Draft Report [The Monetary Policy Committee—Two Years On], proposed by the Chairman, brought up and read.

Ordered, that the draft Report be read a second time, paragraph by paragraph.

Summary of Conclusions and Recommendations postponed.

Paragraphs 1 to 4 read and agreed to.

Paragraph 5 postponed.

Paragraph 6 read, amended and agreed to.

Paragraphs 7 to 10 read and agreed to.

Paragraph 11 read, amended and agreed to.

Paragraphs 12 to 15 read and agreed to.

Paragraph 16 read, amended and agreed to.

Paragraph 17 read and agreed to.

Paragraph 18 read, amended and agreed to.

Paragraphs 19 to 21 read and agreed to.

Paragraph 22 read, as follows:

"We do not see it as our role to criticise specific policy decisions, although we are obviously interested in the overall stance of monetary policy. We are however concerned that the MPC should not leave itself open to the kind of criticism which occurred following the suspension of the earnings data as this could damage the credibility of the monetary framework. We would therefore encourage the non-executive directors of the Court of the Bank to give the issue of the quality of data provided to the MPC a high priority in their oversight of the work of the MPC, and in particular to monitor carefully the implementation of the service level agreement between the Office for National Statistics and the Bank."

Amendment proposed, in line 1, at the beginning, to insert the words "While the evidence presented to us already suggests that the increase of June 1998 appears to have been a serious mistake,".—(Mr Michael Fallon.)

Question put, That the Amendment be made.

The Committee divided.

Amendments made.

Paragraph, as amended, agreed to.

Paragraph divided (now paragraphs 22 and 23).

Paragraph 23 (now 24) read and agreed to.

Paragraph 24 (now 25) read, amended and agreed to.

Paragraphs 25 and 26 (now 26 and 27) read and agreed to.

Paragraph 27 (now 28) read, amended and agreed to.

Paragraphs 28 and 29 (now 29 and 30) read and agreed to.

Paragraph 30 (now 31) read, amended and agreed to.

Paragraphs 31 and 32 (now 32 and 33) read and agreed to.

Paragraphs—(Mr Jim Cousins)—brought up, read the first and second time and inserted (now paragraphs 34 and 35).

Paragraphs 33 to 35 (now 36 to 38) read and agreed to.

Paragraphs 36 and 37 (now 39 and 40) read, amended and agreed to.

Paragraphs 38 to 40 (now 41 to 43) read and agreed to.

Paragraph 41 (now 44) read, amended and agreed to.

Paragraph 42 read, as follows:

"The MPC is currently mandated to aim for an inflation target of 2½ per cent as measured by Retail Price Inflation excluding mortgage interest payments (RPIX). The target is set by the Chancellor and reaffirmed in the Budget each year. The Treasury explained, in a background briefing note, that the rate was set at 2½ per cent to allow for bias in the UK measure and to take into account the adjustment costs (in terms of employment and growth) of reducing inflation in an economy when historically the credibility of monetary policy has been low. The target is symmetrical, so that in the words of the Governor the MPC will be "just as active, rigorous [and] aggressive in pursuing inflation at 2.5 per cent if there is a balance of risks on the downside as we had been on the upside."."

Amendment proposed, in line 9, at the end, to add the words "However, the Chancellor indicated in evidence that he would be prepared to consider moving the inflation target downwards.[128]".—(Mr David Ruffley.)

Question put, That the Amendment be made.

The Committee divided.

Paragraph agreed to.

Paragraph 43 (now 46) read and agreed to.

Paragraph 44 (now 47) read, amended and agreed to.

Paragraphs 45 to 47 (now 48 to 50) read and agreed to.

Paragraph 48 (now 51) read, amended and agreed to.

Paragraphs 49 to 56 (now 52 to 59) read and agreed to.

Paragraph 57 (now 60) read, amended and agreed to.

Paragraph 58 (now 61) read, as follows:

"One of the major problems facing the MPC in the past two years has been the imbalances in the economy caused by the strength of sterling and its resultant disparate effects on the manufacturing sector (which is highly dependent on exports) and the service sector. The TUC argued in their written submission that "interest rates had been set to head off potential inflationary pressures in the private service sector and in the full employment labour markets of the South at the expense of manufacturing and high unemployment Britain." The Bank of England drew specific attention to the exchange rate in its press release following the May 1999 MPC meeting, which stated that "if sterling were not to weaken as assumed ... there might, therefore, need to be a further easing of interest rates in order to keep inflation on track," and the Governor explained to us in his subsequent evidence that "a weaker exchange rate would ease the problem of [sectoral] imbalance which is the real difficulty that we have in conducting monetary policy."

Amendment proposed, in line 11, at the end, to add the words "We agree.".—(Mr Jim Cousins.)

Question put, That the Amendment be made.

The Committee divided.

Another Amendment proposed, in line 11, after the words last added, to add the words "We are concerned at the prominence of the exchange rates in the Bank's recent announcements and at the dangers of confusion between exchange rate and inflation objectives.".—(Mr Michael Fallon.)

Question put, That the Amendment be made.

The Committee divided.

Paragraph, as amended, agreed to.

Paragraph 59 (now 62) read, as follows:

"A number of our witnesses thought that the actions of the MPC and its Government-set inflation mandate had contributed to the current problems. Mr Keegan argued that "the manner in which it [the MPC] embarked on a series of small increases from mid 1997 was an open invitation to speculators to drive the pound higher." The CBI argued that the "Bank of England cannot, on its own, manage the balance of growth." In their view "higher interest rates push up the exchange rate and ... this puts the pressure of the adjustment disproportionately on the traded sector of the economy—in particular manufacturing industry." While the Bank point out in their recent paper on the "Transmission Mechanism" that "the precise impact on exchange rates of an official rate change is uncertain," it is extremely likely that the relatively high interest rates in the UK have had a part in underpinning the strength of sterling."

Amendment proposed, in line 9, after the word "uncertain", to insert the words "We believe".—(Mr Jim Cousins.)

Question put, That the Amendment be made.

The Committee divided.

Paragraph, as amended, agreed to.

Paragraph 60 (now 63) read, as follows:

"One potential solution to the problem suggested by, among others, the TUC is an "... explicit exchange rate policy aimed at keeping the pound stable around a competitive exchange rate." Indeed some commentators did suggest that influencing the exchange rate was one of the main aims of the May press release. However, the Governor while acknowledging that what is happening "to the exchange rate clearly does enter very strongly into ... the policy decision," was emphatic in telling the Committee "we do not believe we can target the exchange rate consistently with targeting inflation." The Chancellor was equally forceful in his evidence stating that "... anybody who thinks that either dropping the inflation target to replace it by an exchange target or running inflation and exchange rate targets at the same time is the right way to achieve domestic stability or convergence is failing to learn the lessons of the 1980s." He was "absolutely clear that we are pursuing an inflation target and ... not pursuing an exchange rate target." We agree that it is extremely unlikely that a policy of running an inflation target and an exchange rate target at the same time would prove successful and we therefore support the current system."

Amendment proposed, in line 11, to leave out from the second word "target" to the end of the paragraph and add the words "We are very concerned that even attempting to influence the exchange rate, directly or indirectly, could conflict with the inflation target. We ask the Bank and the Government for an assurance that no covert exchange rate policy is being developed.".—(Mr David Ruffley.)

Question put, That the Amendment be made.

The Committee divided.

Another Amendment proposed, in line 11, to leave out from the second word "target" to the end of the paragraph and add the words "The strong appreciation of sterling in real effective terms (by 30 per cent since December 1996) has made the task of controlling inflation easier but has inflicted considerable damage on manufacturing. We note that the Bank of England has so far declined to make use of its powers of intervention in foreign exchange markets, judging that it could have little impact on markets. This apart, we recognise that under its current terms of reference the MPC has no alternative but to use interest rates for controlling inflation rather than for managing the exchange rate.".—(Dr Vincent Cable.)

Question put, That the Amendment be made.

The Committee divided.

Question put, That the Amendment be made.

The Committee divided.

Paragraph, as amended, agreed to.

Paragraph 61 (now 64) read, as follows:

"A related problem caused by the strong exchange rate arises from the Government's intention to prepare Britain to be "in a position to join a single currency should we wish to". As Mr Bootle pointed out, this raises a possible policy dilemma for the monetary policy framework. Currently policy is aimed at hitting an inflation target of 2½ per cent; however if the UK is to enter EMU then the UK economy will have to converge on the economies of "euroland". In Mr Bootle's view this will involve two things: convergence in terms of inflation and interest rates and reduction of the exchange rate to a level which is desirable for entry. However, according to Mr Bootle, "you cannot set monetary policy both to hit the 2.5% inflation target and to prepare Britain for the euro and hope to succeed in hitting both except by accident."

An Amendment made.

Question put, That the paragraph, as amended, stand part of the Report.

The Committee divided.

Paragraph 62 (now 65) read.

Question put, That the paragraph stand part of the Report.

The Committee divided.

Paragraph 63 (now 66) read, as follows:

"The Treasury itself refused to accept that any such problem existed. In their view "fiscal stability, coupled with low inflation ... will actually give us the right background to achieve exchange rate stability." This was reiterated by the Chancellor, who argued that "a stable and competitive pound in the medium term ... will result from the pursuit of good policies." Nevertheless as we concluded in our report on this subject last year "Unless an indication is given of our intention to join it is at least open to question whether, in the absence of policies specifically designed to target a particular rate it will be possible to achieve two years of exchange rate stability at an 'appropriate rate' against the euro."."

Amendment proposed, in line 1, to leave out from the beginning to the word "Nevertheless" in line 5 and insert the words "We note with surprise the Treasury's refusal to accept that any such problem existed. In their view 'fiscal stability, coupled with low inflation ... will actually give us the right background to achieve exchange rate stability'. The Chancellor reiterated this in claiming that 'a stable and competitive pound in the medium term ... will result from the pursuit of good policies'. We note that the Chancellor did not categorically rule out the adoption of an exchange rate policy at some time in the future prior to seeking entry into EMU.".—(Mr David Ruffley.)

Question put, That the Amendment be made.

The Committee divided.

Another Amendment proposed, in line 4, to leave out from the word "policies" to the end of the paragraph.—(The Chairman.)

The Committee divided.

Another Amendment proposed, in line 8, at the end, to add the words "In this connection the Committee took note of the sharp fall in the value of the euro of around 14 per cent against the dollar in its first six months of operation and the lesser, although significant, fall against sterling. We conclude that if steps are not taken by the member states participating in the euro venture to restore confidence in the euro currency through taking decisive action in the management of their economies, it could create significant problems for the MPC in seeking to achieve its objectives without worsening the already serious balance of payments deficit which Britain had with the rest of the European Union. We also feel that it would be folly not to at least consider the opinions of those, admittedly a minority in our membership, who argued that the euro, like so many previous single currency exercises, would end in serious economic problems and a lack of international confidence. We consider that the Treasury should put forward the case to nations participating in the euro for a contingency plan either to exclude some nations from the enterprise or to seek to fully restore independent national currencies.".—(Sir Teddy Taylor.)

Question put, That the Amendment be made.

The Committee divided.

Paragraph, as amended, agreed to.

Postponed paragraph 5 read, amended, and agreed to.

Summary of Conclusions and Recommendations read, amended and agreed to.

Resolved, That the Report, as amended, be the Eighth Report of the Committee to the House.

Ordered, That the Chairman do make the Report to the House.

Several papers were ordered to be appended to the Minutes of Evidence.

Ordered, That the Appendices to the Minutes of Evidence taken before the Committee be reported to the House.

The Committee further deliberated.

  [Adjourned till Thursday at half-past Two o'clock.