MR MERVYN KING, MS RACHEL LOMAX, PROFESSOR CHARLES BEAN, DR ANDREW SENTANCE AND PROFESSOR DAVID BLANCHFLOWER

26 MARCH 2008

  Q60  Mr Breed: Just two questions. Dr Sentance, could I just return to the Household Savings Survey, which we have not concentrated much on. We all realise, of course, that the savings ratio has gone down and people have been saying for a long time it has been going down. In the Inflation Report, February 2008, you were saying that the Committee thinks there is some evidence that people might reappraise all of a sudden their whole income and we will start to see people saving again. I just find that somewhat remarkable bearing in mind we have got increased costs, all the pressures, potentially a slowdown in growth. Why are people suddenly going to decide that it is a good idea to save?

  Dr Sentance: In the central forecast underpinning the Inflation Report we have got a rise in the savings ratio. One of the factors that is underpinning that is a more precautionary approach by the household sector. That is one of the recognised factors behind saving identified in the economic analysis.

  Q61  Mr Breed: We have had very good times over the last 10/15 years when there has been disposable income and everything else and it has just gone down and down. Why at a time when it is going to be under pressure is it suddenly going to go up?

  Dr Sentance: If I could just elaborate on that. When we look at the household savings ratio as a concept it is very important to recognise it is the difference between two big flows. There is the amount of gross savings that the households are making and netted off from that is their borrowing. Historically, if you look back you will find it is changes in that borrowing behaviour that have been the most significant factor behind changes in the savings ratio. The way in which this precautionary approach is likely to be reflected is in less willingness to borrow with confidence being reduced, as has already been referred to in this hearing, and also, of course, the constraints on the supply side from credit availability. That is what I would expect to see in the central forecast. However, I would also make another point that there is quite a degree of uncertainty around our forecast at the moment. We cannot predict exactly precisely how this will develop and there are a number of factors at play. There are factors on the supply side in terms of credit availability, factors in terms of willingness to borrow among consumers. But it is not unreasonable in the current climate to expect some increase as we put into our central forecast in the savings ratio.

  Q62  Mr Breed: Thank you. Could I just ask the Governor, going over the statements you have made this morning, I was quite intrigued about the long-term solution to the Bank's problem and then a longer term resolution of the problem and the fact you indicated it should not be to finance more business in this way but to deal with the present problem. Is that euphemistic language for saying you have got to find some more capital to get the balance sheets back, to get this stuff written off as quickly as possible? If so, who in their right mind is going to put huge amounts of capital into banks to write off their foolish losses rather than put it into businesses that are going to finance good business? If you are not going to allow them to do the new stuff, they have to deal with the old stuff, who is going to provide these major lumps of capital?

  Mr King: Banks do have capital and it is not euphemistic language for a statement about the amounts of capital, it is an observation that the problem of illiquidity that is being faced in financial markets, a certain range of financial markets in these asset type securities, not all financial markets but in this range of markets, is very great, but it is an illiquidity of a stock of assets that were created in the past and we need to find a way of dealing with that illiquidity. The way to do that is not to encourage the creation of yet more paper that will in turn become illiquid, but to deal with the stock.

  Q63  Mr Breed: It can be achieved without recapitalising the balance sheets?

  Mr King: Yes. I would not be opposed to a process in which the banks would find more capital, I think most Central Banks would regard that as a very desirable development.

  Q64  Mr Breed: A discount.

  Mr King: But it is not dependent on that.

  Q65  Chairman: Governor, this is the last question, maybe for all of you to comment on. You mentioned nominating a risk and it would be good if each of you had a go at that again. How far did this Budget allow fiscal policy to support monetary policy? I think we will start with Professor Blanchflower, or do you want me to start at the other end?

  Professor Blanchflower: I think I would rather you start at the other end.

  Mr King: Let me nominate the order in that case.

  Professor Blanchflower: I want to go last!

  Mr King: Professor Bean will start, then Ms Lomax, then Dr Sentance and then Professor Blanchflower.

  Professor Bean: What is important for us is that fiscal policy is essentially set with an eye to long-term sustainability; and in that sense the fiscal rules need to be broadly respected. But within that we would certainly expect the automatic stabilisers to be allowed to operate and in that way they would be potentially acting to support our monetary policy decisions. Obviously when we set monetary policy we take the stance of fiscal policy as given. From our perspective that is a perfectly satisfactory position to be in.

  Q66  Chairman: What about your risk?

  Professor Bean: Sorry? What risks do you mean?

  Q67  Chairman: Governor, tell him what you mean.

  Mr King: What risks do you see?

  Professor Bean: You mean to the outlook in general?

  Q68  Chairman: Yes.

  Professor Bean: Oh, to the outlook in general. The two big risks that we have talked about repeatedly this morning. On the one side pressing down on activity from events in financial markets, the credit crunch may be deeper and more persistent. On the upside, the risk of a de-anchoring of inflation expectations so that what we hope will be a short-term pick-up in inflation actually turns out to be more persistent.

  Ms Lomax: As usual, Charlie gives a model answer. In terms of adding to that, I think monetary policy has got quite a lot of room to respond to the present situation, so the question of whether it needs more support from fiscal policy is not at the top of my mind. The key thing is the longer term issues of fiscal sustainability, sticking to the rules, which has always been the point we have stressed when we have come to this Committee. There is no great problem about the relationship between fiscal and monetary policy at the moment. On risks, they clearly centre on the impact of the financial crisis. I cannot help thinking, and I cannot put my finger on it, that there is a relationship between what is going on in financial markets and what is happening to commodity prices, that somehow or other these two big risks we face are related in a way which is very difficult to quantify. It would all be much easier if the financial crisis were to subside and maybe take some of the pressure off commodity prices as well.

  Dr Sentance: I would agree with Rachel's assessment that we have got quite a lot of scope with monetary policy to move to respond to changes in the situation of the economy. The worry would come if you felt that fiscal policy was going to be working in an opposing direction to that or swinging around in an unhelpful way, and I do not see that on the basis of the projections we have got in the Budget. When it comes to risks, I think Charlie summed it up on the two main risks that we are facing. I would draw them together in an observation that I have made while I have been on the Committee that we have seen an awful lot of impact from changes in the global economy and we have seen a lot of global inflation coming through. On both sides of the equation I think we could see more impact from the global economy going forward both in terms of potential inflationary pressures, and we have talked about food and energy prices, but also if the global economy is more heavily impacted in general by developments in financial markets it could work in the opposite direction.

  Professor Blanchflower: I agree with what the others said on the fiscal policy. I prefer to talk about the risks. The difference between me and most of the members of the Committee in terms of the way the Inflation Report was written was my concern with risks to the downside, especially coming from the credit market. I guess from your earlier question, having seen what has happened in the US is that activity will drop dramatically and that would be something I do not want to see. My concern is that it is appropriate to take out some insurance and get ahead of the curve in the sense that the arguments made on the upside were that, but it seems to me those arguments apply on the downside too, so my concern would be one should make sure one is ahead of the curve so that later one is not in a position where something horrible happens, I do not want that to occur. My risks are to the downside and I have concerns that something horrible might come and I do not want that to happen.

  Mr King: Chairman, four excellent answers on which I could not possibly improve! The biggest risk facing the Committee, I think, is that the germ which has affected Rachel spreads to the whole Committee and when it meets in exactly two weeks from today it will have no voice at all!

  Q69  Chairman: Governor, you are back to see us next month and we will have a wider look at issues, so I look forward to that. Rachel, I hope we did not stretch your voice too much this morning.

  Ms Lomax: Thank you very much indeed.

  Q70  Chairman: Dr Sentance, we are seeing you immediately.

  Dr Sentance: I will stay behind!

  Chairman: Thank you very much.