THURSDAY 26 NOVEMBER

MR EDDIE GEORGE, MR MERVYN KING, MR JOHN VICKERS, PROFESSOR WILLEM BUITER, DR DEANNE JULIUS and SIR ALAN BUDD

  140.  Governor, on this point, has not some divergence of view become obvious in the course of this hearing between yourself and Mr King and Professor Buiter because Mr King and Professor Buiter were clearly of the view—I think Professor Buiter, as is his fashion, expressed it most bluntly—that the interest rates we now have had fixed things for the back end of 1999 and that was more or less it. Your view is that there are significant shorter term impacts. Is this not something on which the committee should perhaps consider very carefully because this could affect the future pattern of interest rate movements?
  (Mr George)  I do not think that there is any difference of view between us. I took the view—and indeed it was the common view that Willem wanted to go a little bit further—having seen our forecast, which showed that over the two year time horizon there was a significant risk that we would undershoot even on our central expectation, that there was a significant risk that we would undershoot the inflation target. We responded to that because we thought that actually a half a per cent move now would fix that in the sense of raising the inflation forecast to what we displayed in the Inflation Report where the risk of that undershoot has been effectively eliminated. I think we would all agree with that except for the marginal quarter per cent which Willem felt that it needed, an extra little bit to totally eliminate it.

  141.  In the minutes of the Monetary Policy Committee, the last one, attention is drawn in paragraph 13 to the fact that "domestic output price inflation is at its lowest level since 1975" and that "surveys indicated further falls". Are you telling us that the decisions that you have taken so far are adequate to deal with that?
  (Mr George)  That is our best guess, yes. On domestic output price inflation you are talking about producer prices in manufacturing and they are pretty well flat. Goods prices at the retail level are also extremely subdued, around one per cent I think. Service prices at the retail level are growing at three and a quarter per cent, or something like that, so that it produces the outturn which is RPIX at two and a half per cent. That is the current situation. Simply to look at producer output prices in manufacturing is not a guide to what is going to happen to inflation in the short run or over the two year period.

  142.  One can only assume when you look at these minutes that these minutes are here in order to draw our attention to a factor that the committee feels to be important. Are you saying that on the basis of the current level of interest rates the danger of further falls in producer price inflation has been eliminated?
  (Mr George)  No, we are not saying anything about the prospect for further producer price inflation. What we are saying is that the half a per cent reduction in interest rates that we made earlier this month we judge to be sufficient to bring retail price inflation, in fact retail price inflation minus mortgage interest payments, back on track for two and a half per cent. We do not say anything about what that means for producer output prices. They will be affected by what happens to commodity prices and they will be affected by what happens to earnings and labour costs.

  143.  So if you felt that the dangers of a significant undershoot on that dimension continued there would be scope for further changes in policy?
  (Mr George)  Of course the backward looking producer output data feeds into the inflation forecast and the influences on producer prices also feed into the inflation forecast like commodity prices, like the exchange rate. They are swept in to the thing. If only that changed and producer output prices declined then that clearly in and of itself would be a factor which we would expect to feed through into retail prices and that would affect our view about interest rates. It is extremely unlikely that only that would change or even necessarily that would change in that direction.

  144.  Before I turn to Sir Peter Lloyd who has got one final question, DeAnne Julius has written an article in the Bank of England Quarterly Bulletin on the service sector. What are the policy implications of that article do you think, or can you not share your views with us today?
  (Dr Julius)  We are not clear yet what the policy implications are. The article reflects the first phase of research that has been carried out in the Bank and the purpose of that was really to see whether there are monetary policy implications of this quite substantial shift in the British economy from manufacturing towards services which is a shift that has been going on for a long period of time. Certainly we felt that it was important because we are interested both in the sectoral composition of the economy and how the transmission mechanism works its way through services as well as through manufacturing. It was important that we try to understand more carefully just how output, productivity and prices in the service industries are changing. Unfortunately we could not come to a final answer in the time of the first phase of the project, but we felt it was worth publishing so that others could also be stimulated to think further about this area. It is really a view of the facts, it is a backward looking pulling together what we know about services so far. The article, as you know, ends with questions and with areas for further research rather than conclusions and I think that is a fair and accurate representation of where we are at this point. We are getting involved in the second phase of work and that is looking more specifically at different parts of the service sector to see how the monetary transmission mechanism works, how they react to shocks in interest rates and exchange rates and also to try to disentangle the reasons behind the phenomenon that the Governor just mentioned of service prices, service inflation generally being higher than goods inflation. There are a number of hypotheses that we will be looking at more carefully in that aspect.

  145.  One narrow question. I wonder, Governor, whether any study has been done on the effects that the windfall gains primarily from building society demutualisation had on the economy in general and inflation in particular? Have you looked back at that?
  (Mr George)  We have not, I think, done that retrospectively. Of course we did a lot of work for the early phase and then more work after some of the impact had become apparent and we had a better read of what people actually did with the money they received.

  146.  It usually only becomes apparent well in arrears, does it not?
  (Mr George)  Yes, of course.

  147.  Will you be looking at it again to check what it looked like because such things could happen again?
  (Mr George)  Yes, they could.

  148.  Could I ask you another one. You last raised interest rates in June. Do you not feel that you under-estimated the impact of the Asian crisis on the economy of the world and therefore on us? Were you not rather slow in gathering its full significance?
  (Mr George)  You can take any view you like with hindsight, of course, but actually in June I would say that not just us but I think most people saw that the Asian crisis—because up until then it had really been predominantly an Asian crisis—was beginning to stabilise, the situation in Korea was showing signs of bottoming out and the ASEAN 4 were experiencing a period of very severe domestic adjustment and the direct impact on us was very limited. What I think nobody foresaw quite frankly was the much steeper deterioration in the Japanese situation which was the biggest factor which really was not apparent in June, except to those people who like to look at it with hindsight. You could not see what happened to Russia that took place in the middle of August. At that stage they were in negotiation with the IMF for a package to try to avert any problem of that sort. You could not see the kind of deterioration in the Brazilian situation and you could not see the impact of Russia and of Long Term Capital Management and all of that. Those were essentially new elements in what you would call the Asian crisis and frankly if people foresaw those, they have got a better crystal ball than we have. There is no doubt that there was a deterioration as a result of those things but it is a bit much to expect us to foresee them.

  149.  Looking at your chart you do not have any particular division that looks at overseas developments. Do you feel you cover them with the thoroughness and deliberateness that you really need?
  (Mr George)  Yes. We do actually have people who are looking at this thing continuously within one of the other divisions and, as a matter of fact, we are about to break those people out from the wider division. That is on the G10 countries. We also have, as it were, on the other side of the Bank, the financial stability side of the Bank, people who are monitoring the situation in emerging markets and the European transition economies and so on. Of course, we are getting that feed very importantly from the international organisations all the time. I think we monitor that as closely as anyone else.

  150.  But you will have a division doing all of that?
  (Mr George)  We will have an international conjunctural division with effect from whenever I can spare my private secretary.

  151.  A little while ago my colleague, Dr Cable, asked a question to the effect of why was it that other people had lower interest rates, particularly continental countries, than we have here, to which I think Professor Buiter gave rather reasonably the answer, "we are not responsible for their interest rates" or something to that effect. Maybe I misheard that bit. Is not the real answer that certainly the continental countries are on a totally different economic cycle from us?
  (Professor Buiter)  That is what I said.

  152.  The question I then lead to from that is what likelihood is there in the view of Professor Buiter particularly of this situation changing and the economies converging and these interest rate differentials would therefore cease to exist?
  (Professor Buiter)  Convergence in business cycles among regions or countries that have independent monetary policies, can be delayed by two factors. One, if two countries pursue different monetary policies so monetary policy itself becomes the source of cyclical non-synchronisation. There of course having monetary union would eliminate that particular source of the cycles being out of phase. The other is the regions being hit by different specific asymmetric shocks. One could never expect complete convergence among the UK and Continental economies, just as there is no complete convergence within the UK between the Scottish economy and the Welsh, the north eastern economy and the economy of the south east. There will always be some regionally different cycles but the question is how much and is it bounded enough so that without the use of monetary instruments one can get reasonable macro-economic stability.

  153.  If the question is how much then is it not significant that these differences are widening rather than converging at the moment?
  (Professor Buiter)  The differences are not widening I would say, in fact at the moment they are narrowing.

  154.  The differences in interest rates may be narrowing but there are the differences in cycles, I think you would accept that. Certainly when one compares the link between this country's business cycles and the United States they are very marked and show no sign at the moment of converging at all.
  (Professor Buiter)  That is true but, of course, the trade links with the United States are much less than they are with the Continent.

Sir Michael Spicer:  It depends if one takes into account invisibles and——

Chairman:  This is a thing which is not directly related to our present inquiry but I am sure it is something we will want to return to and we will probably want to have different views on that.

Sir Michael Spicer:  It is an important point. The Professor has agreed that these differences are there and very contrasting with the United States.

  155.  A very brief question. One of the privileges we now have on the Committee is we have the voting records of the members of your Committee. I just want to ask Sir Alan Budd a question. Although your record is not nearly so bad as Professor Buiter's I see that in fact you disagreed with the majority on four occasions. I am wondering is there a view of the minority on the board that perhaps the board is becoming too dull and conservative and should respond more readily to changes in the situation? I see, for example, that in January, February, March and April you voted for an increase whereas the majority said no change. Is there actually a division within the board of some people saying "we should respond to things very quickly and sharply" and others saying "let us do it nice and slowly in a gentlemanly way"?
  (Sir Alan Budd)  I think a lot of this discussion took place earlier when talking in response to the Chairman's question about activism and passivity—I think that was the opposite.
  (Professor Buiter)  Incrementalism.

  156.  I think incrementalism is better than passivity. That implies that the Chairman of the Monetary Policy Committee—the Governor—is just doing nothing which is not the case.
  (Sir Alan Budd)  I think we would find that most of the disagreements that there have been were simply in terms of how we thought it correct to respond to all of the information that was available at the time. This is inevitably a matter on which reasonable people will disagree. I think the fact is extremely interesting that Willem Buiter has moved from someone who was keen to put interest rates up.

  157.  I know, that is amazing.
  (Sir Alan Budd)  That indicates the way in which he has chosen to respond to the information. Certainly there were periods, of course, when my view, along with some of the others, differed from the majority. That is fine, it is just responding to the information as best we can. We do not do it on purpose.

  158.  No, I would not suggest that.
  (Sir Alan Budd)  We are doing it because we accept the individual responsibilities that are imposed on us for our own decisions. This is not a Committee decision in which people can hide themselves in a joint decision, we are individually responsible for our decisions and therefore we have to give the best judgment that we possibly can month by month.

  159.  Just a very final question. I am just looking at the variations and I have a very high regard for the Governor as he well knows, I always have had. What I am wondering is is the factor of jobs something that you consider? I noticed that Professor Buiter in answer to Sir Michael Spicer did not once mention the issue of unemployment and this is a nightmare on the Continent. Is the factor of unemployment and jobs an issue which you feel is relevant when coming to these decisions?
  (Sir Alan Budd)  I think we all completely share our view of what it is we have been asked to do. It could not be clearer what we have been asked to do, indeed Sir Michael Spicer often reminds people of what we have been asked to do which is to achieve the inflation target set to us which is two and a half per cent. Of course we take unemployment into account because we are fully conscious of the effect of our decisions on employment but also extremely conscious of the major role played by unemployment in determining the future path of inflation. If we are successful then one of the benefits of our success we hope will be that unemployment will be permanently lower than would otherwise be the case.

  160.  It is also the case that your primary task, your key task, is to hit the inflation target and you also have to take into account the Government's policies on output and employment. That is what is laid down in the Act.
  (Sir Alan Budd)  That is why we are doing it. As the Governor said, we would not do this unless we thought it was for the general benefit of the whole economy.

Sir Michael Spicer:  It is subject to the primary task.

Chairman:  Certainly. We do not want to have a debate over your objectives because they are laid down by the Government and by Parliament. Could I thank you very much for coming and for answering our questions so fully. Thank you all of you.