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UNCORRECTED TRANSCRIPT OF ORAL EVIDENCE
To be published as HC 643
HOUSE OF COMMONS
TAKEN BEFORE THE
Bank of England August 2013 Inflation Report
Thursday 12 September 2013
Dr Mark Carney, Paul Fisher, Professor David Miles and Ian McCafferty
Evidence heard in Public Questions 1 - 116
USE OF THE TRANSCRIPT
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Taken before the Treasury Committee
on Thursday 12 September 2013
Mr Andrew Tyrie (Chair)
Mr Pat McFadden
Mr Brooks Newmark
Mr David Ruffley
Examination of Witnesses
Witnesses: Dr Mark Carney, Governor of the Bank of England, Paul Fisher, Executive Director, Markets, Bank of England, Professor David Miles, External Member of the Monetary Policy Committee, and Ian McCafferty, External Member of the Monetary Policy Committee, gave evidence.
Q1 Chair: Shall we begin, Governor? Thank you very much for coming to see us this morning. Since we last saw you quite a lot has happened. Among other things, you have announced forward guidance. Did you expect markets to be tighter, looser or to remain the same in response to that announcement?
Dr Carney: Well, the first thing I would make clear is that the objective of forward guidance, as the objective of funding for lending, as the objective of quantitative easement, as the objective of all the monetary policy instruments that the MPC has deployed, is to achieve the inflation target over a reasonable timeframe and in a way that supports activity and employment. What we did with forward guidance in conjunction with the associated report was to provide maximum transparency of the reaction function of the MPC. In doing that, we also discussed the potential impact on financial markets. Let me take them in turn. If we look at longer-term interest rates, just from forward guidance there can be conflicting impacts. It depends on the expectations that were built in in the market in the past of short-term interest rates. It depends on changes potentially in inflation expectation, something we did not want to see, which is why we have the two price stability knock-outs as part of the design of forward guidance, and something we have not seen, which is an increase in inflation expectation, so that is positive and that is consistent with our mandate.
The last aspect is the impact of forward guidance in conjunction with all other tools deployed by the MPC on the outlook for activity and inflation in the UK economy. So in isolation, on longer-term interest rates there are conflicting forces and there certainly was the possibility, we foresaw, of a steepening in the yield curve as a consequence of that. The second aspect is-
Q2 Chair: Sorry, were you expecting that? My question was did you expect long rates to rise, fall or stay the same.
Dr Carney: My personal expectation was that long-term interest rates would rise by the announcement, yes.
Q3 Chair: So you were expecting the reaction that you saw in the key part of the market reactions that developed?
Dr Carney: The second, if I may, Chairman-
Chair: I am sorry to interrupt, but is that correct? You were expecting a rise in long rates?
Dr Carney: Directionally, yes, that was my personal expectation. Others can speak for theirs. The second point I would make, though, obviously nothing ever happens in isolation and forward guidance was introduced at a time where there was an increase in global advanced economy interest rates, a benign increase in global advanced economy interest rates largely driven by revised expectations on the outlook for those economies. It was also introduced and has been followed by a series of very strong data, both hard and soft data, survey and actual data, in the UK. In fact, the strongest run of data relative to market expectations-not the Bank’s expectations, relative to market expectations-that we have seen in over a decade, since contraction.
Q4 Chair: Perhaps I could have made my question more precise, but it was slightly longer. We are talking about what reaction you expected over and above what was going to happen in the markets, going to unfold in the event of business as usual, maintaining existing policy.
Dr Carney: Yes. The expectation, as I said, was that on balance the yield curve would steepen, number one. Number two, what was less clear, which is why we made our reaction function transparent, is what market expectations were around the threshold condition that we set, market expectations around when unemployment would reach 7%. Now, on balance, market expectations-those who actually transact in the markets as opposed to those who forecast unemployment-have come in in terms of the likely timeframe. I would note that those who forecast unemployment, economic analysts, have pushed out their expectations of when they expect the 7% threshold would be achieved. There is a difference of view, which is natural, but what is important is that there is a marked difference in the transparency around how the Bank will react.
Q5 Chair: We will come on to that in a moment, Governor. Just to be clear, you began your remarks in response this morning by saying that we should see forward guidance as part of a range of policies that are being rolled out with similar objectives, the objectives of supporting economic activity consistent with the inflation objective.
Dr Carney: Yes.
Chair: I am paraphrasing the point that you made. You mentioned funding for lending and QE. QE, of course, has brought-both of them are seen as loosening market conditions, whereas you have just told us you were expecting the long rate; therefore, markets overall to tighten-
Dr Carney: That is the long rate, Chair.
Chair: -in response to the policy that you announced. Is that correct?
Dr Carney: That is correct with respect to the long rate, but the long rate is not the sum of monetary conditions in the economy.
Chair: No, it is not-
Dr Carney: And the long rate is not-
Chair: -but it is a very important rate in current conditions.
Dr Carney: It is an important rate, but it is actually not the most important rate for businesses and households in the UK. Seventy per cent of the stock of household lending is floating; 50% of business lending is floating; a further 30% of business lending is repriced within a year. For people and businesses who are actually borrowing, the relevant rate is the floating rate and the floating rate is tied or linked, with some fluctuations, to the Bank rate.
Q6 Chair: Overall, and later this morning we will get into this in more depth, your intention was to provide greater certainty and transparency over what you are doing and you are saying that you recognised at the time that you announced this that in some respects this might appear dovish at the short end of the market and in some respects it might appear hawkish; that is that it might force rates up. Is that an unfair summary?
Dr Carney: The summary I would give, and colleagues will give theirs, is that we expected this to provide more effective stimulus by providing greater transparency so that businesses and households and, yes, market participants would understand the conditions that would be necessary for the MPC to begin to consider tightening monetary policy.
Chair: But you have-
Dr Carney: If I may, Chairman-
Chair: Yes, of course.
Dr Carney: -providing that greater certainty, providing that clarity and transparency, affects monetary conditions. It affects business decisions and decisions of households.
Q7 Chair: Of course. You would have to agree, though, that by providing the certainty many in the markets have concluded that the MPC was more hawkish than they had thought, wouldn’t you?
Dr Carney: You would have to conclude that many in the markets have a view that the threshold condition will be achieved sooner than on average. On average because what the MPC revealed was not a time point but a series of probabilities based on their projection, a projection, if I may, that was at the upper end of forecasts when it was released, that on average the view of the market is that the unemployment threshold will be achieved sooner.
Now, what is important-and I will finish with this-as a message for businesses and households is this is about the conditions that would pertain in the economy at the point where the MPC would begin to consider tightening monetary policy. It is not about a time but it is about conditions, and so it is about jobs growing, it is about incomes growing. In that sense-and that is summarised by the 7% unemployment threshold-at that point we would sit down and assess the appropriate stance on policy.
Q8 Chair: Who do you expect to be listening to this message? I think it is quite sophisticated, if I may say so, Governor, and I expect quite a lot of people who are listening to this session are having to listen very carefully to be sure what is going on. Who exactly do you expect to be picking up this message and acting on it?
Dr Carney: If I may, my experience in talking to businesses, our experience in terms of surveys of household expectations, have been that the message has been understood. It is a clear message in the sense that until we see unemployment fall to 7%, we will not begin to consider the tightening of monetary policy. Now, we are going to do that in a disciplined fashion with those protections on price and financial stability, which we can talk about, but that is the core of the message. It is when the economy is really growing, when we have a sustained recovery, when the economy can withstand a potential tightening of monetary policy, that the MPC will be taking those measures.
Q9 Chair: You do not expect these households to get into the caveat that you have put in or the three knock-outs or to be monitoring what the Financial Stability Committee is saying on financial stability risk? You are asking them to ignore all that and take your summary?
Dr Carney: Absolutely not. Discipline around price and financial stability, anything that we will report on the views of the FPC, our views on inflation expectations, our forecasts for inflation. I would note, Chairman, that since the announcement of forward guidance household inflation expectations as measured by the Bank/NOP survey have fallen.
Q10 Andrea Leadsom: Good morning. Governor, given that the outlook remains for sustained inflation above 2% and the fact that you set your knock-out at 2.5% before you decide to drop the target of 7% unemployment being reached, haven’t you, therefore, by default ditched your medium-term monetary policy target of 2% inflation?
Dr Carney: Thank you for the question, Ms Leadsom. Absolutely not is the short answer. The target is 2%. This is about getting back to the 2% target. As the Committee is well aware, as the British people are well aware, inflation has run above target for most of the last five years. The issue is how we responsibly return inflation to that 2% target in a way that supports output and employment.
Now, because of that exceptional circumstance, because we have been running inflation above and, at the same time, the economy has been operating well below its historical peak but also-and we would have differing views-the potential rate of the economy, because of those two facts, we felt that it was important to provide maximum transparency about how we were going to get from where we are starting today back to the inflation target in a way that ensures that this recovery that has begun is secured.
Q11 Andrea Leadsom: But in your inflation report in August 2013, the MPC’s policy guidance, it says, "There is no presumption that breaching any of these knock-outs would lead to an immediate increase in Bank rate or sale of assets". Can you explain? Because obviously what you have done is to introduce further, in a sense, cliff edges, points at which you could be expected to take action to change policy or to either increase the asset purchases or, indeed, reduce them. Can you explain what exactly that means? "There is no presumption that breaching any of these knock-outs would lead to an immediate increase in Bank rate or sale of assets." Therefore, you are looking at those things but you are not necessarily going to act upon them, self-imposed new targets.
Dr Carney: They are not targets, if I may repeat my earlier answer. The inflation target is 2%. This is about getting back in a responsible manner to that 2% target: first point. Second point: in terms of if one of the knock-outs were to be breached, then we have to take a decision; the MPC would have to take a decision based on the reasons for that knock-out being breached. For example, was it a relative price shock, a geopolitical event that hit the price of oil or energy that pushed inflation above target, a change in an administered price, maybe for valid reasons but that was the aspect that pushed inflation above target as opposed to something that was self-sustaining, an increase in the underlying rate of inflation? We would have to take those judgments. What we have done is we have provided maximum transparency about the way stations or the staging posts when we would take those decisions. Again, I would underscore that we are starting from a rate of inflation just under 3%. We are looking to bring it back to the 2% target in a little over two years. We have set two important price stability knock-outs to discipline that process over the next few years.
Q12 Andrea Leadsom: Thank you. Mr McCafferty, you said, "It is critically important that forward guidance does not compromise the primary objective of the MPC to deliver medium-term price stability". Can you tell us did you have or do you have reservations about using a further-not target but what would you describe it as if not a target?
Dr Carney: We describe it as a knock-out.
Q13 Andrea Leadsom: A knock-out. It is a knock-out, great. I think everyone knows that game. Mr McCafferty, could you explain what your attitude is to this? Were you keen on it or do you have reservations about introducing another knock-out?
Ian McCafferty: No, I think having an inflation knock-out is very crucial to the design of the guidance policy. Had we not had an inflation knock-out I think there was a greater chance that inflation expectations on the public would have increased, which then I think would have put our primary mandate, the achievement of the 2% target in the medium term, at greater risk. I think it is important as a way of maintaining credibility that we have that knock-out. We then have to decide, as the Governor has already said, a knock-out that allows us to go forward given the starting conditions, which meant that the knock-out had to be, I think, slightly in excess of the 2% medium-term target. As a result, I think the 2.5% at 18 to 24 months achieves that balance.
Q14 Andrea Leadsom: Okay. Were any of the MPC colleagues reluctant to go along with "it is a knock-out" on the inflation front, Governor, or any who want to-
Professor Miles: No, I certainly wasn’t. I think it was essential that we made it clear that hitting the inflation target was and remains the centrepiece of monetary policy. I think there was a risk that without making that clear people would say, "This guidance just says they are focusing now on unemployment and nothing else" and the inflation target has somehow been degraded or downgraded. I think it is a pretty important part of the whole guidance.
Paul Fisher: A rise in inflation expectations would exactly offset a lot of benefits of the policy. There are a couple of risks here and the reasons why it is not an automatic response. One of the big risks of inflation going forward at the moment would be a sudden spike in the oil price. It would be very difficult. We would have to sit down and think very hard about whether the right response to that was to increase interest rates. That is the sort of reason why it is not automatic. What we certainly did not want is, for example, the markets to conclude we had given up on the inflation target and the exchange rate to fall a long way because that could also trigger a big rise in inflation and inflation expectations that would probably necessitate a response. It is a knock-out for us to consider exactly what has caused inflation to be above our projection at that point and how we should respond.
Q15 Andrea Leadsom: Yes. Governor, are you concerned at all that having set this knock-out at 7% you could inadvertently trigger a run on the bond market at the moment that that figure is reached? Would you be concerned that the markets might think, "Oh, right, now unemployment is below 7%. Let’s start selling the bond market because the Bank of England is going to reverse the asset purchases"? Is that something that you have considered?
Dr Carney: Well, certainly we considered all contingencies. What we have today and have had since revealing the policy is that the bond market and other asset markets are able to form their own judgments about when the threshold condition could be met. Different people in the market, different institutions, will take different views on that. That is a market and that is a much more continuous evolution of views as opposed to speculation into a black box-not that the MPC was a black box but I will take the extreme-MPC that might one day show up and adjust out of the blue for some participants. The important thing, again, and I am going to go back to this, is what is the message that is sent not just to the markets but to businesses and households? It is about the underlying conditions in the economy that would pertain when we would start to consider those types of decisions.
May I add one other thing just for absolute clarity? Because in your question you raised asset sales and I think we have tried to be clear but I will restate it. Our exit strategy from QE would be that we would look to adjust base rates first before we would consider asset sales, so the first element of a tightening when it comes would not be a sale of assets.
Q16 Andrea Leadsom: Just one last question: would you accept, as your predecessor did not, that should you eventually sell gilts into the marketplace, a third of outstanding UK gilts, that that would, in fact, cause a significant reduction in the price and increase in the yield?
Dr Carney: Well, any distribution of assets, any sale of assets, will be co-ordinated with the Debt Management Office, first point, and those types of judgments have to be part of the strategy, because if in releasing the assets there is a sharp increase in volatility, a sharp tightening of monetary conditions, it can be self-defeating. I would re-emphasise that, of course, we have multiple instruments now where we can tighten policy at that point where it becomes necessary to consider tightening policy. We are not at that point and we have been as transparent as a central Bank can be about the conditions that need to pertain for those types of decisions to be considered.
Q17 Andrea Leadsom: But you would accept that selling gilts, a third of all gilts outstanding, into the market would have a rather dampening effect on the bond markets?
Dr Carney: I would merely note that we would not be foolish enough to sell a third of our entire APF at a given point in time.
Andrea Leadsom: Thank you.
Q18 Mr Newmark: I am trying to understand and grapple in my mind the two targets that you have set. One effectively is a 7% unemployment target, which we are above, and the other one is a 2% or 2.5% inflation target, which we are above. Listening to you now, you are still putting inflation I think as a primary target, if I can use that phrase. I am still not clear on what triggers happen, what you do as we head towards 7% or as we head towards 2%, 2.5%, and what happens if we do not. What sort of critical path do you see happening and what triggers do you see happening along that critical path that could adjust things in your mind? Keep it simple because the thing is that all of us here represent constituents and they are finding it, I think, hard to understand what this new policy is about.
Dr Carney: Well, the first thing is that the inflation target is 2%. There is only one target. The inflation target is 2% measured by CPI inflation. Our responsibility as the MPC is to return inflation to that 2% target over a reasonable timeframe, over a responsible timeframe, and we have been as transparent as we can be in terms of how we will do that while supporting activity and employment.
Now, in terms of the threshold, the 7%, the message to your constituency members is simple. We will not begin to consider the tightening of policy until we see that 7% unemployment. Now, unemployment is reported every month-
Q19 Mr Newmark: Are you keeping interest rates at 0.5%?
Dr Carney: We are not going to change. At a minimum we are keeping interest rates at 0.5% and at a minimum we are keeping the asset purchase facility, all the quantitative easing, at the 375 billion.
Q20 Mr Newmark: Does that mean you are not going to be printing more money in order to-
Dr Carney: It does not mean that. If the recovery were to falter, if additional stimulus were to be required, we would consider whether to provide additional stimulus. What we will not do is-
Q21 Mr Newmark: Okay, but what happens if inflation is still running where it is? Are you still going to be printing more money?
Dr Carney: I will remind you, Mr Newmark, that we are not at the moment engaged in quantitative easing. There is a set stock of assets that are in the asset purchase facility-
Q22 Mr Newmark: But I am trying to understand. You have a toolbox. I am trying to understand which tools you are going to be pulling out as certain things happen.
Dr Carney: Well, if the probability that inflation is going to be above 2.5%, the average inflation rate over an 18 to 24-month horizon, if that probability is above 50% in the judgment of the MPC, then this guidance would no longer apply. Okay, because this is-
Q23 Mr Newmark: Therefore, you would still print money?
Dr Carney: To be clear-
Mr Newmark: Okay, no, I am just-
Dr Carney: No, it is fine, this is important. We are not currently engaged in additional quantitative easing and the MPC has not engaged in additional quantitative easing for some time. What we have said with the guidance is that we will not reduce the stock of assets in the APF and that as assets mature we will just reinvest the proceeds. Now, that is a relatively modest amount of assets that are maturing in the short term, to be clear. We have not taken a decision to add to the stock of outstanding assets. As you are aware, we just had a meeting last week and the decision was not to add to the stock of assets for, one would suggest, fairly obvious reasons that the economy is picking up and the stimulus is working. We are moving in the direction of the unemployment target and, while it is early days, we expect as well that we are consistent with the path to returning inflation to 2%.
Q24 Mr Newmark: Okay. Do you think Martin Weale’s concern about the 2.5% inflation knock-out made markets think twice about the guidance offered?
Dr Carney: Well, it is hard for me to summarise market opinion. I think that Mr Weale’s-
Q25 Mr Newmark: If the Governor of the Bank of England, you, cannot, who can?
Dr Carney: Okay, then I will. Mr Weale’s preference was for a slightly shorter averaging horizon for the inflation knock-out for valid reasons of his own, but he is also bound and he has made clear that he is bound, as all members of the MPC are, by the guidance framework that was adopted, so that 18 to 24-month horizon. My personal view is no, I do not think that distinction, that difference, was a major factor in market reaction, no.
Q26 Mr Newmark: Okay. Can I ask the rest of the panel why did the rest of you not agree with Martin’s position, if you want to comment? Professor Miles?
Professor Miles: Maybe I can have a go. I thought that the right horizon to set this knock-out was a horizon that was far enough away that if you had a transitory shock, say oil prices spike up, which you might expect to have a temporary impact on inflation, you could look through that. So it needed to be long enough that you could look through temporary things but not so far ahead that people thought that this is not a serious knock-out. My own way of thinking about it was it needed to be in some sense the shortest horizon ahead that allowed transitory, temporary things not to affect it. To my mind, that was somewhere in probably the 18-month ahead/two-year horizon. That was my thinking.
Q27 Mr Newmark: Does anybody have any comments? If not, I have other questions.
Paul Fisher: I think the point is you cannot be too precise on numbers like this. Martin wanted to be really short and had a distinct point of view, but for me I was happy with where we came out. You can always argue for it to be slightly longer or slightly shorter. I think Martin wanted it to be a step shorter, but he was the only one who was concerned on that side.
Mr Newmark: Okay. I have a slightly more philosophical question or maybe practical question.
Q28 Chair: Just before we leave that, why two and a half and not two, Mr Fisher?
Paul Fisher: Well, we are currently running inflation at about 2.8%. You mean, sorry, two and a half years or-
Chair: No, I mean-
Dr Carney: Inflation target, yes.
Chair: -2.5% as opposed to 2%.
Paul Fisher: We are currently running at around 2.8% inflation. It is likely to be at that level for a few months. It is never very precise in the forecast but it is about that level. We want to get it to 2%. We want to get it to 2% roughly over a two to three-year horizon in this central expectation of our forecast. Two and a half is roughly halfway between where we are now and where we are going to, so it seems a sensible staging post. If you are on that guide path down and back to the target, to have a way mark of around 2.5% seems a sensible place.
Q29 Chair: Therefore, this 2.5% is certainly not cast in stone and as we go down that slide towards your target, the only target you have, you are going to reduce that, aren’t you? Logically, that should become 2%.
Paul Fisher: Well, you never know. At any point in the future you may suddenly get a shock, which would affect inflation rate for a year.
Mr Newmark: But outside of a shock-
Chair: Hang on, Brooks, that is a different kind of knock-out. Let’s just clarify this point.
Paul Fisher: If we could guarantee there would be no more shocks to inflation, then, of course, you would do that, but that is not the real world.
Q30 Chair: But that is not answering the question at all, Mr Fisher. You told us a moment ago that the reason that you put in 2.5% is that we are in a transitional phase from 2.8% to 2% and 2.5% is, on a rough and ready estimate, halfway down or a distance down that slide towards the target. Correct?
Paul Fisher: Yes.
Q31 Chair: That is the explanation. Assuming that we get further down that slide, logically we should have a lower knock-out rate.
Paul Fisher: No, because at any point in time looking forward there is always the risks of further shocks. Now, I agree with you there is a principle-
Q32 Chair: But why not have it higher now? Then your initial argument is fallacious, Mr Fisher.
Paul Fisher: If we had-
Chair: That is not the reason. Why might a shock now not make you want to have that knock-out at 4% or 6% or any arbitrary figure?
Paul Fisher: Well, there is no point in having an inflation knock-out of, say, 2% because that is the ultimate target. Having an inflation knock-out at 3%, where we already are, again would be a silly thing. You have to have something that has a practical, common-sense application. Two and a half seems about right. Going forward, if the world evolved as you expected and you got down to 2.5%, then obviously the inflation knock-out becomes less and less important, but there is always the risk that you might get further shocks hitting further down the road.
Chair: Brooks wants to come in with a philosophical question.
Q33 Mr Newmark: No, actually, no, I thought Dr Carney’s explanation of a difference between a target and a knock-out was pretty clear to me, so I think I understood what you were saying. If I can go back to me, Mr Chairman, to what extent does the MPC one member/one vote mean that forward guidance can never be as reliable or effective in the UK as in other countries? Dr Carney, since you were in another country before, perhaps you can answer that question.
Dr Carney: I think that it is a strength of the system, the one member/one vote. We had a fulsome and detailed discussion in setting the guidance framework. All members are bound by it-operating under it is probably the best way to phrase it-and will take decisions accordingly. Individual views on the probability of the knock-outs being breached, whether they are either of the price stability ones, will be recorded and obviously the views of the FPC on the financial stability will also be recorded. I think it is a strength and it maximises the transparency.
I will make a last point if you will allow me. There are some fundamental uncertainties in any economy and there are fundamental uncertainties in any recovery as it begins. Some of the uncertainties in the UK are larger than usual; you are well aware of that. What has happened to productivity? How much slack is there in the labour market? What we have done, again, is to provide the transparency around that, use unemployment as the key threshold and then engage in an open discussion and analysis of the probabilities that that will be achieved and over what timeframe that will be achieved and what that means, if I may finish, for the strength of the UK economy.
Q34 Mr Newmark: Are new members going to be expected to sign up to the forward guidance you have agreed?
Dr Carney: I think new members will need to declare whether they are operating under the forward guidance. I would not presume to-
Q35 Mr Newmark: What does that mean?
Dr Carney: Well, if there were new members-well, there will be a new member-
Mr Newmark: There will be new members, yes.
Dr Carney: -in the coming months and that member should indicate whether he is operating under forward guidance or setting his own path, if you will, for monetary policy. There should be maximum transparency and I am certain there will be. I am not presuming; I would not presume to dictate to new members. We all took a decision.
Q36 Mr Newmark: I am assuming you are all working together or do you like the creative tension of having somebody in there who is not going to necessarily buy into that? Would you like to see somebody on that team of decision makers who do not necessarily buy into that because that will help come to a more optimal conclusion in any decisions?
Dr Carney: I think there is value to the clarity that is provided by the forward guidance framework, which is a summary of the reaction function of the MPC. There is value to the tension, if you will, or the creativity that is provided by individual MPC members forming their own views on the outlook for the economy and the impacts for inflation and, in this case, unemployment. That provides a robust setting of monetary policy.
Q37 Mr Newmark: My final question, if I can, Mr Chairman, is to do with your speech of August in which you were sympathetic to the plight of savers, especially given the forward guidance recently announced by the MPC. Are you worried that continuing loose monetary policy may be reducing households’ propensity to save in the future? That is the first part of my question. The second part of my question is really from my local pensioners, the Braintree Pensioners Action Group, who continue to be concerned about the fact that they are effectively dissavers. Whatever savings they have are continuing to be eroded by extremely low interest rates and every week that goes by they are losing money. They are finding things very difficult. Is your policy of maintaining 0.5% almost a price worth paying and is that the message you are giving to pensioners out there?
Dr Carney: There are two aspects to that question. The first is in terms of the incentives to save versus to consume. Certainly, that monetary policy, more accommodative monetary policy on the margin, encourages spending rather than savings, on the margin. Now, what we have done with forward guidance is to provide greater clarity around the stance of monetary policy, I would say more effective stimulus, and one can get into a philosophical debate about the practical implications of that in terms of saving or consumption decisions.
With respect to savers and the pensioners in your constituency and across the land, we do have-as I said in my speech and I will reiterate-tremendous sympathy for the situation that they find themselves in. They have done the right thing. They have set aside money and now they are seeing a return that is lower. The issue is: how much longer does this have to go on? What is the way we can sustainably return the economy to growth and with growth will come higher interest rates for those savers? One of the things we have seen in the last few months, and the Chairman raised it initially, has been an increase in longer-term interest rates in the major advanced economies, the UK included. That is because in part the prospects of sustainable growth have increased. That is the first sign of a strengthening recovery. Our job is to make sure that that is not another false dawn that we saw a few years earlier and to make sure that as soon as possible this economy reaches a form of escape velocity so it can sustain higher interest rates and continue to grow.
Q38 Mr Newmark: Okay. Just to be clear then, my final point is that what you are really saying is you are not that worried that people are not saving, because the bubble was partly created originally by people who were dissavers, who borrowed huge amounts and were not saving. The second thing is from the older people’s standpoint you are saying the future is looking bright, but in the meantime you have had two, three years of a very painful experience; you probably have another two more years ahead of you before we can really see you benefiting from any increase in interest rates.
Dr Carney: Increase in shorter-term interest rates on the second point.
Mr Newmark: Yes.
Dr Carney: What we are looking to avoid, as you are well familiar, is this stretching into decades as opposed to one or two more or two or three more years. Your first point, those would not be the words I would use about household consumption savings decisions. There has been a reduction in the savings rate of British households from very high levels that they spiked to in the wake of the crisis, understandably so, but our forecast basically has consumption growth matching income growth over the horizon of the forecast. We do not see further dissaving and British households on the whole are saving still.
Mr Newmark: Okay, thank you.
Q39 Chair: The Governor has been stressing, Mr Fisher, all along there the importance of greater clarity around monetary policy. That is his phrase. You have given quite a long and complex explanation about the relationship between the 2.5% knock-out and the 2% inflation target. What do you think that is contributing to clarity or transparency?
Paul Fisher: I think it is very clear. We do not start from a position of being close to our 2% target. We start from higher rate inflation. People have to have confidence that we will actually return inflation to the target. Hence we have the inflation knock-out. We have tried to choose a number that will indicate that if inflation moves seriously off track between now and returning to the target we will stop and think again. I think that is a very clear message. We will not let inflation get away.
Q40 Chair: On the other hand, if you do move towards the target you are not giving us any view about whether you should reduce the 2.5% to the target.
Paul Fisher: The target remains 2% at all times. I think we have to say at any point in future there could be shocks to inflation, which would cause us to stop and think again.
Q41 Chair: All right. Well, we have had that exchange. One can argue that there might be an exogenous shock in order to justify any-
Paul Fisher: We cannot start fiddling with the parameters of the policy as we go along. We have to set out a clear policy and then stick to it, is my view. It is 2.5% is the knock-out. It should remain that until we get to the threshold.
Q42 Jesse Norman: Governor, you have said that when forward guidance was introduced you were expecting a rise in long-term interest rates. Is that right?
Dr Carney: That was my personal view, which I discussed at the MPC, yes.
Q43 Jesse Norman: So the rise from your point of view was not accidental?
Dr Carney: To be clear, if I may, that is a directional viewpoint. That was my directional viewpoint on the margins. What of course I do not know and cannot say with certainty is there are a lot of other things that have happened in the intervening weeks. There has been a run of very strong data. There has been continued speculation about the stance of Fed monetary policy. All those factors have contributed to a rise in global interest rates and UK interest rates. I am not going to over-represent my impressions here. I can’t sit here for certain and say that, yes, this is exactly what I would have expected because there are other factors that are influencing the rise in rates. But yes, I did expect that, on balance, the longer end of the yield curve would rise.
Q44 Jesse Norman: So the deliberate effect of the policy was to try to depress short-term rates at the cost of raising long-term rates from your perspective?
Dr Carney: The deliberate intent of the policy was to make as clear as possible the reaction function, in the parlance of economists, but in everyday terms, make clear how the Bank of England and the MPC will respond to economic conditions before we consider tightening policy and, in doing so, providing greater certainty to people in the real economy.
Q45 Jesse Norman: But it was a deliberate effect of policy that long-term interest rates would go up.
Dr Carney: It was my view that long-term interest rates would rise because this policy in conjunction with the other elements that had been put in place before, funding for lending, QE, would help to stimulate the economy and on balance that would be supportive. If I may, Mr Norman, one of the things I think we have to remember is that the policy was introduced during a period where there was just the beginning of a normalisation of term premia in the market, whether across US markets, UK markets, and even continental European markets. Term premia, the risk investors take for holding long-term assets, the risk that rates will adjust over that time period, had been at virtual historical lows, certainly, while one cannot be totally precise about the estimates, negative across the board. That normalisation obviously has contributed to the increase in long-term rates.
Jesse Norman: Sure.
Dr Carney: I will finish. That normalisation is consistent with increased confidence about a recovery in the advanced economies.
Q46 Jesse Norman: I understand. It is just we have quite a lot of stuff to get through so I would really appreciate it if you could possibly tie the answers down a bit more. The point I was trying to get to is you have stated that your position is that the MPC should not begin to tighten monetary policy until unemployment hits 7%. You have already started a policy whose effect is to tighten monetary policy at the long end.
Dr Carney: I disagree.
Jesse Norman: Well, you have just told me that.
Dr Carney: Monetary policy, the stance on monetary policy, cannot be summarised.
Jesse Norman: No, no, at the long end. At the long end it has. Clearly, you have told me it has tightened at the long end. There is no doubt about that.
Dr Carney: Well, it has tightened at the long end but it has not-
Jesse Norman: Okay, good.
Dr Carney: No, no, Mr Norman, it has not tightened monetary policy. A steep yield curve, a steepening yield curve, in fact, on balance, particularly a benign steepening of the yield curve, a yield curve that has steepened because of greater expectations of recovery, is looser policy than a flat curve.
Q47 Jesse Norman: So this is a loose tightening? It is widely regarded as a tightening at the long end. If interest rates go up at the long end it is a tightening.
Dr Carney: I am not sure how widely regarded that is, but if it is regarded that the 10-year gilt rate is the sum of the stance of monetary policy, then that is right.
Q48 Jesse Norman: Let’s pick up a question there because, of course, you made a point about floating rates but, of course, one of the areas that Governments are really trying to increase investment is fixed investment, proper industrial investment in plant. That requires term loans, which are long-term loans, and, therefore, it is going to be intensely geared to long-term interest rates. Just the area of investment that we would like as part of a recovery in manufacturing to take place is going to be affected by this drift upwards in long-term rates. As you say, term premia are changing. Doesn’t that suggest that uncertainty is going up?
Dr Carney: No, it does not. It suggests that it is a normalisation of term premia. If I may, Mr Norman, for long-term capital investment, for projects that have a payback over a longer-term horizon, we want in this economy projects that are based on expectations of positive real interest rates as opposed to negative real interest rates. If a project is only viable with historically low long-term interest rates that are below the actual inflation target, those are not really the projects that are in the best interests of this economy.
Q49 Jesse Norman: I entirely agree with that. Can I ask you another question, which is we have heard from Mr McCafferty and from other members of the MPC that without the 2.5% knock-out the forward guidance would be inflationary; the effect of the 2.5% knock-out is to anchor inflation expectations. Is that also your view?
Dr Carney: I absolutely supported having the knock-out and, yes, it helps to anchor inflation expectations.
Q50 Jesse Norman: That is helpful. Thanks. The question is if we have five years of high inflation on a 2% rate, why on earth should a 2.5% knock-out have the effect of anchoring inflation expectations downwards? Why wouldn’t it simply create a potential new norm for them upwards?
Dr Carney: Well, it hasn’t is the first point. You can look at what has happened to inflation expectations. We have made clear as the MPC that there is another inflation knock-out, which is what happens to inflation expectations, and we would look at a wide range of indicators of that. They have not shown an increase in inflation expectation to my judgment. The point that Mr Fisher made and I made is that we are on a path; we are setting a path to move from these above target rates of inflation back down to the target of 2% in a responsible way that supports the economy. In order to do that, Mr Norman, the judgment of the MPC and my personal judgment was that we needed to provide maximum transparency around that. In the absence of that, we would be potentially having a conversation about a quicker tightening of monetary policy, which would be inappropriate.
Q51 Jesse Norman: Okay, that is interesting. Thank you. Historically, in the UK we have talked about 5% unemployment as being, as it were, a target rate. The Bank has talked about its own estimate of the medium-term equilibrium rate of unemployment being 6.5%. You set 7% as a knock-out. The nature of employment has radically changed over the last few years for technological and other reasons. How sure can you be that you will ever cross the 7% rate? It could be a knock-out with no value.
Dr Carney: I think that is unlikely in our judgment, and certainly if we were incorrect, if we were proved to be incorrect about the medium-term rate of unemployment, that 6.5%, which is our current estimate, ultimately that would show up in terms of our expectations of inflation performance and that would have an impact on the stance of monetary policy. To be clear, and as you are well aware, there have been additional flexibilities introduced into the UK labour market, and so I think one can have the other question, which is why were we as clear as we were around the medium-term equilibrium rate of 6.5% as opposed to the historical natural rate, the rate that pertained prior to the crisis, of around 5%. There are a variety of reasons but I think they are best summed up in the fact that there is a substantial proportion of those who are unemployed who are long-term unemployed now. About 35% of those unemployed are long-term unemployed, as you are aware, as opposed to historical average of about 20%. It is the greater difficulty of those individuals becoming re-employed, reattached to the labour market, which means that we think there is less slack than there would have been relative to the historical rate. We have set a responsible threshold relative to that, 7% relative to the 6.5%.
Q52 Jesse Norman: You do not think there is something slightly Monty Pythonesque about all these caveats and riders sitting around monetary policy making it more complicated because actually it is what it is, unless something kicks in or we change our view?
Dr Carney: Well, if I may, Mr Norman, all these-your terms-caveats and riders and considerations, these are the considerations that play out in the discussions of the MPC.
Q53 Jesse Norman: Yes, but making them public may increase uncertainty rather than reduce it.
Dr Carney: I have a higher degree of confidence in the public’s ability to understand.
Q54 Jesse Norman: Final question; thank you very much for your answers so far. Obviously, you have an MPC meeting at which this forward guidance framework is adopted. Were these your original proposals? Did they change in the meeting?
Dr Carney: We developed the forward guidance proposals and framework as a group, as the MPC, over the course of the month of July into the meeting. It was a joint effort. It was a series of meetings that dominated our work.
Q55 Jesse Norman: You were not, as it were, at the stronger end of the spectrum and getting reined back by some of your colleagues?
Dr Carney: I entirely agreed and was entirely comfortable with the policy as adopted and as calibrated. I think it is exactly the right balance because this is the policy that gets put in place, not from a theoretical perspective but the right policy for this point in time when the UK is beginning to experience a recovery. This is a policy that is designed given the UK’s circumstances, given the start of a recovery, and given considerations about the eventual exit from exceptionally accommodative monetary policy. So, yes, I was entirely comfortable with it.
Jesse Norman: Thank you very much.
Q56 Chair: Sorry, I did not feel that was quite an answer to the question. The question was: were you reined back? Did you come with one proposal that was subsequently amended as a consequence of concerns expressed by other members of the MPC? I think that was pretty much the question.
Dr Carney: No is the short answer, and no because-
Q57 Chair: Everybody moves forward together having had pretty much the same set of thoughts?
Dr Carney: We moved together benefiting from each others’ perspective to come to a conclusion. We debated whether or not, for example, the threshold should be based on unemployment, whether it should be based on a nominal measure such as nominal GDP, whether it should be based on some level of growth, whether we should try to have an estimate of the output gap. We debated both in terms of what the specific conditions would be and how they would be calibrated, how we would talk about it, and the process was very much enriched. If you are asking me personally about how I view working in a committee and getting the most out of a committee, it is not to show up with a proposal and give a binary option with a proposal, but it is to benefit from the expertise, have that debate and, to the maximum extent possible, come to a consensus.
Q58 Chair: Okay, but I was asking the question because you come from a consensual environment and you are now, when you are sitting in the MPC, in an environment where people have individual views and express them publicly, which may differ from the decisions taken.
Dr Carney: Yes, I am fully aware of that and absolutely comfortable with it.
Q59 Chair: Okay. I just want to clarify one other point. You said, I think, a moment ago, but correct me, that this rise in the long rate can, and in this case should, be interpreted as a loosening of policy.
Dr Carney: I said the totality-the question is the shape of the yield curve and so I gave you one aspect of it, which is that if you are managing a financial institution, if you are managing a bank, if you are a lending officer, a steep yield curve is more advantageous to that institution. It incentivises lending more than a flat yield curve and the reason, as you are well aware, Chairman, is that banks tend to borrow. Their job is maturity transformation. They tend to borrow at the short end and then lend at the longer end.
Chair: I understand that. I just wanted to clarify that I had correctly summarised your view.
Dr Carney: Yes, but, if I may, you did not correctly summarise it because you did not focus on the shape of the yield curve, you concentrated only on the level of the long-term rate.
Q60 Chair: I see, so it is what is going on at the very short end that is more than counterbalancing what is going on in the rest of the yield curve?
Dr Carney: It is the combination. It is the combination of them that can provide a stimulative stance, yes.
Q61 Chair: Therefore, overall, your view is that the announcement that you made has loosened policy?
Dr Carney: Overall, my view is that the announcement has reinforced the recovery.
Q62 Chair: Okay, let’s have another go. Has your announcement tightened, loosened or left policy unchanged from where it was?
Dr Carney: Look, it has made policy more effective and more effective policy is more stimulative on the margin, yes.
Q63 Chair: Something that is stimulative is a loosening of policy?
Dr Carney: Something that is stimulative reinforces the recovery.
Q64 Chair: Okay, and that is a loosening of policy? Is that a yes or a no to that one or, "I don’t know"?
Dr Carney: I just prefer my terminology.
Jesse Norman: We are in now Monty Python territory.
Chair: Yes, I fear so. It is interesting how reluctant you are to say that the policy you have announced is a loosening of policy or, indeed, a tightening of policy.
Dr Carney: I think it is important to be consistent and I have been consistent on it in terms of-
Chair: If I may interrupt you, you must surely have a view on whether it changed policy at all, whether it changed the stance at all?
Dr Carney: I think it made policy more effective and, by making it more effective, if you choose to call that loosening, then you can call it loosening. The reason for the hesitation, Chairman-
Q65 Chair: But with great respect, Governor, have you ever heard a Governor of a central Bank come before a committee and say, "Do you know, we announced this policy and we are pleased to announce it has made our existing policy less effective"? I just do not think that is telling us anything. We need to get past that to a discussion about whether it is tightening or loosening.
Dr Carney: Well, here is why I am using that terminology. The stance of monetary policy can be summarised in various financial variables: where are short rates; where are long rates? We have had a discussion of that. But it needs to be supplemented by the common understanding of policy, the understanding not just in financial markets but also by businesses and households, because better understanding of the stance of policy-a given stance of policy that is better understood by people who make spending and investment decisions in the economy is more effective. It reinforces the recovery. The actual stance, the arithmetic depiction of the stance of monetary policy, does not have to change, but if it is better understood it is more effective. You can summarise that as a loosening. I am hesitating on that because the point here was as per the remit of the institution, the remit given to the MPC was to provide greater clarity about the stance of policy, and I think we have done it and I think we chose, as I just said a moment ago, the right calibration on the framework.
Q66 Chair: It is going to be pretty tough down at the Dog and Duck, isn’t it, working out whether this policy is loosened or tightened?
Dr Carney: If I may and then David, the measure of the effectiveness of this policy and all the other policies of the MPC is the return to inflation target in a way that supports growth. That is how we determine whether it is effective, but that is what we need to come back to.
Professor Miles: May I just offer one observation very briefly? I think the order of events was that forward guidance is announced and around the same time there is a whole succession of very positive news about the UK economy. Short-term rates moved up a little bit and longer-term yields, 10-year yields, moved up a little bit more. But I think it is pretty hard to work out how much of the movement in yields is a response to the good economic news and how much of it is a response to forward guidance in isolation from the news. My own interpretation is that nearly all the market reaction has been a response to the good economic news. It may turn out to be somewhat transitory. My own interpretation is that people may be attaching too much weight to the strong news on GDP, which is wholly welcome, and thinking that unemployment is going to fall very rapidly. We will see how that plays out. It may be that some of this reaction is transitory.
Chair: That is a very helpful amplification.
Q67 Mr Ruffley: Governor, have you ever in your time at the central Bank in Canada confessed to loosening policy or tightening policy? Is that language you have ever used before?
Dr Carney: Yes, it is.
Mr Ruffley: You have used it before?
Dr Carney: Yes, and during my time as Governor we both loosened policy and tightened policy.
Q68 Mr Ruffley: I just wondered why you have declined to accept the Chairman’s invitation to say whether or not it was a loosening or a tightening. You chose effectiveness. I understand what you were doing. I am just wondering why you appear to be inconsistent as between your time in Canada and your time here.
Dr Carney: Let me explain. I thought my explanation was-
Q69 Mr Ruffley: I am only asking this question because there is a point about clarity. You may think loosening and tightening is simplistic, but you have used simple language before.
Dr Carney: Yes.
Mr Ruffley: Why not now?
Dr Carney: Let me answer it this way. When I was Governor of the Bank of Canada we adopted time-contingent guidance in the depth of the crisis and the time-contingent guidance was explicit. In other words, "We don’t expect to begin to raise interest rates for 15 months", in effect is what we said. At that point, market expectations were shorter than that, so we were explicitly giving communication around a calendar with the intent of loosening policy, providing duration of stimulus.
The distinction here is that we have not provided calendar guidance. We have not said rates happen at a certain time. We have described the conditions that have to prevail in the economy in order for there to be an adjustment of policy. Different members of the MPC and different people in the market will have different views on when that 7% unemployment condition will happen. The message to business people and to individuals is that we will not begin to consider tightening of policy until we have seen continued growth in the economy that is consistent with the fall in the unemployment rate and is likely to be consistent with the return of productivity growth and real income growth in the economy. In that regard, there is a distinction between time-contingent guidance and the adoption of state-contingent guidance, what we have done here-a very important distinction.
Let me put it in the positive. The approach we took here was very much in my judgment and the judgment of colleagues and the MPC the right approach for the UK economy at this point in time given the start of the recovery and where the uncertainties lie. Now, by making policy more effective we make it more stimulative. It reinforces the economy. That is my judgment. You can ascribe a different label to it if you wish, but that is the logic of what we have done.
Q70 Mr Ruffley: On term premia there is an argument that if you look at the three to five-year part of the yield curve, since August there has been a bigger spike in UK gilts compared with US treasuries, and the increase obviously is to do with the better economic news both here and in America. But some have observed that this bigger increase in gilts is attributable to greater uncertainty, that forward guidance has made the future path of interest rates more, not less, uncertain. Why are they wrong in thinking that?
Dr Carney: Well, I have to say, and Mr Fisher can supplement, our surveys of market contacts, our discussions with market contacts, has been that there has not been a reduction in uncertainty. There has been an increase in clarity about the reaction function of the MPC. Now, again, as you pointed out, better economic data have led certain in the market to have a different view on when those conditions will be achieved, but we are not picking up a term premia move in the shorter end of the curve as opposed to a different view on the path of the economy and, therefore, the implications for monetary policy.
Mr Ruffley: Yes, I was talking about the three to five years, actually.
Dr Carney: I understand that, yes. No, I am speaking specifically to that because it is a different response at the longer end of the curve where there has been an adjustment in term premia globally.
Q71 Mr Ruffley: One explanation of the market reaction is that they do not believe your forecast for the unemployment rate. This is quite important. There seems to be a difference of opinion. Why is that?
Dr Carney: Well, that would be, first and foremost, a question for those individuals.
Q72 Mr Ruffley: Why do you think that they are taking a different view from yourself?
Dr Carney: I think there are a couple of factors. The first is we should be clear, what we have provided in terms of our projection for unemployment is the full suite of probabilities around that projection. For example, it is a roughly one in two chance that the unemployment rate will have fallen to 7% by the middle of 2016. It is about a one in three chance that it will have done so by the middle of 2015 and we provided that information, both fan charts and cumulative probability distributions. That is the first point.
The second point is one of the great uncertainties, as you are well aware, Mr Ruffley, because we have talked about it, is the path of productivity in the UK economy. There has been negative productivity growth since the crisis. The recovery in productivity, as activity and demand recovers, will make a big difference to the path of unemployment-it will also make a big difference to the path of real wages for those who are working-and relatively small differences in the relationship between the growth in productivity and the growth of the economy will shift in calendar time the point at which we reach that 7% unemployment threshold. We have as a central tendency in our forecast an assumption of productivity growth of about 1.8% per annum compared to a North Sea oil-adjusted 2.2% rate prior to the crisis and in the light of a situation where, as I am sure you are aware, the level of productivity in the UK economy is at 2005 levels, roughly 16% below pre-crisis peaks. It is a relatively modest forecast, particularly given the prospects for an endogenous increase in productivity as the economy grows because of economies of scale, people working more, there are a lot of people who are not working as much as they want to in this economy, new firms then entering the labour market or entering the economy and the creative destruction that comes from that.
But to go back to answer the question, a relatively small difference of opinion in terms of the relationship between growth and productivity will shift by quarters-
Mr Ruffley: That would explain it?
Dr Carney: -can explain the difference, which is part of the reason why we emphasise that the 7% threshold is a staging post, if you will. When we get there we have to evaluate what has been the path of productivity, what are broader labour market indicators and, therefore, what is the outlook for activity inflation.
Q73 Mr Ruffley: Sure. I would just like to turn to the August MPC minutes. It noted that most members of the committee thought, and I quote, "The extent of the increase in short-term market interest rates remain greater than could be reconciled with the improvement in the economic outlook". Other members did not think market interest rates were obviously out of line with their view of the outlook. I would just like quickly, and we are short of time, just to go, starting with Professor Miles, to ask which camp were you in and why.
Professor Miles: I was probably in the camp that I thought it was a bit of an overreaction in the market because I think the weight of money seems to be betting, if you will, that we might reach the 7% level more rapidly than I think we will, partly because I think productivity is highly cyclical. I suspect it will bounce back very strongly if we get sustained growth and I hope that happens.
Dr Carney: I would associate myself with that. I again felt that on balance, given the data at that point in time and given what I knew about the reaction function of the MPC, the market had a more positive view of the rate at which unemployment was going to come down and a more pessimistic view on productivity, particularly in the light of the scale of the productivity shortfall. I find it difficult to give full credit to a soviet-style collapse in productivity in the UK, even given what has happened.
Now, the last point I will make on it is that one of the key questions here is the rate at which that pick-up in productivity comes with the pick-up in demand. We expect there will be some lag. Demand will pick up quicker. Unemployment will come down a bit quicker first and then productivity will pick up, but we will find out as the recovery progresses.
Paul Fisher: Similar for me. I think there is a lot of spare capacity in the economy and so much that a pick-up in growth need not imply domestic inflationary pressures pick up any time soon. I think the market may be overlooking that there has been more a sort of Pavlovian response that a return to growth will mean falling unemployment quite quickly. In some ways, falling unemployment quickly is good for the people who get jobs, but it is not necessarily good for national income unless we get the growth that goes with it. If we get stronger growth and falling unemployment, that is fantastic. We will be able to put interest rates up earlier. What would be unfortunate is if you got the fall in unemployment with very slow growth because then the national income for us all is a lot lower.
Ian McCafferty: I have been arguing for some time, I think, that the economy has been picking up relatively strongly as a result of the better data that we have seen in recent months. I think that does help justify for at least some in the market why short rates have gone up and I think, therefore, I would be slightly in the other camp. However, within the scope of our forward guidance programme I also believe that there is scope for perhaps a faster increase in productivity than we have allowed for, which would, therefore, mean that we would not necessarily hit the 7% earlier than we have in the forecast.
Q74 Mr Ruffley: Thank you for those replies. My final question to the Governor: your predecessor expressed some sympathy with the idea that a lower value of sterling could help rebalance the UK economy more quickly than a higher level for sterling. Do you have sympathy with his view?
Dr Carney: I think my predecessor’s view, as I recall being in meetings with him internationally, was formed at the start of the aftermath of the financial crisis and the need for rebalancing. There was a substantial subsequent adjustment in the value of the currency, the effective value of the currency, and I would merely say that sustainable rebalancing of this economy, both internally and externally, requires a return to productivity growth at a minimum and productivity growth, in fact, in excess of what we have in our central forecast.
Mr Ruffley: Okay, thank you.
Q75 Stewart Hosie: Governor, you have made great play today about monetary policy being better understood by households and businesses leading to different and hopefully better decision making. I certainly think in terms of the 7% unemployment target that will be understood. However, when it comes to the two price stability targets, the second suggests that medium-term inflation expectations no longer remain sufficiently well anchored. Even I do not know what that means. What does that mean?
Dr Carney: Well, what we have provided, Mr Hosie, is a suite of measures of medium-term inflation expectations, which include market measures, measures taken out of the market. We can go into detail on them but measures taken out as market prices, asset prices, but also survey measures of households, the most prominent of which is the Bank/NOP survey, which has just come out, surveys of professional forecasters, of what do they think inflation will be, and surveys of businesses. We look at those. What do we look for? We look obviously at the level of inflation expectations, both in the medium and longer term, but we also look for changes in those levels, if they are drifting up or, particularly, if they become more sensitive to economic news, so if there are sharper moves given a good data print as well. We have provided in the inflation report and the guidance document the suite of measures that we look at. We had a discussion at our last meeting on those measures and our individual views on whether inflation expectations remain well anchored, and the judgment of members was yes, that they were.
Q76 Stewart Hosie: But the argument about it being well anchored then would appear to be not that it might fluctuate, but that there would simply be expectations inflation would rise more than was anticipated. Is that not correct?
Dr Carney: Sorry, I did not follow your question.
Stewart Hosie: Well, this seems to be a one-way anchoring. I take it you would only-
Dr Carney: I am sorry, I understand, my apologies. No, anchored to the 2% target, anchored consistent with the 2% target. That is the anchoring, the anchoring consistent with the inflation target of the MPC.
Q77 Stewart Hosie: What is the difference then between this anchoring price stability knock-out and the other one, which is the 0.5% above the 2% target forecast over the 18 to 24-month horizon? What is the fundamental difference between them?
Dr Carney: The fundamental difference is that the forecast is the forecast of the MPC. We do our best work to forecast where inflation is going to be and we look at the relative probability. We have set this in the probability space. Is it more likely than not that inflation will be above 2.5% on average over those 18 to 24 months? We do that forecast. The inflation expectation is an external check. It is another price stability target because these are the expectations of businesses, of households, and that are embedded in market asset prices, so it provides an external check in terms of what the outlook is supported by that.
Q78 Stewart Hosie: That is very helpful. On that first knock-out test, though, the MPC forecast over that 18 to 24-month horizon, what is the average error in MPC forecasting for inflation over that horizon historically? Have we any notion how accurate or inaccurate it is?
Professor Miles: Well, over recent years we have certainly had a not very good forecasting record over that kind of horizon and certainly at times we have been 1%, 1.5%, 2% off. But this is not so much how accurate might our forecast be of inflation in 18 to 24 months, it is what do we think the chances are that we will be the wrong side of 2.5% or the right side of 2.5%.
Q79 Stewart Hosie: Professor Miles, this is precisely about how accurate the forecast is because it is the knock-out of the unemployment threshold that is keeping interest rates low. That is precisely what it is. Sorry.
Professor Miles: Sorry, excuse me cutting across you. In terms of the 2.5% inflation 18 to 24 months ahead, the question is, what do we think the chances are that we will be the wrong side of 2.5% in that horizon? We may be pretty uncertain and, indeed, we should be uncertain about what inflation will be given our own track record and how difficult it is to forecast inflation. The question is, what is the probability? You can be quite uncertain about something but still have a reasonably grounded view that the chances are it will be this side or that side of some levels. This is about our judgment about the probability.
Q80 Stewart Hosie: I do understand what you are saying, the issue of probability versus an absolute forecast target.
Professor Miles: Yes.
Stewart Hosie: But this trigger, this knock-out, is based on that forecast. You may then turn it into a probability, but it is about the forecast.
Just to go back to the historical forecast, you said you had been wrong by 1.5%, 2.5% and that is correct. Was the bias always in one direction, overestimate or underestimate of inflation over the base rate?
Professor Miles: Paul Fisher, who has been at the Bank longer than me might be able to help me on this.
I think if you look at the long period since the MPC was established it has not been biased in one direction or the other. If you look at the more recent period, the last four or five years, since the financial train wreck, predominantly we have been underestimating inflation.
Ian McCafferty: If I can add this, Mr Hosie, one of the reasons that we have therefore two inflation knock-outs is that if we get our forecasts wrong, which I think is one of the implications of your question, but others outside the Bank believe that inflation will be significantly higher-their forecasts are different from ours-and that will show up in the inflation expectations knock-out.
Q81 Stewart Hosie: Indeed it will. Just to answer the question, the assessment I have had is that over the last 32 quarters the MPC have under-forecast inflation in 29 of them. That is a pretty miserable one-sided bias in terms of under-forecasting. We can have this checked but I am pretty sure it is quite accurate.
Paul Fisher: We have had a series of shocks we did not anticipate that have pushed inflation up.
Q82 Stewart Hosie: Indeed. But remember these are seven- to eight-quarter, 18 to 24 month-type views, which is exactly the forecast you intend to use as one of the knock-outs. But, Mr McCafferty, the point you make is really important here. If we have external commentators, external survey results, telling you one thing and MPC analysis telling you something else, according to the rules you have that would be an automatic knock-out for the 7% unemployment threshold to be used. Is that correct?
Dr Carney: That is correct, yes. If the sum of external measures of inflation expectations suggests that they are no longer sufficiently well-anchored, then that is why the knock-out is there, for exactly the reasons that Mr McCafferty underlined. We will not take risk with inflation expectations. This is about returning inflation to target in a responsible way; in a way that supports activity and employment.
Q83 Stewart Hosie: However, at that point all you do in effect is then consider what the interest rate or the QE levels should be at that point. There is no automaticity in terms of action then being taken.
Dr Carney: That is correct. It is a staging post. But the stance of monetary policy is determined by the MPC without automaticity. It is not rule base. But there is clarity in this case with the price stability knock-outs particularly that we are not going to take risks with inflation expectations.
Q84 Stewart Hosie: Okay. So the MPC have a forecast that on past evidence underestimates lightly. The market and other evidence say no, inflation is going to be significantly higher. That triggers a reconsideration of the 7% unemployment threshold. But then the considered view of the central Bank is that you take no action in terms of the base rate. What are the markets to make of that scenario, which is highly likely?
Dr Carney: First off, I don’t think it is highly likely at all. I have more confidence in our forecast accuracy going forward.
Secondly, you have strung together a few hypotheticals there, including a hypothetical on what the policy stance of the MPC would be at that point.
As individual members and as a committee, the MPC is guided in the stance of policy to achieve the inflation target.
Q85 Stewart Hosie: I understand that and, yes, of course there were hypotheticals. But in the same way that you said earlier in response to another question, the caveats, the riders, the considerations, were necessarily the things you had to consider. Then a combination of contradictory evidence leading to a particular outcome, which is certainly a possible outcome, is something you should consider even if it is to look at the reputational damage that scenario might do for the MPC. I think that is quite valid for us to do that.
Do you see any risk of reputational damage to the MPC in the scenario I posed?
Dr Carney: The first thing I would observe is that there has not been a move in measures of inflation expectations. The presence of these knock-outs and the seriousness with which we take them has reinforced, in my opinion rightly so, the inflation targeting credentials of the MPC. We have not changed our target. What we have done is provide greater clarity about how we are going to get there.
Secondly, in terms of a scenario where if there were a need to take action in order to return inflation to target sooner because of one of the knock-outs or to adjust policy because of that, I am confident not just individually that my personal reaction-I am not afraid to raise interest rates. Let’s be absolutely clear. I raised interest rates in Canada. I am the only G7 Governor sitting who has raised interest rates. So I have no issue with doing that if it is appropriate and in circumstances where it is appropriate. I have confidence individually but also in my colleagues that we would take the right decisions, which in itself, if I may, makes that less likely.
Q86 Stewart Hosie: That is helpful. Just one final question. It relates to raising interest rates, to taking the decisions and goes back to an answer you gave to Andrea Leadsom earlier. You said that if you were to take action it would be on the base rate before asset sales. Can I ask what the logic is behind that if the result in terms of tightening money supply was the same? Why would you necessarily put the base rate up before selling assets if it resulted in the same tightening of money supply?
Paul Fisher: The thought we have had on this is that interest rates can easily be used as an active instrument of monetary policy. You can put them up one month, you can even bring them down again if you have gone too far. With asset sales we do have an issue of not wanting to upset the gilts market. So we would want to do asset sales when we could do it over a long period of time, in an orderly fashion, at a moderate pace, so that we did not have that negative impact on the gilt market. So you would use interest rates as the active instrument and you would use asset sales as something that was a longer-term programme. So when we wanted to give the signal it would be interest rates first and then asset sales at some point after that. Now that is our presumptive plan. I don’t think we would want to rule out that there might be some circumstances in which there something was going on that caused us to change that plan. But that is the thinking at the moment. The strategy would be to change rates first.
Q87 Mr McFadden: I would like to ask you about the recovery. In remarks a couple of weeks ago you said, "We are in recovery. It is just beginning. There are some signs of broadening of that but it is just beginning. It’s a long way back, a very long way back. We are lagging virtually everyone else in the advanced world".
Why do you think we are so far behind?
Dr Carney: First just to put that in context and put a number around that, as I am sure you are aware GDP is still a little less than 3% below where it was prior to the crisis.
The reasons that the recovery has been slower in the United Kingdom include the scale of the shock to the banking system and the damage that has caused in terms of access to credit for new businesses, and the necessary adjustment in the balance sheets of households that have become over-indebted in the context of uncertainty and that took decisions to reduce their indebtedness. So that is an additional headwind. The fiscal adjustment has been a drag on growth. Fourthly is the fundamental weakness in the euro area, the largest trading partner as you are aware for British exporters and a weakness that has persisted.
So in all aspects of demand there have been some headwinds. There have been headwinds and the sum of that has been this performance.
Maybe I should just add this: those headwinds have been what monetary policy has been leaning against over the course of that period, appropriately so in my judgment and in the judgment of the MPC. Given the starting point that we are in, the weakness in terms of the level of activity relative to history and the potential of the economy and given where inflation is, it is appropriate to maintain a very accommodative stance in total of monetary policy in order to return inflation to target over a reasonable horizon.
Q88 Mr McFadden: The Chancellor says the economy has turned a corner. Listening to him and the Prime Minister getting the bunting out reminded me a little bit of President Bush making his mission-accomplished speech on the deck of the battleship, which proved to be a tad premature.
Do you think the stance of the Bank in having to issue this forward guidance is testament to your view that the recovery is fragile and therefore we are getting mixed messages from the Bank and the Government as to whether this recovery has really taken hold?
Dr Carney: Obviously I will not speak for the Government. The stance of monetary policy is consistent with reinforcing the recovery and really helping to secure that recovery at a time when the economy is-to use the phrase-turning the corner. Where the economy is beginning to pick up there is a natural tendency to pull forward expectations of when stimulus would be withdrawn. That is why the MPC felt it was appropriate to provide maximum clarity and transparency about the stance of policy over this period.
What does it really mean? What are the conditions that would prevail when in our judgment it would begin to be the time to think about tightening policy? Those conditions are summarised-it is never perfect-but they are summarised in that 7% unemployment threshold. They are conditions that are consistent with growing jobs, the beginning of growing incomes, the pick-up in productivity growth. Then we would look for an adjustment there. So the stance of monetary policy is to secure the recovery in a way that is consistent with achieving the inflation target.
Q89 Mr McFadden: Has the economy turned a corner?
Dr Carney: To give you a fancy answer, the second derivative is certainly positive. The economy has stopped shrinking. It was stagnating. It has now picked up. There has been an acceleration in recent quarters. There are signs that the growth is relatively broad based across consumption; a return in some housing investment; some strength, from a very low base obviously, in exports; some improvement in sentiment around business investment, but there is not yet the follow-through, as there normally is not at this stage in a recovery. So there has been a change in the pace of activity in the economy without question and it is welcome. Our point-or my point, maybe, to personalise it-has been that this is welcome but we should not be satisfied with this. We need to do what we can from the monetary policy perspective to reinforce this early momentum and retain the pace of recovery.
Mr McFadden: It is quite a long answer.
Dr Carney: Were you surprised?
Q90 Mr McFadden: Do you believe the economy has turned a corner?
Dr Carney: If I am given a binary choice on that-
Mr McFadden: It is not really a binary choice.
Dr Carney: I will go back to effective stimulus, if I may. I am hesitant to get pulled into a political debate, for obvious reasons. My personal view, consistent with our forecast, is that we have a recovery and in recent weeks we have seen data consistent with some strengthening of that recovery and some broadening of that recovery. But it is early days in that recovery. You quoted something I believe I did say-I will say it here-which is it is a long way back to get back to the potential of this economy.
Q91 Mr McFadden: Can I ask you specifically about a couple of aspects of the recovery? First, the housing market. We have for quite a long time in the UK had almost a two-speed housing market; one in London and one in the rest of the country. In your speech on 28 August you referred to house prices and their acceleration and the tools that you had available. Are you concerned at all that we might see an unhealthy acceleration in house prices on the back of some of the stimulus measures that have gone in precisely to the market such as right-to-buy schemes and help-to-buy, and all these things?
Dr Carney: If I may, Chair, I will speak primarily in my capacity as a member of the Financial Policy Committee, if that is okay with you, Mr McFadden. I think the issue around housing and the sustainability of the housing recovery and the potential risk that could be generated if there is an overshoot in housing largely fall within the responsibilities of the Financial Policy Committee. Certainly the tools that would be available, the first, second, third lines of defence that would be available to reduce the risk there are at least under the influence of the Financial Policy Committee. To bring it back to monetary policy, one thing we have made clear with guidance was that if there were risks that were being reinforced by the stance of monetary policy-risks in either the financial markets or potentially in the housing market-we would look to the relevant committee, which is the Financial Policy Committee, which is equally split between internal and external members, as you know, to make judgments about those risks and to use/influence a considerable range of other policy options before the judgment would be given that the stance of monetary policy should be adjusted.
Q92 Mr McFadden: In simple terms, what could they do if they were worried that house prices were accelerating?
Dr Carney: I think in simple terms it begins with more intensive supervision of mortgage lending. It begins with that, making sure that underwriting standards are maintained so we do not see a return to the more than 100% loan to value ratios, that there are appropriate standards on loan to income. Again, just in terms of the standards that banks are using, appropriately documented, it starts with more intensive supervision. It can extend all the way to sectoral capital requirements, additional capital that banks would have to hold against certain types of lending, including mortgages. In the middle-and I think it should be a question of open debate-if there were a case where there were vulnerabilities in the judgment of the Financial Policy Committee, whether there should be some guidance provided in terms of loan to value ratios, loan to income ratio caps or other aspects. I know that has been a subject of discussion with this Committee in the past. We do not have powers of direction in that regard but certainly have retained the ability to observe and recommend if necessary.
Q93 Mr McFadden: Isn’t there an irony in that set of circumstances that we would have house prices rising on the back of special schemes of support on the one hand and the MPC trying to rein it back on the other? Isn’t that a little bit like pressing the gas and the brake at the same time?
Dr Carney: There are two aspects. I think first we need to put recent developments in the housing market in some context. Activity levels, mortgage applications, valuations, are still below. There are pockets where this is different, as you are well aware, but across the nation they are still in the range of about two-thirds to three-quarters of pre-crisis levels. So there has been an improvement. We see further improvement in prices and activity-but that is our expectation-and perhaps some acceleration. So we do need to be vigilant about this. Your questions are on point, but we need to also look at the starting point. You are well aware, I am sure, that there are big pockets of the country where there has not been any meaningful recovery in the housing market. So it is in that context that we need to think about where the vulnerabilities could develop and what the reaction should be. It is also part of the context that should inform the judgment about the merits of any particular policies that could be targeted at certain house-price value levels, certain types of buyers and the appropriateness of those, given the overall stance in the market.
Q94 Mr McFadden: Finally I would like to ask you about the labour market end of the recovery. To what extent is the Bank aware that this feels very different in different parts of the country? A bit like the housing market as well. For example, in the city I represent, yesterday in Wolverhampton in the midst of nationally good, encouraging unemployment figures we had an announcement of 1,000 job losses by the local authority.
Is the Bank alive to very different feel of the economy in different parts of the country?
Dr Carney: A few points first. For example, I was in the West Midlands on the 28th, when you mentioned the most recent unemployment figures. They are monthly figures. They do move around a bit. But they spiked up from 9.2 to 9.9 in the West Midlands as you are aware, which is a broader representation of what you are referring to. So we are aware and we certainly look at the differences in unemployment.
We have to set monetary policy for the United Kingdom as a whole and the amount of slack both in the labour market and in firms as a whole, in judging the appropriate stance of policy. What I would take this moment to underscore though is that at the point at which the economy reaches that 7% unemployment threshold, we will not be looking at just one variable. We have made it easy in some respects by using that variable as a threshold but we continue to look at the number of involuntary part-time workers, which is relatively high; where the participation rates are; what is happening to wages; what is happening to average hours worked. Then more broadly what is happening in firms, how much spare capacity there is, what is happening with investment and prospects for productivity picking up. So we have to look at a broad sweep of aspects, representations, of the economy.
I will just take this one last thing, if I may, Chairman. I want to reassure the Committee and others that we continue to do that on a continual basis now even in the context of having forward guidance, so we are constantly updating our individual and collective views of the economy.
Q95 Mr McFadden: On this issue of productivity, part-time work and slack in the labour market, should we take from your evidence today, and that of your colleagues, that you are issuing a bit of note of caution for those who saw yesterday’s unemployment figures as indications that that 7% threshold you have set would be reached very quickly? What you seem to be saying collectively today is that because of the slack in the economy and the number of people working part time who might want to work more hours and the same effect in companies, it would be a mistake to judge yesterday’s figures as a sort of straight path and we might see quite a different pattern as the recovery takes hold. That seems to be what not just you, Governor, but your colleagues are saying.
Dr Carney: My short answer would be yes but I invite my colleagues to speak.
Professor Miles: I would strongly agree with what you just said. Productivity is very cyclical. It is extraordinarily weak. The level of productivity in the UK has fallen 10%, 15% relative to a trajectory we appeared to be on. I suspect quite a lot of that is because we have not had a recovery; because demands have been so weak. I think there is going to be a bounce back, not the whole distance back-we have lost some for ever probably-but a bounce back. I think that will mean that for any given path of demand and output, the fall in unemployment will be a bit lower than it would be in normal times where you didn’t have this enormous gap to try to make up.
Q96 Mr McFadden: My last question, Governor. Do you believe that the introduction of plastic bank notes in the UK will be popular?
Dr Carney: The answer to your question is that one of the reasons why we are conducting an extensive consultation across the UK with more than 30 individual events around the country in the fall and online feedback, is to hear the reaction to polymer bank notes. This was not my decision. It was something that was in train in advance of my arrival, I want to assure you. That said, the introduction of these notes in Canada and elsewhere has proven popular because they are cheaper for taxpayer, they are more durable and they are more environmentally friendly.
Mr McFadden: I suspect consulting on it is wise.
Dr Carney: That is why we are doing it.
Q97 Chair: There has been a discussion about the notes and we have asked to see a specimen to see what they look like.
Dr Carney: We are here to serve.
Chair: We do not need a suitcase full. We will settle for a relatively small number.
Paul Fisher: Would you like me to pass a couple round?
Chair: Not just now, but very shortly.
Q98 Mark Garnier: Mr Fisher, can I start with you, just picking up on an answer to a question the Governor gave a bit earlier about the asset purchase scheme?
We are now in a position where some of these asset purchases are maturing and so there is money now available. You are reinvesting this back into the gilt market. Where are you reinvesting it?
Paul Fisher: The plan will be to reinvest back across the curve in the same way as we have previously, so we don’t want to change the average maturity holding or give any signals by buying different gilts with the reinvestment. We have announced a market notice for this, for the forthcoming gilts, which will be typical of the succeeding operations. We will be doing three operations in the maturity buckets we have already set out, roughly even sizes, in order to reinvest the gilts, as we did with the original purchases.
Q99 Mark Garnier: So there is no concentrated effort on any particular part of the yield curve. As far as you are concerned it will be absolutely completely neutral. Thank you.
Just one other question to get on the record your operations in the market, at any point are you ever moving money around the yield curve? Obviously we are talking about where you will see maturities, but are you ever trying to push the yield curve up at the longer end? Are you making any interventions like that? Or are all your interventions are absolutely neutral and you are just keeping it firm?
Paul Fisher: We have discussed this on the Committee, whether we would want to try to twist the curve and buy more at the long end or something and we have concluded that we did not want to do that. We would have a set of operations that very roughly gave us the average maturity of the outstanding stock, which is where we have been, plus or minus.
Q100 Mark Garnier: Okay. That is very reassuring. Thank you.
Dr Carney, can I turn to you? What is your assessment of the state of UK household balance sheets?
Dr Carney: A couple of responses. First, in aggregate household balance sheets have improved over the course of the last five years, by roughly about 30 percentage points improvement relative to income. So there has been progress. Relative to some other more highly indebted countries, the UK experience is notable in a positive sense. There has been improvement in interest gearing as well. So the debt service ratios-it is another way to say the same thing-have gone down substantially.
That said, there are obviously pockets of concentration of more vulnerable households still with high indebtedness. What is crucial for the sustainability of household balance-sheet positions is what happens on the ground in terms of employment and ultimately wages, which turn on everything that we have been discussing today.
Q101 Mark Garnier: That is very interesting. You refer obviously to the 30% drop in the gearing, from 170% in 2008 to 140% or so now. But in nominal terms household debt has been increasing very strongly since 2007-and subsequent to that-which implies obviously as the economy has grown a little bit over the period and we have seen a lot more people coming in to work that it is nominal incomes that have gone up, which have been driving this reduction in debt.
Dr Carney: Exactly as you say, nominal incomes as opposed to debt pay-down. To state the obvious there has been a slowing pace of debt accumulation, debt taken on, with the slow-down in housing activity.
Q102 Mark Garnier: Absolutely, and that is very reassuring to see that. But nonetheless it leaves we have seen some surveys that have come up, I think it is something like 8% of UK mortgages by value were subject forebearance in 2012, which is quite significant. A consultation by you guys and NMG Consulting indicated that 18% of secured loans were to households with less than £200 of disposable income per month after essential costs. I think we have also seen a survey from the Resolution Foundation where the number of families in Britain with perilous levels of debt repayments could more than double to 1.2 million should interest rates go up to 3.9% by 2017. Clearly we are not expecting interest rates to go up to 3.9% by 2017 but it is not inconceivable.
Does this not mean that as recovery comes and interest rates do start to pick up, and your forward guidance is very helpful, that there are very significant numbers of households that may find themselves being pushed into quite strained positions as a result of a period when we return back to normal interest rates?
Dr Carney: Yes, is the short answer. There are a substantial number of households-and you gave some of the figures-that are in effect in a form of being credit constrained because of the existing debt burdens that they have, an inability to shoulder additional debt and also inability to access additional debt as underwriting standards have tightened. So that has an impact in terms of the pace of the recovery and certainly any pace of consumer recovery reinforces the importance ultimately of not just nominal income growth but real income growth in order to further reduce that burden.
I will just go back to the observation I made earlier, which is that at the heart of MPC’s current central tendency forecast is a rate of consumption growth that is consistent with our expected rate of income growth for those households, so not an additional build-up of this debt burden. So this is one of the headwinds that, in our view, will restrain the pace of recovery over the medium term.
Q103 Mark Garnier: But it is also a serious factor that may lead you collectively in the MPC to feel that a rise in interest rates may be a problem. You may get a part of the economy recovering, you may see inflation starting to pick up, you may feel that the right thing to do is to increase interest rates in order to tighten money supply yet at the same time these households in debt have not resolved their position and that could cause a bigger problem.
Dr Carney: It is a challenge for the economy. For the stance of monetary policy we benefit from having a clear inflation target. So the judgment of the MPC when we reach the point where we need to consider tightening the monetary policy will be based on achieving that inflation target. It will take into account obviously the dynamics of the situation you are describing and the impact of that on demand and activity and feeding back in on the outlook for inflation. Unfortunately-or fortunately, and there are solid reasons for this-we cannot target monetary policy to specific cohorts of individuals. We have to keep the discipline of achieving that inflation target.
Q104 Mark Garnier: But it could have very significant social impact and regional impact as well?
Dr Carney: The experience in the United Kingdom and across the world is that monetary policy does have distributional and regional impacts and there are other suites of policies, both macro-economic and micro-economic policies, that are available to Governments, which can work to counterbalance those.
Q105 Mark Garnier: Do you think households realise how vulnerable they are?
Dr Carney: I think in general the households you describe, which are at the more difficult end, do realise, in part because we have seen the behavioural response to the difficulty of that situation. As the recovery progresses the challenge will be to gradually transition over an appropriate pace from a situation of emergency stimulus that is being provided, to gradual withdrawal of that that is consistent with the inflation target and to ensure that households that are in a position to take on additional debt are thinking all the way through the horizon over which they have to repay that debt to ensure that they can service it.
Q106 Mark Garnier: I think this is a very key point because we have now had a period of six years of these super low interest rates, emergency interest rates if you like. We are beginning to come to that period where, as the Prime Minister and the Chancellor of the Exchequer put it, we are turning the corner, as opposed to have turned the corner; we are turning the corner. But we are beginning to come back to a period where we are beginning to get back to a recovery period and therefore we are beginning to come back to normal interest rates. Yet people’s memories are pretty short. I think this is a very important point. Do you think households at this end of the spectrum where there are potentially problems fully understand what all of this means in terms of interest rates? Really importantly, do they understand what forward guidance means? Do they understand that if the base rate goes to 3% that that is a six fold increase in the cost of financing?
Dr Carney: A couple of things. One is that the advantage of the guidance is it gives visibility to the point at which these types of decisions start to have to be taken. My personal impression-and colleagues can comment- and also as some of our survey evidence shows, is that there is a pretty good understanding of the unemployment threshold. Sometimes-
Q107 Mark Garnier: Do you think people really watch the unemployment numbers on a hawkish basis in order to work out what their-
Dr Carney: This will be revealed and we rely on our colleagues and friends in the media to help transmit that and also some leg-work on the ground going around the country. Not just in human terms but also in terms of the stance of monetary policy it is a very relevant variable, so that helps provide some visibility as to when these types of decisions start to have to be taken.
In terms of the orders of magnitude of the adjustment, it is very early days to be talking in those terms. I will leave it at that.
Q108 John Thurso: Can I apologise for not being here at the beginning? I had the unenviable task of answering questions in the Chamber of behalf of the House of Commons Commission at the start of the day.
Chair: They are the people who control the money and the budget.
John Thurso: Can I come to you first, please, Mr McCafferty, looking at net lending?
How satisfied are you with the progress that is being made in lending, particularly to businesses and most particularly to the SME sector?
Ian McCafferty: I think that the conditions for lending are starting to improve. But I think we would be more satisfied when we see net lending starting to pick up rather more rapidly than we have seen so far. I think the lack of lending particularly to SMEs, which I am sure is part of your question, was one of the reasons that we adjusted the terms of the funding for lending scheme in order to provide greater incentives for banks to lend to SMEs as part of their overall lending programme.
I think though I would like to put the lending to SMEs into some form of perspective because there have been a number of studies or surveys recently that suggest that this is still a very serious problem across the piece. I have seen one statistic that suggests 50% of all SMEs were refused loans. That of course was a measure of those SMEs that had approached their Bank over the recent period whereas other surveys do suggest that about three-quarters of SMEs are, and I quote the phrase from the survey itself, "happy non-borrowers". So I think the indications for the economy itself about the limitations of lending to SMEs can be overstated, but we are working hard to try to improve the conditions for SMEs.
Outside the SME space, things have improved quite significantly over a longer time period. Larger firms, medium and large-size firms, have been making greater recourse to corporate bond markets than was the case before the credit crunch and, as a result, in that area of the corporate space things are looking relatively normal.
Q109 John Thurso: You put your finger on an interesting point, which is the difference between the availability of credit and the actual net lending that is taking place. While I was travelling recently I happened to run into a very senior banker who told me in a passing remark that his job had become desperately rushing round the country trying to find people to lend money to.
How much do you think it is that we have become cautious, particularly at the smaller end, and it is a very comfortable place to be as an SME, not geared, not wanting to expand, comfortable, protected and therefore not wishing to be hurt? How much is it that companies who pre-crash might have been happy to invest and go forward are just saying, "I’m going to sit this one out for another year or two until I see how it goes"?
Ian McCafferty: I think there must be some element of that. That is why I have placed great stress on the need to improve business confidence. A good deal of the low levels of investment, SMEs and others, over the course of the last year or so has been the result of the very low levels of business confidence that we have seen. We can attribute that to all sorts of causes but not least to the uncertainty around the future of the euro zone that certainly depressed confidence heavily through the course of 2012.
We have seen business confidence start to pick up quite markedly, both in terms of the survey evidence directly and in terms of the regional visits that I and my colleagues have undertaken over recent months. I would say that the tone of the conversations that we have had have started to improve. A solid pick up in business investment has yet to show up in terms of survey data-we had some improvement in the second quarter GDP data-I think that is still to come. But a precursor for that pick-up in business investment will be that that improved level of confidence can be sustained.
Q110 John Thurso: Perhaps I can come to you, Professor Miles, on the same question. What is your take? How much of a barrier to recovery is either the availability of credit or perhaps more importantly the take up of it?
Professor Miles: When you speculate that there may be a large number of companies that are quite happy not to borrow at the moment, that is the message I have got as well from talking to companies.
I think in terms of cost and availability there has been a bit of a thaw in the availability of funding to smaller companies. It has been pretty slow but it is gradually moving in the right direction. One piece of anecdotal evidence just over the last few years-I remember that when I joined the Committee if you had 10 or 15 small and medium-sized companies round the table, people talking about what was happening, the only thing they wanted to talk about was the banks and the unavailability of credit, in 2009, 2010. In 2011 and 2012 maybe half the people round the table thought that that was overwhelmingly the most important issue. Now it is maybe two or three people out of 10 or 12 that think it is the most important issue at the moment. It has been painful and gradual but I think that is heading in the right direction.
Q111 John Thurso: Taking that through to then looking at funding for lending, obviously there is the argument funding for lending has worked, if that is what you are now getting. The other argument of course is that we have got to a place where those that couldn’t survive haven’t, those that can survive are doing what they would do, and funding for lending for businesses is not therefore necessary. Where do you sit on that spectrum?
Professor Miles: I think the funding for lending scheme has been effective and powerful, more powerful than you might infer from simply looking at the amount of lending that the Bank has done. To my mind the big advantage of it is that it provides a backstop so that banks know that if funding conditions turn against them in the private market, here is a source of funding at relatively cheap rates. I would not be in any great hurry to try to wind that down because the risks of a shock to the availability of funding in the private market have not completely gone away.
Q112 John Thurso: So going to the confidence question, the funding for lending scheme is quite an important element in that even if it is not being terribly used, because it is there, it gives confidence.
Professor Miles: I think that is right. Yes.
Q113 John Thurso: Governor, can I come to you and ask one question on a different aspect? In your recent speech you talked about the possibility of lowering the liquidity requirements for banks and I think there is an estimate that something in the region of £90 billion of lending capacity could be freed up. How much do you expect that to happen and what impact do you think it might have?
Dr Carney: You are right. It is the upside figure. The strict calculation is £90 billion across the major banks and building societies once they have met the capital threshold. That is to move down to the new 80% level equivalent of the liquidity coverage ratio. It is unusual for institutions to move all the way to just meet a buffer standard, which would be necessary in that case. So one would expect them to be somewhat above in case of shocks in the funding market, other anticipated aspects. So certainly the number will be less.
What also has to be kept in mind is that this is moving down to a four-fifths of a metric, the liquidity coverage ratio, and then gradually moving into 100% achievement of that over the course of the subsequent couple of years.
So it is up to the individual institutions, but my very imprecise view on it would be one would expect about one third or so of that to potentially be released if there is a pick-up in lending. Again, it is a bit like the backstop for funding for lending. You do not have to use it, to pull it down, but it is attitudinal. There is a lot more room to take risk on the margin and take intelligent risk as a bank and perform your core function of lending to the real economy.
It is also important that it is a joined-up approach across the banks. So we have pushed the major institutions to get to that 7% capital threshold, associated leverage ratio. They have credible plans to do so. But we are also in a position where we are providing funding for lending, where we do have some other major liquidity facilities in place. Therefore there is lesser need for them to self-insure on the liquidity side so there is a consistency across bank programmes.
Q114 John Thurso: A very quick question to Paul Fisher, so that I have asked everybody a question. What do the markets think of what the Governor is proposing on liquidity? Briefly. What do your contacts say?
Paul Fisher: The wider market, I think, sees it as a welcome move. You could see the share prices of some of the relevant banks move up quite sharply during the course of the Governor’s speech the other week. So that is the wider market.
The individual banks themselves I think will probably be reluctant to go below, or much below, the 100% guidance. But you have to understand that if you set your guidance at 100%, most of them are well north of that. If you set the guidance at 80% they can perhaps run a lot closer to the 100% than they would have done before. So it will allow them to free up quite a lot of liquidity even if they decide not to go down to the new level.
John Thurso: Thank you.
Q115 Chair: Governor, you have introduced new policy with the intention of providing much greater transparency. Of course we already have a system of monetary policy with a good deal of transparency in it, more than most other countries and with a culture of individual explanation of views, including dissent from decisions and the reasoning that lies behind them.
With that in mind, as policy develops with forward guidance, will you be recording each MPC member’s position on their interpretation of the knock-outs?
Dr Carney: Yes. We will.
Chair: We would like to see that, of course.
Dr Carney: It will be in the minutes that are released next week for the first meeting operating under forward guidance.
Q116 Chair: That is very helpful.
Related to that, of course one of the knock-outs is primarily the responsibility of the FPC. We would also expect to see the FPC’s interpretation of how they intend to go about exercising that responsibility. We recognise this is a new policy. When might we see that?
Dr Carney: We will have the first FPC meeting with this policy in place next week and subsequent minutes and communication would provide the answer to your quite appropriate question.
Chair: So we will be getting that.
Dr Carney: Absolutely.
Chair: That is very helpful. You have given us some very detailed and interesting replies this morning. We are very grateful. You have been going almost exactly two hours. We are very grateful to all four of you for coming and taking forward public explanation of what is quite a significant change in policy.