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UNCORRECTED TRANSCRIPT OF ORAL EVIDENCE
To be published as HC 1867
House of commons
TAKEN BEFORE THE
Bank of England February 2012 Inflation Report
WEDNESDAY 29 february 2012
Sir Mervyn King, Charlie Bean, Paul Tucker and Dr Adam Posen
Evidence heard in Public Questions 1 - 101
USE OF THE TRANSCRIPT
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Taken before the Treasury Committee
on Wednesday 29 February 2012
Mr Andrew Tyrie (Chair)
Mr Andrew Love
Mr Pat McFadden
Mr George Mudie
Mr David Ruffley
Examination of Witnesses
Witnesses: Sir Mervyn King, Governor of the Bank of England, Charlie Bean, Deputy Governor of the Bank of England (Monetary Policy), Paul Tucker, Deputy Governor of the Bank of England (Financial Stability), and Dr Adam Posen, External Member of the Monetary Policy Committee, gave evidence.
Q1 Chair: Thank you very much for coming to see us this morning. Since you were last here, of course, we have had further developments on QE, and I would like to begin by asking Dr Posen whether he thinks QE2, or maybe you will want to call it QE3, will be as successful as QE1.
Dr Posen: Thank you, Mr Chairman. I think it will be. As I believe Deputy Governor Tucker has said on previous occasions, and as he and I discussed roughly a year ago, there is one major difference in QE now versus, say, in 2009, which is that we do not have the outright lock up and panic in the markets, and there is an added benefit, in the sense of being in a bad situation, that QE alleviates that problem and adds confidence. Thankfully, we are not in that kind of overt bad situation so we do not get that additional benefit. But all the other channels of quantitative easing, which my colleagues have discussed and which we have published about in the Quarterly Bulletin, remain operative. They are not as visible and as easily traced as they sometimes are when monetary policy is using solely interest rates, although I think one of the things we have learnt from communication is that people had taken for granted too much the way interest rates used to work, even in the good old days. So the bottom line is, except for that additional fillip from panic response, which thankfully is not part of our programme now, I expect QE to be just as effective as it was.
Q2 Chair: You do not think it will be made less effective by forestalling in the markets?
Dr Posen: I do not. I think there are problems in the markets, as I have gone on record several times, as have other members of the Committee, about the pass-through of interest rates and fees and wedges on what borrowers are being charged on the availability of credit, but I do not think that directly impedes QE. QE works through the asset price channel, through various other channels that we have detailed in the Quarterly Bulletin, and it will continue to be effective. There remains an agenda, regulatory, legislative and otherwise, to improve financial functioning in this country but QE is not the issue.
Q3 Chair: Just for clarity on the extent of the likely impact, Mr Bean, you are on record as having suggested that the impact of earlier purchases was something like 1.5% to 2% of GDP and 1.5% on inflation. Therefore, is it reasonable to suppose that since we have done a fraction of the original package of QE, we can take similar fractions to arrive at what we think the overall effect will be?
Charlie Bean: Yes. The numbers you quote are obviously the results of the staff analysis of the first phase and at this juncture, as Adam has already said-
Chair: On which this Committee had a private meeting with you prior to publication.
Charlie Bean: Yes. As Adam said, we expect the key channels to operate in the same fashion for this round of asset purchases as they did for the first one. Clearly it may turn out that they are slightly different, but at this stage we do not see a strong reason and it would be perfectly reasonable to pro-rate them in the way you suggest.
Chair: These are always ballpark figures.
Charlie Bean: Yes.
Q4 Chair: Dr Posen, what have we learnt from Japan’s recent economic history about the limits of monetary policy?
Dr Posen: Mr Chairman, the Japanese experience teaches us many things but, with regard to monetary policy, I would say four. The first is it is important to react quickly. I think that if you look at what happened in Japan, versus what happened in the UK, the Japanese central bank at the time in the 1990s was slow to react. So their situation was every bit as bad as ours, despite the fact that they had a booming world economy, to which they were exporting at the time, and an undervalued exchange rate. In other words, I think you can make the comparison and see a meaningful difference in our performance, given the circumstances, because we were faster to the block with QE with aggressive interest rate cuts.
The second thing that Japan teaches us-which perhaps does not fit with people’s beliefs about where I sit, but it has to be recognised as a reality-is that deflation, if you fall into it, is both stickier and a little less bad than we thought. When I first came before this Committee when I was nominated for the position I wrote a bit about that in my statement, and it remains true; deflation is much worse than a little inflation and it is very hard to get out of. But you don’t get into this downward horrible spiral that some of us worried about in Japan’s case. There is a lot more stickiness in the system.
That leads to the third thing-monetary policy. Japan has taught us that even in very flexible labour markets-like here in the UK and like Japan, where we are both very similar, we have very flexible labour markets in international comparison-there are limits to how much you can crush wages. There is what we call downward nominal rigidity. So you can either fire people, you can cut their overtime, you can give them no raise, but it is very hard to get people to take pay cuts. It is not impossible but on average it is hard to get that to happen. That means that you have a bit more of a floor to inflation than you might have thought because wage growth tends to be zero or above, even in very bad times. In my view, that helps explain part of the UK’s performance in 2009-10, wage growth went down but there was not as much fall in wages-as much cut-as maybe the situation needed.
Q5 John Thurso: Dr Posen, I am going to ask you some questions, if I may, on your termly report. You noted that "during most of 2011 the differences of opinion within the Committee about our forecasts were markedly wider than in most previous periods". Is this a good thing or a bad thing?
Dr Posen: As a process thing it is a good thing; as an event it is a bad thing. I would note that I believe the Governor made a similar characterisation at various points, and that is where I want to praise the process. This meant, as has been the strong tradition and mode of the Monetary Policy Committee since its founding, that individual members are accountable for their views in a way that is not true at other major central banks, that individual members can differ with the Governor, with the majority of the Committee, ideally constructively-I hope I was constructive-in a way that is constrained at most other central banks. Over time one believes that this should lead to both better policy choices and more accountable policies. To me, the fact that there was this difference, that I was under no pressure to change my position, that in fact I was enabled by the staff and by my fellow members of the Committee to hold to my position and state it clearly, was a triumph of the process.
That said, I remain frustrated with myself that if the Committee in a sense agreed, in September/October of last year, that more policy ease was warranted, to me the arguments may have been quite debatable a year ago, in January/February 2011, but by summer of 2012 I would like to have thought the arguments were pretty clear. So it was a sense of frustration that I was unable to be persuasive in moving the Committee at that point.
Q6 John Thurso: Your forecasts have been regularly gloomier-I suppose would be the adjective-than some of your colleagues, in that you have called for more QE because, presumably, you felt it was merited and others felt it was not, so they were less gloomy. On the point you make about your personal frustration, the transparency we have in individual decision-making is a robust part of the system. Is that just a frustration you will have to put up with, or is there an underlying change to process that you might see that comes from that? Is it just tough luck on you for not persuading your colleagues?
Dr Posen: Each of my colleagues is individually accountable for their votes, as I am. So tough luck on me or their decisions as they choose to make them. I would just make two quick points about process and gloominess. Part of the difference was that I was gloomier, as I tried to set out in my statement; part of the difference was I was also more optimistic, in the sense that I believed inflation expectations would remain anchored, were not going to get out of hand, and that the potential of the UK economy remained largely unchanged, and to varying degrees different members of the Committee had different views on that, so it was not just short-term pessimism, it was also an optimism.
I think what has happened in terms of process is partly due to the leadership of Charlie Bean and Spencer Dale. The staff has done a very good job in my tenure on the Committee, but especially in the last couple of years, of really presenting the Committee with, "If you make this assumption here’s what it is going to look like and if you make that assumption here’s what it is going to look like". So to the degree that the process led to votes that I did not agree with, it was a fair process and it was made at the Committee level. It was not ram-rodded by the staff and it was not hidden or cooked; it was decisions made at the Committee level, which is how I presume it should work.
Q7 John Thurso: One other point on your report, the very last sentence is, "I have also met with investors in sterling-denominated assets from all over the world". What concerns about the UK economy are they expressing to you?
Dr Posen: That is a very good question. The main reason I meet with investors-as many of my colleagues do-both here and abroad, who are in sterling markets, is because we want to know what the market sentiment is. Clearly as they are voting with their money, they are not worried about the gilt market, per se. My recollection of when I speak to major investors in sterling-denominated markets is that they are worried about three things. They are worried about the general issue that in Europe, including the UK, austerity can feed back on itself, and if overdone can become self-defeating in terms of meeting your targets for budget reduction. I am not saying that is my view; I am reporting that as what the investors say.
Secondly, there is a difference of opinion in terms of how the eurozone risk affects sterling. Some people say we should get out of sterling because of the eurozone risk, others say buying sterling to get the upside on the euro area is the same as buying Australia to get the upside on China. You have a safer in and out, which is largely correlated with the events, but which isn’t going to be directly downside if terrible things happen.
Q8 John Thurso: How concerned are you, and should we be, about a potential downgrade of the UK by the rating agencies?
Dr Posen: Speaking for myself, I have never given sovereign ratings that much concern, and in a world where potentially the only triple A sovereigns left might be countries with populations under 10 million, I would not view it as a problem. I view our credibility in markets as hugely important, which, as we just said, is why people like me meet with investors but I do not view sovereign ratings as the be-all and end-all of our credibility with markets.
Q9 Andrea Leadsom: Governor, I am moved to continue my uninteresting line of questioning from our last encounter, where you said that further QE, "is a positive lunch. Everybody is better off because of the actions we have taken, If we ever get back to the point where the value in our portfolio of the gilts has gone down, I will regard this as a triumph because it means we will be back to a world with more normal levels of interest rates and hence more normal levels of growth". That was what you said in response to my question then. But leaving aside the question of profit and loss, if when you come to unwind the asset purchases, and the price of gilts has fallen well below the purchase price, there will then be an excess of the QE-related central bank reserves that will not be mopped up in that process, so how will you actually ensure that that excess is dissipated into the financial markets?
Sir Mervyn King: I think actually unwinding this is one of the more straightforward aspects. Either we would sell the gilts that we had purchased back on to the market or if we felt we were putting too many gilts on the market at the same time, or in a short period, we could issue short-term securities, Bank of England bills, and sell those. Actually mopping up the liquidity is a relatively straightforward aspect of this process. I am in no doubt that if we felt the need to unwind the economic effects of asset purchases, it would be a lot easier to slow the economy down when we come to unwind it than it is now to try to encourage growth in the economy by conducting asset purchases. I think going the other way would be a lot easier than trying to stimulate the economy at present.
Q10 Andrea Leadsom: Theoretically, you now have something like a third of the total outstanding gilts in the market-
Sir Mervyn King: Will have when we finish the current programme.
Andrea Leadsom: Yes. So is there a tipping point? Have you analysed at what point that policy would no longer be effective? For example, could you own half of all the gilts outstanding? You have been accused by, I think, Dr Ros Altmann of simply responding to market expectations, that now it has become a sort of self-fulfilling prophecy you have to do more QE, the markets are expecting it, and if you don’t gilt prices will tumble and it will be a real problem for the economy. Do you recognise that? Is there any concern about the level at which you go to and then suddenly the market thinks, "Right, they can’t go any further so now we are going to see the yield curve change", and that the timing might not be perfect for our economy?
Sir Mervyn King: No. I do not think that is a sensible argument, and I make two points on it. One is that it is true that when we finish this programme we will be around 30% of the market, but of course at that point the Government is issuing gilts every month. As happened last time we went up to 30% and then it fell back again quite rapidly; because we have a big deficit, the Government is selling gilts into the market the whole time. So it is much more likely that we will be falling back from that 30% than we will actually be increasing. I do not see any obvious reason to think there is an arbitrary limit to this at all.
The second point is in terms of expectations. It is true of any monetary policy move that the impact of the actual decision you make depends upon whether it is bigger or smaller than the amount that was expected. The market has different expectations, and different players in the market have different views about how much asset purchase we will eventually carry out. But by and large, I do not think there is any hard and fast expectation that we are inevitably going to do a lot more, and anyway, if that is what the market thinks, what really matters is what we think is the appropriate action to take to keep inflation on track to meet the target in the medium term. So we will take whatever action we think is appropriate and at that point expectations will adjust.
Q11 Andrea Leadsom: I can see that obviously your core target is keeping inflation under control, but your actions, in the monetary sense, are having an impact on market sentiment so that is influencing markets. At the same time, would it not be true to say that you are also interfering in a fiscal sense because, in effect, your view that inflation will go down and therefore you should continue on this path and that interest rates should stay very low, and so on, is actually having an influence in the real economy, because savers are finding that the value of their savings is reducing and borrowers are finding they have further incentives to borrow. Do you accept that QE is uniquely affecting the economy in a way that other monetary tools do not, or do you think it is just another monetary policy tool?
Sir Mervyn King: I don’t think it is unique in any sense. Let us suppose we were in a situation where interest rates were around 5%, we saw that there was an adverse movement in, say, the world economy, which lowered our expectations about growth in the UK and hence inflation, and we decided that it was necessary to cut inflation rates quite significantly to keep to our inflation target. That would also affect the market-expected part of interest rates and so the interest rate that savers could earn. But that is just as true for changes in interest rates as it is for asset purchases. So it certainly has an effect on market expectations, it has an effect on rates of return on savings and investment. But after all that is exactly the mechanism by which monetary policy is meant to work, and if you think the economy is weak then one of the reasons we cut interest rates is to stimulate consumption and reduce saving. That is the mechanism by which it works. But I do not think there is anything special about asset purchases in this sense. It is clearly less familiar, and maybe that is why there is a great deal more misunderstanding about it.
Q12 Andrea Leadsom: Thank you. Mr Bean, can I ask if you agree with that? It has been difficult to pin down, but there are suggestions in things that you have said that you think that QE may have a slightly different impact on the economy. I am just trying to get to whether there is unanimity on the MPC that QE will simply only have a similar impact to any other monetary policy tool.
Charlie Bean: Certainly, conceptually, it is like a change in bank rate. The impact of any policy change, whether it is a change in bank rate or a change in asset purchases, may vary from time to time, depending upon the state of the economy, and the lags with which policy affects the economy may also change. So that is something we are all acutely aware of. But in terms of the generic way policy operates, you can think of it as being very similar for changes in bank rate and changes in asset purchases, as the Governor said.
Q13 Chair: Mr Bean, just on the effects of QE on pension funds, what representations did they make to you, if any, about the effects of the gilt purchases on their requirement to hold gilts?
Charlie Bean: They have not made any representations to me personally. Perhaps it might be useful to say a few words about the effect of asset purchase on pension funds, because a lot of the discussion tends to focus on one side of the story, the impact on annuity rates, and forget the other side of the balance sheet, which is that by design asset purchases are supposed to drive up asset prices. That is why yields fall. There is a tight mathematical link between the two. While annuity rates might have been driven down by our asset purchases, at the same time the value of holdings in pension funds, in gilts, equities and corporate bonds, will have been driven up. So that compensates for the decline in annuity values-at least if a pension fund is in rough balance; if a pension fund has a significant deficit then that deficit is obviously widened.
Q14 Stewart Hosie: Governor, the February minutes from the MPC suggest that larger asset purchases may be required because of the extent of deleveraging still likely to be required. That would seem to imply a correlation between deleveraging and asset purchases at the moment. It would also seem to imply to me that if deleveraging stopped, or slowed, QE would be required far less. Is that a fair assessment?
Sir Mervyn King: In broad terms. Obviously what we would actually do would depend on all the circumstances: the state of the world economy, the euro economy, private demand and so on.
Can I just go back to what I thought was the simplest way in which at least I could understand asset purchases? We conducted asset purchases to inject more money into the economy. We did so because, very unusually, the amount of money in the economy was hardly growing at all. Why was that? Because the banks were deleveraging. The bulk of broad money in the economy comprises liabilities of the banks, bank deposits. As they shrink their balance sheets that shrinks the amount of broad money in the economy. It hardly grew at all. The main purpose of our purchases was to make sure that process did not lead to a point where money was falling as it was in the Great Depression, but to ensure that we could get the growth rates of broad money back up to normal levels.
That I think is broadly why you see the correlation that the more the banks deleverage the more they are pushing down the growth rate in money and, therefore, the more we need to do by way of asset purchases in order to offset that.
Q15 Stewart Hosie: I will come back to what the banks are doing in a moment, but let me ask you this first: in broad terms, how much more deleveraging do you think is necessary? What do the commercial banks yet have to do, in terms of deleveraging, so that you and others-indeed the bank managements themselves-say that the banks are safe? What is the scale, the quantum on that?
Sir Mervyn King: It is almost impossible to say and it depends entirely on market sentiment. The criterion is how much capital the banks need to have in order to persuade people in the market to lend to them, so that they in turn can lend on to customers. Before the crisis-say, 2006-if you asked the question, "How much capital do banks need to have in order to be able to attract funding?" the answer we know, from observation, was "Hardly any". Leverage ratios had reached sky high level. The problem now is that because people have come to realise how risky that was and that even the biggest banks can fail-something which I think was almost inconceivable up until that point, but it happened-now markets are genuinely very nervous. They are nervous because they do not actually have any great experience on which to calibrate how much capital banks need to have to be safe enough to take the risk of lending to them. It is not to do with regulation or capital ratios in Basel at all; this is to do with market sentiment and why it is so important to try to find ways for the banks themselves to convince the market that they are a good bet to lend to.
Q16 Stewart Hosie: Let me just ask a specific question about what the banks are doing. In relation to deleveraging and QE policy, banks are selling-this is banks who have received support-performing assets, not non-performing assets, with 20%, 30%, 40% and 50% discounts, haircuts, even though the businesses that hold those loans know they can re-bank them at 80 pence in the pound. They are selling them to equity funds at way under market value as part of this deleveraging process. What impact is that deleveraging of performing assets likely to have on the Bank of England’s thinking in relation to QE?
Sir Mervyn King: It depends on the consequence of demand for the rates in which banks can obtain funds and then lend on. One of the reasons why at least some banks feel it is a good idea to do this is that they are taking a hit on profitability by selling the assets at a discount, but on the other hand they are reducing the size of the balance sheet and, hence, the leverage ratio of their bank. That is something that gives reassurance to markets. It may have a hit to equity holders in the bank, but it may put them in a position where it is then easier to be able to borrow in the market to finance new lending.
Q17 Stewart Hosie: The bearing of deleveraging performing assets on QE, is there one?
Sir Mervyn King: It would depend. For example, if we felt that banks were in a better position to obtain funds, that the cost they were paying for those funds was going down-there are clearly signs of that since the turn of the year-it would mean that, in our own judgment, it was likely that this would flow through during the first half of this year to a lower cost of funds to companies and households. In its own right that would help to push up our forecast for output and inflation and mean that we would be less likely to do asset purchases-other things equal. It would also depend on the consequences, on the profitability of banks, bank share prices, and so on, because that will also affect the credibility of the bank and whether they can obtain funds. It is a difficult calculation. But as you said at the very beginning, that broad correlation has come about because of the impact of deleveraging in shrinking the money supply, and asset purchases in increasing it.
Stewart Hosie: Okay, that is helpful.
Q18 Mr Mudie: Dr Posen, are you available for questions? You were having a coughing fit there.
Dr Posen: I apologise.
Mr Mudie: No, no need to apologise. I don’t want to ask you a question at a bad moment. Are you okay?
Dr Posen: Yes, thank you very much.
Mr Mudie: In the minutes, there is no mention of any discussion about an alternative method of quantitative easing-in other words, moving away from simply purchasing gilts. In your time on the MPC has this been raised by anyone?
Dr Posen: It has been raised a number of times, and we have had group discussions of it outside the formal monetary meetings, the monthly meetings. The Committee meets both formally and informally at various times through the month. Month to month we have what we call special topics meetings. We have a group lunch once a month. We meet around the minutes and we meet on various things in the forecast cycle, as well as informal meetings between us. There have been both formal meetings and informal discussions of the possibility of buying other things than gilts. When I joined the Committee, in September 2009, there was a series of discussions on that, and it was raised again when Martin Weale joined the Committee, prior to our doing the last round of quantitative easing of asset purchases. As the Governor has made clear, the Bank’s interpretation of the Bank statute is that decisions of what the Monetary Policy Committee may ask to buy are set by the Bank’s executive, so we can have any discussion we like. We have had a discussion, but it would be the internal members of the Committee, the Bank’s executive, who would have to take the decision for us to buy anything else.
Q19 Mr Mudie: Although both the last Chancellor and this Chancellor have invited the Bank to approach a broad base of assets, the Monetary Policy Committee’s hands are tied because the Bank’s executive have decided simply to go to gilts?
Dr Posen: I am not trying to pass the buck, but it is a clear statement that it is the executive that makes the decision so I would suggest you ask members of the executive.
Q20 Mr Mudie: It does raise questions about the independence of the Monetary Policy Committee, doesn’t-or the powers of the Monetary Policy Committee?
Dr Posen: One would like to believe that, if there was a clear and pressing case made by a majority of members of the Committee, the executive would choose to follow that.
Q21 Mr Mudie: It would be difficult to get that if the majority on the Monetary Policy Committee is composed of Bank officials.
Dr Posen: If the Bank officials are not open to reconsidering, but they may be.
Q22 Mr Mudie: The fact that there is nothing in the minutes does not mean it has disappeared, it means that you are simply not raising it formally?
Dr Posen: I would not put it with quite that verve, sir. But yes, it means that there have been recurring discussions often raised by external members. We have had staff work on it. We have had discussion of the full committee on it, because it was not going to be in the offing for actual policy decisions, at any point it was never discussed directly in official MPC meeting.
Q23 Mr Mudie: In view of the difficulties with SMEs-the small and medium-sized enterprises-getting credit, has any member of the Monetary Policy Committee raised the exemplary scheme from the ECB, the long-term refinancing operation?
Dr Posen: We have been watching the LTROs with great interest. We have been assessing real time, both with an eye to what it teaches us about what we can do as well as its impact on the European economy and thus our economy. In addition, you may recall that last September I gave a speech in Gloucestershire about the possibility of the Bank buying certain kinds of assets, or bundles of assets, if they were properly securitised. I believe Martin Weale-I am not going to speak for him, just on the published record before he joined the Committee-had an article in the NIESR Review, which he used to run, talking about other possible purchases. I don’t want to say that there aren’t people really paying attention and trying to learn the lessons, and I would expect that if necessary the Committee would review it. What does "if necessary" mean? Thankfully we are not in an overt crisis, and I believe-as does every other member of the Committee, and certainly everyone before you today-that quantitative easing on gilts is having the desired effect on the British economy.
Just for the record, I agree with the Governor in response to the earlier comment. All these issues of savers and withdrawals, it is exactly the same as interest rates-
Q24 Mr Mudie: Sorry to interrupt you. You don’t think-because it will sadden many people out there in the real world-there is a real crisis in terms of credit in small businesses that has been prolonged and is continuing?
Dr Posen: I have done more in the last six months than almost any other economic official in British public life to draw attention to this issue. I hesitate to use the word "crisis" because when I think "crisis" that word has gotten cheapened. When I think "crisis", I think what my colleagues had to cope with and what this country had to cope with in 2008-09. There is a structural mis-functioning of capital markets and lenders in the UK that there is insufficient lending to small and medium enterprises on the right basis. The financial crisis that preceded the nationalisation of our banks, the concentration of our banking system and the natural stresses that go with a recession have made this even worse now, but it is a fundamental structural issue, sir.
That is why, at least on my part, I advocated the purchase of non-gilt assets by the Bank, as paired with initiatives by Her Majesty’s Government to try to set up a new infrastructure for supporting SME lending. Because it is not so much about monetary policy, per se, and that is why I think it is legitimate-I may or may not agree; but I think it is perfectly legitimate-for the executive of the Bank to draw a line where they want to draw a line, because this does not directly impede our ability to do monetary policy. I am less religious than some people about drawing those lines strictly and adhering to those lines strictly. I believe you can do more compromises and co-ordination than that. But for all my wanting us to do these things, and wanting us to work with the Government to do these things, I do not believe this decision has impeded our ability to do our fundamental mandate on monetary policy.
Q25 Mr Mudie: Governor, this was raised more than once at the press conference, and you gave detailed replies. One of the replies I largely agree with-I think as a Committee we have fenced about it for 18 months now-is that we know there is a credit problem with small businesses. You accept that. Merlin proves that the banks are reluctant to actually lend the necessary funds that are being required, both in the short term by small and medium-sized enterprises but in the long term in terms of rebalancing the economy. We all dig our heads in the sand and the banks make excuses, but it is clear that they have their problems and they are not going away. They are working on it, and they view the medium and small enterprises problem as one that can wait. So there is a problem.
The Bank of England is in a perfect position, on the back of the example of the ECB, to sit down with the banks and to some extent ease their worries and concerns about deleveraging and the need to build up capital. Apart from dogma, what is the rule that stops you doing it?
Sir Mervyn King: What we are doing is equivalent to what the ECB is doing-
Q26 Mr Mudie: It is not working, is it?
Sir Mervyn King: It is not working in the ECB. There is a credit crunch in the euro area. The idea that the long-term repo operations have eased the supply of finance to small businesses in the euro area is a myth. What it has done is to provide a source of funding to banks, particularly in the southern member countries of the euro area, which were experiencing a bank run, enabling them to fund the withdrawal of funds that was occurring, and was essentially a bank run in the second half of last year. That money is flowing into banks in the northern part of Europe. So it has eased the funding conditions, and the prospect of a bank run in the euro area has been removed by the activity of the ECB. Now we were not facing a bank run. We did not have that problem, but we have injected a vast amount of liquidity, so the one thing that the British banking system is not short of is liquidity. If anything, it needs more capital in order to persuade the private sector to lend to it.
The question is what would help small businesses. Small businesses and the amount of money they borrow is a very small sum, relative to the overall balance sheet of the banking system. I agree, and always have agreed with Adam, that there is a structural problem here, but the question is how do we deal with it? I think the right way of dealing with it is to recognise that the only infrastructure we have in Britain at present, for lending to small businesses, is the banking system.
Mr Mudie: I agree with you; the banks. You made that point, yes.
Sir Mervyn King: The question is how do we try to give some encouragement to the banks to lend to small businesses, over and above the amount they are willing to lend now. I think the answer to that is very simple. It is either direction, in terms of the banks that the taxpayer owns, or it is an incentive to do something that the banks would not otherwise do. In other words, a subsidy and questions of subsidy have to be matters for Government. That is what it is.
I remember when I came before this Committee last time, you were very, very clear-every single Member of this Committee was absolutely clear-that where there was a question of taxpayers’ money at risk it was not for the Bank of England to decide, it was for the Chancellor. This is a very good example of that.
Q27 Mr Mudie: I have one last question and I will put it to you this way. When the crisis started you presented the Committee-before Northern Rock went down-with a document of something like eight pages opposing putting money into the banks because of moral hazard. By the time you reached this Committee to speak about that you had done it because-
Sir Mervyn King: No, what we did was-
Mr Mudie: No, you will have your chance but I have to get this question out. Moral hazard is a principle, subsidy is a word, we have a situation where businesses are going down, the banks understandably have their problems but they are the transmission method that you have identified and you-as the ECB are-are in the great position of being able to deal with that. Is it the word "subsidy" that is stopping you? If it is, then that is bad that a word stops you keeping businesses afloat, but if it is not then why aren’t you doing something?
Sir Mervyn King: Because nobody in Government has given us the authority to take actions that will put taxpayers’ money at risk. Alistair Darling was adamant that the Monetary Policy Committee not be given the authority to purchase corporate bonds, or any asset other than gilts. He was very clear about that, and that is set out in the letter. The decision on what corporate bonds we should buy was for the Bank and we should do it in a way that did not put taxpayers’ money at risk. We have a scheme that still buys corporate bonds and the scheme still in operation, and we designed it in such a way as not to put taxpayers’ money at risk.
If we were to do that and to lose money this Committee would be the first group to say, "Under what authority did you lose taxpayers’ money?" If you decide that you wish the Bank to take certain risky decisions, then you have to make clear that that is what you want the Bank to do. But I tell you with small businesses we are in no position to do it. As you just said, Mr Mudie, the banking infrastructure-
Q28 Mr Mudie: We are accepting your transmission method, which is the banks; they should take commercial decisions and take risk into account.
Sir Mervyn King: Yes, and what is it you would like us to do?
Mr Mudie: No more than that.
Sir Mervyn King: But what exactly is it that you would like us to do to the banks to mean that they would actually lend to small businesses? Because making general funding conditions easier, providing more liquidity, does not mean that banks lend to small businesses. They may be more likely to lend to other parts of the financial sector.
Q29 Chair: You have made your point very forcefully. You have said that one of the options for Government is direction. Do you have a view on whether direction would require 100% ownership?
Sir Mervyn King: That has to be a view for Government to decide. I have always felt that owning over 80% of a bank gave you more than a controlling interest. I think the issue and the difficulty-
Q30 Chair: What about the minority shareholder rights, which after all are held by institutional funds?
Sir Mervyn King: That is a question for the lawyers to deal with, but I still think that as to take a judgment as a matter of policy to lend more to small businesses is a decision that, if the majority take, is not deliberately designed to oppress the minority. It is designed to help the economy as a whole. But that has to be an issue for Government. That cannot be for the Bank. That is clear.
Q31 Chair: That point has been made very forcefully. I just want to clarify this point about direction. I also want to clarify a point that Dr Posen made. When you referred back to the speech you gave on bundles of asset purchases, does it remain your view that setting aside any benefits there may be to a particular sector, in terms of its capacity to deliver the objectives of QE, pound for pound, bundles of assets would give you a bigger bang for your buck than you get with the current scheme?
Dr Posen: Not in strict monetary policy terms, but it would have the additional benefit of addressing the structuralist view, which we have discussed, Mr Chairman. It is like saying-I am trying to think of an analogy on the fly-I am going to build my house with really good insulation, so that means that when the storm comes the insulation works, keeps me warm and things are good. In addition, it saves me money on my energy bill.
Chair: Okay. Andrea Leadsom has a quick question and then John Mann.
Q32 Andrea Leadsom: Governor, you said that in response to lack of SME lending, Government has two options: direction or incentive. What about competition? In your quieter moments, do you support this Committee’s proposal that the FCA should have a direct competition mandate to try to enhance the incentives for SME lending?
Sir Mervyn King: I will not comment on the mandate for a body. But I do believe-as Adam said-that one of the problems we face is that we have such a highly concentrated banking sector that when it turns out that one bank gets into serious difficulty and has to be resolved-RBS-it accounts for such a large proportion of total lending. That is an undesirable position to find oneself in. Increasing the source of options for small and medium-sized enterprises is very important. I am glad to say that there are new banks coming in, and there are firms who, not surprisingly, can compete quite effectively now because they do not have the legacy balance sheet problems that some of the original lenders have, which is why they are deleveraging. So this is a very good time to come into the banking sector.
Q33 Chair: You have read our proposals on competition, I am sure.
Sir Mervyn King: I am sure, although momentarily they have escaped me-the clarity of the description of them. Remind me of the key principles.
Q34 Chair: We will come back to them another time, rather than have a lengthy discourse, or perhaps you could set down on the back of an envelope-
Sir Mervyn King: No, I think you should set down on the back of an envelope.
Chair: Perhaps you could set down on the back of an envelope and send it-in fact I think, better than that, on a sheet of paper-any aspects of those proposals with which you disagree. Would you be happy to do that?
Sir Mervyn King: I am sure there aren’t any, but we will have a look.
Q35 John Mann: Dr Posen, do you see any conflict, in terms of your role in the remit of the MPC, between the taxpayer maximising their direct return on the privatising of the part-nationalised banks and any other objectives?
Dr Posen: I do not think it has anything to do with my role at the MPC. I think there is a conflict or trade-off there that your Committee is right to examine. There is a historical pattern that sometimes-often, but not always-elected officials choose to maximise the direct visible budget return. They try to maximise what they get back on the shares they have, because that is very visible and they can go out to the public and say, "Oh look, not only did I get back all the money we put in but I got 10% on this". Whereas you can also choose, subject to legal advice, to do what the Governor was just illustrating-what he called direction-which I very strongly agree with.
If you think about the purpose of a bank, it is multiplying out from its capital base many loans that have effects on small, medium and large enterprises that affect employment. You can do a lot more good for the economy sometimes by doing direction of the banks, and-in line with what Chairman Tyrie said-at least in the short run that might dilute some of the profits for the minority shareholders. So it is like many other things, if the public sector is involved you are not running it as a for profit business. That is not the point. That is why the public sector is involved.
So to me, Mr Mann, you are absolutely right that there is a trade-off there, and the Government has to make the choice. For the time being, because of events in the euro area and other developments, we are so far away from the initial purchase price of these assets that it is not an imminent choice, which means it is that much easier, I would hope, for the Government to decide to consider the kinds of direction that Governor King was just speaking about.
Q36 John Mann: Do you think that it is the role of the Bank to be giving advice on timing?
Dr Posen: On specific timing? I would hope that, just as the Government would consult any number of experts before making such a decision, they would informally consult appropriate people at the Bank. I do not think it is in any sense the public role of the Bank to have some authority over the disposition of assets in the taxpayers’ control, no.
Q37 John Mann: Governor, do you think it would be appropriate in the private role of the Bank to be giving advice on timing?
Sir Mervyn King: Only if asked. If the Chancellor decides to ask us we can give the best advice we can, but that is a matter for him.
Q38 John Mann: It would be odd if you were not, because there could be potential conflicts with your role; there could be conflicts in relation to what you are doing on QE. Would you not anticipate that a Chancellor ought to be able to ask for advice?
Sir Mervyn King: There is a difference between co-ordinating so that we were aware of the timing of operations that the Government have decided to carry out. We could then take that into account when thinking about the timing or handling of our asset purchase operations, or indeed at that point possibly the asset sale operations. I do not think it is something where we should necessarily assume that we have the right to give advice, unless we are asked to give advice. But we are there to offer advice on any subject if the Chancellor wishes to ask us.
Q39 John Mann: Dr Posen, I have listened to you since you came on to the MPC, and you seem to have won the argument on QE. You were the one who was pushing it hard early on and others were not commenting; but you do not appear to be put forward at press conferences by the Bank to explain the success of your argument and why the Bank has got it right. Do you not think there is a role for you to be more of the public face, because every time you have come to this Committee, going back many years, you are the one who has been promoting QE much more than anyone else and you have clearly been listened to?
Dr Posen: Mr Mann, I am obviously gratified that someone was paying attention to what I was saying. Thank you. As I think has been clear from my willingness to be a lone vote for many months, I am not given to weaselling out of things. I am not trying to weasel out. Of all the things we have discussed-Mr Thurso raised process earlier-frankly, the press conferences are the thing I care least about. I think it is entirely appropriate that it is the Governor and the executive who do the press conferences.
What has happened at the press conferences, and I give the Governor credit for this, is that he has gone beyond simply presenting either the Committee’s modal view, let alone his own view. As I cited in my statement to the Committee, he has been explicit at times when there have been differences of opinion. He has, both privately and publicly, encouraged me and others-there were others voting in different ways-to go out there and make our opinions known and I do not feel in any way shut up.
I would like to think that it is entirely appropriate for this Committee to point out-nothing to do with me or other members of the Committee-not so much my vote for QE but the forecast analysis behind it. It is right and appropriate for this Committee to say, "Wow, it looks like, at least on current data and the arguments that happened to be made by Posen-the arguments that fiscal policy was going to be a short term drag, that inflation expectations were not going get out of hand, that wage growth was going to be limited, that the shocks were going to be temporary-therefore, QE was appropriate". It is entirely appropriate in my mind for this Committee to engage with the substance of that and to say to members of the MPC, "Okay, what were your reasons for not buying those arguments six months or a year ago?" and then have them discuss that. I think the members of this Committee have always done that in their speeches and in their statements. So substantively, Mr Mann, I appreciate you bringing it up and I am very happy to have that discussion but in terms of the press conference or anything else, I don’t feel I have in any way been squelched.
There is one thing I want to say to Mr Thurso that relates to what you said, Mr Mann, that I apologise I did not say. I don’t know that this is process. There was one thing about how the MPC came to the decisions it did and then voted unanimously for more QE in October this past year that disturbed me; well, there were two things. One was we went from an 8:1 against to a 9:0 vote for in the span of one month, and it was not because the Committee suddenly decided the world was ending. I do not know what the differences in the process should be, but it seems to me in an ideal world maybe the Committee would have gone from 1:8 to 2:7 to 3:6 over a period of months, and I do not know why it did not turn out that way. It is an interesting question to think about.
The second question that my colleagues and I discussed in MPC meetings, and I believe was reflected in the minutes, which troubles me is there was some sentiment among some members of the Committee that even if the kind of forecast I and others were talking about was right, you might not want to cut rates-actually, do more QE; see to me, rates, QE, it is the same thing-you might not want to loosen further while the inflation rate was above target. I can understand that at an emotional level or a visual level. I frankly think that is a wrong principle. If you genuinely believe that the forecast and what is right for the economy coming ahead is to ease now, it should not matter what heat you would get for easing now. I would encourage this Committee to think about whether, in the current inflation targeting framework, there is some sort of bias against doing that and whether we have to reconsider. Speaking for myself, that was the only argument from my colleagues on the Committee who had different points of view, for all kinds of reasons, that for me personally I took issue with, as I thought, "Not helpful".
Q40 John Mann: Mr Tucker, you have not had a chance to say anything so let me give you the opportunity. If we take the current inflation rate and the Bank’s analysis, say three years ago, of what it was going to be, I seem to recall that the Bank did not quite get it right, that inflation is higher than the Bank said it was going to be. In your view, ought we to be delving more into the question of whether there is some kind of group thinking in the Bank that has led to over-optimism in relation to the projections that have been put forward?
Paul Tucker: Well, big picture, we did not foresee the strength of the rise in commodity prices. Certainly I didn’t. A more interesting question than the one about group-think would be whether the demand push in commodity prices from China and Asia is just much greater, and will continue to be greater than anything that we have managed to fathom so far. I do not think we were the only people that made a mistake, and I do not think that Adam got that right, by the way.
Q41 John Mann: Isn’t there a key question, in precisely that demand push, of whether in fact there is anything that can particularly be done about it or whether, in fact, it is a reality that is there certainly for a period of time-time being perhaps years rather than shorter-and that, therefore, within the Bank you ought to be more upfront with these-shall we call them-dilemmas, in terms of your mandate?
Paul Tucker: Where we have foreseen commodity price strength and high inflation we have been very upfront about it. We have not said we are going to have 2% inflation come what may. We could have done that. It certainly is not the case that inflation getting to 5% was some kind of inevitability. The central bank has a huge influence on where inflation goes, even over relatively short horizons. We could have tightened monetary policy a lot and brought inflation back down to around 2% or thereabouts. Had we done so, the recession would have been a lot deeper, the destruction of the supply capacity of the economy-firms and lost jobs and permanently lost jobs-would have been greater, and as time passed there would have been a good chance that we would have been persistently below the 2% target for a while.
My point is that we have been completely upfront about that. We have relied on what has been in the remit from 1997-98 onwards, that we should take account of undesirable volatility in the economy, and that is why we allowed inflation to get as high as 5%. As I said in my annual essay to you, this is easily the biggest judgment that the Committee has made over the past year. It remains a big judgment, because for all the debates today, massive though they are, if inflation now sticks at 3.5% without a further cost push from the global economy, you will be rightly asking what on earth we were doing, given the clarity of our mandate. This has been a big call. It was one where we put the interests of medium-term inflation first, and by doing so have been able to support demand and, I would say, jobs in the economy. This has been a very, very big judgment, and the differences on the Committee, whether it is 8:1, 7:2, 6:3, pale into insignificance compared with that judgment.
As you look around other central banks in the world, they have not all made the same judgment. Who would have said in 1997 that we would have allowed inflation to go to 5% at some point? People would have thought those were the bad old days.
Chair: John has a very quick question and I would be grateful for a very quick reply.
Q42 John Mann: Similarly on growth, you, like politicians, successive Governments, have seemed to overestimate growth. Is that just a convenience or is that an error in terms of-
Paul Tucker: It is an error. The headwinds from Europe and the slowdown in the States in the autumn were much greater than we expected, and that affects our economy. These external influences have arrested the recovery of our economy and we did not foresee that; it was an error.
Chair: Forecasting errors will always be with us.
Q43 Mr McFadden: Mr Bean, I would like to ask you about the speech you made last week in Scotland, particularly the passage relating to household incomes where you say, "Spending power has been squeezed by the increase in the standard rate of VAT last year and the impact of high energy and import prices, in fact real household income declined a total of 2.5% in the two years after output troughed". The inflation report also says there are three shocks recently faced by households: a marked reduction in their estimate of future earnings, uncertainty over future earnings and tightening credit conditions. So we have their present earnings, their estimates of the future earnings and tightening credit conditions, and that households have not fully adjusted to these shocks. This is vital to the pace of recovery, isn’t it? To what extent do you think households and consumers still have to adjust to a post-recession world?
Charlie Bean: You are absolutely right; this is a key question. Have they fully adjusted or is there more adjustment to come? One thing that clearly appears to be the case, as a result of the crisis and the subsequent recession, is that it has lowered the likely path of future incomes for households. Savings rates have risen sharply, and part of that could be reflective of an adjustment to what has happened to real incomes, but it may also reflect increased uncertainty, the desire by some households to improve their balance sheets, to run down their debts and so forth. So on the Committee we have spent quite a lot of time talking about the prospects for the household savings rate over the three years of the forecast, and it has been one of the fundamental areas of discussion for us.
From my perspective, quite a lot of the adjustment has probably come through. That is why I am reasonably confident, barring any unforeseen adverse shocks during the course of this year, that we should see household spending growth pick up as we go through into the second half of this year as the squeeze on household incomes abates. But if you thought there was a lot more adjustment to come and that households were still adjusting to the change in income prospects, you might reasonably take the view that household income growth would be somewhat weaker going forward, and that is obviously one of the downside risks to the growth outlook.
Q44 Mr McFadden: On that last point about how the position looks going forward, quite a lot of the fan charts in your report predict a gradual recovery-upswing-usually always six months down the line, but the IFS have said that the squeeze on real household disposal incomes that we are in the middle of is the biggest since the war. Do you think policymakers have fully understood how this is influencing all our constituents’ behaviour and their confidence about the future?
Charlie Bean: I think they have. The Governor has made a number of speeches referring to this unprecedented squeeze on household incomes. I think you have to go back to the Depression. This is a very, very unusual period in historical terms.
Q45 Mr McFadden: Household consumption is weak in part because of their own rebalancing between their own priorities, and in part because of the Government’s rebalancing, which is of course affecting the amount of public sector employment, public sector expenditure, and so on. Do you think there is a danger of co-ordination failure, in that you have households retrenching at the same time as Government is retrenching, and at the same time as the private sector. Everybody is consolidating at once and, therefore, compounding the squeeze that is affecting households.
Charlie Bean: There is certainly a danger if all sectors of the economy are simultaneously retrenching. Privately it may be rational for each individual household or business to be behaving in that way, but collectively the outcome is bad for the economy. That is why it is quite important, if consolidation is appearing in some parts of the economy, that you do something to try to stimulate other parts. Of course, one of the purposes of having a loose monetary policy is precisely to help stimulate other parts of the economy, to encourage businesses to invest by keeping the cost of finance relatively low. Obviously the depreciation of the exchange rate, which occurred at a relatively early stage in the crisis, should also help to boost our net exports. Unfortunately, there is a headwind there because of the slow growth in our main export market, particularly in the eurozone, but to some extent monetary policy can help to counterbalance the necessary retrenchment that is taking place in some sectors.
Q46 Mr McFadden: Mr Tucker, where all this leads us to is trying to stimulate investment and exports to try to pull us out of all this. We have talked a lot about QE and the model of QE that has been used by the Bank so far. What else does the Bank have in its policy locker that might stimulate export growth and the kind of rebalancing the Government says it wants to see?
Paul Tucker: The main thing the Bank can do to help that is not stand in the way of the necessary adjustment in our exchange rate, and we haven’t at all. One of the biggest things for our economy over the past four to five years, compared with our continental neighbours, is that sterling has fallen a lot in real terms not just nominally, and monetary stimulus, far from standing in the way of that, has if anything aided that somewhat. I do not think it is easy for us to go beyond that through our straightforward monetary policy, but I think that is quite a big thing to do.
Q47 Mr McFadden: Do you have anything to add to that, Governor? Are we at the limits of the Bank’s effect on the Government’s stated desirable outcome of boosting exports and trade as a way of dragging the country out of this?
Sir Mervyn King: I think the two preconditions of gradually and eventually getting to a better balanced economy are, one, as Paul said, a lower real exchange rate, and the second is more investment; and to do that to ensure that public finances-not overnight, not even in a year or two, but over many years-gradually come back to a more sustainable position. The broad signs of success of policy in the last few years have been, one, that we have managed to absorb a 25% fall in the exchange rate, even bigger than after 1931 when we left the gold standard-a big, big fall in the exchange rate without any pick-up in wage inflation. Obviously, the state of the real economy is largely responsible for that but we have been able to absorb that without any pick-up in wage inflation and domestically generated inflation. Secondly, it has encouraged encourage investment. Whereas two years ago 10-year Government Bond yields in Britain and Italy were identical, theirs have gone north towards 5.5%, 6%, and ours have fallen from 4% to 2%. Other things being equal, that will help long-term investment.
The preconditions are in place, and if there is one word that we need to hang on to, to guide policy in the next three or four years, it is "patience". We have done the things that are necessary. We have to keep our eye on policy. We will adjust asset purchases in either direction as seems appropriate. Gradually I hope we will be able to raise interest rates back to a more normal level, as the economy recovers. But after a financial crisis of this kind, the main lesson of history is that, yes, you need to take quick action; you need to get hold of the banks and restructure them so that they can once again start to perform their normal function, but a large element of all of this is patience. It does take time to recover from a crisis of this kind.
Q48 Michael Fallon: Governor, in your press conference, you described Moody’s decision to put us on negative outlook as a reminder that we face a challenging task. Do you agree with their reasoning?
Sir Mervyn King: I think it was a perfectly reasonable commentary on the UK economy. There are many such commentaries. In the end I think the test is less what they say, the test is how much are people willing to lend to the UK Government for, what interest rate do they demand. That announcement by Moody’s had almost no effect on the yield on Government Bonds.
Q49 Michael Fallon: When you say you broadly agree with them, they warned that we would be downgraded if there was any discretionary fiscal loosening. Do you agree with that?
Sir Mervyn King: That is a statement about their action; their downgrading. It is up to them to decide what they do. As I said, the important thing is to keep the medium-term plan on track, and what I have suggested before is that people underestimate the size of the automatic stabilisers in the UK. That is the extent to which fiscal policy is automatically loosened if the economy is weaker than expected. That is something like 50% of the change in GDP. So these automatic stabilisers are very significant. It removes in the UK, relative to the United States, the need to consider discretionary fiscal policy changes. On top of that, monetary policy is the normal vehicle for handling quarter-to-quarter, or even year-to-year, changes in the path of the economy relative to what was expected. But if you combine monetary policy and the automatic stabilisers, that is a pretty powerful weapon of policy to deal with unexpected movements in growth.
Q50 Michael Fallon: You emphasised the role of the stabilisers at your press conference, and I read that. But I just want to come back to when they warn against discretionary fiscal loosening, do you agree with that warning? Were they right to warn us about that?
Sir Mervyn King: Their statement was couched-as you quoted-in terms of what they would do if the Government were to take certain actions. Now what we have seen is that the action they took recently actually had no impact on the yield that people in the market were willing to lend to the UK Government at. What matters are the views of people in the market, not the view of the rating agencies, and we should not ignore that but I think it is a different issue. I do not think we should be slaves to the rating agencies. But nevertheless, what they said was a reminder that the ratio of debt to GDP is rising. Despite all the actions that are being taken, the ratio of debt to GDP is going up. It will go up for several more years, and it will be even more years after that before it is back to where it is today. That is the scale of the challenge that we face. This is not something we can be complacent about just because the yields today are low. They are low because there is a credible plan in place that people believe in, and it is the belief in that plan that actually matters so much.
Q51 Michael Fallon: Mr Tucker, Moody’s also put the Bank of England itself on negative outlook. Did that hurt you?
Paul Tucker: Not in a way that we noticed.
Q52 Michael Fallon: Did you notice it?
Paul Tucker: We finance our part of the foreign exchange reserves by issuing a bond. They choose to rate our bond. They automatically downgraded it with the UK sovereign rating.
Q53 Michael Fallon: Mr Bean, can I take you to page 38 of the Inflation Report. You say, when it comes to the eurozone crisis, that you cannot quantify the most extreme risks, but that you do build something into the projections. Could you describe what that something is?
Charlie Bean: Okay. First, we obviously have to make some assumptions about the outlook for the world, and that includes some assumption about the likely rates of growth in the eurozone. Broadly speaking, what we have assumed there is that the current strategy of successfully containing the problems in the eurozone, kicking the can down the road-in the phrase that people sometimes use-is broadly successful. So growth is subdued in the eurozone but does not collapse or anything like that. To some extent it will be true that some of the bad downside risks that might be there, associated with disorderly outcomes, will already be taken account of in market prices-equity prices and things like that; and because we condition our forecast on market prices there will be some element of those disorderly outcomes there. But the picture, at least for eurozone growth, is one associated with kicking the can down the road.
Q54 Michael Fallon: Yes. I am still not quite clear from that, when I look at the two charts on this page, how much these projections are already affected by your assessment of eurozone growth.
Charlie Bean: As I say, the projection assumes a pretty subdued outlook for the eurozone over this year and next year. It is one that involves a small contraction in the near term, but it certainly does not involve anything that is associated with the sort of disorderly outcomes that people sometimes talk about, involving countries exiting and things like that. So they are not in the-
Q55 Michael Fallon: No. I understand that the extreme risks aren’t. I am just trying to get a handle on your measurement of the impact on the UK economy of the downturn in the eurozone. Can you crystallise that in a phrase? When you use "pretty subdued", what is the actual impact on our economy?
Charlie Bean: The consequences of low growth in the eurozone are obviously fairly direct on our exports. So that channel is directly built in. What you will not have is any significant spill-over, say, through banking channels. I think the report refers to some of the channels whereby a disorderly outcome might affect the UK, and potentially one of the biggest would be through linkages in the banking systems of the UK across to the eurozone, and also confidence effects. Those channels are not really particularly operative because this is a world where eurozone policymakers manage to keep the show on the road.
Q56 Chair: I am still not clear myself what your answer is actually to Michael’s question. You are writing into your central forecast what you think the most likely outcome is?
Charlie Bean: Yes.
Q57 Chair: But you are not writing at all into the projections the most extreme risks, right?
Charlie Bean: Correct. Yes.
Q58 Chair: Then there is a hierarchy of risk, of ascending risks?
Charlie Bean: Yes, indeed.
Q59 Chair: At some point you have a cut-off. What is that? You must have a list of possible risks that you have drawn up internally.
Charlie Bean: Everything in the fan is conditioned on the assumption that eurozone policymakers manage to keep the show on the road, so that you don’t-
Q60 Chair: Aren’t we looking for something a bit better than "a show on the road", frankly?
Charlie Bean: The thing is that there is a range of possible growth outcomes contained within the fan. What we are excluding is anything involving countries exiting the eurozone or anything involving a major banking crisis in the eurozone that may be associated with default by countries. So all of those things are not in the fan but, as I say, the central projection is conditioned on very subdued growth in the eurozone over the near term, picking up a little bit towards the end. But implicitly, of course, there is uncertainty around that and the uncertainty around those outcomes would be contained in the fan.
Q61 Michael Fallon: That is not assuming any default?
Charlie Bean: Correct.
Q62 Michael Fallon: Not a single default event anywhere across the-
Charlie Bean: No, I mean an orderly default. If you are thinking about the Greek haircut, which has already been announced, and that is part of an orderly process, that would implicitly be here. That is part of the "kicking the can down the road" scenario.
Sir Mervyn King: Can I give an example based on the trade figures? You asked how big this effect is. Let us suppose that our exports to the world as a whole would normally throw up something close to world GDP; perhaps not quite as close as that, but for the forecast for world growth this year, somewhere between 3% and 4%-make it easy, choose 4%-and growth in the euro area, closer to zero. Since half our exports, directly or indirectly, go to the euro area or related European economies, on average we would expect our exports to grow by 2% rather than the 4%, if the euro area were to grow at the same growth as world GDP; 2% off export growth is about half a percentage point off GDP growth. A weak euro area-really weak; basically, no growth at all-might knock half a percentage point off growth in the UK, relative to a situation in which everyone is growing at their normal long-term rate.
Q63 Michael Fallon: It all sounds rather back of the envelope.
Sir Mervyn King: I have given you a back of the envelope explanation rather than the detailed numbers, which I don’t have to hand, but we can send them to you if you so wish. By all means. It is not back of the envelope; it is all very carefully calibrated.
Q64 Michael Fallon: It is not clear from the chart.
Sir Mervyn King: But what you cannot calibrate-the Chairman talked about whether we had a list of risks-and the one thing you cannot do in these circumstances is to write a list of risks, because we do not know exactly in what way a monetary union could break up and could cause real chaos. If you cannot even write down the various things that could possibly happen you certainly cannot attach probabilities to them and put them into a fan chart. There are certain kinds of uncertainty that we think of as completely impossible to calibrate and, therefore, we have left them out of the fan chart, but they may well affect our policy judgment.
Q65 Chair: I do not want to prolong this but it is an important point. I think it would be helpful if you could provide us with that list.
Sir Mervyn King: We do not have a list. I have just explained why we cannot have a list of risks.
Q66 Chair: You haven’t really. I mean, you just said you can’t have a list and then we have had exemplification of three or four, in fact four or five.
Sir Mervyn King: In the chart are things that we have used, based on our short-run growth projection for the euro area, given partly what information others provide us with, and information conditioned on financial asset market prices.
Chair: I think we would like these numbers. We would like you to consider developing this exemplification in the next edition of this report, and it may be that we will want to return to this because I think all of us are a little unsatisfied.
Q67 Jesse Norman: Governor, apologies for coming in on this, but the IMF has recently estimated the effect of the eurozone crisis has been to cost China 1.75% of GDP growth. Is it not possible to do a similar calculation for this country, both historically and currently?
Sir Mervyn King: We can replicate the sort of calculation the IMF have done, but I would caution you on putting any weight on it. This is a situation-this crisis-in which there are the kinds of uncertainty that Keynes and Frank Knight talked about, where you cannot attach probabilities for these risks because you have not been able to observe them before. There are no frequencies that you can observe in order to calculate these probabilities. There are many events that could unfold that we cannot even imagine today. That is why uncertainty is so important. The idea that you can do a simple calculation, whether it is the IMF or anyone else, to produce a number that is meaningful is very dangerous. You can produce a number that people can bandy around when you give speeches if you want, but it will not mean anything. That is the important thing about this.
Q68 Jesse Norman: But on the ones that you could, perhaps we can ask you to give us a number as to what the historic cost has been and the projection, and then we can decide what the political will is to be attached to that.
Sir Mervyn King: I can’t tell you what the cost is at all because you have to be able to write down the counterfactual to do that. That is a completely hypothetical-
Q69 Chair: We won’t prolong this now, but you can hear clearly considerable interest and some concern about the need for more transparency on this point, Governor.
Sir Mervyn King: We could be transparent about what we have done.
Chair: We would be very grateful if you would reflect on it.
Sir Mervyn King: But there are two separate issues
Chair: Rather than decide now or develop the discussion further now-
Sir Mervyn King: There are two separate issues, Chairman.
Chair: Would you rather go away and think about it? I think that would be a good idea, Governor.
Sir Mervyn King: No, I would like to make one point before we do. There are two issues here; one is the transparency of what is in the inflation report. We will certainly write to you and be clear about what we have done. The second issue is whether it is even conceptually possible to produce a number that says, "What would have happened if-?" which is the question that I was asked about this morning.
Q70 Chair: It strikes me that a probability-function chart is trying to achieve that.
Sir Mervyn King: In discussing events that you believe you can genuinely attach probabilities to, and-
Q71 Chair: What we are looking for is those events that you cannot attach a probability to.
Sir Mervyn King: Well, I cannot write those down. I can tell you what is in the chart but I cannot tell you what is not in the chart.
Chair: We have had three or four coming in, there was an exchange just a moment ago, but I would be grateful if you would reflect on this.
Q72 Mr Ruffley: Just on this point, are you saying that the IMF calculation in relation to China is worthless because they ascribed a number?
Sir Mervyn King: Yes. I think it is subject to a very wide margin of error.
Q73 Mr Ruffley: Will you still be prepared to do it on the IMF basis for-
Sir Mervyn King: Can I give the reason why? Look at what happened in 2008-09 where sentiment and business confidence collapsed around the world and world trade fell faster than in the Great Depression. The only way you can explain that is in terms of a collapse of confidence in business sentiment. You cannot explain it in terms of trade links or any other observable phenomena.
I know no way in which it would have been possible beforehand to have made even a guess-back of the envelope or even on a very large computer-about how big that fall in sentiment would be, given the events that occurred and I think it is very dangerous to pretend that we could; we cannot. What we can do is to respond to things that are happening. That is why we have to be alert and use monetary policy quickly to respond to events as they unfold.
Q74 Mr Ruffley: From one kind of uncertainty to another: the output gap. You were very candid in your last press conference early this month when you said, "It is almost impossible to judge what the output gap is". Mr Bean, you said at that same press conference, "We see the impact of the crisis as being one that is temporary on the rate of growth of productivity. We don’t anticipate a permanently lower rate of productivity growth, as a result of what has happened in the last few years". That would seem to support the argument that there is not much slack in the economy. You also point out in your charts that other data point to there being quite a lot of slack in the economy. What I would like to know is why would you assume that productivity is going to snap back to its long-term average?
Charlie Bean: There is an important distinction between the levels and rates of change. The big unknown is how much damage the financial crisis and the recession have wrought on the level of potential supply now. The comment I made at the press conference was about the rate of productivity growth, going forward into the medium term, not necessarily even over the next year or two but a longer run view. As I said there, I do not see a compelling reason why that rate of productivity growth should be very markedly different from what it has been in the past.
One of the big things that stands out, if you look at long runs of historical data, is how constant the rate of productivity growth is; you do not get big variations from decade to decade, by and large. Personally, I am reasonably confident that the rate of growth of productivity, out in the medium to long term, will probably go back to where it was pre-crisis. What is very unclear is, firstly, how much margin for spare capacity there is now, and how much of that loss is really permanent, or if some of it might come back. If you have mothballed some production lines you might be able to bring them back into action. On the other hand, if workers have been unemployed and not been able to gain skills on the job, it may have a much more lasting impact. That is the area where we feel very uncertain.
Q75 Mr Ruffley: On that point, Dr Posen, the last minutes note that there were concerns that "persistently weak growth might impair the future supply capacity of the economy through hysteretic effects". Do you think we should attach quite a lot of weight to the output-destroying aspect?
Dr Posen: Mr Ruffley, we should attach weight to that because it would be a shame to let it happen. If we are convinced that the output gap exists and is non-trivial, which I think there is good reason to believe, and all observers, including the OBR, admit, then any lackadaisical attitude we take to try to bring demand back up to where it should be carries with it the risk you just identified, about eroding the supply capacity. As other colleagues of mine on the MPC have said, we want to be in a position where we are going to have to some day raise rates because inflation is coming back, but we want it to come because the gaps have been closed by demand and not by supply shrinkage.
When you say take it seriously, the point I would add is that I think take it seriously does not mean we have to believe that the supply capacity of this economy either has eroded quickly, or will erode quickly. My views on this have shifted slightly. A year and a half ago, roughly, I gave a speech in which I talked about the hysteresis effects, and even though broadly my basic instincts were in line with what Charlie just said, that is one of the lessons from Japan, frankly, that I did not state. Japan went through this terrible process, a prolonged recession, but when they had recovery they returned to the rate of productivity growth they had in the immediate pre-crisis; not the 1970s, not the glory days, but they did return without inflation to a 2.5% growth for several years.
I am doing research right now with some members of the Bank staff on this, trying to put numbers in the same way you were asking for the European numbers on these processes, and I think it is much more tractable to do estimates of this than the European issue, frankly. There certainly is erosion; when young people are in long term unemployment and cannot find jobs there certainly is erosion. When businesses fail, as Mr Mudie was talking about, there certainly is erosion.
The scale and pace of this erosion, though, is slower and smaller than I would have worried about. In particular, given how well our labour markets function, as bad as youth unemployment is right now-there are reasons to be concerned about that-we are not adding to long-term unemployment, and what I and a lot of people would consider the structurally unemployed, as quickly as, say, we were in the 1990s. It looks more like the 1980s; the trade-off is not that steep. That is one example of why although I think it is something to be very concerned about, and we should not let it happen, I am not worried about the supply capacity eroding the output that quickly.
Similarly, if I may make one other preview of this research-the staff member at the Bank with whom I am working, Neal Hatch, who deserves a lot of credit, and some other staff and I have been working on this-you find that if you break down the economy into sectors, most sectors in the economy have returned to their pre-crisis growth trend as well, which does not prove anything one for one but it is consistent with the view that we have not had a structural disruption in this economy; it was not that we had trouble adjusting, say, putting more employment into manufacturing. That does not mean all sectors are doing great; extraction in the North Sea is still declining in productivity, but it is not declining any faster than it was pre-crisis.
To me the picture is broadly, as Charlie says, that I do not think our supply capacity is eroding very quickly and, therefore, we do not need to worry about the output gap in the near term being closed by supply constraint. But I completely agree with where you started the question; this is something we have to take very seriously. That is one of the reasons, until the present, I was advocating more aggressive policy, because it is a waste to let it happen.
Q76 Mr Ruffley: Yes. One final question, Chairman; Dr Posen, you will be aware there is quite a vigorous debate in Parliament regarding the so-called Beecroft reforms: liberalising employment law a lot more, no-fault dismissals and moving towards an employment protection regime more akin to America, where I think we have seen, since Christmas alone, over 250,000 new private sector jobs created in the US. Is there any evidence that you have, or any belief you have, about how reducing employment protection would make a dent in structural unemployment?
Dr Posen: There is no question, sir, that the sign goes in that way, that there is greater willingness of people to take the jobs that are available at the margin if employment protection is less. That said, I think it would be a mischaracterisation of the UK labour market to suggest that we are hamstrung by labour market regulation at this point. If you look at the way our labour market behaved throughout the crisis, our dysfunctioners were doing a very bad job of putting non-university educated young people into work. In all other aspects, the British labour market worked quite well in international comparison, and so to me it is not like Germany, circa 2003, when they had to do major changes to the employment protection and the generosity of unemployment benefits because they were so askew that there was a very high natural rate of unemployment. I do not want to comment on that specifically, but it would strike me as odd if you were going to do a labour market reform in the UK right now, just on basic economic principles.
Mr Ruffley: On economic principles? I see.
Dr Posen: On basic economic principles, to think that the big, low hanging fruit, the big gain would be in overall flexibility where we seem to be pretty good, versus trying to figure out, looking at what DWP, and NIESR, IFS and Work Foundation and all these various places are thinking about with youth unemployment where it is the one place where we clearly do have a malfunction. To me, from economics, that is the wrong priority.
Q77 Mr Ruffley: Governor, do you agree with that, the economics of it, not the politics? You would not stray into that.
Sir Mervyn King: I am not going to comment on the merits or otherwise of reforms in this area. I am sure you would not want me to stray into what is clearly a very interesting and important political debate.
Q78 Mr Ruffley: And an economic debate, as Dr Posen has explained.
Sir Mervyn King: There is a debate about the merits or otherwise of the proposals and I do not think the Governor of the Bank of England should intrude into that, as you and others on the Committee constantly remind me.
Q79 Mr Ruffley: Dr Posen has given an economic analysis. I am just asking you for your economic analysis.
Sir Mervyn King: I am not going to step into the economic analysis of the merits or otherwise of the proposals. That is exactly what I should stay away from it. But I certainly concur with his conclusion, that this is not itself likely to change our view substantially about the size of the output gap or the amount of spare capacity. I think it has much more to do with the impact of the financial crisis on whether or not ideas and innovations have been turned into successful small businesses, and whether where that has not happened in the last few years is something we shall make up in the future, or maybe we get to the long-run growth but at a permanently lower level. That is something we will only discover down the road.
Q80 Jesse Norman: Mr Bean, have you seen anything recently that gives you increased confidence about the situation in the UK economy?
Charlie Bean: There have been one or two of the high frequency indicators that have been moving in the right direction. Quite a few of the business surveys, particularly the Chartered Institute of Purchasing and Supply indices, have strengthened in the past couple of months. That is true around the world, it should be said, so this looks like a global phenomenon; some recovery from troughs seen round about October time. Retail sales numbers were perhaps a bit stronger than people expected. There have been a few positive signs, but I think it is important not to read too much into one or two indicators rising to the upside. It will take a lot more swallows to make a summer.
Q81 Jesse Norman: But you concur with the Governor’s view that the medicine has been taken; it needs to be allowed to work, the economy is on track?
Charlie Bean: The generic point that the rebalancing of the economy is under way is an appropriate characterisation, in particular that substantial depreciation, which is a necessary ingredient to allow net exports to take up more of a role in demand, is something that has happened. We are seeing it having the expected effect on exports and imports. It came through a little bit more slowly than we expected, but there is now evidence that the competitiveness gain is working as we expected. Certainly when we go round the country and talk to, say, manufacturers who are exporting, particularly if it is to markets other than the eurozone, they are often quite positive about things. Those are good signs.
Q82 Jesse Norman: Thank you very much. Mr Tucker, have you done any work, or has the Bank done any work, on the distributional effects of quantitative easing?
Paul Tucker: Charlie would be closer to this than me. Virtually all the work has been on the aggregate effects, because that is what we are responsible for. In terms of financing, it has made conditions easier for large companies relative to SMEs, for the reasons that we have discussed on previous occasions. It has helped to unlock the capital markets, and larger and medium-sized companies have been able to access those capital markets. That has not been completely negative for smaller companies, because to the extent that the larger companies have repaid bank debt you could regard that as benign deleveraging. A question that I have raised and we do not know the answer-it would be quite hard to find the answer-is to what extent large companies, as they recover, will loosen supply credit terms and customer credit terms to their smaller suppliers, vendor financing, if you like. If we can shift credit conditions for large companies, which I think we have quite significantly, one would hope that there will be some trickledown effect. It is very hard to identify.
Q83 Jesse Norman: It is inevitable, isn’t it, that a policy like this is going to have significant differential effects across different parts of the economy? It is being targeted at certain groups.
Paul Tucker: Absolutely, as do interest rates when we change them.
Q84 Jesse Norman: Exactly. If you drive long-term yields down then savers get hurt, asset prices go up.
Paul Tucker: I want to lean against this "savers get hurt". Charlie and the Governor talked about this in fairly technical terms earlier. If we were not, and had not been, running an easing monetary policy for the last three years or so now, this economy would have been destroyed. Savers are investors in the future. Savers would be hugely worse off had we not been supporting demand in the economy. I know, of course, that we have pulled down the discount rate and the rate of interest paid on deposit accounts is low. I understand and have great sympathy for the effect of that on savers, because many of them did nothing to bring about this dreadful crisis, but I promise you they would be even worse off had we not supported demand to the extent that we have. So the distributional effects are important, but given the gravity of this crisis-excuse me if this is an unfortunate expression-they are second order to where we could have been. We could be in ruination and we are not there, because of the measures that have been taken, not only by our own central bank but other central banks around the world, and they dominate the distributional effects, I would say.
Q85 Jesse Norman: Thank you for that. I am sure when the crisis is over and gone, this will be appropriately rewarded, given the history of it. The point I want to make is that you are not disputing the fact that savers may have been hurt. You are simply saying that the wider effects of inaction, or failure to take the action you took, dominated those. The question does not apply in the same terms quite to pensioners, because pensioners, of course, are not the savers of the future. They are people who are living on savings from the past.
Paul Tucker: Somebody who is 60 and has just taken their pension is still indirectly an investor in the future. If they are expecting to live for 10, 15 years they are not going to get paid out on their pension if asset prices crater over the subsequent-
Sir Mervyn King: Make that 25 more. I don’t want my personal trainer to disappear in 10 years.
Paul Tucker: You are right if it is the last month or year when somebody is drawing a pension, but you are wrong to assume that somebody who starts to draw a pension does not have a stake in the future prosperity of the economy. They do. The only way our citizens prosper at all is through the growth of the economy and the fruits of growth being reasonably-
Q86 Jesse Norman: For the second time you have not disputed the proposition I have made. You simply deflected it. Savers are-
Paul Tucker: It is not a deflection.
Jesse Norman: It is a deflection because you are running two things together.
Paul Tucker: No, I am putting it in context.
Q87 Jesse Norman: You are running together pensioners and investors as some of the people who have an investment in the future. The point I am trying to get to is this. This is a big policy with massive distributional effects, of the kind we have discussed, and one can argue whether or not they are valuable or non-valuable. Of course, in many ways it is very important that the measures that were taken should have been taken. My point is why are we having an argument about subsidy, when there are already groups in the economy who are being vigorously targeted for benefit or loss on the basis of the policy as it is at present? You have already described that there are lots of groups in the economy who do well out of this policy; there are others who do badly. Why is it the case that the Bank is getting hung up on the issue of subsidy when it is thinking about, for example, buying second order assets and fretting that it should not be awarding subsidies for these people when, in fact, its entire policy consists of indirectly allocating benefit or loss to different sectors of the economy?
Sir Mervyn King: Because Parliament has decided that the instruments of monetary policy should be delegated to an independent central bank, even though it has distributional consequences. That is your decision. You voted for that, not us. You in Parliament decided to delegate those responsibilities to us. What matters is that you have the right to decide which instruments of policy to ask us to implement. That is your decision, not ours. We have no right to appropriate to ourselves the choice of which instruments we should be using. That is your decision. That is all I would say.
Q88 Jesse Norman: No one is disputing the democratic empowerment or the fact that the Monetary Policy Committee has the right to use the tools it does. The question is simply why it is drawing a line on the basis of subsidy about, for example, purchasing corporate assets or other kinds of bonds when it is so comfortable to subsidise or target for non-subsidies, negative subsidies, other sectors of the economy in the course of-
Sir Mervyn King: Mr Norman, I find it very interesting that when we take actions that politicians disapprove of they immediately come back and say, "What authority did you have to do that? That should have been the Chancellor that took that decision, not the Bank". When you want us to do actions that you approve of you are terribly keen that we should just go ahead and do it without any remit or authority whatsoever. We have no remit or authority from the Chancellor or from Parliament to carry out the actions that you seem to be suggesting. We have done exactly the things that the Chancellor at the time asked us to do. We put in place a corporate bond purchase scheme. We have implemented that and we have carried out our purchases of gilts. If the Chancellor wishes us to implement other instruments then, of course, we can discuss that. But I come back to this: we ourselves do not want to be put in the position of being asked to make judgments that we are not capable of making. When it comes to assessing which small businesses to lend to and which not, the banks have the ability to do that and we do not. The important thing is to find a mechanism, as Mr Mudie said earlier, to ensure the banks do their job. They have the ability and the infrastructure to do it, nobody else has. Government does not have it.
Jesse Norman: That does not respond to my question at all, I am afraid.
Chair: I am sure we will return to this again.
Q89 Mr Love: We will return to it right now. When the Governor says that the previous Chancellor and the current Chancellor have not given authority, that is not according to the memoirs of the previous Chancellor, and not according to the implicit statements that the current Chancellor is making. Indeed, Dr Posen and other non-executives on the Bank would seem to be sympathetic to the idea of buying assets other than gilts in relation to this. Why are the executive members of the Bank so opposed to doing this?
Sir Mervyn King: Can you give me an example of the assets you think we should be purchasing? I asked the previous Chancellor and got no reply. What assets do you think we should be buying?
Q90 Mr Love: You are the experts. Corporate bonds are one area that we could look at.
Sir Mervyn King: That is what we doing. We are doing that.
Q91 Mr Love: The amount of assets that have been bought-I know it is not a large market for corporate bonds but surely there is more that could be done. The Bank could be meeting with the banks to set up mechanisms to collateralise the debts of small businesses. None of that seems to be happening. If I may say so, Governor-this is a criticism that has been raised by others-you seem somewhat relaxed that everything is going fine. You said in a response to Mr McFadden earlier, on rebalancing, that we have to have patience. I know patience is a great virtue, but there are real concerns out there that the private sector, which should be the motor of the recovery of our economy, is not being stimulated enough.
Sir Mervyn King: Let me answer that directly. In terms of the long-run rebalancing, patience is what we have to accept, and I think that is the right approach. In terms of small and medium-sized enterprises and bank lending, I have consistently and publicly been dissatisfied with what has been done, and I have said so very clearly. I said to the previous Government that the scale of the recapitalisation of the banks was inadequate, and their actions in making sure that the banks lent to SMEs were also inadequate. I made that very clear.
In terms of what other assets you think we should be buying, you have not given me a single answer. In terms of asking banks to put together pieces of paper that are claims on SME loans, I will tell you exactly what will happen. The pieces of paper they will bring to us will be the worst loans, not the good ones, and I will tell you why. It is because in discussing with the present Government a scheme to lend to SMEs the banks were unhappy about the idea of a scheme in which the Government would participate in all SME lending. Why? Because they did not want to share the fruits of the most profitable loans to small businesses. We would end up being offered the bad ones, and if you do that you end up imposing such high haircuts to avoid losses to taxpayers that the system does not actually produce any funding to banks. That is why we have been very clear on this to Government, both this and the previous one, and we have come up with schemes that have involved options for ensuring that the banks lend to SMEs.
I am not relaxed about it at all. I am the person who has put forward proposals for how this might be done. They are not proposals that the banks find favour with, and I am disappointed that the Government that you supported before was unwilling to take on the banks on this issue. They negotiated with the banks and if the banks did not like it that was what came out. That does not seem to me to be a very strong public policy. So I am far from relaxed or complacent, Mr Love. I am rather concerned about it and I have been pressing that and I want a scheme that makes sense economically, not something that is just a gesture.
Q92 Mr Love: In relation to that, the Government are currently negotiating with the banks on credit easing, and if we are to believe the reports in the newspapers it is not going terribly well, perhaps for the reasons that you have just outlined. You sort of indicated in that last reply that you had some involvement in these discussions. Are you consulted, involved? Are you part of the negotiations in relation to the credit easing scheme that is expected to come forward at the time of the Budget?
Sir Mervyn King: We are not part of the negotiations. I have been consulted and we have given our views to the Treasury. I am not going to reveal the content of those private conversations, but we are not part of the negotiations with the banks, quite properly because the negotiations with the banks do involve the question of the extent to which taxpayers’ money should be put at risk.
Q93 Mr Love: Clearly, this will be announced at the time of the Budget and we will await it with interest. Are you convinced that the discussions, the negotiations, will lead to a scheme that will not have the downside that you have just outlined that has been a major concern of the bank?
Sir Mervyn King: I don’t know. I am not in a position to say. I do not know what has been going on in the negotiations. All I would say is that unless there is an element that tries to prevent the banks from picking and choosing which SME loans they share with Government and which not, there is a risk of adverse selection and the taxpayer gets a bad deal. That is why it is very important to find a way in which the incentives to banks are linked directly to the overall stock, I think, of net lending to SMEs.
Q94 Mr Love: Can I ask one final question? It is to Dr Posen. The indications are that in the last quarter of last year broad money, M4, declined. It is also the case that credit is shrinking in the economy. You rather played down the fact that you had supported a larger QE at the last Monetary Policy Committee meeting and said that it did not show any real difference. Are you convinced that with both broad money and credit shrinking at the present time, we are not going to undershoot on the 2% target in two years’ time?
Dr Posen: I am not sure but as I said in my statement, Mr Love, I do share now the forecast that is the modal forecast for the Committee and the inflation report broadly, which means I do think the risks are balanced. I am slightly more worried that it will go on the downside, but I am in a very different position than I was, say, in September when we had taken no action. Since the MPC has added to the asset purchase programme, or will have added if we continue with our current commitment, £125 billion over less than a year, whether or not we add £125 billion or £150 billion is actually not material. What is important is we have done the equivalent, roughly, in my personal view, of a 100 basis points-plus cut in interest rates. I am concerned about the money supply figures, for reasons that the Governor and others have always featured, and that to me speaks about the structural problems that remain in our banking system. Here I would associate myself with things the Governor said earlier, in particular about having new entrants, new banks, and new competitors. There is more than one way to skin a cat.
Sir Mervyn King: The money numbers for January were published this morning and they show a large increase, which more than offsets the fall in November and December. We should not pay too much attention to any one month, but if you take the last three months then money has actually expanded. That is some encouraging news this morning.
Q95 Chair: Mr Bean, do you agree with what you have just heard as a personal view from Dr Posen, that £125 billion is broadly equivalent to 100 basis points?
Sir Mervyn King: Broadly or-
Chair: I was asking Mr Bean.
Sir Mervyn King: Oh sorry.
Charlie Bean: Broadly of the order of magnitude, yes.
Q96 Jesse Norman: I just want to put on record that I entirely disagree with the Governor’s response to and analysis of my line of questioning earlier. I am also amazed at this very disparaging view of politicians that is being promoted by him on behalf of the Bank of England.
My question is to Dr Posen. Is it your view, Dr Posen, that the Chancellor has placed the MPC under an obligation not to consider for possible purchase assets that are not gilts?
Dr Posen: Mr Norman, I am not ducking. I have no view on that because I have never spoken directly to the Chancellor. I only read what is published, so I have no view on that statement whatsoever.
Q97 Jesse Norman: Let me open the question up more widely. Is it genuinely the case that the MPC is under an obligation from the Chancellor not to consider the purchase of assets other than gilts?
Sir Mervyn King: The previous Chancellor set a very clear instruction that decisions on the purchases of corporate bonds, which was the only asset other than gilts that we were authorised to make, should not be decided by the MPC but should be decided by the Bank executive. You can ask him his reasons but I think he had very good reason for that, which is that a nine-person committee voting by majority vote is a very good idea but only if you have a very limited range of things to vote on. If you end up with nine different people with nine different assets or SMEs they want to lend to, this is not a system that will support majority voting.
Q98 Jesse Norman: Did he forbid you from making new proposals in that area?
Sir Mervyn King: To the Committee, yes, because it was not an instrument that the Committee could vote on or decide.
Q99 Chair: I think this is something we might come back to. Governor, am I right in thinking that a staff survey has been done in the Bank?
Sir Mervyn King: Yes.
Q100 Chair: We would be grateful for a look at the broad conclusions that have been circulated, I understand.
Sir Mervyn King: We will write a summary and send you information on that.
Q101 Chair: The summary that has been shown to staff is what we would like to see, in line with practice in other public institutions for their staff surveys.
Sir Mervyn King: We will reflect on the practice and follow that practice.
Chair: Thank you very much, Governor. Thank you very much all of you for coming. It has been enlightening, and nobody could argue that our monetary policy does not have a high degree of transparency. We have certainly had an illuminating exchange. Thank you very much indeed.