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Treasury Committee - Minutes of EvidenceHC 1063
Taken before the Treasury Committee
on Tuesday 26 March 2013
Mr Andrew Tyrie (Chair)
Mr Andrew Love
Mr Pat McFadden
Mr George Mudie
Mr Brooks Newmark
Examination of Witnesses
Witnesses: Robert Chote, Chairman, Office for Budget Responsibility, Steve Nickell CBE, Member of the Budget Responsibility Committee, OBR, and Graham Parker CBE, Member of the Budget Responsibility Committee, OBR.
Q178 Chair: Thank you very much for coming to see us this morning. You have produced another thick document, which most of us have had a chance to take a good look at. May I begin by asking you whether you have had the necessary co-operation from the Treasury to produce this?
Robert Chote: Yes, we have.
Q179 Chair: And have you been asked to change anything that you have had severe doubts about?
Robert Chote: No, we have not.
Q180 Chair: And are you confident that you have given the Treasury all the co-operation that they need; for example, by supplying them with information in a timely matter?
Robert Chote: Yes, I think so.
Q181 Chair: Do you think that your forecasts on the core numbers are any better than the average of outside forecasters?
Robert Chote: For the macro economy, there is no reason to believe that they should be over time, on the grounds that we all have access to the same information that is in the public domain. Where I hope that we do have some advantage-this was the purpose for creating the OBR in the first place-is on the fiscal numbers. So, for example, on developments on public expenditure this year, we have had more information on how that was evolving than was available to the outside world.
Q182 Chair: So it might be, for consideration, that you start to use the average of outside forecasters.
Robert Chote: The difficulty with using the average of outside forecasters is that the particular type of forecast that we need in order to produce a bottom-up, disaggregated fiscal forecast is one that goes out a full five years, which not that many outside forecasters do. You also need to have a much more detailed breakdown of the components of national income and national expenditure, which many outside forecasters would not need to worry about to the same degree-
Chair: We have had this discussion before.
Robert Chote: So there is not something that you can pull off a shelf.
Q183 Chair: May I read to you what your successor at the Institute for Fiscal Studies has said on what he describes as a "rounding error"? I am sure that you are familiar with this. He said: "There is every indication that the numbers have been carefully managed with a close eye on the headline borrowing figures for this year. It is unlikely that this has led either to an economically optimal allocation of spending across years or to a good use of time by officials and Ministers." Is there anything in there that you recognise?
Robert Chote: It is certainly the case that if you look at the change in the deficit from this year to next, extracting a number of special factors-notably the asset purchase facility transfers and the transfer of the Royal Mail pension fund-you have essentially got the deficit very flat between last year, this year and next year. Our forecast showed a very small reduction in the deficit between last year and this year; one that we describe in the report as "fiscally and statistically insignificant." As I think Mr Love mentioned last time, that does not necessarily mean that it is not politically significant.
We went to the Treasury with a forecast that said that the underlying outlook for receipts this year was weaker than we had anticipated back in the December forecast. That was primarily because of the new information on income tax that came in early in the year, and also the fact that the 4G auction produced about £1 billion less than we had anticipated. The Treasury had a choice to make about what it did with public expenditure. In management terms, the Treasury made some decisions on departmental expenditure this year, which it brought to us, and we assessed the likely impact of them. You would have to ask the Treasury whether that was its motivation for coming up with those decisions on public expenditure, but we took them on board as best we could.
Q184 Chair: Which specific decisions do you have in mind?
Robert Chote: If you look at the total departmental expenditure-we are talking about spending on public services, administration, capital spending rather than on social security-the current set of numbers indicates that the Departments will underspend the plans that were set out in the PESA-public expenditure statistical analyses-back in July by about £11 billion. That is a significantly larger underspend relative to in-year plans than you would have seen normally. The Treasury has clearly taken some decisions to bear down on departmental spending to stop some of it happening and to push some of it forward into future years and we needed to take that into account. I am sure that the fact that there was underspending does not come as a surprise to you, because you would have seen the straws in the wind when the supplementary estimates were brought to you in February. They were already showing a larger than usual underspend, and we have seen more evidence going in the same direction in the subsequent discussions that we have had with them.
Q185 Chair: And you are relaxed about this shift of spending from one year to the next, the income shift, and confident that they can be sustained?
Robert Chote: We have taken the best judgment we can on how this is likely to affect the behaviour of Departments. There is always a judgment to be made about how Departments are likely to spend relative to the limits that have been set out for them by the Treasury. They almost always do underspend. There is an incentive for both the Treasury and the Departments not to step over that line, so we have to make a judgment here about how much of that will happen more than normal this year, and the implications for next year, too. What the Government have done is partly to push some spending into next year. They have also reduced the overall limits for next year. We are assuming that Departments will again underspend those limits, as they always have done in the past, but by less than normal because they have done it by more than normal this year.
Q186 Chair: So you are reasonably relaxed about what the Government have done on the underspend?
Robert Chote: It is a choice for them to make; we have to reflect it as best we can.
Q187 Chair: Are these numbers deliverable?
Robert Chote: There is no reason to think not. You have to bear it in mind that, even after the fiscal year is over, you see significant revisions in out-turn expenditure data. That has happened in the past and underlines the fact that a £100 million difference in the deficit from one year to the next is fiscally and statistically insignificant.
Q188 Chair: In your report, you say that applying the multipliers would imply that these underspends have reduced GDP by a further 0.5% in 2012-13. You reckon that the growth forecast has been affected quite a lot by this?
Robert Chote: As I say, you have to view that as a ceiling on that. One reason is that not all of the underspend will appear in areas that have an economic impact. If you are paying bills to international institutions early in the next financial year rather than in the last financial year, you do not expect that to have a great deal of impact. Most of this underspend was in the December forecast. We have a bit more of it, so there is not an explicit adjustment to the growth forecast for this year. If you go back to what we were saying about growth last March, it is not impossible that this underspending in aggregate would help to explain some of that growth downgrade, although, that said, the export performance is, on its own, enough to explain that anyway.
Q189 Chair: What is your view?
Robert Chote: I suspect that some of this does have a genuine impact on economic growth, but I would doubt it all does.
Q190 Chair: So what proportion?
Robert Chote: It is impossible to say, partly because the direct impact of Government consumption, which we talk about, has not tended to be very negative for growth as a result of the way in which Government output is measured.
Q191 Chair: To be fair, you do use the words "applying these multipliers mechanically" in the report, which you did not do a moment ago. What you are really saying is that you are using that as a stylised illustration of the effects, not necessarily that you think it reduced GDP by any particular amount.
Robert Chote: Absolutely.
Chair: And indeed it might have been a very small amount, a negligible amount?
Robert Chote: Yes, it remains to be seen how this is reflected in the national accounts through the year.
Q192 Chair: I am just trying to clarify what you are saying; I am not trying to put words in your mouth. Therefore, given what you have said, it would be quite wrong to conclude that GDP would be much higher if this underspend had not taken place.
Robert Chote: To conclude that it would be much higher would certainly be wrong, yes.
Q193 Chair: Well, 0.5% to 1%-0.5% a year is quite a lot in a market where there is not much GDP going around.
Robert Chote: Every little helps, yes. No, I would think that 0.5% is certainly the ceiling on that; I would expect it to be somewhat less than that.
Q194 John Thurso: It appears that one newspaper broke an embargo of information given by the Treasury. Were you aware that the information was going to be released under embargo ahead of the Budget statement?
Robert Chote: It’s been standard practice for many years, under Governments of all colours, to provide some briefing to political editors generally. Obviously the Evening Standard has a particular issue about its deadline, so I wasn’t surprised that it had the briefing before the event.
Q195 John Thurso: The particular issue that I am asking about is, of course, that the OBR did not exist under other Governments and you provide a considerable amount of very important data, some of which is market sensitive. So, was the OBR consulted about this, or is this a practice that has grown up without consultation?
Robert Chote: It’s been in place long before we were there. We don’t brief anybody on our material before the Chancellor stands up. We wait until our press conference at 3 o’clock in the afternoon.
Q196 John Thurso: You’re answering me very cleverly, Robert, but not the question I am asking you. The question I am asking you is this: is the OBR aware that information is being given out in advance, and-?
Robert Chote: As I said, yes. It’s been long-standing practice and I am aware of that, yes.
Q197 John Thurso: And if it is, do you condone it or approve of it?
Robert Chote: Well, I think that it’s not something-there is clearly a problem if some of the information that is given out is very market-sensitive, and for some measures I think providing that sort of advance briefing would not be very sensible. Given this package, that is not necessarily the case. It was clearly an error by the Evening Standard to put this information out earlier; I have the highest regard for its political writers, and I am sure that it was not a deliberate attempt to do that. The practice is clearly risky, but it is also understandable to want to help people to write in an informed way about this on the day.
Q198 John Thurso: Have you had an opportunity to discuss this with your colleagues since it happened?
Robert Chote: I do not think we have discussed it, no.
Q199 John Thurso: Is it something you will now discuss?
Robert Chote: We could do, if people have a strong view on that.
Q200 John Thurso: Well, market-sensitive information has been released-by accident, we assume-that potentially does some damage. It is not something that anybody expected; it has now happened. The Chancellor is clearly reviewing the processes in the Treasury. Would it not be appropriate for the OBR to make a view known as to its part of what is given to the Treasury and whether or not that should be available?
Robert Chote: As I say, we do not brief on the material that we have produced to anybody in advance of the Chancellor standing up. As I said before, this is an established practice. There are risks in that practice and, as you rightly say, I presume that the permanent secretary and the Chancellor are considering whether those risks are worth bearing.
Q201 John Thurso: Do you think it is a practice that should now be stopped?
Robert Chote: Not necessarily, I don’t think. I think that that is a sensible thing for the review to look at-whether the people who are given briefings need to tighten up the procedures to ensure that these sorts of things do not happen again. Generally speaking, it has worked okay over a long period of time, so I wouldn’t necessarily say that you need to change it. As I say, I think that this was not the first or the last time that somebody has hit the "send" button too early. Not too much damage was done on this occasion, but it’s a wake-up call to everybody on both sides about the potential difficulties that could result if you had something that was of more immediate market sensitivity.
Q202 Mr Newmark: You have been somewhat overly optimistic in your projections in the past couple of years. This year, for some reason, you suddenly forecast short-run growth of 0.6% for 2013, and of 1.8% for 2014. Those are downward revisions of 0.6% and 0.3% respectively. Why have you suddenly downgraded these figures?
Robert Chote: It’s reflecting the data that has emerged since the December forecast. The first point to bear in mind is that the revisions to last year’s data show that the level of GDP in 2012 was higher than we expected over the year as a whole, but that the final quarter showed a larger decline than expected, primarily because of weakness in North sea production as a result of disrupted production. So you need to take that into account.
Looking at the components of expenditure, export performance was weaker at the end of the year, and we basically take that as an indicator that that is likely to continue to be the case for a while. On the consumer side, you have also had average earnings growth coming in weaker, which would seem to imply a weaker outlook for household disposable incomes and, therefore, for consumption. We have also taken a slightly weaker view of investment, partly based on investment intention surveys.
So there is no single, overwhelming factor here. Add the revisions to last year to the growth downgrade for this year, and we are saying that we think the economy will be about three one-thousandths smaller in 2013 than we anticipated back in December; that is the sort of number which is likely to be clouded by revisions, sooner rather than later, I would suspect.
Q203 Mr Newmark: So it is as much an art as it is a science.
Robert Chote: It is certainly never a precise science, it has to be said. We make the best central judgments that we can.
Q204 Mr Newmark: But you do not think you are sandbagging the numbers a little now. Having pushed a little too much on the upside, you are now thinking, "Actually, we have to be a little more cautious here. We are going to be a little more conservative in the way we adjust our projections going forward." It happens in business when managers get it wrong for a couple of years. They then go back to their bosses and start slightly sandbagging the numbers, so things end up being better than they projected.
Robert Chote: I think trying to game things like that is probably asking for trouble. We give the best central forecast that we can and compare it to others. As you can see-certainly if you look at the cumulative forecast to 2016-we are in the middle of a wide range.
Q205 Mr Newmark: Graham, you are smiling over there to Robert’s right. What are your thoughts on the predictive abilities of the OBR of late and on the recent adjustment?
Graham Parker: One thing is that we have done rather better on the public finances-sometimes because things have cancelled out a bit. For out-turns in 2011-12, we were a bit better on the public finances and the deficit than we were on the economy. I have not really got much to add to what Robert said. It is partly a matter of arithmetic: if Q4 is lower, you start the year off from a lower place. In terms of a year-on-year average, that actually depresses it.
Q206 Mr Newmark: Steve, a lot of economic historians say that if we fast-forward and look back, we will find that we did not have a double-dip recession and that things were perhaps a lot better than initially seemed to be the case. Can you explain why there is that disconnect between economic historians, looking back at what happened in the past, and figures at a particular moment in time, which show that things were worse, when, later on, they tend not to look as bad? Could that be the case here?
Steve Nickell: In terms of the number of dip recessions we have, my guess is that, looking back in the future, we will have had rather fewer of them than we thought at the time.
Q207 Mr Newmark: But why is that the case?
Steve Nickell: Because revisions to the data often tend to move things around and smooth things out a bit. But that is neither here nor there; the number of dips in a recession is neither here nor there. I am sure, when we look back on the last three years, the economy will have remained relatively flat. In other words, looking back in 10 years’ time, I doubt we are going to see any transformation in the data or lots of growth; I think things will look flat. The number of dips is, in some sense, irrelevant.
Q208 Mr Newmark: Well, it is relevant in terms of what the public feel.
Steve Nickell: Absolutely.
Mr Newmark: If, suddenly, in 10 years’ time, we look back and we say, "In fact, we didn’t go through a double-dip recession," all the economic commentators will have egg on their face for slamming the Government.
Chair: Business confidence takes dips too, very differently.
Q209 Mr Newmark: What I am really interested to know is, what are economic historians looking at to make that adjustment that you are not looking at today in doing your analysis? Is there something that economic historians, when they are looking back, are taking into account in revising things that means you, as the OBR, should be saying, "Actually, maybe we have to reassess the way we are looking at our growth figures and growth projection figures"? Robert, you can answer that.
Robert Chote: If you look at what happened to the 1990s recession, that recession now looks somewhat shallower, doesn’t have a double dip and is a bit shorter than it was estimated to be in the Blue Book of 1994 or thereabouts. In the early period, shortly after this happens, it is partly because of the addition of new information-additional information. Often it is the national accounts catching up with new information from tax authorities. But it wasn’t that that changed the profile of the 1990s recession; it was primarily the methodological changes to the national accounts that came in the 1998 Blue Book and subsequently. That can have an effect thereafter. We would certainly look with interest at what will happen in the 2014 Blue Book, for example, when a new European system of accounts will come in: will that affect the changes there? So some of it is methodology as well. But as Steve says, it is hard to imagine that we are suddenly going to discover that this really was a very, very much less dramatic recession than it appears to be.
Q210 Mr Newmark: If I may fast forward a little bit, since 2010 you have consistently predicted that growth would revert to a mean of around 3% within three years. These forecasts have so far been revised down every time. Stephen King of HSBC has suggested that these optimistic medium to long-term forecasts are beginning to lose credibility. Are you concerned that you are beginning to lose credibility out there in the market?
Robert Chote: I don’t think so. Most economic forecasters have discovered similar difficulties, obviously, and most of them have those stronger growth rates in the medium term. That is generally a function of the fact that if you have a recession and you don’t assume that all of that recession shows up in destroying the underlying capacity of the economy, you will end up with a greater amount of spare capacity and therefore the scope for above-trend growth for a period, while that spare capacity is being used up. Obviously, if the recovery doesn’t start, that period of catch-up is pushed out into the future, and that has happened a bit.
Q211 Mr Newmark: Is part of that absorption of spare capacity also to do with people who have been destocking their inventories and so on in these tough times, suddenly giving a kick start to demand, in terms of starting to rebuild their inventory again at some future date?
Robert Chote: I think, generally speaking, the stocking/destocking story happens over a rather shorter time horizon. The explanation for the more rapid growth in 2015-16 is not because of restocking.
Q212 Mr Newmark: You are confident, then, that we will revert to near 3% growth within three years at this stage?
Robert Chote: I am certainly not confident. That is our best judgment.
Q213 Mr Newmark: That is what you are predicting, though.
Robert Chote: That is our prediction. You had four macro-economists in to talk to you yesterday. Three of them have stronger medium-term growth forecasts-the ones that they gave to the Treasury last month-than we do. That does not necessarily mean that they are going to be right or we are going to be right. But it is not an unusual feature. Roger Bootle’s outfit have 3% and 3.5% in 2015 and 2016, which is consistent with his view of there being a relatively large amount of spare capacity, as compared with the view of most other forecasters. So I would say that the uncertainties around any of these forecasts dwarf the significance of the differences between them.
Q214 Mr Newmark: If I may quickly touch on the productivity puzzle, to what extent has that been a problem for the OBR forecasts? Graham, you raised your eyebrow there. I am watching body language here. If you twitch, I am going to ask you.
Graham Parker: Everything seems to be a problem for the OBR forecasts on occasion.
Q215 Mr Newmark: You say everything does. Why is that the case? Is it that you are a new organisation and are still finding your feet?
Graham Parker: It is forecasting, so everything is difficult.
Robert Chote: The productivity puzzle is the defining puzzle that is confronting everybody trying to do a forecast and unravel the impact of the financial crisis on supply. It is at the heart of the fact that those people who were much more pessimistic about the outlook for growth have discovered that the labour market has performed much better than they had expected. Going back to Graham’s point about why the deficit shrank over the first couple of years after we were created even though headline growth was much weaker, that is partly down to the productivity puzzle.
Q216 Mr Newmark: Do you think people are being more realistic, more flexible in their approach to employment, so, having worked full time, they willing to go on flexitime, short term or part time? Is that what is causing it? Is it a fact that it is tough to get business, and therefore people are running around chasing business, expending a huge amount of energy for less return as people effectively are pushing margins down? I am just trying to understand what is going on there economically. Steve, do you have any thoughts on that?
Steve Nickell: We don’t know. We know that part-time work, and so on, can explain-
Q217 Mr Newmark: That’s probably why it is a puzzle, because you do not know.
Steve Nickell: Indeed. We do know some things. We know that part-time work, flexibility and so on, does not explain it. It explains a little bit, but it does not explain it. In my view, the best idea is that the tightness of credit has interfered with the allocation of activity from declining areas to expanding areas. It is a fact that, of the overall productivity growth, about 70% is generated by the closure of low-productivity organisations and the opening of higher-productivity organisations. If that process is impeded-
Q218 Mr Newmark: That’s good news, other than the zombie companies, if people are shutting down the less productive areas and opening more productive areas.
Steve Nickell: Yes, but the restrictions on credit have slowed down this process over the last few years.
Q219 Mr Newmark: But when we have spoken to the banks, they have said, "We have got loads of cash, but the demand isn’t there. The only people demanding money are the weaker businesses."
Steve Nickell: Well, banks would perhaps say that, wouldn’t they? In a sense, the opening of or the expansion of businesses that are doing well depends to some extent on the banks having a slightly more open attitude to risk than at present.
Q220 Mr Newmark: They had an open attitude to risk and they all went bankrupt, so they have got to be a little bit more cautious nowadays.
Steve Nickell: Of course, but in some senses there is always a balance to be struck. Banks have to undertake risky activities, and every so often-
Q221 Mr Newmark: We are busy saying to them, "But you mustn’t be taking on risky activities." Are you saying that they should start lending more to more risky businesses out there?
Steve Nickell: Yes.
Mr Newmark: Okay. That’s an interesting ending.
Q222 John Thurso: I want to follow up on the point that is being made. Roger Bootle told us yesterday that the availability of credit in the UK banking system, or rather the lack of it, was a notable contrasting feature to what is happening in America. Adam Posen and others have made the same comment-that one of the key problems in the UK recovery is the lack of credit availability, or the lack of credit coming into the system.
I will start with you, Steve. Have you analysed that? Have you done any work on that? Have you got anything to tell us about what you think the assessment on the actual economy is of that lack of credit?
Steve Nickell: Well, we do analyse the data on what banks and firms say about credit conditions. We have all the data on borrowing. We even forecast the data on borrowing, and our current forecast shows that credit conditions are easing, but I guess we know we are quite a long way from the normal. Just taking a slightly bigger picture, we know that, from time to time, credit becomes too easy and banks throw money at all sorts of projects which go belly-up, and then they lose a lot of money. That happens on a relatively regular basis, and then after that they get very tight.
What has happened recently is much more severe than that. It is not just the usual commercial property boom and bust; it is the fact that, for a variety of reasons, trust within the entire system broke down and banks are contracting their activities. Many banks are continuing to contract their activities.
Q223 John Thurso: That’s the point I really was driving at-whether you had any data on that. The point that is made is that companies have a lot of cash on their balance sheets but are not investing. One of the reasons why they are not investing is that banks are perceived not to be lending and therefore they are less confident about making investment. In particular, the point is made that there are a large number still of relatively difficult assets within the balance sheets, particularly of the nationalised banks, and therefore if you want to take a straightforward and good policy response to that, you take the bad bits out of the good banks and put them to one side. That allows them to get back to concentrating on lending; that, in turn, has a knock-on effect on companies.
I am really trying to see if there are any data available either to support that hypothesis or to say that it is not a good hypothesis. That is really the point of the question.
Steve Nickell: There are a lot of data available, but not of the precision that would be required to know whether the policy that you are suggesting-the bad bank policy-is the one to go for. The thrust of a lot of current policy is to try, one way or another, to get banks to lend more freely, and that kind of policy activity has grown over the last couple of years and continues to grow. My impression is, nevertheless, that it is on a rather small scale. Our difficulty is that we just don’t know when things in the credit market are going to get back to normal.
Q224 Mr McFadden: The IMF has changed its view on the multiplier effect of fiscal contraction in terms of its effect on growth. Have you?
Robert Chote: We haven’t changed the estimates that we published-that were used in the June 2010 Budget. The IMF has, as you say, produced some new estimates. It has produced some highly publicised estimates suggesting that the multipliers might be larger, and some much less highly publicised estimates suggesting that they are quite lower.
Q225 Mr McFadden: It would be quite an admission, wouldn’t it, to have underestimated the effect of fiscal contraction on growth in a recession?
Robert Chote: It wouldn’t be quite an admission. If you look at the evidence upon which people were trying to base their choice of multipliers in the first place, you get a very wide range in the academic evidence, so I think that there is huge uncertainty around that and the best thing you can do is to look at the errors in the forecast that you have made and to see whether that looks like the most obvious explanation for the differences in the way things have turned out.
Q226 Mr McFadden: In the six or seven reports that the OBR has published since 2010, there has been a consistent pattern of having to subsequently downgrade growth estimates, usually for this year and next year, whatever this year and next year might be. Do you think that part of the reason for that might be an underestimation of the effect of fiscal contraction on growth, and if not, what is the reason?
Robert Chote: We looked at this in the forecast evaluation report that we produced in October of last year, and we said there that it was certainly possible that the fiscal contraction had had more of an impact on growth than the multipliers anticipated. It looked to us, though, that the more likely set of explanations were starting from the point that the errors at that stage divided pretty much equally between the contribution from consumer spending, the contribution from business investment and the contribution from exports.
The consumer spending story seemed to be the most important one in the 2011 period. Initially, we underestimated the pace of growth through 2010 and then it started to be weaker than expected from the end of 2010 through to 2011. That primarily seems to be a consequence of the fact that things like higher oil prices, higher food prices, were squeezing what consumers could buy with their budgets, and that had the consequence of less growth there. We got the forecast for cash consumer spending pretty much right, but less of that translated into real activity. If you were looking at a multiplier story, you might have expected us to have over-predicted the amount of cash consumer spending as well as the real contribution to GDP.
If you look more recently, over 2012, more of the surprise has some on the net export side. Part of that is because of the unexpected weakness of UK global export markets and part of it is down to movements in the exchange rate, but, as we described in the report, there was more to it than that, and we highlight in particular what has been going on to exports of financial services: there has been a fall in exports of financial services both in the US and the UK, suggesting that there might be less demand for the sorts of financial services that we both produce. It is hard to square that directly with a multiplier story.
More broadly, there has been a weakness in business investment relative to expectations throughout the period, although business investment numbers have now been revised up and actually do not look very different from the 1990s experience. There again, fiscal consolidation could be part of the explanation for that, but so too could conditions in the financial sector, worries about the eurozone and the fact that people do not know when consumer spending will pick up properly. In terms of the impact of the fiscal position, if there is an effect on business and consumer confidence, does that come from exactly how much of the fiscal consolidation you are implementing in a particular year, or is it because people know that the mountain that the Government eventually has to climb on this has got larger than previously expected because of the weakness of potential GDP?
So we certainly would not rule out the possibility; there is enormous uncertainty around those multipliers, but if you want to find out what led to the body in the library, it is not the most obvious murderer and murder weapon given the evidence that we have today. But we will look at that again when we get to this year’s-we will have another year of data when we get this year’s forecast evaluation report.
Q227 Mr McFadden: You have got a big list there. It might be this, it might be that, it might be something else, but the upshot is that your forecasts in the short run have been consistently wrong and have given a pattern of "jam in two years’ time." Is that a fair summary?
Robert Chote: Coming back to the first point, you are absolutely right that the near-term forecasts have been brought down-
Q228 Mr McFadden: About six times.
Robert Chote: Yes. There has basically been a consistent pattern: we underestimated growth over the middle of 2010 up to end of 2010, and then you have basically had the economy flatlining against expectations pretty much thereafter. The fact that you have stronger growth looking forward-which is a feature, as I say, of most of the forecasters that you were speaking to yesterday and most of the forecasts that you look at otherwise-reflects a judgment: that the very weakness that you have just described means that there is a significant, albeit hard to measure, amount of spare capacity in the economy; unemployment is higher than it needs to be in the long term, for example, and that therefore if one can get the economy growing more rapidly, there is scope for it to do so without you having to slam on the brakes. That is why people tend to have those forecasts further out.
Some people would say, "Okay, we take a very much more pessimistic view of supply and the long-term growth rate." In that case, you would not necessarily see that scope for a pick-up, but I think most people remain to be persuaded that the long-term structural position is that bad.
Q229 Mr McFadden: The second half of this is the longer term. We have established that, in the short term, the OBR has consistently overestimated growth in year one and year two from the starting point of any forecast, only subsequently to downgrade its figures. We asked Roger Bootle about that yesterday and he said: "It seems like, as it were, a series of mistakes, and that therefore the OBR comes out looking bad. In fact, there is only one mistake: consistently to have underestimated how serious the problems are for this economy after the financial crisis-one mistake, and they keep making it." What is your reflection on that?
Robert Chote: If you are looking for the single factor that overarches this period, it is that we have been through a severe financial crisis, and the lessons from history are that severe financial crises take longer to recover from than the standard problem of allowing inflation to get slightly out of control and then having to rein it back. Right back to 2010, the OBR has had forecasts that were weaker than the recovery of the 1990s, for that very reason. Clearly, in hindsight, the impact has been greater over a longer period. As I say, I think you have to take a more disaggregated look at where the errors appear in the forecasts, and there are other reasons than the one I have given, but it is clearly an important one.
Steve Nickell: The Roger Bootle quote is quite slick, but as to the fact that we get forecasts wrong, everybody gets forecasts wrong-we cannot foretell the future. The important point is to come back afterwards and provide a coherent explanation as to why we got the forecasts wrong. Taking the example of consumer spending in 2011, the fact is that we know why we got it wrong-because we underestimated consumer price inflation by one percentage point. As Robert said, we got nominal expenditure on consumption spot on pretty much, but on real consumption, we over-predicted a lot because we underestimated inflation. The inflation arose because of the oil price, food prices and so on, which neither we nor anyone else predicted. So it is not a question of saying the reason might be this or might be that for this particular part of the problem: it was this, and we know what it was. If you read the forecast evaluation report, we provide chapter and verse on nearly all these things.
As to the broad notion that we did not realise how powerful the impact of the credit crunch was going to be, one might, to some extent, plead guilty to that. At the margin, we probably did make mistakes in that direction, but the vast bulk of the errors we make are explained and set out in the forecast evaluation report, and it is simply not the case that we did not really know what was going on.
The area where we do not really know what is going on is the longer term, because we, like most people, assume that productivity growth in the longer run is going to revert to the trend over the last 50 years. If that did not happen, the economy would look quite different in the long run from our forecasts.
Q230 Mr McFadden: That, in a way, is what I am driving at. I began by asking whether it was possible that you had underestimated the effect of the fiscal contraction in the recession, which some people are now saying may be greater than many people first thought.
However, I want to end by asking about the future. You said that lots of other people assumed a bounce-back to something like 2.5% to 3% growth in the future, too, but the fact that lots of other people do it is, in a sense, not a good enough answer. My final question to you is this: given that you have got it wrong on the short term, why should we have confidence in your forecasts for years 3, 4 and 5, which have consistently said there will be a bounce-back to something like 2.5% to 3% growth? Three years on, it has never happened.
Chair: If you can give us a relatively brief reply, I would be grateful.
Robert Chote: Well, you should have no more confidence than the analytics will bear. You can see what the average forecast errors over those periods are. As I say, the notion of a pick-up in growth rates over the medium term is down to a belief that there is more spare capacity. If you look at Capital Economics-Roger’s outfit-they have a weaker growth forecast than us over the next two years and then a stronger growth forecast than us over the subsequent two years, but I am sure he would be the first to say that there was huge uncertainty around that. What we have to do, because fundamentally we are here to forecast the public finances and everybody has the same information about the economy, is to ask what difference it makes if there is more or less spare capacity, which affects that capacity for longer-term growth. What happens if the recovery is stronger or weaker? How does that affect the Government’s ability to hit the fiscal targets that they have set?
We have to place our view of the macro economy, on which we have no more information than anybody else, in the context of past forecast errors and what other people are saying at the same time. It is then for policymakers to judge, not just whether they believe the central forecast, but where they see the risks in deciding how to play policy.
Chair: One thing we know for sure-you will carry on getting it wrong. The question is whether you will be getting it any more wrong than anybody else, and that is an issue that the Committee will keep an eye on.
Q231 John Mann: That is one question. The other question is whether the pattern that is there is overly comfortable for the Treasury, in terms of how it sees the world. That is why the issue of the pattern of errors is so important. Before I come back to that, I would like to hark back to John Thurso’s questioning. I was not satisfied, Mr Chote, with your answer. Who set up the OBR?
Robert Chote: The Government and Parliament in legislation.
Q232 John Mann: Correct. Your report, in line 1, says, "The OBR was established in 2010 to provide independent and authoritative analysis of the UK public finances."
Your answer to a leak of your "independent and authoritative analysis" by a third party was to say, "This has always happened." I am uncomfortable with that. Are we going to see this again or are you going to do something about it? What the Government and the Treasury do is their business, but this is your analysis and your figures that have been put out by a third party in advance of the Budget. That seems a problem for your credibility. Don’t you agree?
Robert Chote: I don’t think it is. It is something that Governments of both parties and Parliament have sat back and seen happen over many years. If you did not want that to happen, it would have been perfectly possible to prevent that from taking place. I do not think it would be our position. If the Treasury, the Government or Parliament decided that there should be absolutely no pre-briefing of the material prior to the Chancellor standing up, I would be perfectly happy. It would not affect us at all. We do not pre-brief. You have been presiding over this for many years, I presume from the belief that it has positive benefits as well. It is not for us to say whether that is appropriate or not.
Q233 John Mann: You have been set up by Parliament as an independent body. Therefore, it is quite different from the past. When we voted that through-I think probably unanimously-it was on the argument that you would be independent. What Government choose to do under the instructions of politicians is not relevant to your data being released. If your data are released in advance next year, will you not be very unhappy about that?
Robert Chote: As I understood it, there was a tweet of the front page of the Evening Standard. I don’t know to what extent that was a release of our data, or a release of the details of the Budget measures. The Budget measures are not our responsibility.
Q234 John Mann: No, but your data.
Robert Chote: I don’t know whether the embargo was broken on that material or not, I’m afraid.
Graham Parker: It did have our forecast for 2013 on the front page.
Robert Chote: If the view taken is that that should come to a stop, that is fine with us. As I say, we don’t pre-brief our material.
Q235 Chair: I am a bit surprised to discover that you did not know whether your own information had been leaked, until you were told by your colleague, Mr Parker.
Robert Chote: Well, as I say, I did not read the front page of the Evening Standard on Budget day.
Q236 Chair: And it has not occurred to you to ask questions about whether your own information has been leaked?
Robert Chote: There has been a long-standing approach of providing some sort of assisted briefing to political editors and to the Evening Standard for many years under those-
Chair: You are repeating the answers. That is not the question I asked.
Q237 John Mann: I think you’ve got the point. Anyway, I am concerned about how overly optimistic you always seem to be. I will not repeat Mr McFadden’s questions because they were well put and clearly answered. However, we gave you a bit of a rough ride last year over the estimate for 4G. Several people on the Committee suggested that perhaps you were being overly optimistic and taking the Treasury line. That proved to be the case. I am interested in the methodology. I will give an example, as I think that that is the best way to get into this.
Robert Chote: For 4G?
Q238 John Mann: No, the methodology that you are taking overall. Let us take infrastructure. There has been a lot of discussion about housing, which is obviously forward looking-at some stage you will be assessing those matters. Money is put in to try to stimulate the housing market. Two things could happen. One is that it stimulates house building, the second is that it pushes up house prices. Either, or a combination, of those could happen. That would make quite a big difference to the impact of that policy, including on growth. I want to know how you are methodologically going to be analysing that. Or are you simply going to accept the Government’s vague assertions of what it will mean?
Robert Chote: No, that would be the indirect effect of a policy on the economic forecast. On the cost of a particular policy, for example 4G, the Government come to us with an estimate, we discuss it with them and suggest changes, and then at the end of the day we have to decide whether we believe that it is a sensible and reasonable forecast or not and reflect that accordingly.
On what you described, let us imagine something. On the mortgage guarantee scheme, on this occasion, there was not enough detail, for example, about the fee that was going to be charged for us to have included that in the forecast. However, if we were going to do that, it would raise precisely the question you describe: what is your judgment about how much this is going to show up in prices and quantities?
In terms of methodology, we have to make a judgment on the basis of the information that we have. If you were to note the fact that the planning system remains an important reason why the supply of new housing is relatively inelastic, and the need of house builders for working capital, I suspect that more of it would have shown up in prices than in quantities. Exactly where you would draw the divide, we would have had to discuss together, but that is exactly the sort of judgment that you apply.
Q239 John Mann: The reason why this strikes me as very important is that there almost seems to be consensus among the political parties that spending on infrastructure is going to stimulate growth. How you analyse that is therefore of much more significant importance than if there was not such a potential reliance on infrastructure projects to stimulate growth. That is why I am interested in the methodology. For example, do the Government tell you about slippages in major infrastructure projects in order for you to build that into your assessments?
Robert Chote: We look directly at the Government’s spending plans for capital and current expenditure. The capital will not necessarily distinguish right down between infrastructure and other forms of capital spending, but we do look at the developments in that. Basically, if there is a big increase in capital spending versus other sorts of spending in the short term, you would look at that through the multipliers and so on and reach a view on that.
In terms of investment more broadly, we are taking a forecast across the economy as a whole, but we look specifically at the plans that the Government lay down for capital and current spending and then have to make judgments, for example, about what proportion of that is actually going to be spent. That comes back to the issue of underspends that the Chairman kicked off with.
Q240 John Mann: Would Mr Parker or Mr Nickell like to comment on either of my lines of questioning?
Steve Nickell: There are two separate things here. There is infrastructure spending by the Government, which is just part of Government spending, and we take account of that. Indeed, some of the underspend this year is slippage of capital spending. But the other aspect of this is the guarantee system, which is not direct infrastructure spending but is the use of guarantees to get the private sector to invest more, and we would analyse that in the way Robert described-mortgage guarantees, housing. The key issue is: is it just going to drive up house prices? By and large, in the short run the answer to that is yes. But in the medium term, will the increased house prices stimulate more house building? Our general answer to that would probably be, "A bit." The historical evidence suggests not very much.
Q241 Chair: This is a three-year scheme, Mr Nickell. You are saying that the benefits are going to come through in the medium term, when the scheme has wound up and the demand effect is unwound.
Steve Nickell: Well, the demand effect probably will not be unwound, in the sense that the prices will go up and one would hope that that would impact on house builders. But, as I have just said, it probably would not impact on that very much.
Q242 Andrea Leadsom: Robert, this time last year we were asking you about the impact of the eurozone crisis on your core forecasts, and it certainly seems, from your own admission, as though the eurozone is to blame for some of the underperformance of the UK economy. You have added to that oil shocks and commodity price inflation.
I just wonder, a year on, why you are now thinking that the eurozone will not continue to have a massively dampening effect on UK growth? What evidence is there? If you can, will you answer this in relation to Cyprus? What evidence is there that the UK economy is going to recover from here, bearing in mind how exposed we are?
Robert Chote: Well, if you look at the contributions to GDP from different areas of spending, we have a relatively modest contribution now from net trade-the balance between export performance and import performance-over the next few years, and less from that than we had back in December. Part of that is down to the growth of UK export markets. For example, if you look at the fact that UK export markets are expected to grow less quickly than world trade as a whole, that is partly because the UK has greater exposure to the eurozone than more rapidly expanding economies in the world. So there are parts of that story there.
There is also the degree to which events in the eurozone are continuing to weigh on a bank’s ability to get hold of finance, and how that feeds through to the financing of consumer and business activity. There, the combination of the FLS and the European measures suggests that there is some improvement in those sorts of conditions, but it is too early yet to be seeing that feeding through to the real economy.
Clearly, Cyprus happened too late for the economic forecast here. At this stage it is hard to see how the Cyprus situation could make the outlook better, but it is probably too early to reach a very informed judgment about how much additional impact that is going to have, both directly via eurozone demand for our exports, and for the bank funding conditions and the health of the financial system. Clearly, that is something that we will keep an eye on when we get to the next forecast. Certainly, we are looking for less assistance from net trade than we have done in the past, and that is partly an issue for the eurozone.
Q243 Andrea Leadsom: Just to be very clear then, effectively you are saying that the British economy is not now as exposed to the performance of the eurozone as it was this time last year. Is that what you are saying?
Robert Chote: I am not sure I would say that. I think if there were to be a severe deterioration in the eurozone we are as exposed to that now as we were then.
Q244 Andrea Leadsom: What I am asking you is, what has changed? If the reason for the overly optimistic forecasts is down to the eurozone, inflation and oil shocks, what has changed to mean that you can now forecast growth a year out and be much more positive? Is that because you are assuming that the eurozone will be in better shape in a year’s time, or because you think that Britain’s growth prospects are not as dependent on the eurozone?
Robert Chote: If you look at export performance, the eurozone is not necessarily the main determinant of why we have got more pessimistic about that previously. If you look over the 2012 period, there has been a very sharp deterioration in export performance, both over time and relative to our expectations. That is more than you can explain by the fact that we are also more pessimistic about the strength of the eurozone economy this year.
An interesting part of that is the question of the specific performance of exports of financial services, which has deteriorated quite significantly. You would not put that down necessarily to the eurozone specifically. You have seen a fall-off in exports of financial services by the US as well, so it may be something about the kind of financial services that we are both providing.
Yes, the eurozone is in greater-the real economy is performing weaker, but you look forward and hope that there will be some improvement in that over time, although, as we say in here, the situation clearly will remain fragile for a long period of time and it is one of the reasons why we have growth in potential output taking time to recover back to the long-term trend and not even reaching it by the end of the forecast.
Q245 Andrea Leadsom: I am still not completely clear. You are forecasting lower growth this year than you expected this time last year, but the following year you are expecting it to recover. Would you say yes or no to the following question? If the eurozone fails to make any recovery whatsoever, will you have been too optimistic in your forecast again? Is that a yes or a no?
Robert Chote: All other things being equal, if the eurozone stays completely flat and there is no recovery, clearly that is bad news for the UK.
Q246 Andrea Leadsom: So then you will have been over-optimistic in your forecast again.
Robert Chote: Other things being equal, export performance will have been weaker and you will have had difficulties in the financial sector. You would expect that to show up in a weaker outturn relative to forecast.
Q247 Andrea Leadsom: What I am trying to get to is the fact that this time last year you made all sorts of provisos, as the Bank of England does, that the real downside risk is the eurozone. But you left it there; you did not try to do any scenario estimates, nor did the Bank of England attempt to do a meltdown scenario versus a slightly bad versus a Cyprus. You are effectively saying that you are really counting on the eurozone sorting itself out, and if it does not, you will be coming back to us saying that your forecasts were overly optimistic again.
Robert Chote: Yes. The forecast is implying a difficult position for the eurozone this year-a gradual improvement over time but by no means getting back to normal, healthy performance further out. If the performance is even weaker than that-we did do a scenario, if you recall, in November 2011, using the OECD’s "euro area bad outcome" scenario-clearly, a similar sort of set of conclusions would arise from that as arose then, which is that you would end up with a weaker outlook for exports, and potential difficulties in the financial sector.
In terms of the biggest damage that could be done, obviously if you have something that hits the integrity of the financial sector again, and therefore exacerbates the problems that Steve was talking about, about your ability to get capital to where it needs to be in the economy, then that would have more long-lasting consequences for UK performance than a short-term dip in our exports would do if it was a less serious outlook.
Q248 Andrea Leadsom: One last question, if I may. Have you had the opportunity yet to consider the impact of the Cyprus crisis on the stability of financial markets? For example, having capital controls is not great in terms of investor confidence in the banking sector. Have you done any analysis of what the impact might be on confidence in banking in the UK economy?
Robert Chote: No, we haven’t. We closed the economy forecast on 7 March. That has come up subsequently, and we obviously will not look at that until closer to the next forecast in November or December, whenever it might be.
Q249 Mark Garnier: May I turn to consumption? You have been hearing a lot about Roger Bootle from yesterday; he obviously made an impression. I asked him about consumption, and he said that, mathematically, to the extent that consumption represents two thirds of the economy, it is an important criterion, but that actually what is far more important in order to get a strong, vibrant economic recovery is more investment and more net exports. Do you agree with that?
Robert Chote: We are looking for contributions from all those areas. If you look at the breakdown of the forecast over the five years, much more from consumption-as you say, consumption, arithmetically being 60% to 70% of the economy as a whole, is always going to be, in normal circumstances, the main contributor. You expect investment to rise as a share of GDP for this period. As I was saying to Mrs Leadsom, the contribution from net exports is relatively modest over that period. Arithmetically, consumer spending and investment would rank ahead of net trade.
Q250 Mark Garnier: What do you think are going to be the drivers of consumption in order to meet any expectations?
Robert Chote: We are still awaiting the point at which you are going to see consumers having their nominal earnings-wages and salaries-growing more quickly than prices: a return to real disposable income growth. Last year there was a temporary boost, because of the high level of inflation in the autumn of 2011 feeding through to income from benefits. Looking forward, that is not there again. It is really looking to this period at which you start to see the return of real disposable income growth. Looking at that compared with where we were in December, the outlook for nominal earnings, cash growth in wages and salaries we assume to be a bit weaker, because productivity has once again turned out to be a bit weaker. Also looking forward, consumer price inflation in the near term looks likely to be a little higher as a consequence of higher oil prices and the impact of the change in sterling on import prices and also the fact that that the outturn data has been slightly higher. So you have both sides of the scissors squeezing a bit and, once again, that means that you have to wait to see real disposable income growth returning to provide an engine for consumer spending.
Q251 Mark Garnier: Is not one of the biggest problems that is facing recovery this huge level of household debt?
Robert Chote: Well, if you look at the income level-
Q252 Mark Garnier: Your colleagues both smiled at that. I am very curious. Steve Nickell, why did you laugh at that?
Steve Nickell: Because I have heard that so often in the last 10 years.
Mark Garnier: Probably from me.
Steve Nickell: Not from you.
Q253 Mark Garnier: You are very dismissive of it. I am interested.
Steve Nickell: Frankly, my feeling is that the level of household debt is not a huge drag on the economy and that what is a huge drag on consumption is the fact that, as Robert has just said, real incomes are falling. If real incomes are falling, it is hard to imagine consumption growing.
Q254 Mark Garnier: None the less, we have household debt of £1.46 trillion. It is up 260% in real terms since 1990. We are at a period of very, very low interest rates. Surely, the average household, with its very high level of debt-even if it is very affordable at this level-must be conscious of the probability of interest rates starting to go up, which has to be inevitable, because I do not think that anybody would think that they are going to go down from this level, so the only way is up. Surely that must be having an effect on household confidence.
Steve Nickell: The reason why household debt has risen such a lot in the last 40 years is because owner-occupation rates have risen. There are just a lot more mortgages than there used to be.
Q255 Mark Garnier: Yes, but it is up 260% in real terms since 1990. That is only two decades.
Steve Nickell: Indeed, and the number of mortgages has risen hugely since 1990, and of course the value of the property secured against this debt has also risen, I am sure by the same order of magnitude. So the-
Q256 Mark Garnier: May I quote another number at you? UK mortgage debt as a percentage of household income has gone from 90% in 2002 to 140% at its peak in 2008. It has come down a little since then. That, in just six years, is a very substantial increase in mortgage debt as a percentage of household income.
Steve Nickell: Yes, that is partly a function of the fact that mortgages got bigger, because houses were more expensive.
Shall we go back to the main issue? If interest rates go up, all these mortgages will become unaffordable. Basically, if you look at the history of what people can afford, it is actually driven by unemployment. Basically, people cannot afford their mortgages when they lose their job. If they have still got a job and their mortgage goes up because interest rates go up, they pay; they just cut back on something else. It is losing your job that is the key. When interest rates go up, one hopes that that will happen in a situation where prospects for the economy look better.
Q257 Mark Garnier: May I challenge you on what you said about the interest rate rise? If we were talking about the base rate going from, say, 5% to 6% or 7%, I would completely agree with you about the marginal increase. But we are talking about interest rates potentially going from 0.5% to 3% or 4%.
Steve Nickell: Not many mortgages are 0.5%.
Q258 Mark Garnier: No, I appreciate that the yield curve is very steep at the shorter end, but none the less if you start seeing interest rates going up, the per monthly repayment-just servicing that interest-is potentially quite a significant kick up. You will not see it going up by, let us say, 20% on what it was last month. You will potentially see the cost of servicing a mortgage going up by 100% on a month-by-month basis, and that is a very different proposition. That is because we are at such a low level of interest rates. The other question that is tied within this is the level of forbearance within the banks.
Q259 Chair: Let us do those questions in turn, because they are both very important. On the first question, what is your response?
Steve Nickell: My response to that is that I think it very unlikely that there will be huge numbers of families who cannot pay if they are still in employment, even if their mortgage goes up. If you are on a repayment mortgage and the interest rate goes up from 3% to 6%, the outgoings on a repayment mortgage do not rise by 100%; they rise by considerably less than that.
Q260 Mark Garnier: But 40% of mortgages are interest only.
Steve Nickell: Okay, but by and large the outgoings on mortgages are at an historically low level.
Chair: That is the worry. That is the question.
Q261 Mark Garnier: That is the whole point.
Steve Nickell: They are at an historically low level. The history of these things is that people pay. And we do not generally find people in employment losing their homes.
Q262 Mark Garnier: The forbearance question is something else that is very important. There seems to be a certain amount of concern among those commentating on the banking market that forbearance is probably a lot greater than we imagine, certainly given the fact that we have very low funding costs for banks. It actually makes it a lot easier for banks to have a great deal more forbearance than you would otherwise have had, were funding costs that much higher. Again, is this not a huge problem potentially lurking in the background, which will only emerge at a time when interest rates start going up?
On the subject of why interest rates might rise-we were talking about having a new Governor of the Bank of England, but the reason why I am so concerned about interest rates, and the reason why I think this question is very important, is that we now have a situation where we have quantitative easing, and the management of the economy is keeping bond yields very low indeed, but we also have a very weak sterling. We are not necessarily seeing the export growth coming through at the speed that we would like, but potentially with the weak sterling we may start importing inflation. As inflation is the key target for the Bank of England, it is entirely possible that to try to counter that, the short-term measures may be to raise interest rates to protect sterling in order to stop importing inflation ahead of any growth in the economy that will come through export growth. To me, the key risk that we are running at the moment is that there will be an inflation problem before there is a growth success, and therefore we will see interest rates rising at the wrong time for households, rather than at the right time when household incomes start going up.
Steve Nickell: Of course that is a danger. What I would say is that the Bank, in the recent past, has seemed to look through the inflationary bursts generated by falls in sterling and oil price shocks and so on. I somewhat doubt that they will change their attitude to inflation generated from this source in the near future. But as you say, that is a danger. Going back to the bigger picture, I think the issue for the consumer at the moment is not the debt but the fall in real wages. The consumer will not start spending unless real wages start rising, and when they do start rising they will start spending. I am less anxious about household debt, while it is backed by household assets, than you are.
Q263 Mark Garnier: Does anybody disagree with that? You all agree? You all seem to be intensely relaxed about the high level of household debt.
Robert Chote: We have had a discussion of that in this report, looking, for example, at the income leverage story and the fact that at the moment that is at lower levels than prior to the crisis. On this issue, I share Steve’s view. When you have got real wages falling, it is not surprising that consumers are not spending as much as you would like.
Q264 Mark Garnier: On the potential hidden problems that are being masked by forbearance, do you think that is an issue?
Robert Chote: In terms of mortgages, it is striking how small the losses on mortgage lending have been historically. So there is not a great deal of vulnerability on that particular score, judging by what has happened.
Q265 Mark Garnier: So there is not a great deal of vulnerability?
Robert Chote: On Steve’s point about people being unable to cope, yes, there is a difficulty if people lose their jobs, but in aggregate the fact is that there has not been a great desire to crystallise losses on mortgage lending.
Q266 Mark Garnier: So you think that there is possibly more forbearance than is healthy?
Robert Chote: I do not know what the optimal level of forbearance is.
Q267 Chair: Forbearance is merited by the fact that you get your money back in the end. So you do know; it is very clear.
Robert Chote: Yes, rather than just the desire not to touch it. Distinguishing how much of that is going on from the other sort is not easy from the data.
Q268 Mr Love: Mr Chote, it won’t surprise you that I want to return briefly to the £11 billion underspend that you talked about with the Chairman, and particularly about shifting payments between years. Your report comments on that and suggests that although the payments are being moved into the next year, accrual accounting might move them back. What order of magnitude are we talking about, and how material is the risk to the £11 billion underspend?
Robert Chote: I doubt it’s a very large element. We don’t have an exact figure for how much of the £11 billion is that sort of activity. When we had our discussions with the Treasury in order to satisfy ourselves that we were going to be able to come up with what we felt was a central forecast, they mentioned that this was one of the things that would be going on. I suspect, given the number of such organisations and the amount of payments, that it will be south of £1 billion, but you would have to ask the Treasury. We do not have a firm figure on that.
My concern was that that sort of thing seemed hard to square with an accrual accounting approach, where you would think it would be back in that year. That said, the way in which EUROSTAT has, for example, treated payments on defence procurement suggests that things in the world of international public finance accounting are never as straightforward as they seem at the beginning. That is why I felt it was important that we highlight that as a potential risk or uncertainty. But it is not going to be a large factor relative to the size of the underspend, and the uncertainty that lies around those sorts of numbers anyway.
Q269 Mr Love: And did the fact that you did not consider it large and you do not consider the amount of borrowing to be a particularity important economic factor-although, as we mentioned in your last appearance here, it could be a strong political factor-mean that you didn’t take it into account; you only took into account the economics and the marginal nature of any shifting payments between years?
Robert Chote: Yes, we basically have to come up with a central forecast for departmental spending this year and in future years based on the information that is brought to us. Clearly, the revenue picture was looking weaker than it had done in December, and then there were choices for the Government to take about what it wanted to do on departmental spending this year. As you will see, we have published considerably more detail of that sort of analysis than we would do normally, precisely because of the sensitivity of this judgment and the fact that it is so far out of line with historical precedents. We wanted to have as much evidence here as we could in order to satisfy ourselves and others that it was as central as it could be, while always being uncertain.
Q270 Mr Love: But you did not go into the figures. Figures above £1 billion have been bandied around in relation to this, but you did not quantify that in any way.
Robert Chote: No; what we asked for was quantification by Government Departments, which has been reflected here and I think that the Treasury put that in their document as well. Graham, is there anything you want to add?
Graham Parker: They did give us more detail when we asked about some of the major items. Some of these international subscriptions are of the order of £100 million or so each. We saw a few of those, but I would be surprised if they added up to much more than about £0.5 billion, possibly.
Q271 Mr Love: May I move on to the new remit of the Monetary Policy Committee, which was a major plank in the Chancellor’s Budget statement? Will that have any impact on your forecasts?
Robert Chote: It has not had any explicit impact on this forecast. As you know, we base our economic forecasts on market expectations of monetary policy, so that was closed down, as I say, back on 7 March. It is interesting that, subsequent to the announcement of the new monetary remit, if you look at the date at which interest rates are expected in the markets to start rising again, that has not moved very much. So I suspect that, in the minds of markets, the new news on the remit has come as a matter of interest to them, but I suspect that they are even more interested in seeing how the Bank is actually going to start to behave from the second half of this year onwards under new management, given the more explicit description of the instruments that it has available to it in the remit.
We have had inflation above target for a considerable period of time, as you were discussing yesterday. There is clearly a difference between that happening ex ante and ex post, but it was certainly too early for us to judge in the forecast what difference this was going to make to monetary policy outcomes. We will see what use the Bank makes of the remit when some more time has passed.
Q272 Mr Love: But the Chancellor has given a very strong steer in relation to this. He has talked about explicit forward guidance and intermediate thresholds. Indeed, he has asked the Bank to report on these matters in August. Is that not a very strong signal that there will be monetary activism, if I may use the phrase?
Robert Chote: Well, it depends, obviously, what you use as the forward guidance and what conditional thresholds you set. Policy makers use those sorts of policies, typically, when they are concerned that the markets have a view about when monetary policy is likely to tighten that they are not happy with. Partly, it will depend on whether the Bank wants to start using that to send that sort of signal, but it is too early. The remit is clearer about the Bank possibly doing that, and Mark Carney has spoken about that in the past as well, but it obviously depends on whether that tool is actually used and what sort of thresholds are set, and how that then affects the expectations of financial markets as to where monetary policy is going.
Q273 Mr Love: But clearly the intention is to improve business confidence and have a low interest rate environment for a significant period of time. When would you make that judgment? Would it be based on a decision by the Monetary Policy Committee and then market reaction to that decision?
Robert Chote: Yes. We basically look at market expectations, so by the time we do our next forecast in the autumn, the markets will obviously have had more time to digest the remit, but more importantly, you will have had the new set-up at the Bank in position for some months, and it will be interesting to see what use of this they have made-for example, in talking about it in August-and whether or not they have started setting explicit conditional thresholds.
Q274 Mr Love: There has been some comment about who was consulted over the change in remit. Were you consulted in any way, informed in advance or aware this change was coming before the Budget statement?
Robert Chote: No, we weren’t consulted about what it should contain. We were shown shortly before the Budget what the new remit was going to look like, but that was after our economic forecast had closed down; so I would not expect to be asked to suggest what it should say.
Q275 Mr Love: Can I come on to a theme that has arisen in various guises this morning? That is our poor export performance. You comment in the Report that the forecast for exports implies a loss of export market share continuing. Yet we have had a devaluation in the pound of 20% to 25% and Martin Weale’s research on this matter suggests that while export performance declines, even with that sort of devaluation, the performance of Germany and the United States, in contrast, has been much better. Clearly the eurozone has got a lot to do with this, but setting that aside for a moment, why are we doing so badly with such a significant devaluation?
Robert Chote: As I say, part of the story is specifically exports of financial services, with the parallel with the US of demand for those sorts of financial services being weaker. If you look at what financial institutions have been trying to do with balance sheets, shrinking overseas exposures and presumably the services that are associated with those, that would be reflected there as well; so that’s part of the story.
The profile for the loss of market share we assume to be falling more slowly, looking into the future, than it has done in the past, which is partly a reflection, maybe, of the financial sector story-some of that effect already being in there; some exchange rate effect as well. But, yes, we do have that continuing. It is partly the UK’s trade being more with, for example, the eurozone, than the more rapidly growing emerging market economies that perhaps the likes of Germany have sent a higher proportion of their exports to.
Q276 Mr Love: That leads to the obvious question. Is devaluation the way forward for improving our export performance, or do we need to look to other mechanisms? We were told yesterday, and certainly the Governor of the Bank of England has stated recently, that devaluation has gone far enough. Is that correct in your view, or do we need to search for markets in other parts of the world that aren’t suffering quite as badly as the eurozone at the present time?
Robert Chote: Well, it is clearly not for us to say whether talking the pound down is a good or bad policy. What we have done in our scenarios is to point out quite how difficult it is to predict what the net impact of a fall in the exchange rate, for whatever reason, may actually deliver. If you go back to the devaluation subsequent to us leaving the exchange rate mechanism you seem to have a reasonably robust export performance, complemented by the fact that it didn’t seem to have too much impact on inflation and therefore to exert the squeeze on consumer spending. More recently, it seems to have fed through quite strongly to inflation and therefore to the squeeze on consumer spending while, as we say, not generating the export improvement you might hope for; so it is not even clear what the sign is of the impact on GDP of a fall in the pound.
One caveat I would stick over the export data, though, is that we do need to remember that to some degree we were here a couple of years ago, when I think we were talking to you, and we were expressing surprise that export performance had not then picked up as much as you would have anticipated in response to the fall in sterling since 2007-only for the data to be subsequently revised, showing that actually export performance over the previous year to 18 months had been stronger than previously anticipated, and more consistent with the response to the exchange rate that you saw in the 1990s. It is clearly possible that that could happen again. We have not, as is our practice, attempted to predict revisions to past data, but I would leave that there as an additional uncertainty over this.
Q277 Teresa Pearce: Mr Parker, with your previous Inland Revenue hat, and Treasury hat, I wondered if you would like to answer some questions regarding the figures for anti-avoidance and the proposed figures of money that is about to be brought in, apparently. Do you know how much of these forecasts are based on behavioural change?
Graham Parker: It varies from measure to measure.
Q278 Teresa Pearce: So for instance, do you know if the offshore initiative with Jersey and Guernsey is mainly behavioural?
Graham Parker: Yes, I think it is mainly behavioural, and there are different types of behaviour, about people who own up or people who move elsewhere.
Q279 Teresa Pearce: Given that with the Swiss initiative one of the options was to move elsewhere, and now elsewhere is going to be reported as well, there are fewer options open to people. Given the projections that were made for the Swiss initiative and the amount of money that it has actually brought in, do you think that the figures for the new Jersey, Guernsey and Isle of Man initiative are accurate?
Graham Parker: It is still a bit early to talk about Switzerland, isn’t it? We have just got the Swiss bank agreeing to pay an amount up front.
Q280 Teresa Pearce: But we already have a number of voluntary parties coming forward. Is that as many as were predicted?
Graham Parker: The better parallel may be Liechtenstein, which was a bit before that, where we got a bit more overall than was originally expected.
Q281 Teresa Pearce: Much of this is based on hope for a change in behaviour; the Chancellor had warned strongly about stamp duty land tax, over and over again, yet there has been an increase in the popularity of those sorts of avoidance schemes. Does that give you any reason to doubt that this initiative will be successful?
Graham Parker: I think it is a bit different for the Isle of Man, Jersey and Guernsey, because we are talking about people who have basically evaded tax that they should have paid, and it is a question of their behaviour. It is a bit different from things such as stamp duty where there is an avoidance industry, and as soon as you close one loophole, they will try to exploit another one. This is individual behaviour we are talking about-they have money in the Isle of Man, for instance-so there is the behaviour in there. We have still allowed for the fact that some of them will move to other offshore places that are not yet covered by these agreements. We went through the costings quite heavily with HMRC and the rest, and we came to a view that we thought it was reasonable.
Q282 Teresa Pearce: In that ballpark?
Graham Parker: Yes. For instance, the behaviour for the Isle of Man, which is coming in first, is slightly different from Jersey and Guernsey, because we think that some people in the Isle of Man might have moved to Jersey and Guernsey, and there are fewer possibilities for them if they want to keep their money quite close to the UK.
Q283 Teresa Pearce: Given that we are expecting a change of behaviour and much of it will be voluntary disclosure, where people will come forward, have any costings been included in these figures to look at whether or not HMRC will have to undergo a litigation strategy against people who do not come forward? Has the cost of litigation been costed at all?
Graham Parker: I don’t think that there is anything explicit in those costings. It may be wrapped up in other costings, such as the general anti-avoidance rule.
Robert Chote: I am not sure: would that actually appear in the costing that is in here? If they were expecting greater litigation costs it would appear in what HMRC is thinking of doing with its DEL allocation. That would not be netted off against-
Q284 Teresa Pearce: So it could be a cost; so that is not a full-
Robert Chote: We try to look at opportunity costs. If HMRC is doing more of one thing, we assume it must be doing less of something else.
Graham Parker: So it might have appeared in there, but I can’t remember anything in those particular costings.
Q285 Teresa Pearce: Mr Chote, earlier you were asked about the leaking of your information on the front page of the Standard. In early March, the Prime Minister spoke about your projections and misrepresented them, you believed, which made you take the unprecedented step of actually writing to him and publishing that letter. Has he replied?
Robert Chote: No.
Teresa Pearce: That’s rude.
Robert Chote: Informally, the officials indicated what he had meant to say, and I said that I felt that would not necessarily have been entirely clear to everybody who heard the speech so I still felt it was appropriate to clarify that publicly. It is not necessarily a letter where I would be waiting by the letterbox for a reply to come in, so I do not feel particularly affronted on those grounds. We made our point.
Teresa Pearce: You made your point.
Q286 Chair: I am sorry, Teresa. Mr Chote, which officials did you speak to?
Robert Chote: Sorry?
Q287 Chair: Which officials did you speak to?
Robert Chote: The Treasury. If you look at the explanations that the Prime Minister gave-
Q288 Chair: I am just asking a simple question. Can you please name the officials you spoke to?
Robert Chote: No, I don’t think I can name individuals I talked to within the Treasury.
Q289 Chair: Were these officials or special advisers?
Robert Chote: To be honest, I cannot remember.
Q290 Chair: Are you sure? It was only a few weeks ago. Have you had a sudden lapse?
Robert Chote: As I say, if you look at one of the many-
Chair: All right, we are not getting anywhere. Don’t worry. We have asked a straight question three times and we have had a nil return.
Q291 Teresa Pearce: Mr Nickell, following your earlier conversation with Mr Garnier on household debt, I was surprised that you said if mortgages go up people will just pay the extra.
Steve Nickell: Why? That is what they tend to do historically.
Q292 Teresa Pearce: Because Shelter has recently published some facts. It says that two thirds of households are struggling to pay their rent or mortgage and more than 1 million people have resorted to payday loans to fill that gap. Its research shows that, compared with 2001, 44% more people are struggling in 2013. Do you think that Shelter is wrong?
Steve Nickell: You mentioned rent and mortgages.
Q293 Teresa Pearce: And mortgages, yes.
Steve Nickell: Yes, I understand, but unless it reveals what proportion is rent and what proportion is mortgage, it is not very helpful. Basically, we know that people on low incomes are much more likely to rent, to have difficultly paying their bills and to use payday lenders. On the issue of how many mortgagees are using payday lenders to help pay their mortgage, I suspect that there are not very many and I suspect that those who do are more likely to have become unemployed or have had something else happen that has severely impacted on their finances. All I am saying is that historically the connection between the number of people who are repossessed and so on and interest rates is not strong. The connection between repossessions and unemployment is incredibly strong. Repossessions surge when unemployment surges.
Q294 Jesse Norman: Mr Nickell, you said earlier that one of your forecasts had been wrong because of an incorrect inflation assumption.
Steve Nickell: An incorrect inflation forecast.
Q295 Jesse Norman: That seemed to imply that it was not because you had got the multipliers wrong. Is that right?
Steve Nickell: Yes.
Q296 Jesse Norman: So you are unpersuaded by recent evidence that multipliers in the past were larger than you had suggested.
Steve Nickell: I am no more persuaded by that than I am by recent evidence, also put out by the IMF, that multipliers are smaller than we thought. The fact is that the OBR, although I was not on it at the time, chose a set of multipliers that it considered to be representative of the evidence. Since then, we have seen no new evidence that as a whole would lead us to change our minds on that.
Q297 Jesse Norman: Mr Chote, how worried are you about the security of your inflation forecast in the numbers that you have given us? I raise the question because you have talked about the output gap falling. There seems to be a possibility that, as the economy emerges towards the end of next year and growth starts to pick up, a combination of housing inflation and increased consumer demand could feed through to higher inflation versus a smaller output gap. That is obviously not a worry that you have been particularly seized by.
Robert Chote: It is clearly possible. One of the striking things about the forecast is that we have a negative output gap and therefore spare capacity persisting right through the forecast. You would expect that on its own to be pulling inflation down, although it is not necessarily clear, given where inflation is to start with, how powerful that effect is.
When we have had to put up our inflation forecast in the past, it has been more to do with external shocks such as oil prices or import prices and so on, or news on energy prices, so regulated prices, rather than a changing judgment on the size of the output gap. There is an offsetting balance as you go further through the forecast; the fact that the output gap remains negative has downward pressure on inflation, but by then you would expect to have some upward above-trend growth, and therefore its closing also has an offsetting effect at the moment. That is why the forecast does not move very much as you go further into the future.
Q298 Jesse Norman: You have said that the revised remit for the Bank of England was shown to you only at the last minute. Would you have reconsidered your assumptions about inflation if you had known about that when you were compiling the forecast?
Robert Chote: No, I think you would want to see how the remit was being applied in practice and what implication that had for market expectations for where monetary policy was going to go.
Q299 Jesse Norman: You mean the effect would be to ratify things that were already happening, as much as setting a new direction for the Bank.
Robert Chote: It remains to be seen how the Bank uses the remit as it is currently expressed.
Q300 Chair: Do you think it might use the remit in a contractuary direction?
Robert Chote: I suspect that is not the intention.
Jesse Norman: That is a helpful clarification. Thank you, Chairman.
Q301 Chair: It is a one-way direction you are looking at.
Robert Chote: It partly depends on how clearly the criteria are set out and the signal that sends if things turn out differently from the way you expected when you set out the criteria.
Q302 Jesse Norman: A combination of the incoming Governor’s remarks plus a change of remit allows you to remain sanguine, pending actual changes.
Robert Chote: Exactly. We need to see how all of that is implemented in practice, and what impact that has on market expectations, by the time we do our next forecast.
Q303 Jesse Norman: You have highlighted the single-tier pension reform as an area of particular uncertainty. Why did you not look at DWP’s modelling of the transitional arrangements on that?
Robert Chote: I think at this stage it was too early. I am not sure the transitional arrangements are fully agreed. Is that right?
Graham Parker: Well, they were in the plan, on which the forecast is based.
Q304 Jesse Norman: But it is an area of uncertainty because you did not look at the numbers.
Graham Parker: Oh yes.
Q305 Jesse Norman: But you could have looked at them if you had wanted.
Graham Parker: We have looked at them, but there is uncertainty about how it will work out in practice.
Q306 Jesse Norman: Do you think it will have an inflationary effect?
Robert Chote: The single-tier pension?
Q307 Jesse Norman: Yes. Pumping it up to £145, or whatever it is.
Robert Chote: Given the changes that that implies for public expenditure forecasts, I wouldn’t have expected so.
Q308 Jesse Norman: Thanks. When you put together your expectations about quantitative easing and its unwinding or continuation, do you discuss those with the Bank of England?
Robert Chote: No. We basically look at the survey evidence of the terminal amount of quantitative easing, and then take a decision on whether that has moved significantly. That has only become an issue since we have had to deal with the APF in particular. You will see we have got a detailed explanation of the flows to and from the Treasury as a consequence of that. We did not feel that there had been a decisive enough move in expectations of quantitative easing to change the forecast for that reason. They have moved around for other reasons, but that was not among them.
Q309 Jesse Norman: Do you take any steps in the OBR to consider the level of entrepreneurship, new business creation, and the vital spirit at the lower end of the economy in new business creation, apart from small business? Is that something you look at or think about?
Robert Chote: Not explicitly. One reason why we continue to have a slow pick-up in trend growth-this comes back to Steve’s point-and part of the explanation for the productivity puzzle is perhaps that small, potentially innovative firms are not able to expand at the rate they would have done in the absence of the financial crisis. That is one reason why you might expect total factor productivity to be relatively weak.
Q310 Jesse Norman: But you are not detecting a surge of entrepreneurship or entrepreneurial activity?
Robert Chote: In terms of new business creation?
Jesse Norman: Just in the economy. You are looking at the economy and you are thinking about what the forecast will be. Are you detecting a surge of entrepreneurship, or is the economy pretty quiescent?
Robert Chote: I do not think we take an explicit view on that, so I do not think there is anything, for example, that has driven the corporate tax receipts as a result of those sorts of pressures.
Q311 Jesse Norman: How would you assess the state of the economy, apart from oil and the financial sector?
Robert Chote: Well, stronger in the sense that those are relatively weak areas. Whether that gives you a very good sense of-
Q312 Jesse Norman: I mean in a historical context.
Robert Chote: It is still a relatively weak recovery in those sorts of areas after the depth of recession that we have had. If you look at the most recent quarter, you see a particular effect in the North Sea, which is one of the reasons why GDP growth was weaker in the fourth quarter than beforehand. North Sea production has been an area where we have consistently seen estimates of production having to be revised down, often because of maintenance or disrupted activity in the North Sea, which has had implications both for the GDP numbers and for North Sea receipts more broadly.
Q313 Mr Mudie: In his evidence yesterday, Roger Bootle expressed the view that the banks were broken, and that they are a vital engine of recovery-I take his word-that are simply not working. We have touched on the bad banks suggestion. Do you agree with Roger Bootle?
Robert Chote: I think the disruption to the financial system is very key to the explanations, as best we have them, for the weakness of productivity and the weakness of potential output; it is the fact that the financial system is not able to channel capital as effectively as it could otherwise to relatively rapidly growing parts of the economy. Obviously, you can look specifically at the two large banks in which the Government now have relatively large shareholdings; they used to be a source of considerable amounts of borrowing to the real economy, and at the moment they are not. In that sense, the difficulties of the financial sector are clearly a major constraint on the performance of the real economy more broadly.
Q314 Mr Mudie: You will have seen us in this Committee berating bankers, time and time again, for not lending to small businesses. They have never been straightforward with us, and I think that it will come to a head this week when the Financial Policy Committee will bring out a report on the true capital position of the banks. Is it not just the case that they cannot lend as we would wish them to, and as we hector them to do; they have got their own problems. They are busy trying to sort their own problems out, and until they are sorted out, is it just a waste of time trying to persuade them, or bully them, into doing something for the real economy and lending?
Robert Chote: It will be interesting to see how much the FPC report bears that out. Clearly, this comes back to the earlier debate about whether it would be better to have a bad bank solution that allowed you to clean up the good ones and to get those banks to lend more. That is obviously outside our remit, but people like the current Governor have expressed that as a possibility.
Q315 Mr Mudie: There is a second thing: a worry would be that if there was a realisation-it has been hanging about for some months now-that we are racing, probably because of Europe and other worries, to recapitalise these banks too quickly against the Vickers timetable of 2018-19, or something, and if the figures come out bad this week, in terms of capital, it is thought the FPC will tighten the hold on the banks even further, which would put lending further back. So we could have a desperate situation of our own making, or we could have a positive situation by leaving that matter alone, taking it more gradually, and taking up the bad banks suggestion. That would give banks a real impetus-they would have no excuses to avoid getting down to proper bank business.
Robert Chote: As you said, it would be interesting to see what the data show, and what the FPC’s response to that will be. The signals from the FPC are that it is conscious of the fact that there is still a desire not to have a regulatory response that does more to hamper the recovery, even though it might be helping you to get where you want to be, which is a more stable position in the longer term. I expect it will continue to be difficult for them to strike the balance between those two objectives.
Q316 Mr Mudie: Robert, have they taken a balanced view? Since the crisis broke, we have almost talked about having the courage to take the punchbowl away when things get too hot, but it works both ways. When it is not so hot-when we are down flat-
Robert Chote: To pour them more punch?
Mr Mudie: Yes.
Chair: We could do with a tonic?
Mr Mudie: We could do with the punchbowl. We could do with those animal spirits released. That is what is happening, but there seems to be no sign. It is early days, but they still seem preoccupied with the negative side, and say, "When it comes, we’ll have the courage to do it." Well, it would take real courage to introduce the punchbowl, wouldn’t it?
Robert Chote: Yes. There are areas where the Government are taking action on bank funding, so the availability of funds that they can then go on to lend to the real economy, the combination of the FLS and the euro, the activities taken at the European level-I think our expectation is that that will show up more in the housing market than in SMEs, necessarily.
Q317 Mr Mudie: That is a pity. When you were talking earlier about exports, you said that one of the difficulties was the falling away of the financial services exports. We are talking about rebalancing. Is the rebalancing that is taking place maybe not showing fruit at the moment, or is there the capacity for the non-financial sector to compensate for the loss of the financial sector’s input, and not only replace but have the capacity to increase exports? Is the capacity there, in terms of the manufacturing side, for example?
Robert Chote: The flip side of the division between the service sector and the goods sector is-Steve will correct me if I am wrong-that the fall in the exchange rate has been more successful in arresting the fall in market share on the goods side than on the services side. There is an additional concern coming back to this point about whether the financial system is able to get capital to firms. Perhaps that is one of the reasons why they have been less able to take advantage of the more rapidly growing export markets and to reallocate capital and assets. That could be part of that story, too.
Q318 Chair: You have said, Mr Nickell, that the Help to Buy scheme will subsidise mortgage lending to some degree, which will push up house prices in the short run, and which may increase house building in the medium term. I think that is what you said a moment ago. Do you think that the housing market, on the available indicators, is undervalued?
Steve Nickell: You mean do I think house prices are too low?
Q319 Chair: If that is what you are saying. I do not know how else I can express it. Are they undervalued?
Steve Nickell: Let’s put it this way: if mortgage availability was at a normal level-not the level in 2006, but in 1998-then house prices would be higher.
Q320 Chair: Yes, but then supply, too, might be at a normal level. Supply is not at a normal level. There has been a lot of house building forgone in the last few years as a result of the recession.
Steve Nickell: Oh, I see.
Q321 Chair: So you have to look at the supply and the demand side.
Steve Nickell: That is perfectly true.
Q322 Chair: Let me try and ask the question in a slightly different way. The most important indicator of whether the market is under or overvalued is held to be, but you can supply your own indicator if you prefer, the multiple of real disposable income.
Steve Nickell: Oh, that is completely wrong.
Q323 Chair: You think that is wrong?
Steve Nickell: Absolutely.
Q324 Chair: That is what it is held to be. What do you think the best indicator is?
Steve Nickell: A ratio of house prices to rents.
Q325 Chair: To rents. Okay.
Steve Nickell: Can I explain why the other one was wrong?
Q326 Chair: Do you think that that is below the right level, or at the market long-run clearing average level?
Steve Nickell: I suspect that house prices would probably be a bit higher in equilibrium, which is what I said before. The reason why the ratio of house prices to disposable income is completely wrong is that it is a number that has been rising by nearly 1% a year for the last 40 years, so it is kind of hopeless. Obviously, one should think of-
Q327 Chair: I do not know whether it is hopeless. It tells you that as people become wealthier, they put a little bit more each time into-
Steve Nickell: They demand more housing.
Q328 Chair: But it also gives you quite a good long-run indication, does it not, of what you would expect the ratio to be as income rises?
Steve Nickell: No. How can it give you an indication if it is a number that has been rising steadily for 40 years?
Q329 Chair: But the answer to the question, "Do you think house prices need further stimulation?" is yes, then. You think they are under that.
Steve Nickell: No. You did not say, "Do they need further stimulation?" You asked me what the equilibrium price of houses was, and I said that it is probably higher than it is today.
Q330 Chair: Right. Therefore we can cope with some further stimulation of house prices.
Steve Nickell: No. I would rather it were lower because we built more houses.
Q331 Chair: Right. I am trying to get at whether you think this scheme is a good idea or not, Mr Nickell-from various angles-and I am struggling at the moment.
Steve Nickell: You are struggling because I am hesitant to-
Q332 Chair: Say anything.
Steve Nickell: I cannot pass comment on Government policy. I have told you what I think the impact of the scheme is, and it is for you to determine whether you think that it is a good thing or not.
Chair: All right, we will leave it there. Thank you very much indeed for coming to see us this morning-it is almost the afternoon, but it is still this morning. We have picked up quite a lot.