Examination of Witnesses (Questions 60-79)|
28 MARCH 2006
Q60 Chairman: Governor, good morning
and welcome to you and your colleagues. Will you introduce your
colleagues for the record please?
Mr King: Yes. On my right is Charles
Bean, Chief Economist at the Bank, on his right is Kate Barker,
one of the external members of the MPC, on my left is Rachel Lomax,
Deputy Governor for Monetary Policy, and on her left is Steve
Nickell, also an external member of the MPC.
Q61 Chairman: I believe you have a short
opening statement to make.
Mr King: Indeed I do, Chairman.
I am grateful again for this opportunity to explain the reasons
for the Monetary Policy Committee's decisions on interest rates
since we last appeared before you in November. Since then the
official interest rate has remained unchanged, and today you have
the opportunity to ask members of the MPC to explain their votes
in recent months. Over the past year, fluctuations in inflation
have been dominated by the movements in energy prices. After first
rising and then falling, inflation has, in the past four months,
been very close to the 2% target. And last month CPI inflation
was exactly 2.0%. In its latest Inflation Report, the MPC published
a central projection for inflation which remained close to the
target. But, of course, the chance that inflation will remain
that close to the target throughout the forecast period is negligible.
There are significant risks to the central projection on both
the upside and downside. Driven by weakness in consumer spending,
economic activity slowed at the beginning of 2005. Consumer spending
and total output growth both recovered over the course of the
year, and were close to their long-term average rates in the fourth
quarter. If that continues over the coming quarters, then the
annual rates of growth will pick up as the weak growth rates in
early 2005 drop out of the comparison. The MPC's central projection
is for quarterly growth rates to continue at around the rates
experienced in the final quarter of last year. That seems to be
supported by the available indicators of output growth in the
first quarter of 2006. A puzzle is that the corresponding measures
of expenditure growth appear somewhat weaker and there may be
downside risks to consumer spending in particular. However, recent
movements in asset prices, against the backdrop of a rapidly expanding
world economy, should be supportive of private sector demand,
and public expenditure growth remains robust. A major risk to
the outlook for growth and inflation comes from energy prices.
Past increases in oil and gas prices may have eroded the supply
capacity of the economy and altered the balance between demand
and supply. The increases in gas prices which were announced recently
are likely to push inflation over the target in the short term
and erode the purchasing power of household incomes thus slowing
the growth of consumer spending. Fortunately, despite higher energy
prices, earnings growth has so far remained relatively stable.
Looking ahead, the MPC will monitor carefully developments in
the labour market and measures of inflation expectations. Finally,
I should remind the Committee that Steve Nickell will be leaving
the Committee in May after serving for six successful years. For
most of that period, inflation has been within 0.5 percentage
points of the target. Richard Lambert is also leaving the Committee
with immediate effect upon his appointment as Director-General
of the CBI after three equally successful years. I would like
to thank both Steve and Richard for their outstanding contributions
to the work of the Committee. Chairman, those are the remarks
that I would like to make this morning, and I and the other members
of the Committee here today stand ready to answer your questions.
Q62 Chairman: Thank you very much,
Governor. May I add my congratulations to Professor Nickell and
Richard Lambert for their courtesy to this Committee and their
very helpful approach. I note that Professor Nickell was the first
person here this morning at the House of Commons kicking his heels
at nine o'clock so he is obviously keen to get on with his new
life! There are a few questions to come before that. The February
Inflation Report shows CPI inflation forecast at 2% for the next
three years. In your statement you said that the chance that inflation
will remain so close to the target throughout the forecast period
is negligible. However, it seems to a student as though you have
cracked it. Are you going to hold tutorials for your fellow central
Mr King: No. I suspect that the
only sensible thing to do in this circumstance is to join Steve
and leave as soon as possible before inflation starts to move
away from the target! It will undoubtedly be different from the
target over the next two years, and it is the same point I am
afraid I make with great tedium repeatedly to this Committee,
which is that a forecast is not just a number. So our central
projection is not the forecast. Our forecast is the entire fan
chart, showing all the possible outcomes. I think the big picture
that we wanted to get across in the Inflation Report is that there
is not a great deal of spare capacity in the economy. There is
certainly room for debate and the Committee has had a debate about
precisely how much there is. Growth, after slowing at the beginning
of last year, is back pretty close to trend rates. The Committee
expects growth to be around trend and inflation to start bang
on target. So the big picture is one that looks remarkably benign.
There are many risks on either side, both in the world economy
and at home which will, in the event, move inflation either side
of the target. It is just that in our forecast in February it
was not obvious to the Committee that there was a bias in the
risks to inflation on one side or the other. The risks to inflation
are fairly balanced and inflation looks to be on track to meet
the target two years or so ahead. That is why we left interest
Q63 Chairman: At our last Committee
hearing you had a fascinating exchange with Angela Eagle about
your role as an Associate Fellow of the Royal Meteorological Society.
Given that role and your Governor of the Bank of England role,
what impact do you think the cold winter and high gas prices had
on the work of the MPC? You have expertise in both these areas.
Mr King: I think the expertise
is probably more in one area than the other! There is no doubt,
as I alluded to just now, that most of the volatility in inflation
in the last year or so has come from movements in energy prices,
first oil prices and now, more recently, gas prices. It is quite
interesting to see that. Perhaps it is a tribute to the success
of the overall framework that underlying inflation is broadly
stable and that movements around 2% are coming from the short-term
fluctuations in gas prices. Those movements, in particular, certainly
mean that inflation in the next few months may well turn out to
be above target because we have now seen announcements of higher
gas prices. That information we did not have when we made our
February inflation projection. Of course, that will unwind and
we would have a correspondingly somewhat lower projection in the
second year. But looking through to about two years ahead, all
those effects will dissipate, so it is very much a near-term effect.
The size of the changes in gas prices are clearly very striking
and it reflects the fact that the gas market is very much a spot
market. We have very little storage capacity in this country.
The Rough storage facility is out of action for the next month
or so because of a fire. It is true that there is the inter-connector
with Belgium through which it had been hoped that gas would flow
into the UK when prices were higher here than on the Continent.
But I am not sure whether it was entirely reasonable to expect
that, given that the gas market on the other side of the Channel
is not exactly reminiscent of the group of atomistic competitors
of textbook theory. We should put much more store into looking
ahead: there will be not just an enhancement to that inter-connector
with Belgium but also a new inter-connector with the Netherlands.
The underlying economics of the gas market across the Channel
are not likely to change quickly even though the European Commission
is taking an interest in it. The real hope for the future is the
new gas pipeline from Norway. Norway has always been a source
of comfort to the UK in the supply of raw materials and I suspect
it will come to our rescue again. There is some disagreement among
the experts as to when that pipeline will be open. Some believe
it will be ready at the beginning of the winter 2006-07; others
feel it will not be ready until 2007. I think we do still face
the prospect of remarkable volatility in gas prices, at least
at the wholesale level, right through the next 12 months and that
is a source of concern, particularly to firms for whom gas prices
are quite a significant proportion of their overall costs.
Q64 Chairman: Professor Nickell,
after six years on the MPC, what do you consider to be your most
significant contribution to the work of the MPC?
Professor Nickell: When I started
out I had to fill in an exam paper and I went and looked at this
exam paper because one of the questions on the exam paper was
"What criteria do you believe should be used to assess your
record as an MPC member?" and one of the things I wrote down
was that inflation should stay close to the target. Well, that
seems fair enough. The other criterion I put was "Would I
have made a significant, positive contribution to the analysis
of the MPC in the view of both other members of the Committee
and outside observers?" That is a hard question for me to
Q65 Chairman: Can I help you by quoting
your exam paper because in that you said, "Of course, the
ultimate proof of the MPC pudding is in the inflationary eating".
That is so elegant! Would you agree with that?
Professor Nickell: What, the elegance?
Yes, of course! As the Governor has already told you, the inflation
has done what it was supposed to on my watch, although it could
be argued that the consequences of my decisions will last for
some time to come so this episode is not really over. I guess
I feel that I have done my bit. I have tried to explain my reasoning
as well as I could and I have made some contribution to thinking
about house prices and about the change in target and so on. Although
it is hard for me to make these sort of judgments, I do not feel
I have anything much to be ashamed of.
Q66 Chairman: Of course not.
Mr King: Can I add one point which
I think is relevant here? Clearly the proof of the pudding is
in the eating and we hope that all our clients out there enjoyed
the eating of the relatively low and stable inflation rate, but,
of course, what goes on in the kitchen is not really visible to
many of the customers. Many outside commentators view the Committee
as a group of people who have completely fixed views, who come
to the table and who simply battle with each other for supremacy
about the outcome. One thing which that view overlooks is that
what the Committee really does is not to struggle with each other
but to struggle with the issues and the data. Steve has made an
enormously important contribution to the conversations that we
have had in the forecast round and in each month's analysis to
make sure that we have discussed the underlying economic issues.
To my mind that is the test of how well the Committee as a whole
is working. Both Steve and Richard have made very important contributions
in that joint collective intellectual endeavour.
Q67 Chairman: In terms of the UK's
monetary policy framework, do you have any suggestions as to how
that could be improved?
Professor Nickell: One of the
keys to such success as the Committee has is because it is a group
of individuals who individually come to a decision about monetary
policy by making their own decisions and then letting the majority
voting take its course. I think this is a very good way of making
decisions and it is superior to an alternative mechanism, which
is a group of individuals coming together and trying to reach
a consensus. I think the former method is probably a bit better.
My own feeling in the light of this, to encourage what one might
call this individualistic pattern that I have got in mind, is
that I personally feel that each member of the Committee should
own a paragraph of the minutes. The majority of the Committee
do not agree with this so it is not likely to happen any time
soon, but that is my personal view because I think that that would
increase transparency. It would also increase the opportunity
for grandstanding, which is always the danger in these things,
but I think that on balance it would be a good move.
Q68 Chairman: During your appointment
hearing in May 2000, when you were questioned by this Committee,
you said you did not want to be known particularly as someone
who will end up in either the `hawk' or `dove' camp. It seems
as though you have ended up in the dove category, certainly that
is the way you have been painted by the media. What has brought
you to that position? Has your background as a labour economist
Professor Nickell: No, I do not
think so. The fact I finished up in the minority for cutting rates
is a bit of an accident of timing in the sense that, as you know,
I have been in the minority of voting for a raise and I have been
in the minority of voting for a cut. I was in the minority of
voting for a raise in 2003, which is not that long ago. By and
large we now seem to be in a time where, at least in my view,
if we are going to do anything, we are going to be cutting. So
if there is going to be a minority, that is going to be the side
on which it is on. I would not say that I have transformed from
a hawk into a dove. If you recall the first meetings, I was in
a minority for raising. It is just that that is the way that the
economy is moving at the present time. I could have imagined times
when I might have left the Committee where I might have been voting
for a raise.
Q69 Chairman: Governor, at the time
of the Tonbridge robbery the Bank announced an immediate review
of security to be undertaken by Sir John Gieve. Has that been
undertaken and has he presented that report to you? Are you satisfied
that the Bank's storage of notes is now sufficiently secure?
Mr King: Yes. The review was in
two parts. The first was an initial review; that has been presented.
The second is a longer-term review of the security implications
of the note circulation scheme. That is a schemeand other
countries have it toounder which notes are stored at different
places around the country in order to minimise the number of journeys
in lorries of bank notes from our printing works to regional banks
around the country. The short-term review produced a number of
recommendations for our own security which have been implemented.
I hope you will forgive me if I do not give details of that. We
produced a list of issues that we want all the members of the
note circulation scheme to consider and they now have ten days
to carry out an audit of their own security in order to see what
changes will be necessary to comply with that. I think the review
has produced some useful ideas, but I am not going to go into
detail on that. In our case it already has been implemented and
we will now look further at the scheme as a whole. One of the
motives for having cash centres was to reduce the number of journeys
carrying bank notes around the country. It is worth pointing out
that last year the number of cash robberies was over 100 a month
in the UK as a whole. There are a lot of attacks, relatively small
scale, on lorries or other places holding cash. There were four
attempted robberies of cash centres. There is clearly a trade-off
between concentrating cash in one place, which is highly secure,
or having many more movements of cash in ways which, inevitably,
are less secure. We will re-examine that trade-off, but I have
no reason to suppose that the judgment that was made when the
scheme was set up was itself faulty in any way.
Q70 Chairman: On a recent visit to
the United States we had the opportunity to meet Ben Bernanke
and he told us that he prefers to maintain the Federal Reserve's
responsibility for banking regulation, due to possible co-ordination
problems that might exist between the central bank and the separate
regulator in the aftermath of a financial crisis. What changes
have been made to the Memorandum of Understanding for Financial
Stability to improve co-ordination between the Bank and the FSA,
and are there any areas that require further improvement?
Mr King: I think he is right to
draw attention to a possible difficulty of separating supervision
from the central bank and I think it is only a hypothetical risk
but it is there. There is no doubt that, following the creation
of the FSA, with a new body focusing on incorporating a number
of other regulatory institutions and the Bank having lost supervision,
there may have been some distance in terms of the practical day-to-day
co-operation that might be necessary. Certainly when Callum McCarthy
and I took over the first questions we asked were what exactly
would happen in the event of a financial crisis, who would speak
with whom; who would telephone whom. That has been clearly worked
out and a lot of effort has been put in in the last two and a
half years to putting together very detailed contingency plans
as to how the FSA and the Bank would work together. Those plans
cover who would speak with whom and the relative responsibilities
of the two bodies in the event of a financial crisis. I am very
glad to say that in two major respects I think the situation has
been clarified. First of allin terms of the detail of who
would do what on the day and how we would communicate with each
otherwe have put in place very detailed arrangements for
financial crisis management and we have practised them. There
have been a series of exercises where we have been able to implement
this and test it in the event of an emergency. Secondly, the Memorandum
of Understanding between the Treasury, the Bank and the FSA, which
was released on Budget Day, I think clarifies very greatly the
relative responsibility of the different institutions which were
not clear from the wording in the previous draft. In particular,
it seems to me very clear now that, if there were to be any suggestion
of public support to a bank or another financial institution in
the event of a crisis, both the FSA and the Bank of England would
give independent advice to the Chancellor as to the merits of
that support. The Chancellor would decide whether or not public
money should be used. If it was to be used, it is almost inevitable
that that operation would be carried out by the Bank of England.
But I would suspect that both the FSA and the Bank would, ex
post, be accountable for the advice that they had given.
Q71 Mr Fallon: I would like to turn
now to the immediate past decisions of the Committee. Professor
Nickell, you said in your 31 January speech that you voted for
interest rate cuts in December and January because the "combination
of the fading oil price effect and the absence of underlying inflationary
pressure leads to CPI inflation undershooting the target further
out if rates had been left on hold". Given that in the February
Inflation Report the CPI inflation projections are considerably
flatter, why did you continue to vote for reductions in both February
Professor Nickell: Basically because
my personal projection would be a little bit below that in the
Inflation Report. Perhaps I could expand a little. First of all,
I think there is some degree of spare capacity in the economy.
For example, since August 2004 unemployment has risen by about
150,000, which is about 0.5% of the labour force, and that plus
the spare capacity within firms indicated by surveys following
the relatively slow output growth last year indicates some degree
of spare capacity in the economy. That means that looking at inflation
going forwardand inflation going forward is determined
by pressures on capacityplus the more or less exogenous
relative price changes that we have been seeing, such as oil and
gas and imports of finished manufacturers and so on, so long as
second round effects on wages continue to be absent, the oil and
gas effect will wash out of the inflation rate after a year or
so, so that pressures on capacity then become the driving force.
Since we have some spare capacity, that means that if there is
going to be pressure on capacity driving up inflation, that is
going to require a period of above trend growth and it is my expectation
at current interest rates that a long enough period of above trend
growth will not be forthcoming. That is basically it.
Q72 Mr Fallon: Do you think the growth
forecasts are simply too simplistic?
Professor Nickell: Yes.
Q73 Mr Fallon: Kate Barker, why did
you vote for no change?
Ms Barker: I gave a speech last
week in which I indicated that I have considerable sympathy with
a number of the points that Steve Nickell has just made. In particular,
my personal growth forecast would also be a little bit below the
central projection of the MPC. However, in the short term the
reason that I have not voted for any cut in interest rates is
that I remain concerned about second round effects. Of course
we have not seen these so far. If you look back over the past
year or so, although CBI inflation has risen quite sharply, RPIX
inflation has changed very little and we are now going to have
a sustained period where we may find that CPI inflation runs a
bit above target. I am not convinced with the pressures that are
coming in from gas prices in the short term and possibly some
continued greater pressures on import prices that we are quite
through the short-term inflation pick up and that we are quite
sure that we are not going to see some second round effects. At
the moment, particularly as the economy is performing reasonably
well, it is reasonably close to trend, I do not see the urgency
for an interest rate cut.
Q74 Mr Fallon: Governor, could I
ask you about the increasing concentration of the interest rate
changes into the Inflation Report months, the four months in which
you publish your report. I think it is true to say that more than
half the interest rate decisions taken since June 1997 have been
in those months, and since late 2001 only two of the nine changes
have been in months other than February, May, August or November.
Are you not concerned that the financial markets might start to
assume that these changes will mostly occur in the months in which
you publish your report?
Mr King: No, I am not worried
about that. As long as people can see what we are doing and draw
their own conclusions, that is transparency. The evidence shows
that it is twice as likely that we would change rates in an Inflation
Report month than in other months. I think that is rather natural
because that is the month in which we can take a fresh look at
the position. We can go back and say, "Did we really get
it right last time? Let us take a completely fresh look."
In the intervening months it is rather natural to focus on the
monthly data and the changes over that month. I do not think that
it is surprising. Indeed you can see in other countries that they
can operate monetary policy perfectly adequately by having meetings
less frequently than once a month. It is never really possible
to say that this is the month in which a change should be made;
there is always some uncertainty. I think it is quite natural
that there would be a greater frequency of changes in an Inflation
Report month, but it certainly is not the case that we would not
be prepared to change interest rates outside an Inflation Report
month; it will depend on the evidence that is in front of us.
We are willing to change interest rates in any given month. I
have never heard anyone say we should not do it because it is
not an Inflation Report month. There is a quarterly cycle of data
too. We chose the Inflation Report months to coincide with the
months in which we had the first estimate of the national accounts,
growth for the previous quarter and some of the quarterly surveys.
There is far more data at that quarterly frequency as well as
the forecast process in which the Committee spends many days together
debating the outlook.
Q75 Mr Fallon: I appreciate that
the number of meetings is laid down in a Statute. Do you not see
that it might make people question the usefulness or ask what
you are doing in the other meetings?
Mr King: That is for them to question.
We know what we are doing in those meetings and people can see
the decisions in the minutes. There is a natural monthly round
to the data and it makes sense for us to meet monthly and to debate
the data. I do not have any qualms about the fact that it has
turned out to be the case ex post that interest rates change
more frequently in Inflation Report months. I do not think anyone
goes into a month thinking "Oh no, we won't do it because
it is not an Inflation Report month". We form a judgment
about the outlook for inflation.
Q76 Mr Fallon: Rachel, four of your
five change votes have been in those Inflation Report months.
Have you not been feeling some tendency to wait for the Inflation
Report sometimes? Why have four of your five votes been in those
Ms Lomax: When you take a judgment
about interest rates you are taking a judgment about where inflation
is likely to go and the Inflation Report month is the moment where
you really pull things together and have a more considered look
at all that. I agree it is a perfectly natural way of doing it
both from the point of view of the Committee is thinking about
where inflation is going and also from the point of view of explaining
to the outside world why we are doing what we are doing. Those
are the months when we publish an Inflation Report and that is
the time when you can really set out your thinking most clearly.
I do not find it odd that we make changes more frequently in Inflation
Report months. It does not mean that we are committed to doing
it, but it is a natural tendency given the way we approach policy
Q77 Mr Fallon: It might be dangerous
if the outside world started to assume you were more likely to
make changes in those months.
Ms Lomax: I think they already
Q78 Mr Fallon: And you do not see
a danger in that?
Ms Lomax: Occasionally we are
going to take them by surprise and that is not the end of the
world either, but you have got to have a good story when you do.
Q79 Mr Newmark: I guess my focus
is going to be on why the Bank is more optimistic with GDP growth
versus external forecasters. According to the February Inflation
Report, external forecasters attributed fairly low probabilities
of 14 and 19% that GDP would exceed 3% during the three months
ending 31 December 2006 and 2007 respectively. This compares to
the Bank's estimates of 48% and 50% probability that growth will
exceed 3% in these periods. I am just curious as to why there
are these differences.
Mr Bean: I think the way you have
phrased the question is already quite useful because you have
phrased it in terms of probabilities, and there is nothing that
is certain in this world looking ahead. It is true that we have
taken a somewhat more optimistic view than many outside forecasters,
not all by any means, but that reflects our assessment of the
impact of things like the rise in equity prices and the recent
pick up in the housing market onto consumer spending, a judgment
that net trade will no longer detract quite so much from growth
as it has in the past and return to contributing a broadly neutral
amount to growth, and also a modest pick up in investment. We
have been disappointed with investment outturns and feel that
they are likely to remain subdued in the near term but further
down the road to pick up a little bit. And we also have some continued
impulse from government spending. I would want to stress that
our central projection does not see growth much above the UK's
long-term trend growth rate. It is only a little bit above that
as you go into 2007 and in that sense it is not a particularly
optimistic projection. So far, some of the indicators for output
in the first quarter of this year suggest that indeed growth has
returned to something like the UK's historical trend. So really
we are not projecting anything that is very much stronger than
that going forward.