Examination of Witnesses (Questions 100-119)
RT HON SIR EDWARD GEORGE, MR MERVYN KING, MR CHRISTOPHER ALLSOPP, MR CHARLES BEAN AND PROFESSOR STEPHEN NICKELL
THURSDAY 28 FEBRUARY 2002
100. They have a community war chest in New York and they are spending money in different areas to regenerate the city.
(Sir Edward George) I do not think you will find that it is the Central Bank that is doing that.
101. The New York Bank is doing that, that is very much a part of his thinking. I think maybe we need to stimulate thinking and take it forward in this country, how we ensure that everybody plays a part in eliminating regional disparities and that is where we are coming from.
(Sir Edward George) Everybody does have their part to play, I agree absolutely with that. I would be extremely surprised if the Federal Reserve Bank in New York or anywhere else in the United States had amounts of money to spend. Those are decisions for Governments. Bill McDonough may have been saying that he was in favour of doing that but I do not think you will find that he suggested that there was anything that the Central Bank could actually itself do about it.
102. To our Committee, and it was an impression gained by all of us, it was refreshing to hear Bill McDonough on that and we wish to take that idea forward in our deliberations.
(Sir Edward George) Absolutely and you are absolutely right to do it.
103. Maybe we could discuss this at a later date.
(Sir Edward George) I think you need to do it with the people who are in a position to take those decisions.
104. I think your views on that would be very important and I would like us to continue this discussion.
(Sir Edward George) It is extremely interesting and rather flattering that you think we could do that.
105. We consider you most important, Governor.
(Sir Edward George) We have an arrangement whereby the Chancellor sets our mandate. I do not seek to tell the Chancellor what to do in his field and he does not seek to tell me what to do in ours.
Chairman: We were getting interesting responses from Professor Nickell there and you cut across that. Maybe we will come back to that another time. Professor Nickell, you have been ruled out of order by the Governor.
106. Thank you very much.
(Professor Nickell) Not a problem.
107. Could you give us your views on the sustainability of the current levels of household debt?
(Sir Edward George) Their debt ratio is high, it is not uniquely high, and it has to be a concern. I do not lie awake at night thinking about it. I do not quite know how to describe it. Of course the debt servicing ratio is relatively low and the danger is that if we are to get into a situation where interest rates have to rise sharply then the debt servicing ratio obviously will go up. You would have to have an extremely sharp rise in interest rates for that to become a really threatening prospect, that is my view. That is why I do not lie awake at night thinking about it. It cannot go on forever in this direction, that is really the point that is made I think.
108. Can you tell us how much of the debt is for consumption and how much of it is paying down existing debt, rolling over past debt?
(Sir Edward George) No, I do not think I can, off the top of my head. I do not think we have data which would give us a very clear view on that. You could look at different bits of data, like credit card debt which goes on continuously. In that case, the old debt is paid off and the new debt is incurred. I do not think I have any numbers on that.
(Mr King) No. There is no real significance to that unless you start off with a view about the appropriate maturity of the debt. As the Governor said, suppose all the debt had a one month maturity, you would expect that each month a large part would roll over so you would expect a large fraction of the flow of new debt would be rolling over but that would not be of any great significance, I do not think.
109. In the February Minutes there is a discussion about rising debt levels potentially increasing the probability that an adjustment to balance sheets would be abrupt rather than smooth and it makes the argument about amplifying the effect on aggregate demand. Then it indicated that some members place little weight on this, others did not place weight on it. On what basis do you think there is a risk to increasing relativity of output and so of inflation? The balance in the Committee was in respect of risk to relativity of inflation.
(Sir Edward George) I am sorry, the question?
110. Relativity risk of inflation as a result of the correction of household balance sheets?
(Sir Edward George) I think the only way I can respond to that is that in the central projection we have made assumptions about what is going to happen to consumption and behind that lies assumptions about what is going to happen to debt. Income is one determinate, wealth another, borrowing another and we have got risks around that. My recollection is that we have got a modest downside risk to what will happen to consumer spending because of the concern that consumers may rein back and may not wish to continue incurring debt at the recent rate. I do not know what more I can say.
111. I think Mr Bean, from what he said earlier, is concerned about it?
(Mr Bean) Yes.
112. Other members of the Committee are not. I want to know why there is a difference?
(Mr Bean) I am marginally more concerned than my colleagues but I would want to emphasise that it is not the case that I lie awake at night worrying and fretting about it.
(Mr Bean) I am slightly worried that consumer demand may continue to grow faster than income on the back of accumulation of debt. Debt to income ratios are at historically quite high levels at the moment although other measures of the stress on household balance sheets look somewhat better. For instance the ratio of interest payments to income is at relatively low levels compared with the peaks that we saw at the end of the 1980s. That could certainly change if interest rates had to rise. That particular series also does not take account of repayment to principal so it may be giving a certain amount of false comfort.
(Mr Bean) My concern is that if consumers continue to build up high levels of debt relative to income, and we go a long way beyond where we are at the moment, that leaves the economy more vulnerable to all sorts of adverse shocks. This is not necessarily a monetary policy induced shock when we raise interest rates but, say, could be a further downturn in the world which leads to some rise in unemployment domestically. If consumers have high debt levels they are more likely to cut back their consumption sharply. That will generate more volatility in demand and output and ultimately more volatility in inflation. That is the concern I have which makes me a little bit more cautious than perhaps my colleagues are on cutting interest rates further to promote consumer demand further.
115. Again in the February minutes it is stated that "It was possible that the effect on household behaviour of any increase in interest rates would also depend on the proportional change rather than just on the absolute change".
(Mr Bean) That is true.
116. Could you say something about the current sensitivity to interest rate changes?
(Mr Bean) That is particularly looking at the interest payments that consumers make on their borrowing. If you think of debt having doubled but the level of interest rates being half the level that they were at the start of the decade then income gearing will go up by the same percentage, say 50 per cent, for a smaller change in interest rates now than was the case in the past. A small change in interest rates, because consumers have higher debt, will have a more powerful effect potentially on interest payments and therefore on to consumption.
117. One of our advisors this week talked about the money illusion problem, that consumers may be looking at nominal rates rather than real rates. What assumptions are you making about an economic slow down if that happens? Could the persistence of debt, which is not eroded by inflation, cause really big trouble? What are your feelings about that?
(Mr Bean) We have built in to the projections a feed back from the level of wealth that consumers have. Part of that, an offset to it, of course, is the debt that they hold. There is a natural stabilising mechanism which is present in the forecast and part of the reason why consumer growth moderates going forward is that the build up of debt reduces their net worth and makes them less inclined to spend a lot going forward. The concern, if you like, is that maybe in the current circumstances that might under-estimate the downside risks. That is my concern in connection with household indebtedness.
118. Finally could I ask the Governor, on page eight, Chart 1.11, there is the ratio of house prices to average annual earnings. We are looking at the trend and what the peak was at the back end of the 1980s. Does that keep you awake at night?
(Sir Edward George) No. It takes quite a lot to keep me awake at night as a matter of fact. I think it is all part of the same picture. Yes, there is a concern but this is the sort of thing that you would expect to see given the policy that we have pursued. I was explaining why we pursued the policy earlier. I would rather see this during this period where we are suffering from the global slow down than to not see this in which case we would share with many other countries recession.
119. Do you think that rate of increase is sustainable?
(Sir Edward George) No, not the rate of increase, just as I do not believe that the rate of growth of consumer spending is sustainable, if you mean indefinitely. We need that if we are going to achieve the inflation target, if we are going to keep aggregate demand growing reasonably close to underlying supply otherwise the alternative is not to try and stimulate domestic demand and then we would have negative growth.
Chairman: A question on the labour market from Michael Fallon.