Examination of Witnesses (Questions 70
THURSDAY 13 JUNE 2002
70. Good morning, Governor. Welcome to you and
your colleagues. Following your recent meeting on the Inflation
Report, can I ask you what you see as the likely challenges that
the MPC will be facing in the coming months?
(Sir Edward George) The issue which has been with
us for some considerable time is trying to balance the external
pressures which have been, of course, weakening the British economy
over the past year or more but are now beginning to turn round,
with the domestic demand pressures in the economy. What we have
been doing, of course, has been to try to sustain domestic demand,
because if we had not done that, the overall economy would have
gone into recession. We have been very conscious that at some
point, as the external situation improvesand that has been
principally a function of demand internationally but also a function
of the exchange ratedomestic demand growth would have to
slow, or moderate anyway. The question is precisely how you balance
those two forces. If that does not happen, if domestic demand
does not slow down and the external demand picks up, that is when
we will generate inflationary pressure.
71. In your report you stated that the MPC "stands
ready to act to contain any developing inflationary pressures
further ahead." One of our witnesses recently, Roger Bootle,
focussed on that particular comment and said that, "taken
together with the central target projections, the shift in emphasis
is probably as close as the MPC gets to adopting a US Fed-style
tightening bias without officially stating it." Are you softening
us up for an increase in interest rates very soon?
(Sir Edward George) Not at all, Chairman. I think
it is entirely consistent with what I have just said that at some
point we will have to moderate the rate of growth of domestic
demand, which has been growing now for some considerable time
well above the trend rate that would be consistent with a stronger
global economy. We have been indicating that at some point we
would have to moderate that. We have pointed out that there are
reasons for supposing that it could moderate of its own accord,
but if that does not happen, we would have to tighten policy in
order to bring that moderation about. So I think it is consistent
with the perception that we are sayingand indeed, this
was the implication of the forecast that we made in the Inflation
Reportif things turned out in the way the forecast has
it, with inflation picking up quite sharply at the very end of
the two-year period, we would have to tighten policy. It is not
a bias statement; it is simply a logical consequence of the analysis.
72. If you had to make a judgment as to whether
it was going to moderate of its own accord, as you said, or if
you would have to take action, which side would you come down
(Sir Edward George) If we found that it was not moderating
of its own accord, we would have no option; we would have to tighten
policy in order to bring that moderation about, assuming that
the external situation improved.
73. Are you confident at the moment that it
will moderate of its own accord?
(Sir Edward George) We do expect there to be some
moderation. We feel that there were factors in the past which
meant that disposable incomes were growing more strongly than
they are likely to looking forward, and that in itself would tend
to moderate the rate of growth of domestic demand, and certainly
we have a moderation in our forecast. I am saying that if that
does not come about, we will have to act to bring it about.
Chairman: Dr Wadhwani was a distinguished
member of your panel, and he has written a number of articles
in the past couple of months. One of them we would like to take
up with you.
74. Dr Wadhwani has said a lot of interesting
things reflecting on his time on the MPC, but one of the things
he points out is that the average two-year-ahead inflation error
has been 50 basis points since you took over operation on the
independent model. Do you accept that finding of his?
(Sir Edward George) That degree of precision is always
a challenge, and in writing that article Sushil Wadhwani made
it very plain that this was based upon a particular econometric
model of the economy. He is entitled to his view; indeed, we have
always encouraged him to express his view, but I do not think
I would necessarily say that this is established wisdom.
75. But he is statistically right, is he not?
Going back over the history of it he is saying that the average
forecast has been 50 basis points too high. That is a factual
statement, is it not?
(Sir Edward George) This is based upon 100 per cent
hindsight, and unfortunately we did not have that at the times
we were making these judgements.
76. Nevertheless, the statement is accurate,
is it not, as a description?
(Sir Edward George) If we had been able to anticipate
the strength of the exchange rate, if we had been able to anticipate
the weakness of the external economy to the degree that we could
now, we might have been able to get away with a somewhat lower
interest rate. That is possible, but certainly not in terms of
the policy making process itself.
77. You are sounding reluctant even to admit
that factually he is right. That is true, is it not?
(Sir Edward George) In the sense that inflation has
been marginally below 2½ per cent over most of the last couple
of years, it is a matter of arithmetic, but I do not actually
think that is relevant to anything much.
(Mr King) Can I just make two points on this? We published
last August the same calculation in the Inflation Report, and
then the overshoot, if you like, was 0.7 percentage points. So
we have been publishing these numbers for three years now. This
is not terribly new. The number of observations went up from 6
to 10 in this latest calculation, and we will have another box
in the Inflation Report in August. These numbers we have brought
before you each August for the last three years. This is not new.
Secondly, this is not the result of a model; this is a judgement.
The forecast that is published is the judgement of the Committee.
78. All he is saying is, looking back over the
period of independence so far, fundamentally he is making a case
for saying he thinks you have been running policy too tight, and
it would have been possibleall right, with hindsightto
have been running slightly looser policy, you would still have
hit the inflation target, not overshot it, but the economy would
have delivered marginally higher growth.
(Sir Edward George) If we had had 100 per cent hindsight.
79. Is there anything in his argument?
(Mr King) I would make two points about this. Right
through this period unemployment was falling, and output was growing,
if anything, above trend. I do not see why you would want a period
in which output would have been growing even more above trend,
which would have to be compensated in the future by output growing
more slowly, because there is no suggestion here that we would
have improved the trend rate of growth by having a marginally
lower interest rate. Secondly, if the day I leave the Bank you
can tell me that, with the benefit of 100 per cent hindsight,
interest rates should have been a quarter of a per cent either
lower or higher, I will take that now.