were we to have a committee with five external members and four internal members perhaps we would have rolling five-year terms. Dr Julius: Reading everyone's evidence, it seemed to me that most if not all of the former members of the MPC felt that there should be longer periods and more protection for the independence of external members. There was a difference in terms of length of appointment. My own view is that a three-year term is quite a good length for the first time and a second term should be permitted if both sides feel it is appropriate, but that the six-year total limit should be applied to both internal and external members so there would be an equality of historical experience and continuity on the committee. The reason I am not in favour of a single five or six-year term is that it has two disadvantages. One is that it may well be somebody is appointed who is not really competent for the job, and to be stuck with that person, as it were, for five or six years is not particularly helpful. In the public or private sector often one does not know that. Someone can look very good on paper and do very well at interview and in the job it just does not work out. I think there is a risk in having a long-term appointment like that. The second issue is that if it is an appropriate, good person a five or six-year appointment is quite a long commitment to a rather cloistered job that may be out of the mainstream of the individual's own career path, particularly if he or she is not from academia and comes from the private sector or financial markets. Although that person could resign, say, four years into a six-year term it would be something of a political issue; it would be in the newspapers and there would need to be a good reason. It might be difficult to attract that sort of person to a job for which the term was, say, six years. Q158 Mr Love: Professor Goodhart, you talked of the possible danger that internal bank members could become subject to "group-think". Do you think there are any dangers of a herd mentality among external members; if so, how would you guard against it? How do you ensure that all the external members do not think similarly? Professor Goodhart: They certainly have never had a herd mentality. Q159 Mr Love: That is reassuring. Professor Goodhart: One of my colleague Willem Buiter thought that one could have two views at any time. How do you guard against it? I would encourage some of the externals to keep a foot outside the bank. The kinds of people who would be appointed are at a sufficiently mature stage of their careers that they are unlikely to be subject to excessive pressure. I do not believe that this is likely to be a danger, and there certainly never has been any kind of danger. Q160 Chairman: We have had the opportunity to visit the bank and meet the court. Do you think it is the court's job to pick up weaknesses in MPC members? What is its job? Dr Julius: That is a good question. In some ways the court is a rather grand body with very little to do, particularly since the introduction of the new Bank of England Act and the FSA regulatory side split away from the bank. Yet the court is still required under the Act to meet monthly and to have regional representation, but the MPC gets the bulk of its regional knowledge from the bank's agents, not from an occasional anecdote that might be present at court. The role of court is not very well defined which I believe is a fault of the Act rather than either the people on the court or the internal Bank of England people. It would be possible under the proposal made in my evidence to have the internal appointees to the MPC de-linked from hierarchy in the bank, choosing the best internal people to serve three-year terms as part of the MPC. It would be possible to give the court a role in selecting those people, because if they are internal they certainly should not be selected by someone to whom they report, ultimately the governor. That is a possibility but it would have to be considered along with other changes. Q161 Chairman: Dr Julius, I believe that you are the only one here who has been a member of the court as well, so your evidence is very pertinent to that. I gained the feeling from talking to the court previously that its role was ill-defined and perhaps it is something on which we should comment in our report. Ms Bell: That might be the practice, but I believe the Act is quite clear about its role: it is to make sure that the MPC's procedures are there and it is getting the right sort of information. It receives a set of documents annually. When Pagan made a report on modelling at the bank that went to court; when observers from other central banks sit through some of the so‑called pre-MPC briefing meetings there are peer review questionnaires prepared and all of that goes to court. It receives quite a lot of information. Perhaps it could make more of it. Q162 Chairman: Perhaps an education process must take place here. Dr Julius: I think that the court has a useful role as backstop. At times of strain - there was a period of strain when the external members felt that more resources were needed to support them - the court played a very useful role. Certainly, one would hope that if there should be any sort of financial irregularity inside the bank the audit committee, which is a subset of court, would discover that weakness. Q163 Chairman: Therefore, it acts as a good shop steward? Dr Julius: Yes. Q164 Mr Gauke: I want to follow up the point about resources more generally. How do you feel about the amount of resources provided to external members? Is there anything that you feel you could have done that you were not able to do because of lack of resources? Dr Wadhwani: When I got there the quantum of resource was not enough but that was resolved. I was then perfectly content with the situation. There have been rumours around that there may be an attempt to take these resources back from external MPC members which I believe would be a retrograde step. Dr Julius: One element that would have been useful, even after the expansion of resources, was more modelling capability in the external MPC staff. Ms Bell has been there more recently than I have, so she will have a better view on what is available now, but during the time I was there it would have been useful to be able to have the capacity between forecast meetings, for example, to run the model with some different assumptions that I might think were a little more appropriate than whatever might have been the joint view of the committee. That capability was not there, and the internal bank modelling staff was entirely preoccupied, naturally, in preparing for the forecast rounds in which we were involved. Ms Bell: I think that some of that is to do with the sort of people who are recruited into the unit. I see no reason why you could not have modelling, and at times there have been people with that capability. My experience was that the resources were adequate. I do not say that they were overly-generous. At some points they were really needed. For example, when the new model was coming in the staff in the external unit spent a lot of time working with the external members to make sure they understood the model. There were lots of in-depth briefing meetings with the modelling team. Little seminars were run for themselves and for us about the new model. All of that was quite resource-intensive and essential. I agree that it would be wrong if that resource was diluted in any way. Professor Goodhart: It takes us back to the earlier question of whether there should be at least one expert in modelling. Ms Bell has just talked about the model. There is not just a model; there is an infinite number of macro-economic models. One of the dangers for the bank is that people place too much weight on whatever the current bank model may be. There is no such thing as a correct model. One of the points that always needs to be considered is whether possibly the model that the bank currently uses may be insufficient and inadequate in certain ways, and one of the roles of the externals ought to be to be able to challenge the bank model. Q165 Mr Gauke: I move back to the issue of the appointments process. Do you have any views as to the adequacy of the current process or suggestions as to how it could be improved? Professor Goodhart has raised one or two issues in this area and perhaps he would wish to kick off. Professor Goodhart: I think it is a very difficult one. The question about whether your Committee should have the ability to refuse appointment is part of a much wider issue of the relative role of the legislature and executive and the position of the MPC is one among many. It is a very much wider issue that should perhaps be looked at in a broader sense. Subject to that, there are difficulties. One cannot go too public because for a variety of reasons various people may be approached and not want to accept the position. I think it would be unfortunate if their names became known and somebody realised that they were not necessarily the first choice. The difficulty is that nobody knows anything at all about the whole process. The word that has been used is "opaque". There is no information or attempt to give any specification about what is wanted. How the Chancellor and Treasury go about obtaining names and what the role of the governor of the bank is in this is simply unknown. Q166 Mr Gauke: How much do you think that is to do with the structure of the arrangements about appointments and how much of it might be more to do with the individual personalities involved? Professor Goodhart: I do not really know the answer to that. If my colleagues are better able to answer it I would be very happy. Dr Wadhwani: There has been a lot of criticism about the appointments process, but when I think back to 1997 and the introduction of the independent Bank of England and it was explained that the external members would be technocrats - indeed, the first crop were - I remember having a fear that over time that would be eroded and one would have increasingly overt political appointments. That has not happened. One should congratulate the Chancellor or Government for the fact that that did not happen. It may be that over time that will not prove to be resilient. A different Chancellor may act differently and that may be the justification for changing the process. Dr Julius: In my view the process has not been very professional. It is known that these are three-year terms and so it is public knowledge well in advance who is coming to the end of the term. In most organisations when you know that you will be losing someone in a year or so you begin to figure out the specification for the kind of individual you want to replace that person. Possibly you will hire head-hunters, go out yourself or look internally to find that person. How to replace someone in a structured, organised way is not rocket science. I think that it would be easily possible to do that also for an MPC member. I suggest in my evidence that at least six months before someone's term is coming to an end there should be a conversation between that individual and the Chancellor, or whoever he designates, on both sides about whether or not that person should go for a second term and it should be agreed. If that person is not to stay on, or it is the end of the second term, there should be a published specification for the kind of expertise that would be sought, because one does not want one uniform external member. One might want an academic depending on who else was on the committee; one might want a business person or a forecaster or modeller; one might want a City person. One wants a diverse committee that has the ability to look at the economy from different dimensions. Based on that published specification, which this Committee could well review or have an input into - because it should be an open specification - the process should take place to find the person. I do not support using the Nolan process as suggested by Stephen Nickell. Because it is such a narrow specification and one is looking for a rather technical person one is likely to find such an individual if it is a confidential process. That could take place very easily. When the person is presented to this Committee it will be able to look at the specification on the one hand and the person on the other and make its own judgment as to whether the individual is appropriate. Q167 Mr Gauke: It has been suggested to this Committee that there should be some formal report from external MPC members annually. Does that find favour with you? Do you believe that there is a need for more to be done to allow external members to express their personal views? Ms Bell: I believe that a lot more can be done within the current structure. I see no reason why the votes should not be published when the decision is made, although it would be harder at that early stage to have accompanying explanations. There have been times when the market would have benefited from knowing it was a close vote as opposed to a unanimous one. That sort of information can be given. I would be against members turning up at the policy meetings with a prepared text feeling that they would be quoted verbatim in the minutes, because it would make it much more stilted and a less dynamic discussion. As a result the decision might be less good, but I see no reason why when you get to the minutes meeting and the immediate policy decision paragraphs are being written individual views cannot be identified by name. Occasionally, if someone is in a minority of one it is quite clear what his or her views are but if it is more than one person it may be helpful to start to break down who said what. Perhaps where there is a divergence of view also in the inflation report that could be brought out a little more. I think that it is then the job of this Committee to be a bit stronger in eliciting individual views. Professor Goodhart: We are much more individual at the MPC than any other equivalent central bank. The ECB does everything by consensus and in America the FOMC very rarely dissents from what the chairman indicates. The criticism in most other countries is that the UK is far too individualist and indications that x says this and y says that are likely to confuse the market. I do not believe that. I think that individualism in this country is splendid, and it has already gone far further than any other country. To ask for much more at this stage is probably going too far. Q168 Chairman: Dr Wadhwani, were you consensual? Dr Wadhwani: Yes; I was a collegiate. Q169 Mr Gauke: Is there a consensus that you are all individuals in your own right? Professor Goodhart: Absolutely. Q170 Mr Breed: I turn briefly to house prices and household debt which come up on a number of occasions in our discussions. To what extent is it right to characterise the rise in house prices and household debt as two sides of the same coin which have been caused for so many years by the generally low level of interest rates within the economy? Ms Bell: One certainly could characterise it in that way. The job of the MPC is to understand what is going on, but the role is to target inflation so these things should be taken into account insofar as they affect the forecast and outlook for inflation. I disagree with some other members of the panel about the time horizon over which that should be looked at. If issues such as debt and house prices start to affect the monetary transmission mechanism that is something that needs to be taken into account. Perhaps one of the downsides to the incredible success of the Monetary Policy Committee is that there is a feeling out there that it has done well with inflation and perhaps a few more targets should be thrown at it to see if it can control everything. I believe that that misunderstands the nature of monetary policy and how really narrow it is. I think that the best job the MPC can do is to focus very precisely on achieving exactly the target that has been set for it and not try to stabilise asset prices as well. Dr Julius: I believe that the issue of house prices in this country is mostly a supply side phenomenon. I am a fan of the Barker report and the finger that she points to the planning system. Those are matters which the MPC has no competence or ability to influence. Q171 Mr Breed: We should not worry about it at all? Professor Goodhart: I am not entirely in accord with my two colleagues to my left. My view is that housing prices ought to be in the CPI and the fact they are not is a grave disadvantage. The problem as to how to include housing prices in the CPI is an extremely difficult one. Nobody has yet come to a consensual agreement about the right way to do it. There has been a great study in EUROSTAT about which of the alternatives is better. Since it cannot come to any agreement the simplest way out of it is not to include housing prices at all, which in my view means that the inflation measure in this country has been wrong. I entirely agree with Lord George and my colleagues that it is crucial the MPC should control a broad measure of inflation. I also agree that the fact the CPI is not best designed at the moment is a secondary issue. The MPC is doing a very good job and anyhow the index is the Chancellor's choice, but I believe that one way or another housing prices ought to be in it. It is a major issue, because the question of what inflation is will vary quite a lot if housing prices move quite differently from the price of other goods and services, as they have very frequently over the past 10 years. Q172 Mr Breed: I was quite interested in reading your evidence about contra-cyclical and pro-cyclical trends. I recall competition and credit controls in about 1970 when the bank took special deposits out of the banking system in order to reduce the money supply and act as a flywheel. All of that went out of the window and now everybody is lending money on houses left, right and centre, and I believe that that has contributed significantly to the overall increase. The amount of money available for house purchases is significantly greater than it was. To what extent is the fact that in the UK housing is such an important factor - perhaps more important than in many other countries - a problem in bringing house prices into the CPI? Is that situation unique to the UK economy as opposed to others? Professor Goodhart: No, it is not. Everybody has difficulty with housing prices and I can think of at least three ways that one might try to include housing prices in the CPI. In different countries there are different approaches. It is a complicated, technical issue but a very important one. Q173 Mr Breed: In your opinion could it be done? Dr Wadhwani: Even if you do not include housing in the CPI because you await resolution of some of the technical issues there is something that the MPC can and should do, in the sense that historically the major monetary policy areas - one thinks of Japan in the 1990s and the US in the 1930s - were associated with taking the eye off the asset price ball. For those reasons, I continue to believe that the MPC should be leaning against the wind in terms of asset prices. One continues to target consumer inflation but one does it in a way that one leans against the wind vis à vis asset price imbalances. Q174 Mr Breed: Looking at household debt, different commentators take different views. What is your view on the current levels of household debt, secured as well as secured? Do you think that the bank should take account of that in any analysis? Professor Goodhart: It does take account of it in looking at the developments in the broad economy. Remember that household debt has also been matched by very considerable increases in household financial assets, but they are not held by the same households. The problem is that this is a distributional issue, and it can also be an important social issue. It does not necessarily play so much of a role in trying to maintain the inflation target overall. The bank and also the FSA have been very careful to consider how far the debt issue may affect the stability of the financial system. You are all aware of sub-prime mortgages. Very considerable studies and stress tests have been made that have asked banks and building societies what might happen if house prices suddenly came down and people were unable to pay their debt. The general result of those tests has been that it would not affect the British financial system very much but it could have serious adverse effects on some people who got in over their heads. Q175 Mr Breed: It is not a new phenomenon. I remember so many years ago the secondary banking crisis and things called lifeboats and so on. There does not seem to be anything new in this. Is the level of household debt a concern of the bank? Dr Wadhwani: Broadly, I agree with virtually everything that Professor Goodhart said on that subject so I will not repeat it. The only small qualification is that what we are seeing in the US currently may be quite illuminating for us. The consensus view is that the sub‑prime mortgage problem is confined to the poorer sections of society; it is a distributional issue and it will not have wider macro-repercussions. That belief is about to be tested and we will have to wait and see. Dr Julius: It is also relevant that much of that segment of the market is not an element to which commercial banks - the basic financial institutions in this economy, or indeed the US economy - are exposed. That is the reason they sell prime mortgages. Although the risk has been spread in the economy when the banking system is profitable and in pretty good shape the issue of household debt is not nearly as big a concern as it would be if the banking system was also marginal. Mr Breed: Those who have the assets may have the ability to service the underlying debt; those who do not have assets may not have that ability. Q176 Chairman: Before we finish perhaps I may ask each of the witnesses for their views on the next 10 years, because that is part of our inquiry. What is the one thing that should be done in the next 10 years, or what message do you think we should be considering for the next 10 years? Professor Goodhart: Do not get too worried if the economy does not behave as well in the next 10 years as in the past. We have to recognise that we have been living in a golden age, but it is really too good to last. Do not let your expectations get too high. Dr Wadhwani: Again, I agree with Professor Goodhart. The only other comment is that I hope in the next 10 years the MPC becomes more confident in some sense. In the past 10 years as it has felt its way there has been a reluctance to project forward some of the supply side benefits that it has begun to see in its forecasts. I think that that has led it to be too cautious in terms of setting policy. I hope that it does not repeat that in the next 10 years. Dr Julius: I am more optimistic about the next 10 years. Nonetheless, I think that it is very important that the excellent structure we now have for monetary policy in this country is continually monitored by this Committee, the press and others to ensure that the calibre of the people who make the decisions within that structure remains high and that individual accountability, equality through the voting system and the competence of all members of the MPC is retained. Ms Bell: The next 10 years will undoubtedly be different from the past 10 years and I do not think we can guess at what the shocks might be. I believe that the framework is a good one and the MPC ought to be able to continue to do pretty well, although it would be nice to have the odd letter. As to confidence, it may need to continue the battle on the importance of low inflation. Professor Goodhart said earlier that a lot of people did not remember the problem of inflation in the past, and I do not believe that we should become too relaxed in believing that the importance of maintaining a stable monetary framework is accepted widely. Those areas of communication and continuing to build a consensus for low inflation are matters that might have to be strengthened and built upon over the next decade. Chairman: We have lots of written evidence for which we thank you. As I went through it, I have good news for one of you. Mr Austin Mitchell wrote to us to say that soon after the MPC was established as MP for Grimsby he invited the governor and the members to Grimsby to see the real problems in the world. That invitation was declined but to her great credit DeAnne Julius came and was impressed and influenced by what local business told us. Dr Julius, I am sure you are popular everywhere, but you are really popular in Grimsby. I thank the witnesses for their time and evidence. |