Examination of witnesses (Questions 100-119)|
TUESDAY 6 FEBRUARY 2001
Sir Teddy Taylor
100. I have a brief follow-up question. Sir
Alan referred to the misjudgment over the exchange rate being
responsible for this minor difference in inflation. Do you think
there is anything more we could have done with the exchange rate?
We have read about these substantial interventions taking place;
we also had the sales of gold which are designed to try and help
the euro; and then we have just heard that 16 areas are issuing
euro bonds. Is there anything more you could do to try and help
the euro and to bring the exchange rate more in balance? We seem
to be doing everything possible with intervention, selling gold
and issuing bonds. What more could you do?
(Sir Alan Budd) I do not think the Monetary Policy
Committee could have done more about the exchange rate because,
if it was uncomfortable with the high level of the exchange rate,
then the way to get an exchange rate down is to cut interest rates.
That is quite inappropriate, given the inflation objective that
they had. They did from time to time contemplate intervention.
It is not at all clear that that would have been effective. They
had to live with a world in which sterling was strong and no doubt
had lower interest rates during this period than would otherwise
have been the case. I see no set of policy measures which would
have allowed the Monetary Policy Committee to have brought sterling
down and continued to achieve its inflation objective.
101. One final point: should we really be so
worried about it because the one thing, as someone who works with
trade figures all the time, I have been amazed at is that since
we have joined we have had a deficit of £155,000 million.
Over the last six months, our trade with the EU has actually been
positive. I just wonder why we should be worried about the euro
a great deal when what has been an appalling deficit has suddenly
turned into a balance.
(Sir Alan Budd) It may be more appropriate for other
people to answer that question. I tend to be someone who does
not worry particularly about the exchange rate. Those who do worry
about it would be better to explain that.
(Professor Buiter) I do not worry about trading imbalances.
(Mr Flemming) Some of the things from which you take
comfort are things that we did not know in advance. As I mentioned,
there have been a number of developments which have made what
may, with hindsight, have been a slightly over-tight policy less
painful than we would have expected. Some of those have been in
the labour market and some of those have been in productivity
and the ability of British industry to export, despite an apparent
loss of competitiveness.
(Professor Buiter) I agree there is nothing the MPC
could have done to make for a more balanced external picture but
the Government could have used its powers to announce an early,
more competitive joining rate for the UK with the euro. That would
have solved the exchange rate problem. That was not an option
open to the MPC, of course.
102. Do you think that would have worked?
(Professor Buiter) Oh, yes.
103. John Flemming, one of the criticisms of
the first two years of the MPC is that they seemed to make a much
larger number of small changes in rates compared to, say, the
Federal Reserve or the German bank. Now we have been in a position
where the rates have not changed for nearly a year. Do you think
that indicates a change in approach to decision making from a
rather proactive approach, if I can characterise it as that, to
something a little more sluggish and reactive?
(Mr Flemming) I think it is possible. My neighbours
know better. One of the original members of the Monetary Policy
Committee, Professor Charles Goodhart, believes quite strongly,
and has given lectures and papers on the subject, that essentially
every month they met the information would be slightly different
from what it was the month before and that they should incorporate
that information, as best they could in their judgment, as to
the appropriate interest rate and that would almost certainly
be different from the month before, and therefore you could essentially
expect monthly changes. It is possible that there is a link between
his departureI do not know how much influence he exercised
over his colleaguesand the greater stability. There are
other hypotheses. Mr Barrell mentioned the possibility that they
had all read an article published in The National Institute's
Economic Review, or indeed that originally there was a sort of
sitting on the edge of seats because of an anxiety. Nobody knew
how easy it was going to be, if indeed it is easy, to stay within
the 1 per cent band. The Deputy Governor wrote something to the
effect that the new arrangements were going to breathe new life
into the ability of people to write letters and, as has been pointed
out, no letter of explanation has yet been written to the Chancellor.
They have been much more successful in keeping it in a narrow
band and that may initially have required a willingness to be
proactive in order to establish a reputation. Once the reputation
is built and if the markets believe that the MPC is capable of
keeping inflation within a very narrow band around the target,
then that will be built into a number of financial market reactions
to events in a way which makes it easier for the MPC to achieve
it without being so fidgety.
104. Do you suspect that is what is now happening?
(Mr Flemming) I would attach quite a lot of weight
to that explanation, yes.
(Professor Buiter) I find it very hard to explain
a change from rather frequent change to what is now a year of
constant interest rates. Since I actually think that constant
interest rates have been pretty nearly right as far as I can tell,
I cannot take issue with that. The difference in behaviour is
105. When did you leave the MPC?
(Professor Buiter) At the same time as Charles.
106. Do you think that has got anything to do
(Professor Buiter) I do not think so, no. The rates
had already been constant for five or six months before we left.
(Mr Barrell) I have a comment on what has happened.
We have to remember it is a new framework and, although building
up credibility is important to changing the environment, this
was a new committee of people who had not, on the whole, been
setting interest rates before. It received information that changed
their decision and then noticed that very little happened as a
response to their changes. In the first year or so the Committee
may have been learning that small changes do very little. The
evidence is that they probably just damped inflation movements
a bit and damped output movements a bit but did hardly anything.
After two years of realising that changing every month does very
little, they probably, maybe subconsciously, decided that there
was no point in changing unless there were significant news. I
think we have to recognise this is a learning process for all
the people involved and it was a completely new activity for many.
Sir Teddy Taylor
107. With all this talk about minor changes,
I wonder if any of these gentlemen have read this wonderful document
which I receive called "The Lombard Street Research Committee
Economic Review" which seems to be a very wise and influential
publication. I always derive a great deal of knowledge from it.
They are warning here that the talk about a cut in interest rates
early next year is quite wrong. The prospect in early 2001 is
not for a slow-down but for an upturn in UK demand growth. I wonder
if in fact the various reports we have had of the growing self-confidence
of the MPC and the possibility of another reduction in interest
rates is more likely or do you think perhaps the Lombard people
and their view might be right in saying that there will not be
any changes, minor or major, in interest rates because of the
upturn in demand?
(Professor Buiter) Everything is possible but not
everything is likely. That document is on my desk but I have not
read it yet. Extrapolating from past experience, and you have
just referred to recent monetary growth in the UK, that is an
indicator and certainly that makes it interesting. There are indicators
even now pointing in different directionsweak GDP growth
in the last quarter on the one hand and retail sales slightly
down but strength in services and stronger wage settlements. Again,
things never point in the same direction. It is certainly possible
that it will turn out that, rather than the cuts that people seem
to expect, in due course an increase may be required. I do not
think it is the most likely outcome but it is possible.
108. You do not know. It may be right or it
may be wrong?
(Professor Buiter) I think most likely it is wrong.
109. This is written by a professor, you know?
(Mr Flemming) He is a one lecture a year professor,
and a former student of mine. He is far too sensible to live on
an academic salary. He has also been consistently concerned with
a particular set of ideas. This question is rather similar to
the question about the exchange rate. I believe that the Monetary
Policy Committee has state-of-the-art forecasting models. The
state-of-the-art is not terribly advanced and does take a very
wide range of data into account, including movements in financial
aggregates of the kind that Professor Congdon specialises in monitoring,
and likewise in the exchange rate. His critique is not really
a critique of their forecasting methods and it would be quite
interesting to see an attempt to demonstrate that the Monetary
Policy Committee in its forecasting gives too little weight to
financial aggregates which could be used to produce forecasts.
It is true that the most recent golden guru award, or whatever
it is called, for forecasting went not to Professor Congdon but
to Professor Minford, who has a somewhat similar approach.
110. You may be right.
(Mr Barrell) In terms of whether he is right or not,
the passage by which he might achieve his conclusions would be
different from ours by a very long way. Although inflation is
currently dropping and although our growth may be slowing slightly,
the Monetary Policy Committee makes it clear that it is supposed
to look ahead not just to this quarter or even the next quarter.
All the signs are that inflationary pressures are not declining
in the UK in the medium term. They are not particularly rising
but the exchange rate has dropped by some amount, especially against
the euro. Any medium-term projection has inflation around the
target by the end of the year. Therefore, there is no strong case
for cutting interest rates. There is no strong evidence that the
US is going into recession and therefore there is no strong case
for an international reaction. The Monetary Policy Committee should
stand ready but at the minute I would not argue that it has a
case for cutting interest rates. However, it may have different
information from the different models.
111. Could I put these questions to Sir Alan
and then to Professor Buiter. Don Kohn in his report, when he
talked about intermediate term research at the Bank, said that
more such research stretching over more than one forecast round
might allow a somewhat more thorough analysis of important topics.
I wondered what your experience was of the sufficiency or insufficiency
of such intermediate term research going beyond one forecast round.
(Professor Buiter) There is in the Banks Monetary
Analysis Unit and elsewhere a continued research programme, which
deals both with short term cyclical and this longer term structural
issue, so that is going on. Clearly, having more resources is
always better than fewer resources but it is a question of prioritisation.
Within the budget, both the money budget and the manpower budget
they have available, the emphasis is not obviously wrong. It is
true that the Federal Reserve, especially if you add in the regional
reserve banks, has resources at its disposal that dwarf what the
Bank of England has. The question may be asked as to whether that
is a proper use of public money, if it is rather excessive. Perhaps
some more resources for longer term structural analysis would
be welcome but I would not take it out of current resources allocated
to more cyclical or monetary issues.
112. You do not think Don Kohn's comments are
(Professor Buiter) They are important. I would just
like some more resources. I do not think there is a mis-allocation
of resources within the Bank. If you are talking about the total
quantum, I think they could do with a little more.
(Sir Alan Budd) I share that view put forward by Professor
113. Could I go on to ask you about longer term
research issues? Do you think research on the new economy is being
adequately addressed in terms of research?
(Sir Alan Budd) I am not sure if I am in a position
to know that. I have no doubt they are attaching very great priority
to it but I do not know at this very moment precisely what research
they are undertaking.
(Professor Buiter) I am at least seven months out
of date. When I was there, there were three members of the MPC
aloneDeAnne Julius, Sushil Wadhwani and myselfwho
were actively researching, with our own dedicated support staff,
new economy type issues. In MA as a whole there were also people
working on all the relevant new economy issues underlying GDP
growth rates and productivity, changes in market behaviour induced
by a greater globalisation and sharpening competition to changes
in the natural rate of employment. Certainly it is part of the
114. One important driver for inflation is what
is happening to productivity. In the last Red Book and elsewhere
the Treasury expressed some, I believe the word was "puzzlement"
at what was happening to UK productivity. We heard of the US experience.
I just wondered what your understanding was of the MPC's views
on this important issue and what further work they were trying
to do to solve what the Treasury describes as a puzzle.
(Sir Alan Budd) The puzzle, as I am sure you know,
was the low growth of productivity in the United Kingdom as recorded
compared with this extraordinary high growth of productivity in
the United States, as recorded. The MPC tried to understand why
this was. It was extraordinary that there had been a period of
recovery in the United Kingdom which normally brings with it measured
productivity gains, and this had not happened. They spent a great
deal of time looking at this. Subsequently, as I am sure you know,
recorded productivity growth has picked up in the United Kingdom,
so there is somewhat less than there previously was, but this
would also be related to the sorts of new economy issues to which
Professor Buiter was referring.
115. Despite the pick-up, they acknowledge that
in the Red Book. They go on to say that it is still puzzlingly
low compared with the US experience. The reason I ask it is that,
if we were to make any sensible analysis of what is going to happen
with the inflation record of the MPC, one has to have a proper
handle on productivity. I am sure you would agree with that.
(Sir Alan Budd) Yes.
116. I just wondered why the American experience
is not mirrored here and whether or not that is not being addressed
in more detail and more publicly by the MPC.
(Professor Buiter) For 20 years US productivity performance
was failing, even compared to the UK, and in the mid-Nineties
it suddenly all came right. You will see in years to come how
much of that, even if structural, will be sustained in the future
or is, cyclical and/or one-off. The US miracle is a five-year
miracle. One has to be very careful about over-emphasising it.
Having said that, in these developments the US tends to be, at
least one business cycle ahead of the rest of the world, including
the UK. If there is a trickle down of new economy type developments
or whatever, US productivity growth will move here. That is probably
still to come here. I doubt that it would take on the magnitude
we have seen in these five years in the US basically because there
is no sign of the UK investment rate being boosted as much as
the US investment rate. The supply of risk capital is very much
more efficient in the US. Indeed as regards the supply of risk-takers
and entrepreneurs, the US is much more of an entrepreneurial culture.
When things come together in the US, advantage can be taken of
that. Nevertheless, that is all consistent with 20 years of misery.
I would not go overboard about the US miracle.
117. Admirable in many ways though that view
is, do you think it is a view that the MPC takes?
(Professor Buiter) I think there are nine views on
this in the MPC, literally. The views are all over the range and
people actively research these issues. There are those who believe
that the new Jerusalem is around the corner and those who are
still worried about the old Jerusalem.
118. Do you think research will be inclusive
or persuasive in favour of one view or the other; i.e. that it
is five-year led or that it is more long term?
(Professor Buiter) It will take time. Nothing will
ever convince those people who do not want to be convinced. It
is a cumulative effect of the evidence.
119. With respect, some body of research will
be more persuasive one way or the other. It is not going to be
(Professor Buiter) We will find out and learn more.
You cannot make inferences about trends on five years of data.
Anybody who says you can is a fraud. It just cannot be done.