Examination of Witnesses (Questions 85-99)|
TUESDAY 17 JUNE 2003
85. Welcome. As you know, we are conducting
an inquiry into the ECB's monetary strategy and organisation.
It would be useful if I could ask you how you think, on monetary
policy, so far, the ECB has worked out? How successful has it
(Professor Giavazzi) There is an issue
of substance and one of form. As far as substance goes, the Bank,
taking into account it is a relatively young institution with
no history behind it, has been pragmatic and has behaved overall
as I would expect a central bank to behave. Where the Bank has
been lacking is in the ability to communicate clearly to the outside
world what they were doing, how they were making decisions. The
outcome of this inability to communicate makes it very difficult
to hold them accountable, to understand whether they have been
behaving or not. As far as substance, I think they have behaved
well. As far as form, it is very difficult to hold them accountable.
(Mr Bootle) I largely agree with that verdict. The
ECB has come in for a lot of criticism in this country for all
sorts of things. A lot of it has been ill judged. In particular,
the ECB has managed to avoid making any gross policy mistakes.
I cannot think of it having made a major policy mistake. It has
avoided being completely misled by aspects of its remit and the
way it has officially interpreted it, such as the monetary pillar.
It has avoided being misled into gross errors. It has been much
more flexible than the rhetoric would have you believe. However,
I think there are a number of aspects of the set-up which are
deeply worrying for the future and in particular, although it
has not had an easy ride, it has not yet had the degree of serious
challenge that I think it is now facing with regard to deflation.
In those circumstances, these minor quibbles one might have about
communication and how the target is framed and interpreted could
prove to be of the utmost importance.
86. Can you say a little more about that? You
are basically saying we are in a new world. Is the implication
of what you are saying that the ECB's remit is not the right one?
(Mr Bootle) There are several aspects that are worrying.
It strikes me as being deeply disturbing that, from the papers
I was sent, one of the questions before us is what is the ECB's
inflation target. I find it very odd that we should be having
a debate about what the ECB's inflation target is. There is an
awful lot of confusion, following the revision. Some people think
there was a change; others think there was not. Professor Issing
has said that nothing is different and below two per cent
is just a clarification of what we have been doing so far. That
strikes me as being an extremely odd and potentially dangerous
position when we are entering a situation where deflationary forces
could become very strong. Similarly, there is a lack of clarity
about why we are using the expression "price stability".
Historically, one knows why this is. It is because of the inheritance
from the Bundesbank and the obsession with fighting inflation
but when the prime danger is deflation and when there are structural
reasons within the expanded eurozone in particularone assumes
in due course the accession countries will join the eurowhile
some countries should have inflation somewhat higher than has
been aimed for already, just parroting these words over and over
again about price stability without clarity is extremely damaging.
In particular, it reminds me of the position of the Bank of Japan.
If the Bank of Japan had had clarity and other people had been
clear about what its responsibilities were and there had been
an open, full discussion of the problems, the possibilities, the
tools, instruments and the dangers, I suspect Japan would not
be in the position it is in today.
87. Do you want to add to your opening remarks?
(Professor Giavazzi) To put this in perspective, there
are two successful central banks in the world. One is the Bank
of England and the other is the US Federal Reserve. It is surprising
how different they are. The Bank of England has a clear remit.
It is accountable. It publishes an inflation report. The monetary
policy decision making is very open with individual votes published.
The Fed on the contrary, first of all, is not even independent.
Congress could fire Mr Greenspan overnight. It is also a very
discretionary institution whose success largely depends on the
personality of the chairman. They are both successful so I do
not think we have a single model of what a successful central
bank is. I think we both share the view that we would prefer the
Bank of England model because it relies less on personalities.
If the next chairman of the Fed were less successful than Volcker
or Greenspan, there might be trouble, but they are very different
88. We have a different target from the European
Central Bank. How would you compare our kind of targeting with
that of the European Central Bank? Should they not move closer
to the sort of situation we have with the Bank of England? Should
there not be some outside input into all of this? In Britain we
have the government and the Bank of England. In the European Central
bank they do not have anything like the kind of outside input
which may be regarded as a deficiency. Do you regard it as a deficiency?
If so, how should it be remedied?
(Professor Giavazzi) I think it is very
difficult to find an economist who does not think that targeting
a specific inflation rate is the proper way to go for a central
bank which does not keep an exchange rate target. The ECB has
practically an inflation target although formally it is hard to
follow what they do. First, they do not have a clear, symmetrical
range. The up to two per cent rule is not clear. Professor
Issing does not interpret the up to two per cent as symmetrical.
Secondly, they have never been very clear about what the horizon
is. We know that monetary policy works with lags of a year or
a year and a half. They should be clear whether they are targeting
inflation a year or two years down the road and they have never
been. This may put them in a difficult position. Assume that inflation
jumps up three months from now. They could be held responsible
for this even if they do not have an influence on the situation.
On whether the target should be given to them by the government
or left to the Central Bank to decide, I would be concerned to
let ECOFIN with 15 or possibly 25 finance ministers agree on the
target. I would prefer simply price stability as the objective.
89. I can see why Roger Bootle is worried about
the deflation threat, but is not the record so far quite encouraging,
suggesting that they may not make the mistakes of the Bank of
Japan? Considering the fact that they rather disregarded this
apparent indication of how they should go from the monetary figures
and have sometimes acted to lower interest rates when the official
signs appear to be that they should be acting against inflation,
does this not suggest that they are aware of the inflationary
dangers and one should be cautious and worried but not necessarily
feel that a cataclysm is round the corner?
(Mr Bootle) I think that is partly right.
I mentioned in my opening statement that I think the facts belie
the rhetoric and they do not warrant the criticism that has been
made of them. They have been much more flexible in practice than
you would think from the rhetoric. Nevertheless, they have displayed
quite a lot of slowness in adapting to changing situations. We
have already remarked on the poor communication skills and the
confusion that has existed after interest rate decisions. Indeed,
the confusions exist now even with regard to what the target is
and how to interpret it. One thing one knows about countering
deflation is that this is an intensely psychological phenomenon.
The Bank of Japan is in a battle for people's minds. The way that
there is so much confusion in the ECB and about the ECB does not
lead one to be confident that in those circumstances it would
act either well in advance or clearly enough to carry the system
Lord Lea of Crondall
90. We Have had several conversations, as you
know, about this already. One of the recurrent themes is, to use
the expression used by Roger Bootle, this theme of poor communication
skills but I think the jury is still out on it. There are vested
interests in what you might call the markets in journalism for
wanting to say that there has been some ambiguity but even in
America there is ambiguity. Somebody quotedI do not know
whether it was Volcker or Greenspanat a press conference,
saying, "If you have understood what I have just been saying
I did not make myself clear." That is different from the
Bank of England situation but we cannot have the Bank of England
situation in the ECB, am I not right, for all the reasons about
the politics of a large number of countries and in particular
not everyone speaks English with the same nuance as we do. You
simply cannot have "unelected bankers" and the democratic
deficit problem made worse by doing it like the Bank of England
do it. The same people who often criticise unelected bankers running
Europe are very happy with the Bank of England so there is that
difference as well, is there not, in not being able to do it like
the Bank of England so we are left with this problem of what we
call poor communication skills. Apart from nailing it down and
saying symmetrical around two per cent, what is the substantive
question behind these so-called poor communication skills?
(Mr Bootle) There certainly are problems
created by the multinational nature of the institution. It would
not be easy to do things the way the Bank of England does them.
I do not want to sound as though everything that the Bank of England
does is wonderful and should be copied everywhere but quite a
lot of features of the Bank of England system are pretty good.
It is not just a communications problem. It is also now the proposals
for the restructured voting which stem from the same source, namely
the constant need to account for the different nationalities in
the makeup of the ECB. There was a question earlier on from Lord
Sheldon about outside input. It seems to me that, difficult though
it is, there will be a lot to be said for the ECB tackling this
issue by moving towards something more like the Bank of England
position having independent experts on the committee and breaking
away from the notion of national representation; and then some
other form of institutional oversight, either at a different level
or through the European Parliament has to cater to the question
of national interests and accountability. Otherwise, I suspect
whatever is done, whether in terms of the way the decisions are
made in meetings, how they are presented in press conferences,
what the voting structure is, all these things are going to be
from a technical point of view distinctly sub-optimal.
91. To gloss your response to Lord Sheldon,
you would have a sort of two-tier systemthese are my words,
not yoursin the sense that you would treat the supervisory
board as not having executive authority which would be for this
other agency, which would be responsible?
(Mr Bootle) That is probably what I would do.
92. I would like to go back to Mr Bootle's point
on the Bank of Japan. Surely the essence of what has been happening
there is that ten years ago Japan had a downward budget and it
now has a deficit of about seven per cent. What has been
happening there is that the Japanese government has been managing
a slow deterioration of the economy by making the Bank of Japan
buy up almost all the debt it has issued at very low rates of
interest so in effect it has saved the Japanese people from depression.
There is gloom in the boardrooms but there is not rioting in the
streets. Investors have seen their paper fortunes decline very
rapidly so it has been a very crucial operation which is quite
impossible to have in the European set-up of the power of the
government of Japan, which the government in Europe does not have,
to require the static to finance effectively mega-Keynesian policies.
Do you think that is right?
(Mr Bootle) The Japanese situation is
complicated. We do not want to get drawn very far down that particular
byway but most people who have thought about this issue would
argue that the failure to tackle deflation in Japan is essentially
a political failure. It is a failure of institutions. There is
not a technical problem about ending deflation. You ask yourself
why the Japanese have been poor at doing it. I think a substantial
part of the reason lies with the behaviour of the Central Bank.
Its decisions have been poor. It has been extremely slow. It has
been very confused, divided and just opaque about what it believes
it is up to. It has not been a contributor to the successful fighting
of deflation. You have in Japan a chronic problem which the text
books will all tell you is a non-problem and is solvable at the
drop of a hat. Why do they have this problem? The answer is institutional
failure. That is the sense in which I was saying that I thought
all these issues of what the target is, how things are voted on,
how they are communicated could come to be critical.
93. You mentioned the Bank of Japan but it is
really the remit that central banks have. The crucial difference
between the Fed and the ECB is the remit of the Fed is pretty
simple. It is basically maximum growth consistent with stable
prices. That is a remit which is certainly much more relevant
to the present situation than the remit based entirely on inflation.
In the case of the Bank of England it is a different one because
it is the government which sees the growth part and it can change
the targets at any moment on inflation.
(Professor Giavazzi) The statutes of the ECB state
that, consistent with having achieved price stability, the bank
should support the general economic policies of the EU. As in
the Fed and as in the Bank of England, price stability is at a
higher pillar compared to growth, but they are both there and
I think the wording is very similar. The interpretation can be
different from one bank to another but the statutes are very similar.
94. The Fed has no inflation target and that
is very important. Once you give a central bank a public inflation
target, that is what everybody looks at and that is what it judges
its performance most on.
(Professor Giavazzi) If you want to go by the books,
even the ECB does not have an inflation target. ECOFIN does not
give it an inflation target. The bank could tomorrow change the
two per cent into three per cent. It is more flexible
than the Bank of England in that sense and more similar to the
Fed. They may not do it but formally they could, say, because
of the entry into the euro of the countries of central and eastern
Europe, which have higher structural inflation.
95. Mr Bootle, would you give your views on
the remit issue? Do you think the remit of the ECB ought to be
changed to be more in line with the Fed?
(Mr Bootle) I agree with what the Professor
has just said. If you look at the articles, the wording is very
similar to what is said for the Bank of England: without prejudice
to the objective of price stability, to give support to the other
policies which include growth, full employment and so forth. The
problem is that there is very little agreement as to exactly what
all this means. In one appearance before the European Parliament
Duisenberg listed these other responsibilities which include the
distribution of income and said, "Heaven knows what on earth
people think the ECB can do about all this." There is an
acknowledgement that there is this other set of objectives and
yet there is a confusion about quite how in practical terms it
should affect the ECB policy. That also exists in the UK. What
precise status should there be given to that second set of objectives?
In the UK's case, the way I interpret what has happened with the
MPC is that as time has gone on that second, supposedly subsidiary,
objective has taken on increased importance. No one has actually
said it quite but the way that the MPC has acted has been to give
that other objective more importance. According to the ECB statutes,
the same thing could happen. The thing could be interpreted in
such a way as to give growth more importance without necessarily
having to change the wording. The problem is more the inheritance
of the ECB. It had the Bundesbank inheritance round its neck from
the beginning and the obsession of large parts of the European
establishment with fighting inflation. Therefore, any hint of
trying to give recognition to the growth objective was potentially
dangerous. That is why one suspects it has not received due weight
as an objective, but it seems to me that it could do, even under
the present set-up.
(Professor Giavazzi) The central banks all over the
world which follow an inflation target regime produce inflation
reports, and there is now an independent ranking done by academics
of who does the best one. The Bank of England has come out number
one. Surprisingly, the Central Bank of Brazil is number two. The
Swedes did not come out very well; they are number seven or eight.
These Reports are very helpful in forcing the bank to explain
where they think inflation is going, where output and employment
are going and therefore explaining what decisions they make. The
ECB is getting there. Their projections are moving slowly in that
direction. In my view, the bank should be pushed in the direction
of developing these instruments that are very useful, the tools
like inflation reports, and to compare the projections in the
reports with those produced by other central banks and maybe put
them in the ranking.
Lord Armstrong of Ilminster
96. Do both our witnesses think that the ECB
should give itself or be given a symmetric inflation target, a
range around its central point?
(Professor Giavazzi) Yes.
(Mr Bootle) I certainly do.
Lord Sheldon: Professor Giavazzi did answer
my question but Roger Bootle did not come in about the question
should there not be some outside input into the European Central
Bank on inflation targets and how they should operate? There was
mention about the finance ministries coming in.
97. I think he did say there should be outside
(Mr Bootle) Yes, along the MPC lines.
It is rather embarrassing to be banging on about how wonderful
the MPC is but it would be better also if the inflation objective
were not decided by the ECB but were decided from the outside
and given to the ECB.
98. It is that "outside" that I was
(Mr Bootle) Who should it be?
Lord Sheldon: Yes.
99. That is the problem.
(Mr Bootle) That is a serious problem
to which I do not think I have a particularly striking or compelling
answer. Bearing in mind the deficiencies of the ECB and the awkwardnesses
of the way policy is framed and presented, for the ECB to be deciding
on this itself is potentially very dangerous, particularly with
regard to not just the form of the target but the target level.
I do not think there has been enough debate about what the number
should be at the centre of the symmetrical range. This goes to
the point I made earlier about the deflation danger and why precisely
they are aiming for the inflation number that they are. To aim
for a number below two per cent for the eurozone as a whole
is already imposing a substantial deflationary threat on Germany
and, as and when the eurozone is extended to the east, that threat
will be even greater. I would argue that not only should the target
be symmetrical but it should probably be at a number a fair bit
higher than two per cent in order to allow for that very
factor. It goes again to what I said earlier about price stability.
Why should the ECB be able to price stability accurately? It seems
to me that there will be strong arguments as to why it should
be aiming for something which involves a higher, positive rate
of inflation. If it does not do that, it endangers a substantial
part of the eurozone with regard to deflation.