Examination of Witnesses (Questions 1-19)
24 MARCH 2009 MR
MERVYN KING,
MR PAUL
TUCKER, MR
SPENCER DALE,
PROFESSOR TIM
BESLEY AND
PROFESSOR DAVID
BLANCHFLOWER
Q1 Chairman: Good morning, Governor,
and to your colleagues. Welcome to this hearing on the Inflation
Report. Can you identify everyone for the shorthand writer, please?
Mr King: On my
immediate right is Spencer Dale, the Executive Director for Monetary
Policy, and on his right is Tim Besley, one of the external members
of the MPC. On my immediate left is Paul Tucker, the Deputy Governor
for Financial Stability and on his left is David Blanchflower,
another of our external members.
Q2 Chairman: Welcome. Governor, Lord
Mandelson seems to have been everywhere, even regarding his comments
on the Bank of England, saying that the Bank of England is in
pole position and that he wished that negotiations with them had
gone quicker regarding the car industry. First of all, do you
accept that charge and, secondly, do you feel that the public
and highly voluble attacks on the Bank of England undermine your
independence?
Mr King: I was puzzled by the
statement, but let me just explain what our position is. We opened
last autumn a facility for the use of asset-backed security paper,
including paper-backed loans to finance car purchase. That facility
has been open since September and, indeed, some paper related
to car loans is being used in that facility.[1]
That is one thing that we are doing. The second thing we are doing
is that the measures we announced recently in the asset purchase
facility for the Bank to buy commercial paper are also open to
car firms, and, indeed, the industry has access to that facility.
I was slightly surprised, because the car industry is, indeed,
getting help from the Bank. Of course, the question is whether
it deserves special help. I have a great deal of sympathy for
the car industry, I think they are facing particular problems
at present, but the judgment as to whether an industry deserves
special help really has to be one for the Government, it cannot
be one for the Bank of England. Indeed, a piece of paper arrived
on my desk this very morning for a joint press release from the
Federal Reserve and the US Treasury, issued overnight, which said,
"Actions taken by the Federal Reserve should also aim to
improve financial or credit conditions broadly, not to allocate
credit to narrowly defined sectors or classes of borrowers. Government
decisions to influence the allocation of credit are the province
of the fiscal authorities." I think that makes it pretty
clear that central banks should not be in the business of making
judgments about which sectors of the economy should benefit from
a preferential allocation of credit, even if there is a good argument
for doing that, it must be in the hands of the Government, and
since the Government owns a large majority stake in one and a
significant stake in two of the three main domestic lenders, if
it wishes to engage in preferential credit allocation, the ability
to do so is in its own hands.
Q3 Chairman: So, in summation, you and
your colleagues have delivered what has been asked of you?
Mr King: I have not been asked
to engage in any preferential credit allocations, which is one
reason why we are slightly surprised to see the comments, to be
honest.
Q4 Chairman: But in that and other
areas generally, you have done what is asked of you?
Mr King: Absolutely, and these
facilities have been available since September for the asset-backed
paper.
Q5 Chairman: Good. The rate of return
on average instant access savings accounts is now what people
would describe as a pathetic 0.17%, and as Members of Parliament
and as Committee members we have had a lot of correspondence on
that from savers. You have expressed your sympathy for savers
in the past, but how concerned are you that people will lose the
savings habit?
Mr King: I think this goes back
to what I call the paradox of policy. I think it does not make
sense to engage on a national campaign to raise savings rates
in the very short run; we will need to do so once we get out of
the crisis. In the short run we have to engage in measures to
ensure that spending returns to more normal levels in order to
prevent significant falls in output and rises in unemployment.
Once we have got through that immediate problem, then the challenge
will, indeed, be to raise the national savings rate, both public
and private.
Q6 Chairman: Will there be a chance
of getting on the national debate the policy of banks charging
customers for looking after their deposits? Do you think that
will be an issue we will be talking about in the future?
Mr King: I think certainly the
banks will want to raise the question, if interest rates are at
such a low level, what is the basis on which they will make their
return? In the past they have been doing so on the turn between
borrowing and lending rates. That has now narrowed very substantially,
so the question of charges may well come up, but that is a matter
not for me, it is a matter for the banks and those who regulate
the banks.
Q7 Sir Peter Viggers: Quantitative
easing. Why is buying assets better than printing money and throwing
it out of a helicopter?
Mr King: Because we get the asset.
I think the important thing is to make sure that what we are looking
to do here is to have an increase in the amount of broad money
in the economy such that that money is then used, we hope, to
buy other assets, which might lead to an increase in the prices
of those assets, which will have a positive wealth effect that
might encourage spending and it might reduce some of the risk
premium in the other asset markets which have been deterring corporate
borrowing and making it more expensive. I think we feel the right
thing to do is to really engage in a range of measures, and I
think the twin-track approach that we have adopted is both to
engage in asset purchases in order to increase the amount of money
in the economy, but we have also been engaging in asset purchases
in those corporate credit markets where we feel that it may be
possible that a limited range of purchases would stimulate further
private sector issuance, and that is why we engaged in the schemes
to buy commercial paper and why we announced last week the scheme
to buy corporate bonds, and the first purchases of bonds will
take place tomorrow. For those particular kinds of operation—commercial
paper and corporate bonds—the criterion for success is not
the amount of purchases that we engage in, it is the leverage
that such purchases might have on the credit spreads in markets
and the private sector issuance of that paper, and it is only
two or three weeks into the scheme but I think we are mildly encouraged
by what we are seeing so far. The spreads on commercial paper
have come down by about 30 to 50 basis points. We have seen an
example of a company that said, having been able to issue commercial
paper to the Bank of England, that having been done, the next
time it was actually possible to issue it at the same spread to
the private sector in the market. That was encouraging, but the
scale of these purchases is not the criterion for success. We
expect these to be small. They are not meant to substitute private
sector issuance and take-up of the paper but merely to try to
reduce the spreads, improve the liquidity in these markets in
order to make it easier and cheaper for companies to obtain finance
in this way given the difficulties that we see in the banking
sector.
Q8 Sir Peter Viggers: So there are
two distinct tracks.
Mr King: Yes.
Q9 Sir Peter Viggers: You referred
in your February Inflation Report to purchases of high quality
but temporarily illiquid assets issued by private sector borrowers.
So those are meant to be high quality assets.
Mr King: That is what I call the
unconventional unconventional purchases.
Q10 Sir Peter Viggers: That is completely
different from the asset purchase facility, which is intended
to provide a market for—
Mr King: They both are under the
umbrella heading of the asset purchase facility, but they are
different kinds of operations. The asset purchase facility is
designed to enable the Bank both to engage in these commercial
paper corporate bonds, if we think there is a case for doing other
credit instruments, then we will look at that, but then the other
operation, what I call the conventional unconventional purchases,
is about relatively standard use of the central bank, which is
to buy government gilts in the secondary market. We are doing
this all the time. The difference is that we are now doing it
in order to increase the supply of broad money in the economy;
and the reason this looks unfamiliar, obviously, is that for the
last 40 years we spent most of the time trying to reduce the amount
of money in the economy to prevent inflation picking up. We are
at the point now where we feel that, looking ahead at the two
to three year horizon, the risk is on the downside, hence we want
to do the opposite of what we would normally do.
Q11 Sir Peter Viggers: Inflation
targeting through interest rate policy has been developed over
decades and is very sophisticated, whereas how much do we know
about the effectiveness of inflation targeting, as through quantitative
easing? How certain are you of success in this field?
Mr King: I do not think the choice
of the target is the issue here. You could have money supply targeting,
you could have price level targeting, almost any kind of targeting,
without a single remit—you could have a Fed type remit—you
would still have the same issue as to whether the instrument that
is now available to the Bank of England is adequate. Obviously,
with the bank rate very close to zero, that is no longer an effective
instrument open to us in order to ease policy. In order to ease
policy, therefore, we have adopted what is a relatively standard
approach, which is to buy government securities in the market.
That way we do not distort private sector yields or take a judgment
on which private sector assets we should buy, and this increases
the amount of money in the economy. The reason we are doing that
is because our judgment is that since last autumn, with the remarkable
change in conditions last autumn, the amount of money in the economy
is simply not growing fast enough to enable us to reach a sustainable
growth rate with inflation close to the target. As I say, this
is quite the opposite of most of the last 40 years, where the
challenge has been to bring down the growth rate of money in order
to limit inflation.
Q12 Sir Peter Viggers: As sure as
night follows day, I put it to you, the inflationary pressures
which are being built into the system will eventually force their
way up and governments around the world will find that a level
of inflation will be helpful to them to pay for the expensive
measures they are currently taking. Do you recognise that scenario
and do you think it is too far down the road to worry about at
this point? Should we be preparing for it?
Mr King: No, that kind of scenario
is never too far down the road to worry about it, and that is
why it is most important that we stick to a clear inflation target,
because the one thing that will prevent that happening is a clear
inflation target to which the central bank is given a public remit
by Parliament to stick to, and that is the anchor which everyone
should hold on to. The aim at present, with the concern about
inflation being below the target in the medium term, is we are
trying to bring the future outlook for inflation back up to the
target. That is why we are engaging in the quantitative easing,
but we have absolutely no interest or wish to see inflation go
above that.
Q13 Sir Peter Viggers: Can I ask
one special question. I have a declared interest as the chairman
of a pension fund. Are there special problems for pension funds
arising from deflation?
Mr King: I do not think there
need be. It has always seemed to be that a good strategy for a
pension fund is to invest in a portfolio of assets that match
their liabilities, and a pension fund that did that would find
that, whatever the swings in long-term interest rates, their assets
would be moving around in value in the same way as their liabilities.
The pension fund that hedges its risks by investing in assets
that match its liabilities would not find this a problem.
Q14 Mr Fallon: Governor, your initial
decision was to pump £75 billion in, in new money. Why £75
billion? Where did that figure come from?
Mr King: When we looked at the
numbers, we said, as I explained before, that we thought that
both broad money and the growth of nominal demand in the economy
were running at a growth rate which was too low to enable us to
meet the inflation target and see economic recovery. Indeed, the
growth rate was pretty close to zero. We thought the growth rate
ought to rise by something of the order of 5%, almost a one-off
injection of broad money of 5%. Five per cent of total nominal
demand in the economy is pretty close to 5% of broad money held
by the non-financial sector and happens to be £75 billion.
That was the method we used to calibrate, broadly, the scale of
transactions. That cannot be exact, because the final impact on
the broad money supply, or nominal demand, will be either higher
or lower than the initial injection, depending on what agents
who sell their gilts to us do with the money, and that is something
we will discover over time. We need to be prepared to adapt that
strategy in either direction, but as a starting point, I think,
it made some sense.
Q15 Mr Fallon: You referred earlier
to the leverage effect. You must have made some calculation of
the multiplier of the £75 billion. If it worked successfully,
what will the multiplier effect be?
Mr King: I think it is very hard
to quantify, because we do not have the experience to do it. It
would be a false position to try and pretend to do that. It could
be higher or lower. If people who have got the money, having sold
assets to us, decide to repay bank debt and the banks then decide
not to expand the balance sheet in other directions, then actually
it could be less than one for one, but, on the other hand, if
people, having sold assets to us, use their extra money balances
to buy other assets, then the effect could be bigger than one
for one, we will just have to wait and see, but we are monitoring
that carefully. Obviously the numbers on money and credit and
nominal demand will be key factors in our judgment as to whether
we need to modify the scale of the operations.
Q16 Mr Fallon: When do you think
we will know whether the £75 billion is working or not?
Mr King: It is hard to know what
the counterfactual is, of course—so that is one of the difficulties—but
I think in six months' time we should be able to look back and
see what impact this has had on money, credit and nominal spending.
We will be looking at it month by month, and we have our quarterly
forecast horizon, but I think over that horizon we certainly should
see some of the immediate impacts of the operations.
Q17 Mr Fallon: The total allocation
was 150, I think, agreed by the Chancellor. You have done 10 so
far. Would you expect over six months to have done the whole 75
or the whole 150?
Mr King: I think we would aim
to do something close to 75 in three months. We would then be
able to wait and see the impact of that and then decide what to
do, but the target we are working to is to try to complete something
of the order of 75 in three months.
I cannot be precise because how much we will
sell through the credit easing operations, the unconventional
unconventional operations, is hard to judge. As I say, the experience
of the Fed has been that, actually, they have cut back on the
scale of those sales because the operation has been quite successful
in generating private capital raising, so we might need to do
less if it works.
But we will watch this and we will aim to
do about 75 billion in three months. That is the target we are
working to.
Q18 Mr Fallon: You have moved on
from commercial paper to corporate partners. Is there agreement
in the MPC about the type of assets that should or should not
be purchased under the facility?
Mr King: There is certainly agreement
on the general level of riskiness involved. We are going for investment
grade operations—that is the remit we have been given by
the Chancellor because of the potential risk to the taxpayer—but
the choice of the individual instruments and the precise methods
has been delegated to the Executive of the Bank by the Chancellor,
not the MPC.
Q19 Mr Fallon: What is the exit plan
for all this? If you put £75 billion worth of new broad money
into the system, is there an exit plan for getting it out again?
Mr King: It may be that we do
not need to take it out, provided the further growth of money
is in line with the growth of nominal national income, but we
have an exit strategy. The obvious thing is that we would raise
interest rates, tighten monetary policy. That we can do at any
point the Monetary Policy Committee decides. The key anchor for
us is the inflation target. That is what will guide the exit strategy.
We have to take actions that we feel are consistent with keeping
inflation close to the target in the medium-term. We will have
to consult with the Debt Management Office and obtain their agreement
to sell the assets, and that is reasonable because we got the
Debt Management Office to agree that they would not offset our
purchases through their issuance strategy. So the one thing that
has to be done is that any operation we carry out with these asset
purchases, perhaps subsequently sales, has to be co-ordinated
with the Debt Management Office.
1 <ep<nh Note by witness: This facility
in fact opened in the first week of October. Back
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