Witnesses (Questions 1-48)|
SIR MERVYN KING, PAUL TUCKER, SPENCER DALE, DR ADAM
POSEN AND PROFESSOR DAVID MILES
28 JUNE 2011
Q1 Chair: Governor,
thank you very much for coming before us today. I think we can
go straight into questions.
Sir Mervyn King: Yes. Given that
the Mansion House speech was two weeks ago and the minutes came
out last week, I don't think there is any need to update you through
an opening statement.
Chair: We feel statements are only really
needed where there is some good market reason for them.
Sir Mervyn King: There may be
Chair: We have had that discussion before.
I would like to begin by asking you about sovereign risk and what
probability you ascribe to the risk of a Greek default.
Sir Mervyn King: I personally
don't ascribe a risk to Greek default. That is not for me to do.
Some calculations that we published last week in our latest Financial
Stability Report, based on a number of assumptions that may
not hold, suggested that the market ascribes a probability of
80% to some aspect of default, depending on how big a default
it was. But it is not for me to say or judge and, indeed, I think
the more important thing is to try and tackle the underlying problems
than speculate about whether there will or will not be a default.
Q2 Chair: But in
order to make an assessment of the effect on the UK economy, you
have to also make a judgement about those sovereign risks, don't
Sir Mervyn King: We certainly
have to make a judgement about the impact of those sovereign risks
and what would happen if there were to be a default, but it is
less helpful at this stage to worry too much about the finer points
of whether the probability is 85%, 70% or some other number.
Q3 Chair: In other
words, although you are not second-guessing the markets, are you,
for the purpose of the work you have done on this, taking the
market judgement as your base camp?
Sir Mervyn King: No, what we are
doing is to say that there is sufficient concern in the market
about the possibility of a default for us to think carefully about
contingency plans and the consequences of this event.
Q4 Chair: You have
done that. It is clear that you have given quite a bit of thought
to this, and that is set out on pages 18 and 19 of your Financial
Stability Report. In your press conference, first of all,
you make it clear that you think that this is a solvency crisis
and not a liquidity crisis, and as it is a solvency crisis, you
then go on to say that there are only two routes out of this.
One is forgiveness or gifts and the other is a step improvement
in the relative competitiveness of the economy concerned; in this
case, Greece. If the only routes out are one of those two, what
do you think is the most likely?
Sir Mervyn King: That is a political
judgement, and I wouldn't want to stray on to that terrain. It
is not for me to second-guess what people would like to do. All
I would say is that I think this problem goes much wider than
just the euro area. One of the problems in the build-up to the
financial crisis was the continuing pattern of trade surpluses
and trade deficits, which, as a matter of arithmetic, means that
some countries were continuing to borrow from other countries
on a continuing and substantial scale, and what the crisis revealedas
indeed had been said many times before the crisis hitwas
that this was unsustainable and could not carry on. So if it is
unsustainable the question is how you make the adjustment. All
countries are in that position. The United States has to make
an adjustment and we have to make an adjustment. We have made
the adjustment in terms of a fall in the nominal exchange rate,
which has improved the competitiveness of UK industry such that
we can now rebalance our economy and, one way or another, that
same process of adjustment has to take place in all countries
that were running substantial current account deficits and had
built up significant stocks of net external debt.
Q5 Chair: When you
talk about a mechanism for improving competitiveness, you are
talking about devaluation, aren't you?
Sir Mervyn King: No. Ireland has
pursued a different strategy, which is to reduce domestic wages
and prices in order to become more competitive. They have had
some success in following that strategy, but of course it has
the side effect that if you have fixed nominal debt, external
debt which is denominated in foreign currencyor at least
in a currency, in their case eurosand they reduce the euro
value of their domestic wages and prices, the real burden of the
debt increases. So what they gain on the swings, to some extent
they lose on the roundabouts. But each country has to work out
for itself the best way of trying to deal with the economic logic
that if you have a very large net external debt and you want to
continue to service that debt, the only way to do it is to run
trade surpluses. That is the economic logic. It has applied over
many periods in history and it applies now, it applies to us,
but it particularly applies in the euro area and it is up to them
to find a way through it.
The point of my remarks on Friday was to say
that, whereas providing liquidity support may buy time to put
in place a long-term strategy under which this competitiveness
can be regained, so far the time that has been bought by the provision
of liquidity has not really been used to put in place programmes
that will guarantee a significant improvement in competitiveness.
Q6 Chair: Your replies
did not give the impression that you think buying more time is
useful; indeed, you add the words "may be useful". You
are not advocating buying more time now, are you, Governor?
Sir Mervyn King: It is not for
me to suggest what should be done. What I am pointing out is that
buying time is not sufficient. That time has to be used.
Q7 Chair: Is it in
the UK's interest that more time be bought?
Sir Mervyn King: That is not for
me to say. That is for the Government to say.
Chair: That ball will be very much in
your court if instability becomes a crisis.
Sir Mervyn King: It will indeed,
and I think we all have an interest in trying to find a way through
it. Buying time appears attractive very often, because the immediate
crisis appears to go away. People get to bed earlier, they relax
more, but in fact, if the underlying problems have not changed,
the crisis comes back in an even more severe form, and that has
been the case right through the past 18 months in trying to deal
with Greece, Portugal and Ireland, and indeed in the problems
for the euro area as a whole, which is why I say that there are
dangers in just buying time, because if you forget the problem
and say, "Well, thank goodness that has gone away for a few
weeks" that can be a very dangerous attitude of mind.
Q8 Chair: You are
giving very full and interesting replies to these questions, and
I understand your reticence in certain aspects of your replies.
You have also said that uncertainty is a majorperhaps the
majorcause of problems at the moment in the markets in
this area; it is not knowing exactly where the risk is, including
where the risk is for the UK economy. With that in mind, coming
back to my first question to you, don't you think that one way
of reducing uncertainty is for the major public institutions to
be more forthright about what risk rating they ascribe to sovereign
Sir Mervyn King: I certainly think
that, in the present circumstances, more transparency about sovereign
exposures would help, certainly, yes, and I think the willingness
to be transparent about that might help to give more confidence.
Of course, it will also reveal some of the interlinkages, and
I don't want to pretend that there is any easy solution from the
position that we are now in.
Q9 Chair: So while
you haven't been prepared to give me your probability of default
risk for Greece, you think that it might be helpful for the eurozone
to do so?
Sir Mervyn King: No, I don't think
there is any point speculating on probabilities of default. Where
there is value is in trying to ensure that financial institutions
and governments are very open about their exposures to other countries,
both sovereign banks and private non-financial sector exposures,
and I think that can do a great deal to help financial markets
evaluate where the risks are. I think financial markets have to
make their own judgement as to what the political outcome of this
process will be, because in large part it is a political process.
If there is a credit default event or there is a sovereign failure,
then that will be a political judgement and a political decision.
I don't think it is easy to decide that on purely economic grounds.
What can be done is to be transparent about the facts, as we are
now, the exposures, and then financial institutions can make their
Q10 Jesse Norman:
Governor, what contingency plans have you put in place against
a Greek default?
Sir Mervyn King: Against?
Jesse Norman: A Greek default.
Sir Mervyn King: I am not going
to go into details about the contingency plan discussions that
we have had with the Government, but what I would say is, if you
look at the provisions for liquidity insurance that we have put
in place for our own banking system, they are radically different
from the ones that were in existence in the summer of 2007, when
the financial crisis began. We learnt from that experience, and
we have put in place now special auctions for liquidity, which
we can introduce immediately if we need to. They are held at regular
timetables now but we could hold them tomorrow if we had to. These
auctionsI think it is a first in the worldthey have
been very carefully designed so that banks can bid against either
narrow or broader collateral, and that gives us a signal about
the potential degree of liquidity strains, and there is the discount
window facility, which is a new facility against which we lend
against almost any collateral but with increasing haircuts as
that collateral becomes riskier.
It is also the case that the FSA, working with
ourselves, are looking very carefully at the exposures of all
UK financial institutions. What I would sayand I think
this is the concern that no one can do very much aboutis
that the economic logic that I explained about countries with
large amounts of net external debt, and the need to convert trade
deficits into trade surpluses in order to be able to service that
net external debt, applies to a number of countries and not just
Greece. If, as their crisis evolves and develops, financial markets
came to the view that these problems had not been tackled, there
was no long-run plan for dealing with the need to regain competitiveness
in these other countries, then of course the crisis could not
only spread, but it would lead people to speculate, "Well,
okay, here is a UK bank, which we are told has rather little exposure
to Greece and we can see that, but we don't necessarily know all
the exposures of the French and German banks to which the UK banks
are themselves exposed". So trying to work out these other
links is very hard to judge.
As I said on Friday, even knowing the mechanical
linksa matrix of interconnections between banksdoes
not guarantee that there can't be a sudden loss of confidence
in which those who fund banks decide to step back and say, "Look,
we have no idea which European bank is exposed really to which
other European bank, therefore we will just stop funding European
banks". I think US banks and other national banks could be
drawn in in those circumstances. I am not saying that is the most
likely event, but it is the sort of circumstance that we ought
to be concerned about and try and find a way of dealing with it.
As we saw in the crisis with banks themselves,
in 2007, 2008, of course everyone involved, the management, the
shareholders of banks desperately wanted to believe that this
was a liquidity problem, but it wasn't. It was a problem of excessive
debt, excessive leverage, and in the end, the only solution that
worked was not one of providing liquidity. Yes, we had to provide
it to buy time, but what worked was the recapitalisation of the
banks to put in more capital to make the underlying problems manageable.
It took two goes to do that but it was done, and I think that
is the big lesson, which is, if you ignore the underlying problems
and just pretend this is a matter of liquidity provision, in fact
the underlying problems may just go on getting worse before you
get around to dealing with it. There is no alternative ultimately
for dealing with the fundamental problems.
Q11 Jesse Norman:
Thank you for that very full answer. How serious is the issue
of our indebtedness due to public sector pensions in this country?
Sir Mervyn King: That is a completely
different question, and I think one of the things that we have
learnt from the euro area crisis is that the fundamental problem
there is one of external indebtedness. That is not relevant to
the question of pension provision in the UK.
Jesse Norman: I have changed the
Sir Mervyn King: Yes, you are
changing the subject. I think, in trying to assess the state of
the public finances, one should look at not just the current payments,
and the current deficits, but future liabilities. Of course that
has to be judged in the context not just of future liabilities,
whether it be pensions, PFI projects or any other kind of liability,
but also assets. So you have to make a projection of potential
tax revenues and growth of the economy and the age distribution.
Now, there is a broad band of work, and indeed the Treasury published
some work on thisit is called intergenerational accountingin
trying to produce numbers. The difficulty with all of that work,
as you can imagine, is that the numbers are incredibly sensitive
to small changes in judgement about growth of population, pension
provision and so on. So I think we certainly ought to look at
the public finances in the context of these long-term developments,
and one of the great contributions that your Committee can make
is to ensure that each time the annual Budget is discussed, it
is discussed in addition with the context of what is the long-run
outlook for public finances, not just the deficit over the next
two or three years.
Q12 Jesse Norman:
Thank you. Obviously, it seems to me on the public sector pension
side, there is no compensating asset, it is merely a liability,
is that not right, and would it not be quantified to some degree
Sir Mervyn King: If it is an unfunded
pension scheme, yes.
Jesse Norman: Yes, which most
of these are.
Sir Mervyn King: Not all, but
most of the ones applying to general Government are.
Jesse Norman: Have you made an
estimate within the Bank of the scale of this indebtedness?
Sir Mervyn King: No. That is the
Treasury's responsibility. They have done work on this and I know
they have talked to outside experts in this intergenerational
accounting. I suggest you talk to them about it.
Q13 Jesse Norman:
How far did you consider, if it all, and how sensitive are your
judgements about inflation and interest rate levels to the possibility
of foreclosures in the housing market?
Sir Mervyn King: Clearly we look
at this, because it could affect consumer spending and one of
the weaker items of aggregate demand at present is consumer spending.
In large part, this is reflecting the inevitable adjustment over
the next few years from domestic demand to net external demand.
It is our way of dealing with this problem of the trade deficits
that accumulated. So we expect to see relatively weak consumer
All I would say is that, at present, what is quite
interesting is that we have seen a 15% fall in house prices; it
has come back a bit, house prices are broadly flat at present.
Activity is certainly very weak, but the number of mortgage arrears
and the number of repossessions is way down on anything that we
saw in early 1990s. Of course a moment's reflection suggests that
the answer to that is that whereas, in the late 1980s, early 1990s,
interest rates doubled to 15%, they have now gone in the opposite
direction, so that someone who is still in a job is, if anything,
finding it easier to service the mortgage than they were before
the crisis hit. So that is one reason why the problem of repossessions
and arrears is much lower than it was now.
I know there is some concern among some people
that if interest rates were to rise, then the problem would become
very great, but I think that can be exaggerated. The reason we
would raise interest rates, certainly back to the levels they
were at, would be in the context of a much stronger economy, which
you would imagine would have unemployment, if anything, falling
rather than rising, and in those circumstances there would be
some offsetting factors. It should also be the caseand
I think this is very importantthat the interest rates that
borrowers themselves face would not rise as sharply as the increase
in bank rate. After all, when we cut bank rate, bank rate fell
by much more than the actual interest rates that borrowers were
paying fell. The spreads between the rates that banks were charging
to their borrowers and bank rate went up a great deal, and I think
that along the path of an increase in bank rate, which inevitably
will come at some point from where we are now back to more normal
levels, significantly higher than they are now, that is going
to be accompaniedyou would expect it to be accompaniedby
a process in which the spread between the rates that banks charge
their borrowers and bank rate would not go back to the very low
levels that they were, but would undoubtedly narrow.
Q14 Jesse Norman:
I question that answer in one regard, which is that you seem to
be tying changes in the interest rates to the MPC to growth in
the economy, rather than to inflation, because you have just described
interest rates as going with growth and therefore not necessarily
disconcerting homeowners. Is that really true? The second question
would be that seems to imply a rather long-term approach, in which
interest rates are going to stay rather low for a while, since
the economy is undoubtedly going to be slow for a while.
Sir Mervyn King: No, I am sorry
if I misspoke. The factors that determine the path of interest
rates are of course the path of inflation, but unless there were
to be a rise in inflation expectations, which was uncorrelated
with any pick-up in economic growth, then I think the statement
that I made would be true. We would normally expect that the circumstances
in which inflation expectations would pick up would be ones in
which people felt there was a tighter labour market and that it
was more likely that domestic prices would be put up. What we
see at present is an unusual combination, and a very unattractive
one, in which domestic wages and prices are not really rising,
but the prices that are reflecting the cost of goods imported
from overseas, or tax changes, energy prices from the rest of
the world, utility prices, are leading there to be a significant
wedge between what you can think of as domestically generated
inflation and the level of CPI.
Q15 Michael Fallon:
Mr Dale, when is inflation going to move back to 2%?
I think that is very difficult to judge, given the significant
uncertainty surrounding the inflation outlook. The projection
in the May Inflation Report was that we expect inflation
to come back closer to target in around two to three years, and
I think that remains my central view.
Q16 Michael Fallon:
Two to three years. I see. Have you seen the Centre for Policy
Studies' report showing that in the 12 quarterly Inflation
Reports from August 2007, the average forecast for inflation
a year ahead by you was 1.9%, but the actual was 3.2%? That is
an average error of 1.3%. Why should we believe you this time?
Spencer Dale: I haven't seen that
actual report, but the fact that inflation has surprised us I
am perfectly well aware of. Looking back over the last few years,
there are two main issues I think where we've been surprised and
why inflation has turned out stronger than we expected. The first
was the degree of pass-through from the low exchange rate into
retail prices has surprised us. I wrote a speech explaining the
nature in which we were surprised and how we have learnt from
that surprise. As a result we now expect greater pass-through
The second aspect is that oil and other commodity
prices have all increased very substantially relative to what
we expected. The prices of oil, food and metal prices have each
increased by between 30% and 45% over the past year. I don't know
of any forecasters or of any financial markets that expected that
increase. These two factors, account very substantially for the
stronger than expected inflation over the past year.
Q17 Michael Fallon:
How long can you keep looking through current inflation and still
maintain forecasting credibility?
Spencer Dale: I think the key
issue for us is we have to explain, if inflation turns out to
be stronger than we expected, why we think that is the case and
what lessons we should learn from that; then secondly, provide
a good rationale, an explanation for why we think inflation will
gradually moderate. That explanation is very much along the lines
the Governor was just suggesting. We think much of the strength
of inflation is driven by factors which only have a temporary
effect on inflation, either emanating from the rest of the world,
particularly in terms of commodity prices or the increase in VAT,
and that domestically generated inflationmost obviously
in terms of wagesremains quite low. So as those price level
effects wear off from inflation, you would expect inflation to
moderate towards the level of domestically-generated inflation.
Q18 Michael Fallon:
David Miles, in the last Quarterly Bulletin, the Bank says,
"There is little evidence that inflation expectations have
become significantly de-anchored, and few signs that they have
affected prices or wage-setting behaviour". Do you agree
Professor David Miles: I do. I
think if you look at the surveysand we look at a lot of
surveys on the MPC of household expectations of inflationover
the near term, the next year, they have moved up quite sharply.
Of course, that pretty much matches our own best guess as to what
inflation will do over the next year or so. But I think the more
important question is; what do people think about where inflation
will be two, three, four years down the road? There the story
is a slightly different one, and my reading of the surveysand
they point in slightly different directionsis that expectations
three, four years down the road are not very different now from
the average over the period 1997 to 2007 when, on the whole, inflation
was pretty close to the target. I don't look at the surveys and
say, "Here is a clear sign that people have lost faith that
inflation will ever come back to the target level".
Michael Fallon: But your own chart
in the last Inflation Report, chart 4.8, shows that for
two years ahead, household expectations are running at twice your
Professor David Miles: Inflation
over the next two years starting from now? I think on our own
forecasts, that is our own best guess as to what we think will
happen, the most likely outcome is that inflation will stay rather
substantially above the target level. So I think what the household
expectations are doing is in a sense reflecting the information
that we process ourselves, and the view isn't that different from
our own internal judgements.
Q19 Michael Fallon:
How do we reconcile these two things: the bulletin saying there
is little evidence of significant de-anchoring, and the Inflation
Report showing that household expectations are twice yours?
Professor David Miles: I am not
sure that they are twice ours. They
Michael Fallon: Yes, they are.
That is what chart 4.8 at page 36 shows; two years ahead, household
expectations are twice yours.
Professor David Miles: Sorry,
which chart are we looking at again, please?
Michael Fallon: 4.8.
Professor David Miles: These are
the changes. Looking at this chart, these are the changes in expectations.
I am not sure we are looking at the level of expectations of what
households believe inflation will be over that period. I think
that the key question here is, is there evidence that, looking
further down the road, households clearly believe that inflation
will not come back to the target level at any time? There is a
risk of course but I don't think there is clear evidence yet that
that is the case.
Michael Fallon: Mr Posen, do you
see any evidence?
Dr Adam Posen: I would take very
much the same tack that my colleagues Spencer and David did, but
I would put it a little more forcefully. The household expectations
measures are signs of concern and experience by households. They
matter, but they are not a good forecast for what is going to
happen. When we speak about inflation expectations being de-anchored,
we are talking about things like exchange rates and gilt markets,
which have not responded in any way. When there has been new information,
they do not act as though, "Oh that means things are flying
out of control". For example, last month, following the minutes,
the estimate in the markets of when the MPC would raise rates
moved more than six months further into the future. That had no
meaningful effect on sterling or gilt prices. I believe this relates
to what Spencer and the Governor have previously said. Our job
is not to blindly hit the target. Our job is to explain and justify
why we are taking the approach we are, and people in markets and
people in professional forecasting have broadly understood what
we are doing. They may not approve of it all, but they broadly
understand why we are doing it.
The final point I would make, sir, is thatand
again, this picks up on something I believe David was just sayingthe
issue isn't just what people report in a survey. You could ask
on a survey about pensions, as Mr Norman raised, and they will
tell you all kinds of things that may or may not be accurate.
The issue is, are they able to then demand wages that are out
of whack with the growth in productivity, and there is absolutely
no sign of that in the UK economy right now.
Q20 Michael Fallon:
You are pretty dismissive of household views, aren't you? I mean,
how do we
Dr Adam Posen: No, I am quite
dismissive of household forecasts. I am not dismissive of household
Michael Fallon: Okay. But if your
own forecast over the last three years has been out on average
by 1.3% every time, forecasting inflation a year ahead, why should
we be so dismissive of households that expect it to be higher
than you do?
Dr Adam Posen: You will see that
households were off by more than we were in the past. Secondly,
I think Spencer mentioned two of the reasons why our forecasts
were not accurate, but I think we are overlooking another. That
is the VAT increase that came through automatically as part of
CPI inflation, and for obvious political and legal reasons we
don't put a VAT into our forecast ahead of an election. So part
of the reason our forecast was too low was because it was not
our place, ahead of the election and the decisions by the current
Government, to say, "Oh inflation is going to be up 1.5%
because they are going to raise VAT by 2.5 points and they are
going to raise indirect taxes". So I think we did have an
errorI completely agree with Spencerand as I said
to the Members of this Committee last time I appeared, we got
it completely wrong on the exchange rates. We are accountable
for that, we got that wrong, we should be held accountable for
that, but I do not believe the full magnitude of the literal subtraction
you are doing, sir, represents what happened, because of the VAT
Q21 Mr Mudie:
Adam, I think we are going to overwork you, you are getting another
question. The June minutes suggest a member of the committee was
asking for an immediate expansion of the committee's programme
of asset purchases, quantitative easing. I toyed with the delightful
thought it might be the Governor, but I settled on you. Was this
you, and why are you particularly continuing to press for quantitative
Dr Adam Posen: Thank you for the
question. I appreciate the opportunity to explain my views. It
was indeed me who voted that, and I believe the minutes are out
so there is no secret that it was me. That is a consistent pattern
I have been voting for some time. Again, as Mr Fallon raises,
my forecasts may be wrong but if the previous question had been
to me about what I expect inflation to be a year from now, I expect
it to be below target. Again, there will be a spread of things
around it, events in the euro area; the kind of confidence shock
the Governor spoke about could wipe all this out and make it moot.
As I said in a speech last night, I and my colleagues
on the committee have made a judgement call about energy prices,
that they are likely not to go up at the continuous rate that
they did in the first part of this year. If we are wrong about
that, even I, the über dove, would have to raise rates. That
said, on the assumption that energy prices largely, on average,
only go up a little and the assumption thatGod forbidnothing
terrible happens in the euro area, my belief is that inflation
will be well below target by this time next year, and two years
This goes to the three issues that I raised the last
time I was before the Committee that seem to have been borne out
by events: first, that consumption would be weaker than was in
the MPC's modal forecast, in part due to the fiscal contraction,
and part due to the savings issues the Governor has raised, and
consumption has indeed been weak; second, that wage increases
would be weak. Workers would be unable to get back in real wages
what they have been losing in inflation and other things. That
again has turned out to be the case. Thirdand this is probably
my point of biggest difference with some of my colleagues on the
MPC, and in the spirit of what I said to Mr FallonI do
not believe that long-term inflation expectations in the financial
markets or in wage-setting are moving in response to the previous
misses, because we have done a reasonable job of explaining them
and reasonable people would understand why inflation has been
where it has been. They are not automatically saying, "Oh
they missed the target, so therefore I should make the bad forecast
and assume they are going to inflate everything away". That
would be a false forecast.
So if you put those three things together, I expect
consumption to be even weaker than is already in the IR;
I expect wage growth to be weaker than is already in the committee
forecast, and I do not expect any meaningful drift upwards in
inflation expectations that translate into exchange movements
or interest rate movements. Then it seems to me that the policy
is insufficiently stimulative and we should be doing more.
Q22 Mr Mudie:
Governor, you might want to comment on that, but don't you think
there is an additional reason, which is a social reason? I am
looking at what is driving the economy at the moment, and it seems
to be that we are all waiting for the banks to recapitalise and
then we can get back to some sort of normal life, but in that
time, people are going through a very hard time. Would not a bit
of quantitative easingand I think finessed, if possible,
so that the receiving banks take it on the basis that they will
deal with small businesses and households better than they are
at the momentgo some way to increasing demand and maybe
bringing a bit of growth?
Sir Mervyn King: Obviously our
task is to meet the remits set by you in Parliament, and that
remit does allow for us not to try to bring inflation back to
the target immediately if that would lead to undesirable volatility
of output, and I think most of us on the committee have taken
the view that to tighten policy now would be to risk that. I share
qualitatively much of what Adam says. Obviously, the precise quantitative
mapping of that into policy decisions, I voted for no change,
I haven't voted for an increase in asset purchases. But I think
the differences among members of the committee are easy to exaggerate.
After all, the differences range only from whether interest rates
should rise by a quarter of a percentage point now to whether
there should be an extra £50 billion of asset purchases.
I think these are differences that reasonable people can clearly
come to believe in, but it is within the broad context of a position
in which inflation is clearly uncomfortably high, and this is
representingand it is a symptom, it is not a causea
symptom of a very substantial squeeze on real living standards.
I am definitely concerned by the factors that you
mention, which is the squeeze on real living standards. I don't
believe it is easy to do much about that. This is the way in which
we as a country are adjusting to the consequences of the financial
crisis and the macro-economic rebalancing that is necessary to
get through that process. It is going to be an uncomfortable period.
There is no doubt about that. Our task clearly is to set bank
rate on a path that we think will bring inflation back to the
target in a reasonable time horizon, and I think all of us on
the committee have signed up to that, and that is what we are
trying to do. But inevitably, reasonable people can disagree about
what that policy should be from month to month.
Q23 Mr Mudie:
I just take the words you say, though, about there is not much
you can do about it, but a bit of quantitative easing is a little
that if it fed through to the economy and helped ordinary people
get a better standard of living or even maintain their standard
of living, it would be something. What is the economic reason
for not doing it?
Sir Mervyn King: I think it wouldalbeit
in very much more difficult circumstances than most in the pastbe
another example where we would be accused of having taken the
easy option and hence made more difficult the ability to get low
inflation in the medium term.
The reason why most of us have voted for no
change in bank rates so far is that, as Adam said, we have not
seen signs that the current high level of inflation is feeding
through to second round effects on domestic wages and prices.
If we were to see that, then I think we would be concerned that
our ability to meet the inflation target in the medium term might
require a much more severe policy further down the road, and there
is no reason why we should want to do that. We should take action
now. But we don't see that at present and that is why a majority
on the committee voted for no change at present.
Q24 Mr Mudie:
For what it is worth, I think the committee werenot bravevery
sensible to withstand the hysteria that went on about raising
interest rates to deal with what were external matters. I am raising
that I think that was the right decision on interest rates, but
the lack of action on quantitative easing when we have this low
growth, and in fact no growth over the last six months, is worrying.
Can I raise another question? You are here dealing
with the Inflation Report, but you brought another very
important report out, the Financial Stability Report, and
that was the first report under the Financial Policy Committee
in the new setup, and there are some important recommendations
in here, very important. The first thing is, do you not think
it would be a good idea to start, as soon as possible, the type
of hearing we have for the Monetary Policy Committee on inflation
with the Financial Policy Committee on financial stability? There
are broad-ranging recommendations in here that I would love to
get stuck into more than the stagnant world that is inflation
at the moment.
Sir Mervyn King: The answer to
your question is yes.
Q25 Mr Mudie:
Wonderful. Let me just have a first go at it, just a first go,
just one question. I was delighted with the
Sir Mervyn King: We only have
two members of the MPC here. We stand ready to answer your questions
at any time.
Mr Mudie: No, that is very helpful;
I hope it is taken up by the Committee, because I think it very
important we get in at the beginning with you. But one of the
important things, one of your recommendations, recommendation
4, on interconnectedness and derivatives and so on, your recommendation
is to the FSAI think I will read it to you"To
monitor closely". That seems to carry over the sort of behaviour
pre-crisis, where we are putting things on record and we are monitoring,
and so on. Is there an unspoken view or is there anything stopping
the Financial Policy Committee, while the FSA are monitoring and
investigating it, from starting their thoughts and starting to
warn the market that you are concerned about this, there are dangers
in the growth of this and if it gets too far the Financial Policy
Committee would be prepared to take action?
Sir Mervyn King: Yes, I agree
with you on that, and I hope that the report itself will constitute
a warning, which carries much more weight than the Bank of England's
warning could before the crisis because we had no involvement
in any process that could do anything about it. The FPC clearly
does. If the legislation that is proposed to set up the FPC is
passed by Parliament, then FPC would have the statutory powers
to direct the FSAthe then PRA, it would beto take
various actions, and also the FCA, and that is important. At present,
we don't have those powers and we can't do it, but I do think
that what matters more than anything else is that the ability
of the FPC as a body, with external members, knowing that it will
have statutory powers, should carry sufficient weight that participants
in financial markets will listen very carefully to what we say.
Q26 Andrea Leadsom:
Good morning. I would like to go back very quickly to a comment
you just made, Governor, which is that the difference between
members of the committee is tiny, it is about 0.25% increase versus
a bit more QE. But would you not agree that it might be tiny in
numerical terms, but the enormous significance of the direction
of travel is very market sensitive and incredibly important? Would
you just comment on that?
Sir Mervyn King: I certainly take
the point that when we are at a turning point for policy the market
is concerned about the direction of travel, but I think that the
big picture is one where the challenges facing the committee are
agreed and understood by everyone on the committee. I don't think
there is any real debate about that. The right debate, and it
is the one which we should always have, is precisely what we do
at this stage, and there is a range of views from, "I don't
think that we should engage in more stimulation now", to
the view of othersincluding Spencerthat we should
now start the process of tightening somewhat. Both of these views
have very good arguments in favour of them. It is a difficult
balance, and no doubt at some point we shall do one or other of
those actions. But the future will tell us that. It is the evolution
of the economy, how the data unfolds that will tell us which to
go. I think at this stage, what is helpful in terms of the debate
is that we can alert everyone in the market to what the arguments
are, and I think that is the most important thing. Everyone in
the market has their own view as to where the economy will go,
but what we want to do is to point out to them in our judgement
what the balance of risks is to inflation, looking further, 18
months, two years ahead. That is our job and I think the debate
on the committee helps to bring that out.
Q27 Andrea Leadsom:
Thank you. In the last minutes, the external members, Adam Posen
and David Miles, note that, "The fiscal challenges in the
euro-area periphery highlighted the potential for further adverse
shocks to demand. For some of these members, it was possible that
further asset purchases might become warranted if the downside
risks to medium-term inflation materialised". Could you both
set out your views specifically on that point?
Professor David Miles: I will
just quickly say something about that. I think there are a whole
range of risks to demand and output in the UK. One of the big
ones at the moment, as we have already discussed this morning,
is what is happening in the peripheral areas of the eurozone.
Who knows how that will play out, but clearly there is a possibility
it plays out badly and has a negative knock-on impact on demand
in the UK. My own view is that if that were to happen, or indeed
if some of the other risks to demand and output in the UK were
to materialise, that would make it much more likely that I would
vote for further asset purchases, because we would want to offset
that. I think if we did not do that the path of likely future
inflation would move down, because unemployment would be greater,
slack in the economy would be greater, and I think it would be
appropriate to respond to that by having a more expansionary monetary
policy. That is not what I think the most likely outcome is but
it is certainly a possibility.
Q28 Andrea Leadsom:
Can you give us the benefit of your views on what are the biggest
adverse shocks, because obviously the eurozone is a very important
potential adverse shock. You said that there are others. Can you
tell us what they are?
Professor David Miles: I think
the degree of confidence among households in the UK about their
economic future is extremely fragile. My best guessthe
thing I think is most likelyis that output will start growing
from here, that unemployment will not rise significantly and may
stay more or less flat and ultimately may come down a bit. But
it is perfectly reasonable for people to worry about much worse
outcomes than that, and that has the potential to be self-fulfilling.
If people become even more nervous about the future, they may
decide to spend even less, the household savings rate rises, the
level of demand falls and what is currently a soft patch turns
into a more extended period of weak activity.
Q29 Andrea Leadsom:
But that wouldn't be a shock, so there are not specific shocks
you are concerned about, for example, another commodity price
shockanother enormous instability would be perhaps a default
in the eurozonethere are no potential domestic shocks that
you are worrying about at the moment?
Professor David Miles: I think
there is a potential for one of the shocks you just mentioned
to play a serious role, but it could go either way. I think commodity
prices changes fall into the category of things that would happen
to the UK. They are beyond our control, but they would have substantial
knock-on impacts, and who knows how that might play out. Just
in the last week we have seen oil prices fall 10% or more, and
who knows where they will be three or four months down the road.
But this has the potential to have a big impact, both on near
term inflation but also on disposable income and demand.
Q30 Andrea Leadsom:
Are you considering the impacts of industrial action, for example,
on the level of demand and confidence in the UK economy?
Professor David Miles: It is not
so easy to see a strong link between industrial action, which
in the short term largely looks like it will be in the public
sector, and the overall level of demand. I think it is quite difficult
to trace through significant channels there.
Andrea Leadsom: Mr Posen, would
Dr Adam Posen: I will try to be
brief. Thank you, Ms Leadsom. I essentially begin with what the
Governor said. We are agreed on most of the channels and the mechanisms
of how the economy works, so my mean expectation is a step down
from some of the others and then my explanation of what the shocks
would do is very similar to theirs. It just starts off from a
less good place. To me, there are three major shocks. Obviously,
the first is the euro area. The primary effect of that would be
through trade and demand because, as the Prime Minister has pointed
out, we still trade more with Ireland than we do with all the
BRICs combined. Critically, the issue is the financial market
shocks, the potential for lock-up of liquidity and withdrawal
of banking the Governor mentioned, and which the report of the
other committee came out with last week.
Q31 Andrea Leadsom:
Sorry to interrupt you but, on that specific point, do you think
that the Bank of England now has the remedy in place? Do you think
that the potential for another crisis of liquidity, a complete
sort of drying up of liquidity, is possible to happen again or
do you think that there are systems in place to deal with it?
Dr Adam Posen: I am fully confident
that the system we now have in place to provide emergency liquidity
is a huge improvement over what existed prior to 2007-08. I am
also fully confident thanks in part to my colleagues, the
Governor and Deputy Governor Tucker and their colleagues in the
financial stability sidethat they have done more to track,
reveal, force recognition of the most vulnerable banking aspects
of the UK in this area. It is not my place to judge but, just
as a fan, I fully support what they have done and I fully support
the call for transparency.
It remainsand this leads back to a point
Mr Mudie was raising that I just wanted to go back tothat
the small and medium enterprise sector in the UK is particularly
vulnerable to banking crises. That is true in every advanced economy
because it is banks that do most of the lending on secured loans
and relationship banking for small business. They have very few
alternatives. When banks contract, banks then only do very gilt-edgedif
you'll excuse the expressionlending. We are already seeing
some of that. It has not been sufficiently bad to keep the GDP
numbers on investment from being decent, but I share Mr Mudie's
concern and I have spoken about this in the past.
If there were to be a financial problem in the euro
area or, say, through the US banks, which the Governor rightly
raised, that would probably reduce liquidity for small and medium
enterprises in this country, and that is serious about employment,
that is serious about investment, and that is serious about inflation.
It is very difficult to imagine, all else equal, inflation going
up fast in that environment.
Q32 Andrea Leadsom:
One last question to turn this argument on its head slightly.
In the event that the next direction of travel was in fact to
tighten, are you considering the net effect of raising interest
rates versus reversing QE, because, for example, obviously if
you were to raise interest rates by 0.25% and then start to reverse
QE, you would have the impact of a tightening without the knock-on
effect for mortgage owners. Does the Bank take into account the
impact of raising base rates on home owners specifically?
Sir Mervyn King: Our remit from
you in Parliament is to take account of its impact on inflation,
and that is what we will do. We had a committee discussion on
this, and we said that our instinct would be that we would start
by raising bank rate and then move to discuss the speed at which
we would want to reverse the asset purchases. The reason why we
would start with bank rate is because we feel it would be sensible,
with asset purchases, to unwind that programme through a programme
of sales over a number of months. That is better done in the context
of a period in which the committee felt that it was pretty confident
that it would want to engage in some tightening over a three and
six-month period. I think it is very hard to find yourself in
that position before you have made the first move. So I think
that we would make the first move on bank rate and then we would
debate among ourselves the relative merits of unwinding asset
purchases, versus further increases in bank rate. That of course
is a hypothetical question. It is one that the committee will
return to when it finds itself in that position.
Q33 Mark Garnier:
David Miles, you spoke at the Home Builders Federation policy
conference in March, talking about the housing market and the
mortgage market. You talked about a transition in the housing
market from one equilibrium to another. Two parts to the question:
how long do you think that will take and how do you see the new
equilibrium in the future?
Professor David Miles: I think
the transition is from a world in which mortgage pricing and the
availability of mortgage was at unsustainable levelsI am
talking about 2005, 2006 and 2007, before the financial crisis
really hit usa transition from that world to something
that is more sustainable. In that more sustainable world, I expect
that the spread between mortgage rates and Bank Rates on new mortgages
will be a bit higher, and the deposit that people need to raise
before they enter the market will also be a bit higher. On the
transition, I think that means that the number of first-time buyers
falls very, very sharply. That is what we are in right at the
moment. I did a rather simplistic "back of the envelope"
calculation, described in that speech, which suggested that the
transition might last four or five years or so. I think it is
very hard to be precise about that. If four or five years is of
the right order of magnitude, and you thought that that transition
got under way once the crisis had reached its worst point at the
end of 2008, one might be looking for 2012-13 transactions to
be moving back to a more normal level. I think it is that kind
of timescale. I don't think one can predict to the nearest quarter
when things, in terms of transactions and mortgage lending, might
move back to more normal levels, but I suspect it will happen
some time over the next few years.
Q34 Mark Garnier:
If you are talking about the mortgage market going back to a more
traditional level, say 10 or 15 years ago, before the bubble was
created, does it not follow then that the housing market will
go back to a similar sort of level? I was thinking specifically
of the average house price versus the average wage, which on a
long-term basis has been around 4½ times, and I think went
to around 8½ times during the bubble, and is still quite
high. Do you think that means we are going to have a long-term
correction of the housing market alongside the
Professor David Miles: I am sceptical
as to whether one would expect the level of house prices relative
to people's incomes to return to some average from the past, partly
because a couple of things have changed. Firstly, on average,
we have become richer through time, and the supply of land in
the UK is fixed. Therefore, you would expect real house prices
to move up, maybe even relative to people's incomes. Secondly,
the level of long-term real interest rates for many years now
has been substantially lower than was the case in the 1950s, 1960s,
1970s and 1980s. Those things will have an impact on the long-run
ratio between house prices and people's incomes.
I think one thing we should expectand we have
seen it alreadyis that the level of owner/occupation in
the UK might move back down to a slightly lower level than we
had a few years ago, and I don't see that as a harmful or bad
thing. It will mean we have a slightly bigger rented sector but
that is not a sign that the market isn't working properly.
Q35 Mark Garnier:
Can I just finally turn to something you mentioned a bit earlier
in Ms Leadsom's questions. You said households' view of their
own economic outlook is fragile. To what extent do you think households,
as a result of this long period of low interest rates, are now
a lot more sensitive to interest rates? Again, with your answer,
I am looking for two things. One is, first of all, in numeric
terms, what is their sensitivity in terms of, if interest rates
go up have you calculated the numeric impact? I think also, very
importantly, is their knowledge of their sensitivity, their understanding
of interest rates and what it means if interest rates start going
up in terms of their day-to-day living standards?
Professor David Miles: It is certainly
true that the total amount of household debt in the UK, relative
to the size of the economy, is significantly larger than it was
10, 20 years ago. Although it has moved down a little bit relative
to income, more recently, it is still at a much higher level than
was true in the 1970s and 1980s. That in itself would suggest
that the sensitivity to a change in interest rates, mortgage rates
in particular, will be a little bit higher. But I am not so pessimistic
about the risks that arrears and repossessions move up very sharply
as interest rates move up a bit. Part of the reason for that is
that there has been very little net new mortgage lending in the
last few years. What that means is that the vast majority of people,
with a mortgage right now in the UK, had that mortgage more than
three or four years ago, and therefore were used to an environment
in which their mortgage rate might have been 5% or 6% and therefore
materially higher than it is today.
Q36 John Mann:
I wrote and I asked quite a few questions last year suggesting
that, using the barometer of Retford High Street, in small towns,
as this year went on, we would see significant brands exiting
the high street and we would see small traders either going under
or throwing in the towel. That seems to be happening. Indeed,
just today we see the news with Thorntons, which is one of precisely
those brands that I anticipated would retrench out of many high
streets. Mr Dale, you are the Chief Economist, do you think this
process is going to continue in the small towns across the country
throughout the rest of this year?
Spencer Dale: I think the broad
pattern that consumption will remain weak may well continue. What
we have seen in the past couple of years are very sharp falls
in consumption, and I think that has possibly contributed to some
particular retail stores going out of business. I don't expect
to see further significant falls in consumption, but the fact
that we may see very weak consumption growth over the next year
or so I do think is likely, for the reasons that the Governor
and others have outlined.
Q37 John Mann:
One of the consequences of thisand the reason I suggested
the second half of this year was because of the impact of public
sector job losses, but also of job movements from small towns
to larger centres, which is also going onis of course there
is a knock-on effect. When it comes to the small trader, the small
business, and you are looking at quantitative easing again potentially,
Governor, what is the downside for small businesses if you went
for the QE?
Sir Mervyn King: The arguments
for and against QE for our view would have to be not to do with
particular sectors of the economy, whether it is small businesses
or home owners, but to do with the outlook for inflation, and
that is the basis on which we have to make that judgement. One
of the things that is going on at present is a significant deleveraging,
a contraction of bank balance sheets. The sectors that are suffering
most from thatas Adam referred to earlier onare
those parts of the economy that don't find it easy to raise finance
by issuing equities or bonds on the market but rely on banks.
That is very much the SME sector. Lending to businesses by banks
is still falling. That is not an environment in which it is easy
for small businesses to operate, and clearly that is a concern
for the long-run health of that small business sector. I said
to this Committee before I thought there were only two ways through
that: one was to either use the ability of Government-owned banks
to lend to SMEs or to wait until the banking sector got back to
health, would begin to lend again, and to encourage more competition
in the banking sectors. Governments of both parties have gone
for that second option.
Q38 John Mann:
What about the impact if the US follows the same approach? Is
that going to have an impact on whether you would determine further
Sir Mervyn King: No. I regard
quantitative easing as a perfectly conventional monetary policy
tool. It was used and debated at great length in the 1980s. This
is nothing new. It had a different name then. It was called "over-funding"
and "under-funding". This is something that we can do.
I think it is of particular relevance when interest rates are
extremely low, but nevertheless it can be used at any point. We
will do this entirely on our judgement about the outlook for the
Q39 John Mann:
But the US is doing the same thing. Isn't there a potential impact
on world commodity prices, and isn't this going to again disproportionately
impact against SMEs who don't have those options through bonds
Sir Mervyn King: Overall policy
is bound to be concerned with the objectives of each country,
that is to do with inflation, and if we feel that there is a threat
to inflation caused by easing policy, then we won't do it. But
you are right to say that the process of adjustment from the pre-crisis
position to the new equilibrium we need to get to is one, which
in that transition, makes life particularly difficult for those
firms and sectors of the economy that depend on finance from banks.
Q40 John Mann:
A final question, perhaps for the external members. It does seem
to me that there are policies now having a disproportionate impact
on SMEs, as opposed to the rest of the business sector, and that
SMEs are getting trappedespecially the small SMEs, such
as the sole tradersin a situation with increasing inflation
that they are not going to get out of in many instances, and that
we could even see a restructuring of the whole economy based on
that that could be to our long-term detriment, and I wondered
what you thought about the position. Are SMEs being overlooked
too much in what we are doing?
Dr Adam Posen: As I think you
are aware, Mr Mann, I, David Miles and the Governor have all spoken
out in the past about this issue, so at least I certainly share
your concerns, and I am just back from visits to the Potteries,
to Aberdeen, to North Wales and Bangor. I have visited groups
of small businesses several times over the last couple of months,
and the concerns about funding as well as about inflation are
very real. I think going beyond what the Governor says, though,
about our need, in line with the remit we have been set to focus
on the economy as a whole, I would additionally point out that
no matter what the policy would be, in a time of higher inflation
or a time of contraction, SMEs will always suffer more. It is
like in a sense if the flu is coming aroundand I don't
mean to be patronising the SMEsif you have children, they
are inherently more vulnerable than adults. SMEs, especially the
smallest ones, especially retail-oriented ones, are going to inherently
be more vulnerable than other companies, because of this dependence
on external finance that is harder to get.
That is why I fully support what the Governor has
said and some of the things the Independent Commission on Banking
has said. As I was saying just yesterday in Aberdeen at the Institute
of Directors and then at the Chamber of Commerce, we need more
competition in the banking sector in the UK; we need more Government
programmes, to the extent that we cannot rapidly get up competition
for lending and provision of finance from Government in the UK
economy, and that is not something that our interest rate policy
can affect one way or the other without doing great harm to the
rest of the economy.
The final thing I would say is you mentioned
the idea that maybe we are having a long-term restructuring. Clearly
there is something changing in the high streets, so when last
summer I was in Caithness, there is a huge Tesco right up there,
just a few miles east of John O'Groates, and obviously the Wick
high street isn't doing very well if there's a huge Tesco; and
you have Carrefour in France and you have Walmart in the US. There
is a reason things are going that way. People seem to prefer that.
If the Parliament of the UK, or planning commissions at a local
level, decide they want to stand against that, that is their right,
but that is a kind of long-term cross-national force of people's
preferences. There is absolutely nothing I think the monetary
policy can or should be doing about it.
Professor David Miles: I will
come back very briefly on one thing. As Adam said, I think the
difficult thing for smaller companies is that their options to
finance themselves are so much narrower than for a larger company.
A larger company can issue in the bond market and in the equity
market. A larger company probably typically has relationships
with maybe three or four banks, so if one of them decides to pull
out, there may be one or two others to go to. Smaller companies
are simply not in that position. Usually they have dealt with
one bank. It may be the case that you have a smaller company that
dealt with an Irish bank that has decided more or less to pull
out of the UK. That is a very difficult position to be left in,
and I think it takes time for those companies, if they can, to
form relationships with other banks that may be in a better position
to lend to them. I would say that I have noticed a slight improvement
in the tone of this discussion. Certainly a year ago and very
definitely 18 months ago, in travelling around the country and
talking to smaller businesses, this was the number one issue they
wanted to talk about; the availability of finance, the difficulty
of getting bank finance. I think it has dropped down the list
a little bit, but what has come to the top of the list is what
has happened to their costs, and in particular commodity prices
- energy and gas and metals; you name the commodity, they have
gone up a huge amount. That is a real problem.
Q41 John Thurso:
David Miles, in your report to us, you make a very interesting
point that we have touched on a little bit before, which is the
low level of spreads between bank rates, and the rates that banks
charge when lending to households and firms remains substantially
higher than before the recession. In fact, chart 1.9 reflects
that very graphically. So a quarter point or a half point increase
in the bank rate it would be hoped would be absorbed in that,
so it wouldn't have much impact. So how big a rate rise would
be required to have an impact on inflation expectations going
Professor David Miles: There are
a lot of different channels, as I know you appreciate, through
which monetary policy can work. Some of them are the impact on
the cost of mortgages and other debt to households, but there
can also be effects on gilt yields, on the interest rates that
corporates pay when they issue money in the bond market. There
may be knock-on impacts on asset prices as well. So there is a
range of different channels, only one of whichalthough
a very important oneis what is the impact on the cost of,
I think it is likely that, at a point at which Bank
Rate goes up from this extraordinarily low level, that won't be
reflected one-for-one in mortgage rates. I would be surprised
if it wasn't reflected to some extent: in other words, I would
expect the spread between Bank Rate and average mortgage rate
on new loans to come down somewhat, but not to fall by the full
amount of whatever the increase in Bank Rate is. I think it is
a bit tricky to work out in advance and try and quantify that,
but I think we should expect there to be a less than one-for-one
increase in mortgage rates when Bank Rate does go up.
Q42 John Thurso:
Is it not the case that to a certain extent the committee is between
a rock and a hard place, because if you wanted to use an increase
in rates to achieve any measurable dampening of inflation going
forward, you would have to stick it up by 2%, or something, to
achieve anything? I mean, a quarter or a half is just going to
get lost in the wash. Therefore, given the enormous shock that
a decision like that would have on the economy, it is unthinkable,
and therefore you have a tool you can't use?
Professor David Miles: I wouldn't
say it was a tool we could not use. I would agree with you that
if all we did, at the point where a majority decides this is the
right strategy, were to increase interest rates by 25 basis points
and people thought that was the end of the story, the impact of
that in itself might be rather small. It is much more likely that
people will see a path and a progression of monetary policy beginning
with an initial tightening in policy, but more likely than not
followed by further movements in interest rates down the road,
and I think it is the totality of the impact of all that that
would likely be non-trivial.
John Thurso: The point I am trying
to get is that at the moment you are faced with a much more complex
decision than possibly in the sunny days of the past, where you
could up it a bit to get an effect or down it a bit to get an
effect, whereas this is a much more complex picture, and a simple
up and down is a much more complex decision than it might have
been three or four years ago.
Professor David Miles: I very
much agree with that. I think it is a more complicated picture,
because many of these mechanisms that looked relatively stable
between, say, 1997 and 2007 have moved in ways that it is difficult
to quantify now. So I agree with you, it is more difficult.
Q43 John Thurso:
Can I quickly come to you, Adam Posenand thank you for
the plug for Tesco in Wickand your speech in Aberdeen and
banking. I note two things. One is that in aggregate the corporate
sector has been running a substantial financial surplus.
Dr Adam Posen: Yes.
John Thurso: So the corporate
sector has quite a lot of cash and it is hanging on to it and
not doing anything. On the other hand, the banks seem to be struggling
at best, failing at worst, to get anywhere near delivering on
Merlin. So to what extent is the banking structure the problem,
and your suggestion of creating a much wider and more competitive
banking centre essential for growth?
Dr Adam Posen: Thank you, and
thank you for the plug for my speech in Aberdeen. I think this
is absolutely essential for growth for both the short and the
long term in the UK. As everybody in this room is aware, the issue
of funding domestic investment and domestic industry in the UK
is one that has been talked about since the late 19th century
and the Macmillan Commission in the '20s. But the point is this
is real. It is not just people talking about, "Oh the City".
You look at the data. Genuinely the domestic bond market, the
domestic banking market, the domestic commercial paper market
has been underdeveloped in the UK, even at the same time that
the City of London continues to provide fantastic financial services
globally. You can't easily trace and say, "Okay, therefore
investment level ongoing is lower in the UK than in other places"
although it is, and this probably has something to do with that.
In the short term, for many of the reasons my colleagues have
mentionedand you are well aware, and in line with what
Mr Mann was sayingthe situation has only gotten worse.
When you say corporations are sitting on cash
on their balance sheets, it is in part, for some of themand
I think I would argue many of thema self-defence, that
they feel they are not going to have access to credit, or the
criteria to be used for them any time they want to go get credit
will involve a much higher fee or a much longer delay, and so
they feel they have to hold more cash on their balance sheet to
self-protect and self-finance. The fact that we have corporations
that on average in the UK, and to a very broad range, are in better
financial shape and have been paying down debt, as the Governor
saysif you look at our M4 number, that is because companies
and people are paying down debtare still not able to access
credit is very disturbing.
Just to bring the point home. David was mentioning
how there are concerns about inflation, but one of the things
that I keep hearing from small business as well is concerns essentially
about variations on trade credit, on debtor days, on how long
it takes them to get payment, on big companies, and not to pick
on Tesco but say any grocer, major supermarket chain pushing back
on agricultural people, agricultural producersI have heard
this every place I gopushing down on margins. You put all
this together, some of that is unavoidable, but a lot of that
would be avoidable, if there were more opportunities for financing
for these companies, banks were forced to meet good terms and
the buyers from these small companies did not have so much financial
leverage over them. So I think this is a fundamental thing. I
think there are steps this Committee, the House of Commons, this
Government should be considering.
Q44 John Thurso:
What steps should we be considering? Sorry, I have probably overstepped
the mark on time.
Dr Adam Posen: No. Again, and
just to be clear, this is not in my remit on the MPC. This is
just my opinion; having a reasonably educated but individual opinion.
First thing, in line with what the commission has said and other
peopleincluding the Governorhave said, I think you
need to have more than four main high street banks in this country.
I think you need to have fewer banks that have such a huge share
of lending. There is obviously a transitions issue, particularly
with Lloyds-HBOS, considering the mortgage issues that the Bank
of England report raised last week, but when we, the British people,
when you, the Government, responding for the British people, execute
the sale of these shares, it is fine to talk about getting the
highest price and it is fine to talk about making sure everybody
has a share. I would urge that you consider the structure; one
of the criteria you use for how you re-privatise these banks is
how you change the structure of the banking industry in the UK.
Q45 John Thurso:
Just so I get that straight, what you are suggesting is that the
best public good may be in using this absolutely unique one-off
possibility through state ownership of a large chunk of banking
to restructure it to the advantage of the consumer?
Dr Adam Posen: Yes. You put that
better than I did. And to the advantage of small and medium enterprise,
and therefore to employment and investment in this economy. It
might cost youpenny-wise, pound-foolishsomething
in terms of the immediate benefits to the Treasury. If you break
up an oligopolistic system, the dominant players may be worth
less to the stock market because there is more competition. But
in terms ofas you correctly put it, I believethe
public good, the greater good of the UK economy, over time the
benefits would be much greater, and since we have seen when there
are banks, like Virgin Bank or other banks, that talk about coming
into the market but don't seem to be able to come into the market
and grow quickly, there are obviously some barriers to entry there
and barriers to growth of alternatives. So it seems to meas
you put it, I agreea unique opportunity to take things
that are brick and mortar, personnel and franchise that already
exist, and sell them off in a different way.
Chair: Paul Tucker, you
haven't had much of an outing this morning so far and
Paul Tucker: I was wondering when
to chip in.
Chair: before we finish, we would
like to give you something to get your teeth into.
Sir Mervyn King: He will be playing
in the second half.
Q46 Chair: Yes, he
is going to be much more active in the second half anyway, but
why don't I offer you an opportunity to comment on the Bank for
International Settlements' view that we should all be raising
Paul Tucker: I certainly don't
think it should be just cast aside. About an hour ago, Michael
Fallon asked about inflation being between 4% and 5%. This is
distinctly uncomfortable. In fact, I had been thinking of chipping
in because I am concerned that you, and the people listening,
could gain the impression that this is a committee that is uniformly
drifting in the direction of thinking more stimulus may be needed.
More stimulus may be needed. Bad things can happen, and if bad
things happen that don't threaten an upward drift in inflation,
then maybe we will have to provide further stimulus, but for me
the threshold for that would be high. I am one of those whofrom
the backend of last yearhave worried about the possibility
of an upward drift in inflation expectations. I accept the balance
of the comments made by my colleagues that so far those risks
have not crystallised, although the evidence is mixed. But the
longer that inflation remains so high, the more likely it is that
when we say, "Oh it is one-off factor. It is another one-off
factor" people in this country will think, "They use
the sentence, 'It is a one-off factor' or 'a one-off event' in
a completely different way from anyone normal'" and
Q47 Chair: BIS is
suggesting, though, that we normalise monetary policy now, aren't
Paul Tucker: You can see my votes
have been that I have not voted for that. The economy has turned
out softer this year than I would have expected. My own position
has been that we should start to withdraw the monetary stimulus
once we have securely achieved what I call escape velocity; growing
at a pace that starts to absorb the slack in the economy. The
economy has been weaker than we expected and that has not happened.
We now face another risk though. The longer that the weakness
persists, the more likely it is that the supply capacity of the
economy will get eroded, which in plainer terms means that long-term
unemployment increases, people leave the workforce, investment
remains weak and capital gets scrapped.
We could find ourselves in circumstances where the
upward pressures on inflation don't come from strong growth, but
come from an erosion of supply, and it is for that reasongoing
back to John Thurso's questionthat I do think this is a
peculiarly difficult moment to make policy. Yes, the transmission
mechanism of our instruments is more complicated than usual, but
I don't think that is the big thing. The big thing is that the
forces buffeting this economy frankly are all over the place,
making it very difficult to predict what is going on.
The only thing that we must absolutely remain determined
about, in those circumstances, is that people don't lose faith
in us and our determination to keep inflation coming down. We
are not happy that inflation has been so much higher than our
target, of course we are not. This has made life much more difficult
for the country and much more difficult for us in underlining
our credibility, and that is what we will remain focused on.
Q48 Chair: Adam Posen,
we have just heard Paul Tucker say that the BIS view should not
be dismissed, but you did dismiss it in Aberdeen pretty vigorously,
did you not? In fact, you described it as nonsense. Do you have
anything you want to add to what you have just heard?
Dr Adam Posen: Yes. It is nonsense.
Let me make a quick statement about why it is general nonsense
and then explain why I take a different tack than my colleague,
Paul, does. In general terms, what the BIS said in its annual
report was mistaken in three senses. First, they argued that there
is a general issue of running out of "room to grow throughout
the world economy". That is possibly true of China and a
couple of other overheating emerging markets who have made the
mistake of maintaining a peg to the dollar when it is inappropriate
for them. There is no evidence of that kind of overheating any
place else; possibly Germany. There is a little bit of an uptake
in wages there, but nowhere else in the euro area.
The second thing that they do that is crazy
or nonsense is that the one contribution intellectually of the
BIS in the past decade was they emphasised the fact that we can't
ignore when there is large amounts of credit growth. The large
amounts of credit growth that are uncontrolled can lead to very
bad outcomes. That is why it is quite strange to me to have the
BIS now calling for a tightening of monetary policy whenas
we were just discussinghere in the UK, and in most other
Western economies, there is basically zero credit growth. So the
BIS is standing itself on the head and saying, "Despite the
thing that we told you is the main reason, besides inflation,
you should worry about raising rates not being the case right
now, we want you to raise rates". That is why it is nonsense.
The third reason why it is an issueand
this is one place where I am very much an outlier on the committee
and in other placesis I object to the very concept of normalisation
of interest rates. There are certain things like, say, Nationwide
and other building societies who have certain kinds of long-term
contracts for whom near-zero nominal interest rates are important,
but in general there is nothing normal about a high or a low interest
rate. The only question is, is it appropriate for the economy
at that time? They are infected with this idea that something
terrible happens just because we are setting interest rates at
a given level.
So where I differ from Paul Tucker on the UKand
this goes back to my response to Mr Fallon, which may indeed be
unpersuasive, and he may find Mr Tucker's response much more persuasiveI
see no sign that people in markets, people in economic decision
places, people who are paid or put their own money on the table,
are losing faith in the credibility of the Bank of England, because
they get basic economics, they get the explanations we have given.
They know we were wrong about the exchange rate, but they know
we were largely right about the rest of it. Therefore, we are
not seeingand this is what I presented in Aberdeen last
nightany evidence of upward creep in market-determined
interest rates, any evidence of upward creep in wages, of unit
labour costs. If you compare this to the 1970s and 1980s, it looks
nothing like that. So therefore, I don't see any reason to act
in that direction.
Chair: You have been forced
to sit opposite Montagu Norman, you tell us. Who would you prefer
to have in front of you, Mervyn King?
Dr Adam Posen: I do have Mervyn
King in front of me, and that is always an inspiration.
Chair: As a more permanent reminder?
Dr Adam Posen: Oh John Maynard
Chair: That is a very
helpful contribution. David Miles, you have been scribbling away
heavily there, which suggests that you may have a contribution
to make to this debate about the BIS.
Professor David Miles: I have
not read in detail what the BIS said. If they were saying that
monetary policy should be tightened right now, then I am in exactly
the same place as Paul. My voting record is what it is. I don't
think that that is where we should be. If they were saying that
interest rates at this current extremely low level were unsustainable
and shouldn't be left here for evermore, then I think that is
a statement of the close to the blindingly obvious, which very
few of us would disagree with.
I should say I strongly agree with what Paul said
a moment ago, which is the centrality of the inflation target
and the importance of us maintainingas I think we have
to done to date, although there are riskspeople's faith
that we will bring inflation back to the target. That is absolutely
crucial. I think Paul is right to point out that there are risks.
The longer that inflation stays above target, there are risks
that that credibility may get eroded, but I don't think that's
where we are right now.
Chair: Thank you very much for coming
to give evidence to us this morning. We will take a five-minute
break and then resume on the accountability aspects.