MR MERVYN KING, MS RACHEL LOMAX, MR CHARLES BEAN, PROFESSOR TIM BESLEY AND PROFESSOR DAVID BLANCHFLOWER

29 NOVEMBER 2007

  Q40  Mr Todd: I think you are drawing a distinction between your role and that of the ONS which probably not many would be able to perceive. The ONS has to estimate growth at a particular point in time, which is what you also do. You then project into the future your expectations of growth. What your fan chart in the report shows is that over the past three years, not throughout the period shown in that chart, the ONS has become less and less able accurately to estimate what is going on at a particular point in time. You have taken the estimate it has produced and mapped it against what actually turned out to be the case.

  Mr King: The ONS has decided that it does not want to get into the business of trying to forecast what might happen. The ONS says that given the information it already has this is its estimate.

  Q41  Mr Todd: That is not what it does when it produces the estimate of growth at a particular point in time. It is not asked to forecast what it will be but to say what it is now. What the graph shows is that it is not doing that particularly accurately and that the revisions are consistently in a particular direction and by a reasonably consistent margin. I am wondering whether you are being just a little kind about this disagreement and there is not some basis for discussing with the ONS—it probably happens already—some of the methodological issues that clearly have led you to produce your own estimate of what is happening at the moment and use that as the base for your future projections.

  Mr King: What we want to do here is to be transparent as to our judgments about what has been happening. Charles Bean has talked a lot about this to the ONS, so I ask him to comment.

  Mr Bean: The point I want to really ram home is the distinction between measurement, which is what the ONS is about, and interpretation which is our game.

  Q42  Mr Todd: But in producing an estimate it is interpreting, is it not?

  Mr Bean: The ONS is collecting information from a large number of households and businesses and on the basis of that it reports.

  Q43  Mr Todd: It is interpreting to produce an estimate, is it not?

  Mr Bean: Not to the same degree that we do. It is trying to report the implications of the information that it collects from households and businesses, but more information accrues over time from things like tax returns and stuff like that. Importantly, it does not immediately fully reconcile the demand, output and income sides of GDP, which should give the same message. It does not carry out a full reconciliation of that until two years after the initial estimates are in, because it recognises there is a lot more information still coming in. We have to take a view of what we believe is happening in the economy now. As the governor has already said, the past history of revisions suggests that on average there is a tendency for the output data to be revised upwards. You said that there was a consistency about it.

  Q44  Mr Todd: Only for a period. If you take your graph as a whole in the period 2001-02 the ONS's estimate was pretty much in the middle of the span and the drift has happened only in the past three or four years.

  Mr Bean: No; that is a misinterpretation of what is going on. Most of the revisions occur in the year or two after the initial estimates come in. Once you are two or three years down the road there is not much more information coming in, so the data do not tend to be revised very much. The fact that our central projection—if you like, a "backcast"—lies above the ONS data for the past couple of years is not an indication that suddenly it has got worse over that period, but merely reflects the fact that the information is still coming in and revisions are most likely to occur to the most recent data, not data that is some years old. Our judgment is that it is more likely than not to be revised up, although there is a great deal of uncertainty—the virtue of putting the back data in the form of a fan chart is that it shows that downward as well as upwards revisions are possible. That reflects both the past history of revisions, which information we use in forming our judgment, and the information from business surveys.

  Q45  Mr Todd: Are there any other ONS data sets that you are examining with care to see whether or not you can work better with them?

  Mr Bean: The methodology that has been developed here has been designed precisely so that we can apply it across a whole range of ONS data and take account of the fact that in principle there may be accounting identities across various series that we would want to impose. For instance, we know GDP is identical to the sum of consumption, investment, government spending and net exports. Therefore, if we take the view that output growth is stronger, then it must be associated with a stronger demand component. The technology that the staff have been developing over the past few years is precisely to take account of that multi-dimensional aspect of the problem.

  Mr King: I think that the principle the ONS has followed is a perfectly sensible one based on doing only what one can do. All the ONS can do is measure the information that is coming in. Guessing where it might make revisions in future based on its past revisions and business surveys is something that anybody can do. We have done it in a particular way; city economists and others might do it in a different way. It is not obvious why the ONS should take on a role that other people could do. What it can do that no one else can do is process the information that comes to the ONS.

  Q46  Mr Breed: Perhaps we can turn briefly to the labour markets. Professor Besley appears to have got of lightly this morning so I shall direct my questions to him. Your colleagues at the other end of the table have rightly expressed the view that consumption is an important element of this. An important part of that is security of income, job security and that sort of thing. Why has employment growth been subdued despite what appear to be capacity pressures and weak wage growth?

  Professor Besley: As you have probably observed from the report, recently we had an agents' survey directed precisely at that question. Certainly, one of the reasons—I am quite persuaded by it—is that we have observed fairly weak employment growth, productivity improvements and, in the wake of the last increase in oil prices, firms have been inclined to cut back on labour hiring during a period when wages need to adjust downwards to compensate for the rise in energy costs. That would also explain in part why employment growth has been weak over that period. You have probably read the rather nice summary in the report of the agents' findings. What comes top of the list is the productivity story, but the other supply side stories corroborate the idea that there was a series of supply side factors including higher energy costs and productivity improvements.

  Q47  Mr Breed: Leaving aside the financial sector—that is somewhat different—and looking at the rest of the labour market, do you foresee next year being just as tough or will we see some sort of bounce? Will there be more potential for employment growth? The fear is that it may be on the decline which obviously will affect confidence and consumption.

  Professor Besley: To the extent that the economy is slowing and the demand side is weak there will be a knock-on effect onto employment, but the imponderable is how wages respond to that. To the extent that wages can adjust in the face of that and there is a lower demand for wage increases we would expect less of that to translate into increases in unemployment. One has to form a judgment on how far there may be wage rigidity in the face of that. That is why we look forward to the next wage round to see the extent to which people demand realistic pay increases in the light of demand conditions that prevail at the time. To the extent that they do we are hopeful that there will not be a marked increase in unemployment over that period.

  Q48  Mr Breed: History tells us, although it is not exactly the same, that the incidence of a modest fall in the housing market and a slight rise in unemployment generates lack of confidence which starts what can be an unfortunate spiral. You do not believe that is likely to be the case?

  Professor Besley: I take slight issue with your description of house prices having an impact on this. House prices are a reflection of a number of factors which themselves would drive what we describe, namely they reflect people's confidence about their income growth over time, the availability of credit and are generally a reflection of the economy. In that sense I do not think of one causing the spiral; they are all reflections of what might be a situation where we have a relatively more difficult or less benign climate as we have been anticipating in the near term in response to some of the difficulties in credit markets we have seen.

  Q49  Nick Ainger: In relation to the turmoil in the markets you said that the consequences for the UK were difficult to assess and they would be likely to be evident first in the housing and commercial property markets. Taking the situation we have now and are likely to have for a considerable length of time, there are rising energy prices, difficulties for exporters particularly at the high-value end and the aerospace sector as well and a slowdown in the housing market, which presumably will have a knock-on effect on the construction industry and Ikea, Homebase and so on. Given all those circumstances—we have not had anything like them in the experience of this Government in 10 years—surely there will be a significant impact on employment levels. If you are not of that view why is that not the case?

  Mr King: I think this question goes back to what I said before about looking at the numbers and making a quantitative judgment. The qualitative description that you give is quite consistent either with the central projection in the forecast in the November report or something more serious. The judgment we made in the November inflation report was that the quantitative impact of what we had seen so far would lead to a noticeable slowing in the growth rate of the economy but not a slowdown below the long run average growth rate for so long that it would have a marked increase in unemployment. One could imagine a much sharper slowdown in the UK economy which would have a noticeable impact on levels of unemployment. That is not our central projection. I think the role of the Monetary Policy Committee now is not to pretend it can be confident as to what will happen but to look at the numbers each day, week and month as they come in and form a quantitative judgment as to what is happening to overall demand to set monetary policy on track and keep inflation close to the target with the consequence that we return to broad economic stability. That is the central projection in the November report. Of course, there is no guarantee that it will happen, and it is unlikely that it will happen as smoothly as in a central projection, but we have to monitor the data very carefully. I do not pretend that we can be confident as to what will happen, but I am confident that we respond to developments as they evolve.

  Q50  Nick Ainger: Professor Blanchflower, the exchange rate is particularly important for a company such as Airbus. I read recently that the recent falls in the dollar—because all aeroplanes are traded in dollars—means that it has had to look again at the possibility of further redundancies throughout its operation in Europe. What estimate is made of the possible employment impact if the current ratio remains the same or gets even worse?

  Professor Blanchflower: It is hard to know. The governor said a moment ago that sterling has fallen against the euro and so it has had a positive effect in some sense on the economy, but clearly some who trade in dollars are impacted by the bilateral change in the dollar. I have concerns about employment and I have expressed those in a number of places. There has been more slack in this labour market than others have thought, so I do not think that in the labour market we come from a position of strength. I think the explanation for why wages have been benign is that unemployment is measured in a number of ways, including inactivity and fear of unemployment, so as to that I do not quite share the views of a number of other people. There is great concern going forward that growth will not be strong because we have seen two things. In the past we have seen a growth in public sector employment which is slowing. In the past two years I have written about a number of things about it. The vast proportion of job growth has been in self-employment and obviously that does not appear to be sustainable. Something like two-thirds of all the job growth has been in self-employment and the concern has been, as referred to a moment ago, that small firms are especially impacted by a credit crunch. You might think that those folks will be particularly impacted. I am much more concerned about that and probably share your initial comment. I believe and have been saying that the implications for the labour market are not benign and that monetary policy is restrictive. I am concerned about the effects on the labour market. That has been a central plank of the views I have held which perhaps are not that different from your initial statement.

  Q51  Jim Cousins: Professor Besley, you referred earlier to realistic wage increases. I just wondered what they were.

  Professor Besley: They depend on the conditions of any given business. There is no answer to that for the economy as a whole. It should be determined at plant level based on the business conditions faced by specific businesses. It is not my role to dictate what those numbers should be.

  Q52  Jim Cousins: The governor said that your job was to look at numbers. What numbers would make you happy if you were looking at wage increases?

  Professor Besley: Obviously, if wage increases are not to impose significant inflationary pressure they must be consistent with meeting the inflation target, so we look at rates of growth of labour productivity and, on top of that, we would expect a modest increase over and above that to reflect the attainability of the inflation target. The kinds of wage increases we have seen historically—between 4% and 5%—have been consistent with maintaining the inflation target over the period that it has been in place.

  Q53  Jim Cousins: Do you think that monetary policy will be successful in containing costs and prices over the next year or 18 months?

  Professor Besley: Monetary policy does not work by containing costs and prices but by trying to balance the growth of potential supply with aggregate demand in the economy. To that extent our task is to try to manage that balance. Costs and prices are a reflection of a series of decisions that are made by firms in view of the pressure of demand and the supply conditions they face.

  Q54  Jim Cousins: In the monetary policy review CPI inflation is determined by the stance of monetary policy ultimately?

  Professor Besley: Yes.

  Q55  Jim Cousins: Do you believe it will be determined by the stance of monetary policy over the next 18 months?

  Professor Besley: By and large, yes. There are many factors, particularly on the cost side—what happens to commodity prices—which will have a significant impact over that period, but in terms of the broad outlook, trying to manage the balance of aggregate demand relative to the supply potential over the period, I think that monetary policy will play a significant role.

  Q56  Jim Cousins: How can monetary policy affect the impact on the economy of commodity prices, fuel price rises and so forth?

  Professor Besley: It has no direct impact. Obviously, it has indirect effects through the impact of monetary policy on the exchange rate, but more generally one has to try to set a path for aggregate demand with monetary policy to be consistent with the inflation target given the forces that arise from those cost shocks.

  Q57  Jim Cousins: Do you agree with Professor Blanchflower who told us earlier that he did not know what was coming?

  Professor Besley: In what sense? Of course, we do not know what is coming; we are not clairvoyants.

  Q58  Jim Cousins: Professor Blanchflower drew a distinction between the past 10 years in which monetary policy had proved to be very effective in containing the impact of costs and prices and managing the real market interest rates in the economy as compared with more recent times where we do not know what is coming. What is your view about that?

  Professor Besley: I certainly subscribe to the view that we are perhaps in a distinctly trickier period than some of the situation we have faced in the past. When people have discussed the feasibility of inflation targets and the sustainability of such a regime questions have been raised as to how far shocks on the cost side of the economy will be particularly awkward. When we had the run-up in oil prices, which we have now seen go up again, it raised a number of questions about how to use monetary policy to balance supply and demand in the event of cost shocks. To the extent we face very unfavourable tail winds, if you like, in the form of shocks coming from the cost side, it will make the conduct of monetary policy considerably more difficult. I do not think it is anything to do with a much bigger increase in the uncertainty of the outlook as such; it is just that one faces a particular set of shocks, that is, a demand shock through the credit effect and a supply shock through commodity prices at the same time. That makes for a non-benign environment in which to set monetary policy.

  Q59  Jim Cousins: Professor Blanchflower, do you agree with the Governor that the decisions of the Monetary Policy Committee will be implemented by the money markets?

  Professor Blanchflower: I bow to the Governor because I do not have a particular view on that.