House of Commons Treasury Committee

Bank of England February 2013 Inflation Report

Oral and written evidence

Tuesday 26 February 2013 Charles Bean, Deputy Governor, Monetary Policy, Paul Tucker, Deputy Governor, Financial Stability, Professor David Miles, Member, Monetary Policy Committee, Ian McCafferty, Member, Monetary Policy Committee, Bank of England

Ordered by the House of Commons to be printed 26 February 2013

HC 989 Published on 3 April 2013 by authority of the House of Commons London: The Stationery Office Limited £7.50

The Treasury Committee

The Treasury Committee is appointed by the House of Commons to examine the expenditure, administration, and policy of HM Treasury, HM Revenue and Customs and associated public bodies.

Current membership Mr Andrew Tyrie MP (Conservative, Chichester) (Chairman) Mark Garnier MP (Conservative, Wyre Forest) Stewart Hosie MP (Scottish National Party, Dundee East) Andrea Leadsom MP (Conservative, South Northamptonshire) Mr Andy Love MP (Labour, Edmonton) John Mann MP (Labour, Bassetlaw) Rt Hon Pat McFadden MP (Labour, Wolverhampton South West) Mr George Mudie MP (Labour, Leeds East) Mr Brooks Newmark MP (Conservative, Braintree) Jesse Norman MP (Conservative, Hereford and South Herefordshire) Teresa Pearce MP (Labour, Erith and Thamesmead) David Ruffley MP, (Conservative, Bury St Edmunds) John Thurso MP (Liberal Democrat, Caithness, Sutherland, and Easter Ross)

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Ev List of witnesses

Tuesday 26 February 2013 Page

Charles Bean, Deputy Governor, Monetary Policy, Bank of England , Paul Tucker, Deputy Governor, Financial Stability, Bank of England, Professor David Miles, Member, Monetary Policy Committee, Ian McCafferty, Member, Monetary Policy Committee

List of written evidence

1 Report to the Treasury Committee by Paul Tucker, Deputy Governor Financial Stability, Bank of England Ev 21 2 Report to the Treasury Committee by Charles Bean, Deputy Governor Monetary policy, Bank of England Ev 22 3 Supplementary written evidence submitted by Paul Tucker, Deputy Governor, Financial Stability, Bank of England Ev 23

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Treasury Committee: Evidence Ev 1

Oral evidence

Taken before the Treasury Committee on Tuesday 26 February 2013

Members present: Mr Andrew Tyrie (Chair)

Mark Garnier Mr George Mudie Andrea Leadsom Jesse Norman John Mann Mr David Ruffley Mr Pat McFadden John Thurso ______

Examination of Witnesses

Witnesses: Charles Bean, Deputy Governor, Monetary Policy, Bank of England, Paul Tucker, Deputy Governor, Financial Stability, Bank of England, Professor David Miles, external member of the Monetary Policy Committee, and Ian McCafferty, external member of the Monetary Policy Committee, gave evidence.

Chair: Thank you very much for coming before us with the ECB taking the primary role in supervising this morning. As you probably know from experience, systemically important financial institutions. the acoustics of the old part of Parliament is not quite Chair: Okay. You have four more. as good as the rest, so we would be particularly Charles Bean: Okay. The next four are all going to grateful if you can speak up for us. I hope that you be dealing with what happens when things go wrong. can hear us, Charlie. Can you hear? The second one would be a supplier of liquidity to Charles Bean: I am fine, thank you, just. banks that get into difficulty a lender of last resort and that clearly you do have in the form of the European Q1 Chair: You can hear only just, okay. Perhaps I Central Bank and the constituent national central can begin with a question to you, Mr Bean. What do banks. That is in existence. you think the essential ingredients of a banking union are and do we have one at the moment in the eurozone? Q4 Chair: What about the transfer of losses? What Charles Bean: Okay. I think I would identify five happens on the fiscal side? components. The first is a common supervisory Charles Bean: Let me just go through the list and I mechanism—regulatory arrangements—and think you will see how everything fits together. As far obviously there is discussion taking place at the as lender of last resort goes, central banks when they moment between members of the eurozone, and some are providing support lend against collateral so there other countries for that matter, on how to set that up should not be any losses associated with that. and operate it, and they are some way down that road. Q5 Chair: Sorry, before we go any further, what do Q2 Chair: Is that a necessary condition? you think about the quality of this collateral across the Charles Bean: I think so. Obviously, when you ask eurozone at the moment? Do you have any views about what is necessary for a banking union I am about the quality of that collateral? assuming you mean a banking union that we think is Charles Bean: I think it is reasonable to think that durable and works reasonably well. Some of the items the collateral has certainly been impaired, say, in the I am going to give you you may not have, in which periphery countries and that is an issue obviously that case you run more risk that the banking union may a central bank always has to take on board when it not function well. decides whether to provide support to a bank that is Chair: That is fine. I was just trying to check that we in difficulty. Essentially, will it get its money back? are not talking about what is desirable; we are talking about what is essential. Inevitably, that collateral, as I say, is going to be Charles Bean: I think they are sensible ingredients impaired in some countries at the current juncture. for a durable banking union. Chair: So that is the lender of last resort. Chair: I would like to talk about what is essential for Charles Bean: Lender of last resort. The third a durable banking union, only that. ingredient would be a suitable resolution regime for Charles Bean: Yes, okay. handling failing banks, winding them down, restructuring them or whatever. Now, the Financial Q3 Chair: We need a single supervisory mechanism? Stability Board has identified key attributes that you Charles Bean: Single supervisory— want in a good resolution regime. I think it is fair to Chair: Do we have it at the moment? say although Paul may correct me because he knows Charles Bean: No. As I say, that is the thing that the more about this than I do that it is not true to say that primary discussion within the eurozone is about. The all countries in the eurozone presently have resolution plan is to have something in operation probably regimes that are consistent with those key attributes. towards the end of this year or beginning of next year, But they are in the process of implementing them. cobber Pack: U PL: COE1 [E] Processed: [02-04-2013 16:06] Job: 028182 Unit: PG01 Source: /MILES/PKU/INPUT/028182/028182_o001_th_TC 26.02.13.xml

Ev 2 Treasury Committee: Evidence

26 February 2013 Charles Bean, Paul Tucker, Professor David Miles and Ian McCafferty

Q6 Chair: Just to be clear, we do not have that systemic financial concerns, but it is not something I either, yet? would regard as essential; desirable but not de rigueur. Charles Bean: Not yet, no, but that is in train. Q13 Chair: What we have here is five essential Q7 Chair: So, so far three essential ingredients, none requirements of which four and a half are missing? of them in place? Charles Bean: Well, I am not sure I would say the Charles Bean: No, the lender of last resort is. half. I think the lender of last resort— Chair: Of which four are not yet in place. Q8 Chair: You have not explained how this collateral Charles Bean: Not yet fully in place, some of them is going to be made effective in the periphery. in progress, but clearly well short. Charles Bean: Well, that is not a problem about the lender of last resort not being— Q14 Chair: When Mario Draghi says he will do whatever it takes to protect the eurozone, there is a Q9 Chair: Who is going to pick up the tab, Mr Bean? touch of the “wing and a prayer” here, isn’t there, Charles Bean: Okay, let me get to that in a minute. because he does not have any tools? The final two I think do connect with your concerns. Charles Bean: Well, his comment was particularly in The fourth item that I would identify is a common connection with the heightened concerns in financial deposit insurance scheme, and here you may need the markets that some countries would leave the eurozone ability to bring in funds from outside a country. A so that you were getting what is referred to as country that is in fiscal difficulty may not have the redenomination risk in those countries’ bond yields. wherewithal to provide the support to depositors Because if, say, a country like Greece exited, it would unless the deposit scheme has been prefunded. be highly likely that the new currency there would depreciate sharply, and that extra premium would be Q10 Chair: I am sorry to keep interrupting, but just built into the associated bond yields. Mario’s remarks for clarity—these are only questions for back in the middle of last summer were particularly directed at saying, “The euro is for keeps. We will do clarification—what we are really talking about here is what is necessary to take that redenomination risk off northern tier countries insuring Greek bank deposits? the table”. Charles Bean: In all likelihood, yes, or Cypriot bank deposits or whoever it may be. If the liabilities Q15 Chair: Do you think that a banking union is an associated with the banking system exceed the essential part of bringing stability to the eurozone? capacity of the Government to pay them, to make the Charles Bean: I think it is desirable. Where we are at deposit insurance scheme credible and, therefore, the moment, there is— discourage depositors from withdrawing their money, Chair: But not essential? Do you think that the people need to think there is a backstop there, which eurozone could be stabilised without a banking union? in this case, as you say, would need to be probably Charles Bean: Well, I would say it is very highly the northern countries. desirable. It would make it much easier to stabilise it. The final ingredient would be a mechanism for The reason for that is that there is a strong symbiotic injecting fresh capital into banks that have failed and relationship between the fiscal position of the need recapitalisation. Just as with the deposit periphery countries and the position of the banking insurance scheme, you may need a source of funds systems so that the banks often hold a lot of the outside for that if the country in question is in fiscal sovereign debt of those countries. So if the sovereign difficulties. goes bust those banks go bust. Equally, if the banks get into trouble, the sovereign has to provide the extra Q11 Chair: Do we have that? capital and so forth to restart the banking system. Charles Bean: No, certainly not at the moment, Somehow or other you want to try to break that “doom although there is the suggestion that the European loop” between the two of them. One way of doing Stability Mechanism should be able to provide that in that is a banking union where there is the possibility the future. Governments, particularly like Germany, of some injection of funds from outside that country. have been keen that those injections should not take place until other elements of the banking union, like Q16 Chair: You are saying it is very highly desirable a supervisory scheme, were in force. We are short of but not essential that we have a banking union in order that at the moment but, in principle, you have a to stabilise the eurozone? facility that could provide that. Charles Bean: Yes, very, very highly desirable.

Q12 Chair: The one item that was identified in a Q17 Chair: Now, we are not members of the recent IMF report on this subject that you have not eurozone, obviously. The reason that I am asking mentioned is a common macroprudential regime. You these questions is that the Bank of England has are thinking of that as something that is perhaps identified the eurozone as a key risk to UK economic desirable but not essential? growth and recovery. Given what you have said here, Charles Bean: Certainly, the way I would think about that a banking union is highly desirable to stabilise a banking union is to do with the micro supervision, the eurozone and that four of the five necessary the micro arrangements for the banking system. A ingredients for a banking union are missing, despite macroprudential overlay would be highly desirable. your natural sunny disposition, Mr Bean—not always The idea of macroprudential policy is it takes on board in evidence from the Bank of England—you would cobber Pack: U PL: COE1 [O] Processed: [02-04-2013 16:06] Job: 028182 Unit: PG01 Source: /MILES/PKU/INPUT/028182/028182_o001_th_TC 26.02.13.xml

Treasury Committee: Evidence Ev 3

26 February 2013 Charles Bean, Paul Tucker, Professor David Miles and Ian McCafferty have to come round to the view, wouldn’t you, that Chair: Okay, otherwise we will move on. you are a bit on the pessimistic side about its Professor Miles: Well, let me say one thing very prospects? briefly. I do think this is a tall order. If it is the case Charles Bean: Well, not necessarily because, as I that the banking union requires the provision have said, these countries are on the route to creating sometimes of outside capital to the banks of one a banking union, putting resolution regimes in place. country from some central pool, and if it requires a The supervisory mechanism discussions are taking single deposit protection scheme, which necessarily place with the aim of putting that in place by the end might involve big cross-border transfers of funds, I of the year. They are on track to do these things and think that is a big ask. clearly the sooner it is done, the better. Chair: It sounds like a race against time. Q20 Chair: Okay. What I have been trying to explore Charles Bean: Well, the nature of the problems in the is the bank’s overall view of the depth of risk eurozone is that these are not things that are going to associated with the eurozone that you have identified be solved overnight. This is a long haul back, but the in general terms in your quarterly reviews and in other sooner the preconditions are put in place, the more publications and, indeed, in speeches. I think we have likely we are to get out the other side without major some feel for this, but I am going to— disruption. Paul Tucker: It has receded somewhat but it is still there. Q18 Chair: Now, the body language of your three Chair: I am going to hand over to Andrea Leadsom. colleagues, two in particular, has struck me while you have been giving your very straightforward answers. Q21 Andrea Leadsom: Mr Tucker, it does seem to I would particularly like to give Mr Tucker an me that it is extraordinarily complacent the way that opportunity to say something, since he is at least as the bank for the last couple of years has always had a responsible for this area as any of the four of you. little rider with its inflation comments that this is all, There was a grimace at one point from Professor of course, subject to the problems in the eurozone, Miles, so I am going to give him an opportunity; then which are not going away. There has been a complete I am going to pass the questioning to Andrea failure on the part of the bank to give any scenario Leadsom. But first, Mr Tucker. analysis, in spite of the attempts of this Committee to Paul Tucker: Charlie has summed it up. I think your persuade you to do so. A very direct question to you: line of questioning is over-pessimistic about the you are saying that the eurozone has gone off on the determination among these countries in the monetary right path towards European banking union. Isn’t it union to develop a banking union. That is reflected in absolutely inconceivable that German taxpayers will our view of the fact that threats from the euro area to truly undertake the deposit insurance for Greek the UK have receded somewhat. As Charlie said, and depositors or, indeed, the bailout of Spanish banks I would underline this, there is a directive in an should it come to that? Isn’t it absolutely politically advanced stage of preparation on resolution that so far inconceivable? Isn’t that the sort of analysis that you is extremely good; it could get worse but so far it is need to be doing, as to how on earth they are going to extremely good. They have announced that once they make that happen? Isn’t it the case that the European have got that through, and that applies to all 27 banking union is only limited to a single supervisor member states, including us—the Chancellor talked because that is the only bit of European banking union to you about this in your other Committee yesterday that is politically acceptable within the eurozone? afternoon—they will launch proposals for a single Paul Tucker: You are probably better equipped than resolution authority and so on for the banking union. me to make the political judgments about— Why do I emphasise that? Because all roads lead back Andrea Leadsom: No, but the impact on the British to what happens when banks fail. Even with fiscal economy is fundamental. transfers, there are bank failures that would stretch the Paul Tucker: I am going to answer your question. I monetary union just as bank failures here have think you are better equipped than me probably to stretched the fiscal position in this country. A make judgments about political preparedness in necessary condition for a successful monetary union Germany. What I would observe is that they have is a banking union with a really good resolution already shown some willingness for transfer regime. More broadly, I would say strategically, payments. How far that goes, who knows? I think on monetary union will not be sustainable in the very the banking union they have announced that they are long run without a high degree of economic union. going to do more than the single supervisory The reason I think the markets have taken some mechanism. They are planning to introduce a reassurance since the announcements about the resolution regime for the banking union, which will banking union is that the markets take it as a signal go further than the 27 member state thing. that the members of the monetary union are prepared On what you say about the Bank, I do not think— to take steps, and more steps, towards fiscal union. colleagues will want to come in—at all we have been trying to hide the risks from the euro area. On the Q19 Chair: Okay. David Miles? contrary, the Financial Policy Committee has taken a Professor Miles: I am not sure what I was grimacing tough stand over the past year in saying to banks, at, but I do— “You must build up your capital and your resilience Chair: Do you have something you particularly want against the tidal wave that may be coming our way to say? from the euro area if it unravels”, which looked to be Professor Miles: Well, I do have one— a tangible probability in the middle of last year and cobber Pack: U PL: COE1 [E] Processed: [02-04-2013 16:06] Job: 028182 Unit: PG01 Source: /MILES/PKU/INPUT/028182/028182_o001_th_TC 26.02.13.xml

Ev 4 Treasury Committee: Evidence

26 February 2013 Charles Bean, Paul Tucker, Professor David Miles and Ian McCafferty somewhat beyond. As Monetary Policy Committee them as resilient as they can be against an members, can we put numbers on that and incorporate Armageddon in the euro area without in the process it in our fan charts? I think we would find that very making the path of recovery in this country worse. If hard to do. I think anybody would find that hard to the euro area falls apart, the most direct, unpleasant do. What we have been clear about is that we are not channel to this country would be from a collapse of going to go for spurious accuracy in our forecasts. the euro area banking system cascading into the UK Rather, we are going to say this is a major threat, it banking system. The UK banking system has made is not certain to crystallise, and we are doing things itself somewhat more resilient and we wait to hear elsewhere with our regulatory instruments to try to from the regulators in March at the next FPC meeting. protect the UK against those threats. I think that If the premise of your question is, we have said all including numbers in the fan chart—I doubt whether this is terribly risky and we have done nothing, that they would have satisfied you because you would could not be further from the truth. have said we were making them up. The other thing I would underline is that, compared with five or six years ago, when we would not as an Q22 Andrea Leadsom: Okay. Mr McCafferty, what institution have had the instruments to say to the do you think about the argument that it is impossible regulators, “You must do something about this”, this to disalign the politics of the eurozone with the is an example of the new regime announced in 2010 economics of the eurozone? Arguably, the survival of being used. the eurozone is about politics, not economics, because On your question about the extent to which we follow it is whether there is the political will for the northern the politics of this country, one of the things we have European countries to bail out the southern European. done—I have certainly been involved in leading this, In the end, if the markets push them to test that point, as has Charlie—is make greater use of the Foreign then we will find out, but that has a very profound Office than perhaps we did five or six years ago to impact, doesn’t it, on Britain’s economy? We are ensure that we can track the views of various different already seeing that the strength of the euro is actually potential outcomes in these countries. I do not think having a chilling effect on the eurozone’s economic any of you, with respect, would be able to predict recovery, which in itself has a chilling effect on the either the makeup of the German coalition, assuming UK’s economic recovery. Isn’t it the case, therefore, there is a coalition after their election, or indeed the that in this particular area the Bank of England simply commitments that may be given during the election cannot hide behind the idea that, “This is politics and campaign in Germany. Do we think the German we don’t do politics”? election will be tremendously important? Yes, I think Ian McCafferty: I do not think we are hiding behind it will be very important indeed. I hope it gets the the fact this is as much a political as an economic coverage that it warrants in the UK media. question. On Paul’s point about putting numbers to political questions, that is extremely difficult and is, Q24 Andrea Leadsom: Okay. Mr Bean, one final as it were, at the extreme edge of the risk fan chart question. Dr Carney wrote to this Committee saying that we put around the central projections. But I would that the Bank will need to support the Government as also agree with him that I think the risks of an it engages in efforts of the euro area to re-found the immediate break-up have receded over the course of European monetary union. What do you think he this year as a result both of the actions of the ECB means by that? How do you interpret that? and of the manifest choices of the political parties and Charles Bean: I should imagine that he means by that their electorates across Europe. It is clear that the that we play a full part in the European fora in which German electorate has been more willing to we are represented, although we interact with other countenance some fiscal transfers than was perhaps European countries. Obviously, the Financial Stability expected, certainly in this country a year ago. I think Board and the Basel Committee is one forum where that does mean that the immediate risks of break-up we are represented and we interact, and Paul can have receded, albeit that, as we have seen overnight, expand on that if necessary, but also in fora like politics is difficult to predict, certainly with the case informal ECOFIN meetings and things like that. We of the Italian election, and as a result risks still remain. are one of the people at the table and we can encourage our European partners to move faster in Q23 Andrea Leadsom: Mr Tucker, what analysis what we think is the right direction. have you done on the politics—for example, the forthcoming election in Germany—and the impact Q25 Andrea Leadsom: Do you think he is right to that that might have on policy that in turn affects the be calling for increased German private sector wages economy? What I am trying to get at here is, to what to ease the balance of payments problem? extent can you simply say, “This is a major threat” Charles Bean: Well, I was not aware that Mark had and leave it at that, “but we are not going to put called for actions in other countries, so you will numbers on it because it is too difficult”? Or, to what excuse me if I am not aware of that particular— extent does the Bank feel it ought to have a contingency plan in case the politics overtakes the Q26 Andrea Leadsom: But is it appropriate for the economics? central bank in one country to be calling for action to Paul Tucker: This idea that we have done nothing is be taken in another country? nonsense, with respect. We have been absolutely clear Charles Bean: It is perfectly reasonable, I think, for with the regulators that they need to ensure that the people to point out the consequence of imbalances. balance sheets of UK banks are strengthened to make We have imbalances at a global level between some cobber Pack: U PL: COE1 [O] Processed: [02-04-2013 16:06] Job: 028182 Unit: PG01 Source: /MILES/PKU/INPUT/028182/028182_o001_th_TC 26.02.13.xml

Treasury Committee: Evidence Ev 5

26 February 2013 Charles Bean, Paul Tucker, Professor David Miles and Ian McCafferty of the emerging markets and the deficit countries like both the current and previous Governor of the Bank the United States and so forth, and we have of England. We have to deliver over the medium term imbalances within the eurozone. One of the problems a low and stable inflation rate, but we have to be if you focus excessively on austerity as the solution mindful of the fact of causing undue volatility in to the countries that were in deficit and have fiscal output in the short term at the same time. I think the problems is you end up with insufficient demand issues are probably more acute, as we speak, than they overall. A sensible thing is also to look for an increase have been for much of the history of the MPC. The in demand in the surplus countries that have more circumstances are more difficult. Both inflation and room to manoeuvre. There are various ways that you GDP growth are more volatile currently than they might decide to go about doing that. I suspect the have been for much of that history. As a result, I think quote of Mark Carney that you are citing had the Bank has had to exercise that flexibility probably something to do with the desirability of realising that more explicitly over the course of recent years than it you need a two-handed approach to dealing with perhaps did five and 10 years ago. But I think the imbalances. It is not a case of putting all the weight Bank has always seen the mandate as one in which it on the deficit countries making the adjustments. That delivers stable inflation over the medium term but same argument applies at the global level, where the without delivering undue volatility in output. That, to imbalances that we had before the financial crisis, me, is the definition of flexible inflation targeting. which were partly drivers of that crisis, are still with us. They have narrowed to a degree, but that in my view largely reflects cyclical developments and the Q29 John Mann: You have fitted into the MPC’s fundamental problems still need to be addressed. consensus very quickly since your appointment. Paul Tucker: In this world of a single supervisory Before you were on, when I questioned the current mechanism centred on the ECB, we think that that Governor at this Committee there was no ambiguity provides a good basis for really good co-operation when I raised precisely this issue. The current between the Bank of England as supervisor and the Governor was adamant that there should not be a ECB as supervisor. Big picture, in the western world flexibility. There was a target and it was right that the there are going to be four big supervisors: the Federal target should be set. Reserve, the ECB, the Bank of England, and the Ian McCafferty: There is a target and we are Swiss. That is a somewhat simpler world than at the operating to that target, but the speed with which we moment, and we also think that with supervision bring inflation back to that target and the timeframe moving to the Bank of England and supervision in the over which we bring inflation back to that target banking union being centred on the ECB, we will be provides an element of flexibility. able to draw on excellent relations with the ECB to improve supervisory co-operation. Mark may have Q30 John Mann: Are you in favour of German had that in mind, too. wages increasing? Ian McCafferty: It depends for what reason German Q27 Chair: Before I move the questioning on to wages would be increasing. If they are increasing John Mann, is there anything you want to add to that, because German productivity has increased, then I Professor Miles? think it would be a very good thing. If it were simply Professor Miles: Just one thing on the eurozone to introduce inflation into the system, then no, I would situation. I think in some sense the risk of things going not be. badly wrong in the eurozone has already crystallised. Many of the economies are going backwards at a rate Q31 John Mann: What is your attitude to the labour of knots. Overall growth in the eurozone over the last year or so has been close to zero, so I do not think market constraints in this country? Do you think that this is a case of “Well, it could go wrong”. It has gone the labour market here is sufficiently flexible? wrong. I think the projections that we have made in Ian McCafferty: Sufficiently flexible for what the Inflation Report are based on the assumption that purpose? growth remains very weak and anaemic throughout John Mann: Sufficiently flexible for growth into the the next few years. future. Paul Tucker: That is in the fan chart. It is the tidal Ian McCafferty: Yes, I do. In terms of the legislative wave Armageddon risk that is not in the fan chart. and regulatory framework, I think we have a very flexible labour market and I think that has been Q28 John Mann: Mr McCafferty, we have learnt that demonstrated by its performance over the course of you are not a hawk and you are not a dove. I the last decade or more. What I have suggested in my wondered whether you are a flexible inflation- recent speech is that there may be some changes in targeting man. the behaviour of individual companies who are Ian McCafferty: I am an inflexible or flexible? perhaps more mindful now of the value of individual John Mann: Flexible. workers and the skills that those workers can acquire Ian McCafferty: I think I, along with the rest of the over the course of a long period with an individual committee, am a flexible inflation targeter. I think the company, which makes firms reluctant to part with Bank and the MPC has been a flexible inflation labour even when demand is weak. I would not targeter since its inception nearly 20 years ago now. necessarily say that that is a significant reduction in From that point of view, I think I would refer back to overall flexibility. That is probably a good thing for some comments that have been made in the past by the long-term health of the economy. cobber Pack: U PL: COE1 [E] Processed: [02-04-2013 16:06] Job: 028182 Unit: PG01 Source: /MILES/PKU/INPUT/028182/028182_o001_th_TC 26.02.13.xml

Ev 6 Treasury Committee: Evidence

26 February 2013 Charles Bean, Paul Tucker, Professor David Miles and Ian McCafferty

Q32 John Mann: Do you think it would be a interpreted now, or should we think of this as a problem for the approach of the Monetary Policy longer timeframe? Committee if the labour market here became less Professor Miles: I am not sure the two-year horizon flexible? has ever been quite so clear. It certainly is not part of Ian McCafferty: To the extent that it would increase the remit. the natural rate of unemployment and, therefore, Chair: I do not have the quotes in front of me, but I worsen the trade-off between the level of can assure you Mervyn King has given statements to unemployment and the performance of the labour this Committee to that effect. market and the prevailing rate of inflation, yes. Professor Miles: Well, the remit, which I do not think has changed materially—maybe not changed at all in Q33 John Mann: That answer is predicated on a the relevant parts—has always said that if inflation British labour market, but of course, as we have seen moves away from the target level because shocks have repeatedly, large numbers of the new jobs being taken it either above or below, then it would not make created have been filled flexibly by the European sense for the Monetary Policy Committee to try to labour market. Can you conceive of economic come back to target in the shortest possible period. problems should we move out of the single European Because that could involve enormous swings in market, in terms of labour mobility? monetary policy, which would generate enormous Ian McCafferty: On balance, I would argue that that swings in the real economy. There was never in the freedom of movement across borders over the course of the past few years has been beneficial to the UK remit any statement about, “And two years is the economy in allowing new skills and filling jobs where appropriate horizon”. I think I am right in saying that there has been demand. I think, yes, were we to move until about 2004, it was the case that the fan charts in out of that degree of flexibility cross-border, then I the Inflation Report tended to go two years ahead. I would be concerned. think from 2004 that was extended out so that we showed three years. But that was not a sign that Q34 John Mann: If we were to pull out of the single somehow the right horizon moved from two to three market, the more than whispers we hear from years. I think it is a matter of judgment what the trade- American and Japanese business people is that they off is between trying to move inflation back in a very would look at investments here. That is one issue, but short period, as opposed to over a slightly longer labour market flexibility is another. There is the period. It depends very much on the reason why political issue of whether we are in the European inflation may have moved away from it. Union, but the European single area is a separate factor—i.e., direct access to the single market. Can Q37 Chair: Okay. What is your judgment on that you conceive of a situation where we could leave both question? the European Union and the European single area and, Professor Miles: At the moment, the central forecast therefore, be outside the single market? is that inflation is near the target level in 2–3 years. It Ian McCafferty: I am not quite sure what you mean is somewhat above it two years ahead but pretty much by can I conceive of this. Clearly, that is a political at it by the end of 2015. To my mind that is consistent decision on the part of both the electorate and the with the spirit of the remit. Now, if you focus just on elected Government and I am not going to comment the two-year-ahead horizon—so, the first quarter of on that as a hypothetical future solution. I think that, 2015—the single most likely outcome is that inflation, to the extent that we have that flexibility in both our from memory, will be 2.3%, 2.4%, something like employment market and in the extent of investment that. Although there is a chart—I have it here on page flows, these are both of benefit to the UK economy. 41 of the Inflation Report, chart 5.5 which shows the probability that inflation is above or below the 2% Q35 John Mann: How would you summarise the level of different horizons. If you take the two-year impact, were we to be outside the single market—in point, roughly speaking, it says that our judgment is other words, outside the EU and the European single that there is about a 55% chance we are above 2% area? What is the economic impact of that happening and 45% chance that we are beneath 2%. So it is not within what would be the end of the current economic 50:50. That does not happen until a little bit further cycle, 2017? down the road. My own interpretation of that chart is Ian McCafferty: I am not going to speculate on any that that profile is consistent with the spirit of the timing of any change in our relationship. As I have said, I think that the benefits both to the labour market remit we have been given. and to the flows of FDI are beneficial. Charles Bean: Can I—

Q36 Chair: Professor Miles, could we have your Q38 Chair: In a second. I just want to clarify what views on flexible inflation targeting? That flexibility, Professor Miles is saying. You are implicitly saying reflected in the timeframe over which inflation has there has not been any change in the interpretation of been brought back to target, has always been the horizon over which inflation is to be brought back interpreted under cross-examination before this to trend, as far as you are aware, since 2004? Committee as two years, partly on the grounds, no Professor Miles: That is correct. I just speak for doubt, that that is the time it takes conventional myself. Having looked carefully at the remit, I have monetary policy to feed through, or most of it to feed not changed my interpretation of what that made through. Do you think that it is still two years as acceptable and unacceptable. cobber Pack: U PL: COE1 [O] Processed: [02-04-2013 16:06] Job: 028182 Unit: PG01 Source: /MILES/PKU/INPUT/028182/028182_o001_th_TC 26.02.13.xml

Treasury Committee: Evidence Ev 7

26 February 2013 Charles Bean, Paul Tucker, Professor David Miles and Ian McCafferty

Q39 Chair: Therefore, when we hear all this talk Chair:—and therefore, you are agreeing with about flexible inflation targeting, there has been no Professor Miles that all this press talk is a storm in background briefing going on to the press and this has a teacup? all just been a bit of a press storm in a teacup? Charles Bean: Yes. The one rider I would add is that Professor Miles: I have always thought that the remit you can have a legitimate debate, and this is a policy defined flexible inflation targeting and that remit has judgment, about how much flexibility you want and not changed. what sorts of shocks you might be willing to accommodate. That is a real issue. Q40 Chair: You are answering yes to that question of mine? Q43 Chair: We may well come on to that in just Professor Miles: That there has not been a change? a moment, but Mr Tucker was particularly eager to Chair: That the press talk about all this was a storm get in. in a teacup? Paul Tucker: The 2004 change, which I was part of, Professor Miles: I think so, yes. was significant. We wanted to disabuse the world of focusing overly on two years. My recollection is that Q41 Chair: Okay. Now everyone seems to want to sometimes, inflation was projected to be a round target chip in. Quick remark from Mr Bean and then Mr of two years but the slope was upwards or downwards. Tucker. Well, of course, that means that the horizon was not Charles Bean: Let us get this absolutely clear. The two years because we were effectively projecting that notion of flexible inflation targeting has been around it was going to depart from target off-screen, as it a long time, right since pretty much the birth of the were. The 2004 change was very significant. I was inflation targeting regime. The Governor in his speeches often talks in terms of constrained discretion particularly keen on it to get away from any but it is essentially the same thing. The idea is present obsessive thing. in the academic literature from the 1990s describing This point about being flexible inflation targeters has how to operate an inflation targeting regime. The two- to be repeated over and over again, and the language year thing I think really came about almost by changes from one generation to the next. The way accident because in the early days of the regime we Eddie George put it was in terms of not being inflation wanted to emphasise that there was very little we nutters. The way Ben Bernanke and Mervyn talked could do to affect inflation today. You could only about it was in terms of constrained discretion. Today affect inflation further down the road because it takes the popular language has become flexible inflation time for monetary policy to affect demand and then targeting. Do not get seduced that there is anything for the changes in demand to feed through into significant going on. inflation. Now, if you just have one-off cost shocks, The third point I would make is that, far more they have typically passed through the system by a significant than what we are projecting now in taking couple of years. The circumstances at the moment are roughly three years, we allowed inflation to go to 5%. slightly different because some of the cost shocks that We could have squeezed that out of the economy by we are being subject to and particularly in this area of pushing the economy into a deeper recession. I said administered and regulated prices will take longer to to you before, this was the biggest judgment I think pass through because they apply not just to this year. we have made since the committee started and it We know they are going to recur next year and should assure everybody that we are in today’s possibly a little bit beyond. So it makes sense to be language flexible inflation targeters but without ever, thinking about bringing inflation back rather longer. ever taking our eye off medium-term inflation Certainly, I have never subscribed to the view that expectations. None of this, I trust, is resiling from a there was something magic about two years. The commitment to sound money and that is the thing of whole reason that we introduced the extra year on to which you need to be repeatedly assured. the forecast back in 2004 was precisely to try to get people away from focusing rigidly on where our central projection was two years out. Q44 John Thurso: Can I come to you, Mr Bean? I In a number of speeches before the financial crisis, I particularly want to ask a couple of questions on your talked about whether monetary policy should lean annual report, but I will start—because we have just against the wind of a building credit asset price brought it up—with the point that you made: bubble, and made precisely the argument that it may “Inflation has been subject to further adverse shocks, make sense consciously to undershoot an inflation including much larger than expected contributions target if it improved your chances of hitting it further from university tuition fees and from other down the road. ‘administered and regulated’ prices.” Were you surprised by those changes to these prices? Q42 Chair: That is another big question but— Charles Bean: Which ones particularly? Charles Bean: It is a very big question. John Thurso: Well, either or all of them. Chair:—just to be clear on the first point, you are Charles Bean: Okay. As far as the university fees go, saying there was always two to three years since 2004 the effect turned out to be bigger than we expected. built into this? Now, we obviously knew that the tuition fee increases Charles Bean: Yes. were coming in, but what we did not know was Chair: That has not changed a scrap— precisely what the mix of the student population was Charles Bean: Yes, and actually— going to be between different fee categories. cobber Pack: U PL: COE1 [E] Processed: [02-04-2013 16:06] Job: 028182 Unit: PG01 Source: /MILES/PKU/INPUT/028182/028182_o001_th_TC 26.02.13.xml

Ev 8 Treasury Committee: Evidence

26 February 2013 Charles Bean, Paul Tucker, Professor David Miles and Ian McCafferty

Q45 John Thurso: How far apart was the reality would contribute something like half a percentage from what you were estimating? point, maybe a little bit less, to inflation. Over the next Charles Bean: It first came in around November, I year or two we expect they are going to be guess, so, corresponding to the September RPI—but contributing about one percentage point, so that is half that was significantly higher than we had expected. As our target. It is a reason why you would expect I say, it was not down to not knowing what the levels inflation to be running a bit above the target. But it of tuition fees were, but we did not know what the would not be a justification for inflation being 5%. student mix was going to be until the students actually turned up. Q49 John Thurso: We have heard I think every year since I have been on this Committee something of that Q46 John Thurso: With regard to the administered nature. I just wonder, if I can ask the Michael Fallon and regulated— question, at what point do we arrive at the point where Charles Bean: There are a number of things there, you are saying, “Well, actually, there are these like sewerage services and so forth, but I think the changes every year and, therefore, we ought to say it one that has, if you like, been news to us recently has is not a medium-term but a long-term problem”? been energy and utility prices. Obviously, we have Charles Bean: The unfortunate thing about the last recently had bigger increases than those in the past, five years is that the shocks have been predominantly but that has generally been driven by the wholesale in the upward direction. It is perfectly reasonable to price of energy—oil and gas—on the world market. think there will be times when they are going in the This time there were also other increases, things like other direction, and some of the shocks within this the cost of transmission networks, distribution period—the original cut in VAT, the start of the networks, which are contributing significantly. From financial crisis and when oil prices collapsed in what we have been told, they are going to continue to 2009—obviously did go in the other direction. But contribute over the next year or two. As I say, that is overall, the last five or six years have tended to be news to us relative to where we were six months ago. characterised by a sequence of different upward shocks. I think where you get into difficult territory is Q47 John Thurso: These are all things that from the if you have a shock that you know is going to keep outside one might say had a degree of predictability, on recurring year after year. Arguably, we did have a in the sense that we knew tuition fees would have an shock of that variety in the pre-crisis period that is impact but, as you have explained, it was the degree still having some effect, and that is the downward of it that was the surprise. But we know about the pressure from access to cheaper manufacturers from work that has been done on transmission charging and the emerging markets, especially China. The question the upgrading of the system and so on. The question then comes in the inflation targetting regime we have; that is behind that is, to what extent do these things if you have that repeated shock, should you be saying, come as a shock and to what extent should we actually “I am going to keep on looking through it” or should be looking to say there are always going to be things you say, “Well, actually, in these circumstances I like this? Does this not call into question the should be aiming to hold inflation at 2% and ensure fundamental forecasting? the other wages and prices adjust in the economy Charles Bean: Well, first, you do not know how the appropriately”? energy companies are necessarily going to respond to that increase in cost. Even if you know something is Q50 John Thurso: Can I turn to the second question going up, they may well absorb it in terms of lower I wanted to ask you, which comes from your last margins. Now, we talk to the energy companies so paragraph explaining monetary policy? In May last we get intelligence from them. As soon as we learn year you made one of your speeches that was entitled, something from them we can incorporate that in our I think, “Pension Funds and Quantitative Easing”. You forecasts. Obviously, the staff try to keep ahead of the were really seeking to address the question of whether game on these things as much as they can. But one QE is having a negative impact on pension funds and has to admit that there are times when we find out broadly you came to the view that it is not. We have something and think, “Oh, maybe we should have recently had considerable evidence from people discovered that a little sooner”. representing pensioners complaining fairly bitterly about the impact. Do you think they are wrong to be Q48 John Thurso: The reason I raise this is, if you complaining to us about that? take your paragraph about the picture generally as it Charles Bean: First, I should clarify what the starts off, there is this one sentence that really picks conclusion of that speech was. One of the things I out these things: “further adverse shocks, including wanted to do in that speech was draw attention to the much larger…” fact that QE affects both sides of the pension fund Charles Bean: Well, that is because it is relevant at balance sheet. the current juncture. It is not as big a disturbance, John Thurso: Yes, you made the point that where obviously, as those huge movements in oil prices that you start from has a big impact on where you end up. we have seen. The price of oil during the last five Charles Bean: Absolutely. There is no dispute that years has been between $35 a barrel and $145 a barrel. for a pension fund that is in significant deficit, the Sterling has fallen 25%. That is a huge shock. Now, downward pressure on yields that has been associated the administered and regulated price bit is not the with quantitative easing will have worsened that same order of magnitude. Normally, these deficit. Basically, those pension funds are short of the components, which are about 16% of the basket, assets that they need. They have to pay more to cobber Pack: U PL: COE1 [O] Processed: [02-04-2013 16:06] Job: 028182 Unit: PG01 Source: /MILES/PKU/INPUT/028182/028182_o001_th_TC 26.02.13.xml

Treasury Committee: Evidence Ev 9

26 February 2013 Charles Bean, Paul Tucker, Professor David Miles and Ian McCafferty purchase those. I want to stress I was not disputing Charles Bean: Yes. Basically, you have to get the that fact and the sort of numbers that I came up with money to— are in the same ballpark as the National Association John Thurso: Well, we have started, have we? of Pension Funds, but I think it is very important to Charles Bean: But that is the way you get it there. try to unpick movements in deficits that might be And then you can envisage this as being, okay, the associated with quantitative easing from movements first leg that is financed by selling some Government in deficits, say, that might have resulted from the big bonds. Then we the Bank go and buy the Government collapse in stock prices that happened around the start bonds on the secondary market in exchange for the of the financial crisis. money that we create. We are exchanging bond liabilities for monetary liabilities of the state, Q51 John Thurso: Among the pensioners rather than essentially. So any action of this sort you can always pension funds, of course, the complaint is that the split into what is essentially a fiscal action and a particular problems arise when you are converting to financing action we do the financing bit with QE. If an annuity at this time because you will get a you like, you can think of us financing a large chunk particularly bad rate. We now have far more of the budget deficits in recent years—there has been pensioners than we have ever had before and they some temporary monetary finance that has gone along were until five or six years ago a major boost to the with them but which we will unwind in due course. economy. People in marketing were writing books But the real issue for you is, do you want to do the about the grey panthers and the amount of money they first leg and, if so, is an increase in tax allowances the had to spend. That is a consuming force that is being most sensible thing to do? One of the things that we quite severely constrained. In the light of that, should know is, if you have a temporary increase in people’s we not have some concerns about the suppression of income, they tend to save most of it. So it is probably that purchasing power? not a very effective way of getting the economy going. Charles Bean: First of all, the bulk of pensioners But as to the question of whether there should be more were already retired. They will be drawing their fiscal action, that is up for you and the Chancellor pension already and in some cases they will be to decide. holding assets—bonds, equities—which would actually have gone up in value. They could actually Q54 John Thurso: This is what I am afraid of. have been made better off. The group you might have Helicoptering money would be a Treasury call, not a more concern about are the people who started Bank call? drawing their pensions during the last couple of years. Charles Bean: Yes, absolutely. The first leg of it is You are exactly right that their annuity rates are lower. the Treasury’s. But whether they are made worse off or not depends Chair: The King helicopter then is still under— on how they had invested the assets that they are John Thurso: Is an Osborne engine. converting into an annuity in the first place. If they had been invested in a mix of bonds and equities, Q55 Mark Garnier: Mr Bean, if I can carry on with roughly speaking the two effects offset. That is, interest rates and just start very quickly with this broadly speaking, what our estimates suggest. Now, Moody’s downgrading that we saw on Friday. Just most pensioners drawing the annuity probably do not prior to the downgrading the 10-year bond yield was really associate the movement in the value of their 211 basis points and obviously it has now been pension pot with our monetary actions, but they do downgraded and the market is suggesting that we are associate the declining annuity rate. So they see one now actually at 201 basis points so, in fact, the bond side of the picture and not the other. yield has gone down arguably on the back of this. What are your thoughts about what is going on? Q52 John Thurso: The final point, which is slightly Charles Bean: The downgrade is largely a reflection off piste but is along the same lines, concerns the of the economic developments in the economy. I do concept of financed fiscal deficits, obviously relating not regard it as being a great deal of news in and of to Adair’s speech last week, which I read with great itself. It is obviously significant in the political sphere, interest. To what extent ought we, instead of trying to but in the economic sphere the impact of stuff string up a pipe with QE, actually start pouring disappointing growth, a slightly worse fiscal position money down the pipe with helicopter money? than the Government expected and so forth—that was Charles Bean: I think there is some woolly thinking already being gradually discounted into Government in this territory. I am not suggesting Adair was one of bond yields. The markets largely have been expecting them but— a downgrade and possibly other ratings agencies may John Thurso: I am quite happy to admit to woolly follow suit. This is, of course, just one notch; there thinking. I have done it all my life. are a lot more notches to go. But the actual downgrade Charles Bean: No, helicopter money was an itself from an economic perspective. I do not see as intellectual experiment that Milton Friedman adding anything new. introduced to make a theoretical point. In practice, if you wanted to do helicopter money in the real world, Q56 Mark Garnier: In itself. I am just slightly more an increase in tax allowances would be the natural interested in the fact that we have seen a 10-basis way of doing it. point fall in the gilt yield in a day and a half. Charles Bean: Basically, gilt yields and the exchange Q53 John Thurso: This would be the personal tax rate have bounced around in the last couple of days. allowances? After the Moody’s announcement yields went up and cobber Pack: U PL: COE1 [E] Processed: [02-04-2013 16:06] Job: 028182 Unit: PG01 Source: /MILES/PKU/INPUT/028182/028182_o001_th_TC 26.02.13.xml

Ev 10 Treasury Committee: Evidence

26 February 2013 Charles Bean, Paul Tucker, Professor David Miles and Ian McCafferty the exchange rate fell. Just today on the back of the process carefully to avoid the markets overreacting. It Italian elections it has all been reversed. is likely that we will unwind our purchases over a relatively long period. We are not going to try to sell Q57 Mark Garnier: No, fair enough. Just getting all the gilts back within the space of three months or back to the low interest rates and the effect of QE, Dr anything like that. It will be over probably an Ros Altmann recently came before us and she was extended time period. arguing that the effect of QE is to reduce the risk-free rate to next to nothing, thereby inducing people to Q61 Mark Garnier: None the less, if the market make fairly peculiar decisions as to what is a good perceives you as being in the process of unwinding return and possibly go into quite risky assets in order QE, then it will try to predict it and that— to try to seek yield. Do you think she has a point? Charles Bean: Indeed, and that is why our Charles Bean: She has a point in the sense that that communication and our messaging will be very is how QE works—the whole idea. important leading into that, in that we will need to signal clearly to the markets when we are moving in Q58 Mark Garnier: But is it artificially adjusted that direction, giving clear signals about the pace at risk? which we expect to do this. You are absolutely right Charles Bean: I would not say artificially. What we that there is an issue here that we will have to deal are doing is changing the composition of the state’s with. liabilities in a way that drives down long-term interest rates and encourages investors of all sorts to move Q62 Mark Garnier: Of course, not only will you be into riskier assets. What we have at the moment is, if competing with the markets that are going to be trying you like, excessive risk aversion, so by undertaking to predict what you are doing, you are going to be QE we are leaning against that. Now, it is quite competing with the Government, who also have to go reasonable to have concerns. You do not want to push into the gilt markets. Paul Tucker, do you want to— it too far and end up generating something that creates Paul Tucker: You are absolutely right. The lesson problems when it unwinds. So that is obviously from 1994, which it should be remembered not only something we look at very closely. Also, you would caused a dislocation in bond markets but almost get very worried if it was generating a build-up of caused some of the largest financial institutions in the leverage as people were trying to exploit yields world to fail—not on this side of the Atlantic—is a elsewhere. We have not seen that. What we have seen salutary tale. The lessons are, as Charlie said, to so far, we think, is largely a plain vanilla switch into communicate clearly so that people do not overreact. riskier assets. These are things like corporate bonds. We can make errors the other way as well. Looking We do not have a move into really risky assets, but back to a decade ago, if one signals that one is going corporate bonds, equities, so reducing the cost of to move in super slow motion when the economy finance to businesses. That is how we are trying to warrants something else, one can store up trouble as stimulate demand in the economy. well. The other substantive thing I would add to what Charlie said is that the supervisors are going to have Q59 Mark Garnier: Okay. You are encouraging to be aware of what interest rate risk positions the people to try to look for riskier assets? banks and the other key players have. That was the Charles Bean: Yes. That is how it works. thing that should have been understood in 1994 and it was not. Q60 Mark Garnier: She also argued that—Paul Tucker, I am quite interested in your views on this— Q63 Andrea Leadsom: I just wondered, Mr Tucker, because you have this artificial depression of yields at what you would say to Dr Ros Altmann’s assertion the moment, when it goes back to a period of that according to surveys of the over-50s, QE’s impact normalcy, if you like, it is more likely to snap back on them has been to persuade them to save rather than rather than go back in a controlled sort of way. Given spend. Is there a risk, or have you ruled out the risk, the fact that we have £1.46 trillion, I think, of that QE has in fact stifled consumption in some way? household debt, clearly that is going to have a very Paul Tucker: I think that without QE in 2009, the severe impact on households. Again, what are your economy would have sunk away in a desperate way thoughts about how things are going to go back to a and that would have been hugely damaging to savers. period of normalcy, if you like, and do you think that I think QE has helped over the past couple of years there is significant risk for households? as well. It has brought down the cost of capital and Charles Bean: On the final point about it having a it has underpinned wealth, and net, that has been a large impact on household debt, that is not so obvious positive thing. because most households are not borrowing over 20 years. Their interest rates are determined by the much Q64 Andrea Leadsom: But we need consumption, shorter end. The generic point here about what don’t we? happens as we move towards withdrawing the Paul Tucker: We do need consumption, but we also stimulus is an important one. All central banks that need net trade as well, even more. The most obvious have been making these large-scale asset purchases reason for arrested recovery is where you began, are aware of the risk of getting a sharp snap-back in which is a huge threat during last year from the euro the yield curve. The example that is regularly given is area that diluted the traction that monetary policy what happened in the United States in 1994. What that could have. We were affecting the financial markets means is that we will need to try to manage that in a powerful way. That was not being transmitted cobber Pack: U PL: COE1 [O] Processed: [02-04-2013 16:06] Job: 028182 Unit: PG01 Source: /MILES/PKU/INPUT/028182/028182_o001_th_TC 26.02.13.xml

Treasury Committee: Evidence Ev 11

26 February 2013 Charles Bean, Paul Tucker, Professor David Miles and Ian McCafferty into spending. Why not? All monetary policy, every of the committee advocated cancelling the gilts that instrument we have, is trying to get somebody else to you bought under the asset purchase facility? As I spend: households or businesses. If they, to use understand it, the reason that would not work is that, slightly extravagant language, think that the world were you to cancel those gilts that you hold, rather might be about to come to an end, they squirrel some than unwind the position by selling them back, you money away or defer investment. I think, as I said in would reduce the tool for tightening monetary policy; my annual essay to you, that with the euro area risks and secondly, you would still have an ongoing liability having receded somewhat, the QE we have done can to pay interest on the reserves that had been created. gain traction and help a recovery in spending. I wrote That would logically mean you either hold the interest that, of course, before the Italian election results and policy rate at zero—not very likely—or you have to we will have to see just how potent an effect they create more electronic money to satisfy the interest have on markets and on sentiment. you owe to the banks in question. Paul Tucker: That is right, yes. Q65 Chair: Just on a very closely related point, what Mr Ruffley: I understand that, but has anyone on the are the risks of a currency war, Mr Tucker? committee ever articulated that as a way of easing Paul Tucker: We must avoid them. We must avoid policy into the future? slipping back into protectionism. We must avoid Paul Tucker: Not that I recall. I stand subject to balkanisation in global finance. We must avoid beggar correction by others, but not that I recall. I think it thy neighbour policies generally and, as Mervyn has would be a stunt, and, for the reasons that you say, if said overnight in Tokyo, we can avoid all of these you did it on a grand enough scale we would go bust. things as long as central banks around the world— Mr Ruffley: Yes. That is why it was a clarification and other policy makers—stick to their domestic price question. stability objectives. The most important choice about Paul Tucker: Which on the whole would be a very monetary policy in this country over the past 20 years bad thing. has been to have a domestic price stability objective, Mr Ruffley: Yes. rather than an external anchor. That is what we did Charles Bean: I have certainly put exactly the when we came out of the ERM. That is what we have argument that you have just made in one of my been given to do and we must do that and nothing speeches. else. When you ease monetary policy, when you are expected to ease monetary policy, that will have an Mr Ruffley: Yes, on 31 October, I remember. effect. Charles Bean: Yes. There is one other thing that is tremendously important and that I fear has had some effect— Q68 Mr Ruffley: The second question is for you, modest—over the past few weeks, but which we must Professor Bean. It concerns the point you raised about be very careful about. If either we or other central helicopter money. Am I right in thinking that, to your banks signal that we are going to tolerate a higher knowledge, neither you nor any other member of the level of inflation permanently—if we were to MPC has discussed the fiscal proposition which would somehow lead the markets to think that we like 3%, be part of a helicopter drop? That is to say, have you and that is what it is going to be—then yes, you will spoken to Ministers or are you aware of anybody find a fall in the exchange rate. But it will be a fall in speaking to Ministers about that fiscal part of the the nominal exchange rate only. It won’t be a fall in equation? the real exchange rate and it will do absolutely Charles Bean: I certainly have not. nothing for the recovery in that trade. Mr Ruffley: You haven’t. Our ability to conduct monetary policy in a way that Charles Bean: I can only obviously talk from my own is helpful to the economy and helpful to the recovery personal discussions. Others here may meet people. depends absolutely on our commitment, and belief in They may have had discussions. I somehow doubt it, our commitment, to sound money, which means a 2% but— inflation target over the medium run, and we need to be immensely careful when we talk around the world Q69 Mr Ruffley: Perhaps just very quickly, because about these things that that is not put into question. we have just under half of the MPC here. Have any of you, other than Professor Bean, discussed Q66 Chair: So, just to be clear, there is no tacit helicopter drops in the terms that Professor Bean policy or acceptance of a real sterling devaluation? described it: that there would have to be a fiscal Paul Tucker: No, no. What there is is that, on the one judgment to cut taxes, which is clearly nothing to do hand, we say, as a matter of analysis, that we believe with the Bank? Have you aired that, Professor Miles, that the real exchange rate needs to fall compared to with current Ministers? where it was a few years ago to get the necessary Professor Miles: No, and I completely agree with the rebalancing in the economy. As a matter of policy, analysis of Charlie Bean on what helicopter drops when we set our instruments we are trying to achieve mean. I did talk about it at some length, actually, in a a 2% inflation target over the medium run, without speech I gave last year the Scottish Economic Society exacerbating the recovery in the near term. lecture in the middle of the year. I pretty much said what Charlie just said. I quite agree with his analysis Q67 Mr Ruffley: I would like to begin by asking two on this. clarification questions. The first relates to QE and is Mr Ruffley: Yes. Any discussions with Ministers for Mr Tucker. To your knowledge has any member about— cobber Pack: U PL: COE1 [E] Processed: [02-04-2013 16:06] Job: 028182 Unit: PG01 Source: /MILES/PKU/INPUT/028182/028182_o001_th_TC 26.02.13.xml

Ev 12 Treasury Committee: Evidence

26 February 2013 Charles Bean, Paul Tucker, Professor David Miles and Ian McCafferty

Paul Tucker: If I may say so, on the one hand it is the markets for working capital finance in this country important that analysis of all kinds is out there. On are not as healthy as they were a generation ago. Now, the other hand, I think we need to make it clear that in old-fashioned speak this was the bill of exchange, we are committed to sound money, and the reason I and I do not want to be represented or represent say this is as follows, and this is consistent with what myself as saying, “Let’s go back to the bill on Charlie said. One version of helicopter money is— London; 1870 was absolutely tremendous”. But I do well, the core idea—the Government pursues a fiscal think—and I called last spring for bankers and expansion and we finance it with the printing of corporate treasurers to work on this—that the money. So the important question is: who decides authorities and the Bank could play a role in that. The what? If the Government decides on a fiscal lifeblood of working capital finance to medium-sized expansion—any Government—and orders us to print firms, at least, for around a century was a trade finance the money, then that is abandoning the current instrument that was transferrable and marketable, and monetary regime, and do not expect the markets to that we would buy. There is so much debate about react pleasantly. That will be taken as an abandonment the Bank of England not being prepared to lend to of sound money. companies. That is not true. We are lending to The alternative political economy outcome is a companies via the FLS. I would simply like to explore Government wants to undertake a fiscal expansion and whether or not some kind of working capital finance have it financed with the printing of money, and we instrument could be rejuvenated. say, “Oh, we’re not going to print that money. We’ll I do not have a plan in my pocket for how this should only print it up to, such and such” and everybody feels be done. My years of being the markets director are that that is the Bank of England telling the behind me. But I would like that to be debated. Government what its fiscal strategy is. The final thing I would say—and I think it is Q71 Mr Ruffley: It is a very interesting answer, tremendously important—is that things have to get because what took my eye in the February minutes much, much worse before any of these ideas are even was exactly this point: that consideration of measures remotely serious, and before that debt financed fiscal to support the flow of credit more broadly, including expansion would be contemplated by almost any from non-bank lenders, was also warranted and it Government, rather than printing money to have a seems to me— fiscal expansion. I am not advocating that that should Paul Tucker: That is a reflection of something I said. be the case now—I want to make that absolutely Mr Ruffley: But I just want to clarify it. clear—but in the interests of filling out the analytical Paul Tucker: Absolutely. I am not just saying this space, there is a risk that the market and you, as to you. Parliament, and the public are misled as to where the policy debate is and should be at the moment. Q72 Mr Ruffley: But these are in the minutes, rather than it being a personal and brilliantly articulated Q70 Mr Ruffley: That is very helpful, and for the view. But what more work is the Monetary Policy avoidance of doubt neither of those two positions on Committee going to do in relation to that, perhaps, cancelling gilts or helicopter drops are positions I Professor Bean? It seemed to be an MPC view that advocated. I said they were clarificatory questions, this should be explored—consideration of measures. and your responses have been useful. Charles Bean: No, it was part of the discussion. We Could I turn to credit flows to the economy and had quite a wide-ranging discussion of various funding to lending, and perhaps I could stay with you, options, in the course of which Paul said pretty much Mr Tucker? Do you think all credit is equal or do you what he has just said to you now. The question then think business lending has a greater stimulatory effect is: can we come up with a scheme that looks like it than mortgage lending? might be attractive, that might work? These may not Paul Tucker: I don’t know. I think both matter be things that we alone can do, but this is something enormously. Households and consumption is the we need to put some thought into and that is basically biggest part of spending in the economy. Small and Paul’s point. medium-sized businesses are the lifeblood of the productive side of the economy. I am worried, as are Q73 Mr Ruffley: I think this is helpful. When will others, that our current battery of credit policies may you be in a position to let this Committee know, or is not be reaching as far into the SME sector as they research being done on this? might, and I should make clear that in saying this I am Charles Bean: It is something we will work on inside speaking for myself. I think we need to be watchful of the Bank to see if we can come up with something. two things: the first is not all lending to small firms It is obviously an area where the market side has a and medium-sized firms in the economy comes from particular role. banks. It also comes from non-banks. At present the Mr Ruffley: Yes, but in the fullness of time— FLS is for on-lending to households or on-lending to Charles Bean: In the fullness of time. We may decide firms. We should have a think about this. I am neutral there isn’t anything useful we can do in this sphere, about what the outcome should be, to be clear with but Paul is perfectly reasonably saying we should you. I think we should have a think about whether we think about this. can harness non-bank lenders in some way, possibly via the banks. Q74 Mr Ruffley: This is very useful and, with your The second thing—and I talked about this in a speech permission, Chairman, just one final and brief in late spring of last year—is I find it regrettable that question. The funding for lending initiative is cobber Pack: U PL: COE1 [O] Processed: [02-04-2013 16:06] Job: 028182 Unit: PG01 Source: /MILES/PKU/INPUT/028182/028182_o001_th_TC 26.02.13.xml

Treasury Committee: Evidence Ev 13

26 February 2013 Charles Bean, Paul Tucker, Professor David Miles and Ian McCafferty currently controlled, as I understand it, between your Ian McCafferty: The only thing I would add at this executive and the Treasury. Given that the role of the stage is in answer to Mr Ruffley’s question. I have not FLS is to plug a gap in the transmission mechanism spoken to Ministers about fiscal issues. I agree with of the Monetary Policy Committee, is there scope for everything my three colleagues have said about the it to become more closely controlled by the MPC as analytics of the issue, and I do think one of the most an MPC tool, and what is the dynamic with HMT? important elements of the current QE programme, Charles Bean: First of all, we operate the FLS, we do which we would lose with either helicopter money or all the mechanics of it and so forth. The bank staff with the cancellation of gilts, is that ability to reverse monitor the collateral and all that. The other thing is the policy. I think that is critical to our credibility. it is not a scheme that lends itself to continuous Chair: Professor Miles? tweaking in the same way that you might with Bank Professor Miles: Coming back to the impact of QE, I Rate or the quantity of asset purchases. What the FLS agree with something Ros Altmann said—to this does is basically supply banks with funding cheaper Committee, I think—which is that one of the side- than they can get in the market. The reason we effects of QE is that it generates a search for yield. As introduced it was precisely because funding costs had Charlie said, actually that is a good thing. That is not been rising through last year, partly on the back of a bad thing. I think one side-effect of search for yield what was going on in the eurozone. We were worried has been the knock-on impact in the corporate bond that would lead to a credit crunch, and there were market where yields have come down over the period signs that that might be starting to happen. So the when we have been buying gilts very, very primary aim was to work against that and, indeed, substantially. The number of new companies issuing funding costs have come down very substantially— that have not issued in the corporate bond market more than 100 basis points. So it has achieved what it before has increased. I think part of the helpful side- set out to in that regard. But we also put in these extra effect of QE is to increase somewhat the universe of incentives to encourage banks to lend more than they companies that now think about using the corporate otherwise would have done to the real economy in the bond market. Now that doesn’t stretch all the way way the scheme is priced. Now, as far as the banks down to small companies, but it begins to stretch are concerned, they want some certainty about the down to some of the medium-sized companies, and pricing of the scheme in deciding where they are that is exactly one of the beneficial side-effects of QE. going to take advantage of it, how much to extend their lending and so forth. It would not be constructive Q77 Chair: That is a helpful illustration or guidance of us to be continually tweaking the parameters from on yield compression and it is not all necessarily bad. month to month. You have to be very quick, Mr Tucker, you have had If it was clear that we had got the calibration of the a good innings so far. scheme wrong and it wasn’t having the effect we Paul Tucker: I absolutely agree with what Charlie and thought it was going to, then we would obviously David have said about search for yield, but I would need to think, “Do we need to change something?” hate it if in five to 10 years time we have it quoted But frankly, the way it is working at the moment is back to us: “Oh, the Bank of England was pretty much as we expected it to. We have seen the encouraging a search for yield blind to the risks that effect on funding costs that we wanted to see. That could build up in the financial system”. The whole has largely passed through into the rates that are being point of giving us both functions—I have said this charged, certainly on household mortgages, and the publicly, and I am sure you have—is we need to have availability of finance for larger companies. There is two sides to our brain: while monetary policy might less evidence so far of the effect that we would like desirably stimulate risk-taking, we have to make sure that that risk is taken in places that can bear the risk, to see for smaller companies, and certainly they are if and when it crystallises, rather than blowing up the the group that have less access to alternative sources world again. of finance. Chair: Yes. We will settle for two sides of one brain rather than two brains. Q75 Chair: Larger businesses are okay already. Charles Bean: Yes, yes. Q78 Mr Mudie: Mr Tucker, paragraph 36 of the Chair: Many of them are cash rich. minutes in the Monetary Policy Committee opens, Charles Bean: Yes; that would not necessarily be true “The committee discussed the appropriate policy of all businesses, but certainly many of them. But we response to the combination of the weakness in the did expect it to take more time to feed through to economy and the prospect of a further prolonged the smaller company end of things, where it is more period of above target inflation”. It deals with the heterogeneous and so forth. latter—inflation—for the rest of the paragraph and Chair: Bu we will keep an eye on it. then finishes with an intriguing, “The committee also Charles Bean: But we are keeping an eye on it. agreed that it stood ready to provide additional monetary stimulus if warranted by the outlook for Q76 Chair: Mr McCafferty and Professor Miles, you growth and inflation”. You have dealt with inflation, have been virtually spectators for the last 20 minutes and I am surprised and saddened that there seems to or so. I just want to give you an opportunity to add be no appropriate policy response regarding the anything—first Mr McCafferty and then Professor outlook for growth and the business that is warranted Miles—to what you have just heard. You do not have by it. If you have spotted growth in the last two years, to, but do you have anything you want to say? Mr Tucker, I would be glad if you pointed it out. Why cobber Pack: U PL: COE1 [E] Processed: [02-04-2013 16:06] Job: 028182 Unit: PG01 Source: /MILES/PKU/INPUT/028182/028182_o001_th_TC 26.02.13.xml

Ev 14 Treasury Committee: Evidence

26 February 2013 Charles Bean, Paul Tucker, Professor David Miles and Ian McCafferty did you and the other members of the committee, Mr Mudie: Yes, go on then. excluding Professor Miles, think there was no need Paul Tucker: I answered the question in terms of QE for this—that no policy response for growth was but, as I said to Mr Ruffley earlier, I personally have warranted? been raising questions and promoting ideas about— Paul Tucker: I would say three things. First of all, we Mr Mudie: Mr Tucker, that is the next question. wanted to make clear in the last sentence that nobody Paul Tucker: That is where you are going? All right. on this committee thinks that QE has reached the end of the road and it is not a useful instrument any more, Q82 Mr Mudie: In paragraph you 33 state, “The and we stand prepared to do more if we judge that Committee reviewed the range of possible monetary necessary. Given speculation about whether we do policy instruments”. You list some of them, and then think that QE has reached the end of the road, it was you say the ones you list all had drawbacks, and these important to make that clear. Secondly, in my own drawbacks remained and excused you from accepting case—as I make clear in my annual essay to you as any of them. “The committee would nevertheless well—I think that the QE that we have already done continue to examine all of the policies potentially is likely to gain more traction now that the headwinds available to it”. What are the drawbacks that you have from Europe have receded somewhat, subject to Italy experienced with the purchase of alternative assets, overnight, on which one cannot yet form a judgment. and what are the other policies available? I think this is a really important point, Mr Mudie, at Paul Tucker: I will come to the purchase of other least for me. We did this QE last year. It affected assets. I have talked about FLS already. We touch on financial market conditions. The impact on spending in this paragraph reducing the Bank rate or the rate was effectively switched off, for the reasons that I paid on reserves from 50 basis points, say, to zero. have described earlier, because of the huge uncertainty One possible risk of doing so is to make life even and threats coming from the international harder for some of the building societies and small environment. As those recede, I would expect the lenders, particularly— effects of the existing QE on financial market Mr Mudie: No, I haven’t raised that issue. conditions to start to affect the economy. That Paul Tucker: Specifically, can I— weighed with me. Mr Mudie: No, Mr Tucker; I am sorry but time is The third thing I would say is, I think we are very limited and I am asking specific questions. The absolutely conscious of trying to support growth and question is on the alternative asset purchases: what are recovery, consistent with maintaining inflation the drawbacks? Secondly, what are the other possible conditions. We are not inflation nutters. I promise you measures that don’t have drawbacks that you have that if it became perceived that we had given up on admitted to putting on the table for consideration? inflation and that we were only going to support Paul Tucker: On the second question, I have raised recovery in growth, what we would find after a few the question of what the limits would be to setting— quarters was that we couldn’t provide that support for Mr Mudie: No, Mr Tucker; again, I am asking you growth because the bond markets and everybody else specifically about your minutes. There were other had reacted adversely. It is only by maintaining our measures. Can you tell us what others were on the commitment to sound money that we can do what you table that did not have drawbacks, but you have personally most want us to do. Now, will we get that decided in the fullness of time—to take Mr Bean’s absolutely right every month or every quarter? Of phrase—you will come round to. course we won’t, but I do not think you should take Paul Tucker: We are going to continue to think about away from this any lack of willingness to support these. I hope we will think about whether there are growth. By letting inflation go to 5% on a judgment constraints to setting negative interest rates. This is an that perceptions of our commitment to price stability idea that I have raised. This would be an extraordinary were not diluted, we were doing that precisely so as thing to do and it needs to be thought through very to support growth. carefully. On the purchase of other assets, I have absolutely no Q79 Mr Mudie: But that is not a choice that is theological or religious principled objection to our necessarily on the table, is it, letting inflation go to buying non-gilt assets. What I would say to you is 5%? there are practical considerations that deserve weight. Paul Tucker: No. The main classes of assets in this country are equity and land. This is not like the United States of America Q80 Mr Mudie: But it is interesting, Mr Tucker, that where there is a wealth of other assets denominated you responded only on QE, as though that was the in sterling. There aren’t tradable pieces of commercial only— loans. We are lending against commercial loans and Paul Tucker: No, it is not. No, no. in my judgment, for what it is worth, lending against Mr Mudie: No. It was an appropriate policy report, commercial loans and buying commercial loans is but it was not specifically about QE. more or less the same thing, in terms of its economic Paul Tucker: Yes. effect and the help that it can provide.

Q81 Mr Mudie: Two of your three points were on Q83 Mr Mudie: What are the other ones that are not QE and the other was on inflation, which you dealt mentioned here that you are potentially looking at? with without any warning of a 5% inflation rate. Let’s Paul Tucker: I think we have mentioned the FLS come to paragraph 33— things. That is a— Paul Tucker: Can I just say on that, Mr Mudie? Mr Mudie: That is in operation now. cobber Pack: U PL: COE1 [O] Processed: [02-04-2013 16:06] Job: 028182 Unit: PG01 Source: /MILES/PKU/INPUT/028182/028182_o001_th_TC 26.02.13.xml

Treasury Committee: Evidence Ev 15

26 February 2013 Charles Bean, Paul Tucker, Professor David Miles and Ian McCafferty

Paul Tucker: No, in answer to Mr Ruffley I talked our responsibility and it would, I think, be wrong for about possible extensions, which I have aired, which us to carry around a specific menu. The broad point would be quite significant, in terms of lending to non- in economics that we have made is that things that banks or lending via non-banks, and also trying to could improve— revive a market and working capital finance where we could once again buy pieces of working capital Q87 Mr Mudie: With the greatest of respect, your finance paper—the old bill on London. I have said minute says, “In that context the committee also that publicly. discussed other policy measures at the bank together—”; so you discussed it but you don’t have a Q84 Mr Mudie: I am not getting personal and I am list of them? interested in your views, but I am really interested in Paul Tucker: Perhaps we should have included the what alternatives were on the table when you had this words “in broad terms”. I wish following this broad discussion. I would welcome you sending the exchange that we had. If you have taken away from Committee a list of other items that are not these minutes the idea that there is a— mentioned here— Mr Mudie: That you are working on something. Paul Tucker: These are the main items that we Paul Tucker:—specific list of things on the supply discussed. side which calls for the competence of Government, there is not. Q85 Mr Mudie: That is not how the minute reads. These were some of them and they were ones with Q88 Chair: That is very helpful clarification. We drawbacks, so they are mentioned as though they are have had a lot of clarification today. We have a couple already dismissed. If you have dismissed these, I am of colleagues who want to come in, but I just want to simply asking what other monetary policy initiatives ask you—not now, but perhaps in writing—if you you have up your sleeve if we have this sad position could set out the extent of your thinking, and it may with growth and we need to get some monetary help. be only very sketchily developed, on how you would Paul Tucker: First, I do not believe these are go about putting a floor to negative interest rates. dismissed. When we say we are leaving them on the Paul Tucker: That is a good question. table and continuing to consider them— Chair: That is why we are asking it and we look [Interruption.] I have mentioned to you this morning forward to your answer. the negative interest rate. That is a pretty radical idea, and not something anyone should clutch on to as the Q89 Mr McFadden: I would like to return to this answer to the question of the universe. In terms of issue of the pound and the exchange rate. The new credit supply to the economy—which matters so incoming Governor of the bank has said that the UK’s much, given our beaten up banking system—in export performance is the worst in the G20. That is response to Mr Ruffley I have amplified on what is despite devaluation of around about 20% or more in stated very briefly here, and I hope that is helpful to the last four or five years. Let’s start with you, Mr you. Bean; why do you think the UK’s export performance has been so poor relative to other countries, and why Q86 Mr Mudie: I have a final question, on paragraph have we not seen more benefits to exports from this 35, which states: “It seems possible that a further devaluation? broad based monetary stimulus would on its own be Charles Bean: There is a box in the inflation report insufficient.” We accept that. You continue: “The in chapter two, which I think is quite useful at this committee also discussed other potential measures point. If you have it. that the bank together with other UK authorities might Mr McFadden: Yes, I have it here. deploy” and you finish by saying, “A number of more Charles Bean: It is on page 24. Chart A just shows targeted interventions to boost demand and the supply the extent of the sterling depreciation, 25% since the capacity of the economy and to facilitate rebalancing beginning of the crisis. So a large depreciation, no might be entertained, but many of these fell to other doubt about that. First, I think it is worth saying that UK authorities.” Can you list them? there are two elements that have worked pretty much Paul Tucker: The thing that lies within our as we expected. The behaviour of imports has been in competence is to try gradually to improve the line with past experience. And if you look at chart C, performance of the banking system, and the FPC is which shows our share of exports in an appropriate doing that by— global measure of trade, as far as goods are concerned, Mr Mudie: No, no, again, Mr Tucker— that share had been falling and since the depreciation Paul Tucker: I am sorry. that has levelled off. In pretty much— Mr Mudie: This is the minutes of a meeting and the minutes say there were a number of more targeted Q90 Mr McFadden: Levelled off—but it has not. interventions but many of these were in partnership Charles Bean: This is a share and the overall market with other authorities. I am simply asking: could you size might be getting bigger. So the puzzle lies in what supply the Committee with a list of these other has happened to exports of services. That is the big possible interventions, albeit in partnership with other puzzle. If you notice in that same chart, that was UK authorities? Can you also identify, when you pass where we had been increasing share during the years us this note, the other UK authorities? leading up to the crisis and, if anything, you might Paul Tucker: The main area is supply-side policies. have hoped the depreciation would have allowed that We do not have a detailed list of that. It is not within to keep carrying on. It hasn’t. It has flattened off and cobber Pack: U PL: COE1 [E] Processed: [02-04-2013 16:06] Job: 028182 Unit: PG01 Source: /MILES/PKU/INPUT/028182/028182_o001_th_TC 26.02.13.xml

Ev 16 Treasury Committee: Evidence

26 February 2013 Charles Bean, Paul Tucker, Professor David Miles and Ian McCafferty fallen back. Some of that is down to exports of order business. Another one told me they were on- financial services, and it is obviously connected with shoring their call centre, which they had previously the financial crisis. But there is also a wider weakness off-shored to India because it was now cost-effective in exports of business services more generally. for them to do that. So we do hear stories of the What is not clear to us at the moment is to what extent mechanisms working the way they are supposed to. we can expect that unexpected weakness, particularly But it is fair to say we have been disappointed about in those categories, to come back? Or is it something not getting more of a kick to the recovery from net we have lost permanently, like a permanent adverse exports. shock to our ability as a trading nation? You might Mr McFadden: That is what I am getting at. think that some of this might be relatively persistent— Charles Bean: No, absolutely. There is absolutely no the bit that is connected to exports for banking doubt that we have been disappointed relative to our services. If that is the case you might take the view, expectations. “Well, we need an even bigger depreciation to make our exports of goods and other services more Q93 Mr McFadden: If someone had said to you four competitive and to lean even more against imports”. or five years ago, “We are going to have a depreciation in sterling of about 20% to 25% relative to other major Q91 Mr McFadden: Is that your view? currencies” you would have expected more of an Charles Bean: I am not convinced that we necessarily effect? need a nominal depreciation to get that. One of the Charles Bean: Yes, absolutely. things that chart A brings out is the fact that measures Mr McFadden: Does anyone else want to come in of the real exchange rate have been appreciating on this? recently. The one that I look at most often- and I Paul Tucker: I agree with what Charlie has said. The regard as the most useful thing to look at- is the only thing I would add is quite an important question yellow line, which is based on relative unit labour in the years ahead will be whether exports of financial costs between countries. You can see that line has services increase again. Whether we like it or not, this come back quite a lot. We have lost about half of the is a significant part of our economy. It has been a gain that we got. That reflects the weak productivity significant part of our external trade in the past. My performance in the UK. So the crucial question here personal expectation, for what it is worth, is that as is: do you think that weak productivity performance the world heals—assuming it does heal—exports of is actually something that would solve itself as the financial services will pick up again. But I would add economy picks up? that we need our external trade to be more diversified geographically, which is the point that Mark has made Q92 Mr McFadden: So in simple terms you are about the Far East and Mervyn has made in the past as saying that this line shows that by keeping people in well. We can no more afford to rely on just exporting work we are increasing our unit labour cost and financial services than we could rely 25 years ago on perhaps making life more difficult for ourselves when just exporting manufactured goods. it comes to exports; is that what you are inferring? Charles Bean: It means that the competitive Q94 Mr McFadden: But even in terms of your point advantage to businesses is less than it might otherwise on goods, this chart on page 25 shows a flat picture be. That is not to say they should sack everybody, for the last six years. because there are obviously advantages to keeping Paul Tucker: That is the geographical point. people in work. It helps to keep demand up. But if as Charles Bean: Are you talking about chart C here? the economy recovers. Businesses find they can utilise Mr McFadden: Yes, chart C. their labour more efficiently, you will find that Charles Bean: Yes, and remember this is just a share productivity improves naturally. That is the argument of the market. that David was making earlier on this morning. The other thing that is worth saying is that it may well Q95 Mr McFadden: Yes, but it is relative to other take time for exporters to respond to the change in the currencies that we are talking about. That should have profitability that the depreciation has allowed. If you helped us. are someone who is thinking about getting into Charles Bean: Yes. This has helped us. It would be foreign markets— nice to see this red line going up instead of being flat. Mr McFadden: This depreciation, most of it happened in 2008–09— Q96 Mr McFadden: That is what I am driving at. Charles Bean: But it is not just that. It is also the Let me ask you then about the future, if that is the conditions in the foreign markets themselves. It is not past. In your MPC deliberations do you take a view straightforward to suddenly start exporting to China on this currency question? Is that a central part of your or into bits of the eurozone that you haven’t targeted thinking? Is there an MPC view on the currency, before, and in an environment where there is a lot of where you would like to see it go? uncertainty you are probably pretty cautious about Charles Bean: No. The exchange rate is obviously some of these things. So it may well be that some of important to the outlook for both inflation and output. this is just down to taking time to see some of the When the currency is weaker that tends to push up benefits. I should say I was on a visit to the north- import prices, so it raises the inflation profile. It has a west last week, visiting businesses. One business told two-edged impact on activity. On the one hand the me that they were consciously switching more of their higher import prices reduce the real incomes of sourcing to UK suppliers of clothing. This was a mail households and that tends to dampen consumer cobber Pack: U PL: COE1 [O] Processed: [02-04-2013 16:06] Job: 028182 Unit: PG01 Source: /MILES/PKU/INPUT/028182/028182_o001_th_TC 26.02.13.xml

Treasury Committee: Evidence Ev 17

26 February 2013 Charles Bean, Paul Tucker, Professor David Miles and Ian McCafferty spending. But on the other hand we hope that it has Q100 Mr McFadden: Let me just finish with this. I some beneficial effect on exports, and we still think am conscious of time. Under the heading, “The Bank that net, the effect is probably expansionary from an of England does what it does not what it says” James exchange rate depreciation. So where sterling is, and Mackintosh wrote in the FT the other day, “Perhaps where it is likely to go, is very important to us in Sir Mervyn’s vote”—and by implication yours, forming a judgment. Professor Miles—“was merely part of his ongoing effort to talk down the pound. If so, it worked.” Q97 Mr McFadden: That is what I am trying to Professor Miles: That wasn’t my motivation for tease our of you— voting the way I voted. As you will know, I have Charles Bean: Yes, I know. voted this way for some months now. It was based on Mr McFadden:—whether you have a desire for the an assessment of the likelihood of growth falling in direction of travel. different ranges—my assessment that stronger growth Charles Bean: No, absolutely not. The markets will would be more likely to come if monetary policy was take the exchange rate where it will and we do look more expansionary. I also take the view that at issues such as, do we think the risk to sterling might quantitative easing and more asset purchases are likely be in one direction or another? For instance, if we are to increase the pace of growth in the UK, not running a current account deficit—as we were for the particularly through the exchange rate, which I think decade before the financial crisis—we did repeatedly is highly unpredictable, but through some of the other say that at some stage we thought there would need channels we were talking about earlier. We talked to be an exchange rate depreciation to rebalance the about the search for yield, making investment in economy and eliminate the current account deficit. corporate bonds and in equities, more attractive, and that having a positive impact on demand. Q98 Mr McFadden: But rebalancing has not Q101 Mr McFadden: Mr Tucker, you earlier said happened. that this was the kind of road to hell, this competitive Charles Bean: There has been some rebalancing but currency devaluation. The G20 Finance Minister has not anywhere as much as we would like to have seen. issued a very pious statement saying this would all be bad, but talk is cheap, isn’t it? The actions of us here Q99 Mr McFadden: Professor Miles, you voted with and other states will speak louder than G20 finance the Governor to have more QE at the last MPC statements. meeting. When the minutes were published the Paul Tucker: I think I have used the words “sound markets were somewhat surprised by this division in money” three times this morning. I do not believe for the MPC on this issue, and one of the quick a second that David or Mervyn’s or Paul Fisher’s vote consequences of that was downward pressure on the was motivated by trying to manipulate the currency, pound. Did you regard that as a fairly benign if not and if they tried to I think they would fail. desirable consequence? Was that part of your Monetary policy has an effect on currencies. We need thinking? to stick to explaining what we do, in terms of the Professor Miles: I am not sure about benign and I am mainstream effects, and be careful about what we say. not sure how long lasting it will be ether. We have At this point of an economic cycle, where—big very few reliable models of the exchange rate, so it picture—I think we have to be patient, it is very wasn’t part of any strategy to try and get the exchange important not to lose our nerve and talk in ways where rate to move. I think the exchange rate is pretty much we can be misunderstood. Because it is not just unpredictable, and when we produce our own actions that make a difference; in the short term talk forecasts we use as the least bad forecast simply what can make a difference too and I think the G20 and the the market expects the exchange rate to be. It always G7 have sensibly been trying to row back their talk turns out to be wrong but it is probably the least bad and to bring it into line with the actions, and I forecast. So I don’t think there was any expectation welcome that. that there would be some reliable movement in response to the way the voting went. Q102 Chair: Very quickly, bringing us back to an I hadn’t changed my vote, as you will know. I have earlier point that was made about labour hoarding, Mr taken a view for quite a long while that stronger McCafferty, do you think there is a lot of labour growth in the UK would be very welcome—I think hoarding going on and do you think that is retarding we all believe that—but also consistent with inflation recovery? gradually moving back to the target level, I felt having Ian McCafferty: Chairman, I am not sure I like the a slightly more expansionary monetary policy would term “labour hoarding” because it makes it sound like make that growth more likely, and partly for the it is a very negative concept. What I said in my speech reason that Charlie mentioned a moment ago, which was that I do believe that the nature of the way in is the likelihood that some part of poor productivity which employers and employees work together within just reflects weak growth in itself. If you believe that, the labour market has changed, and that one of the as I do, that would mean that stronger growth would values employers are increasingly recognising is of improve productivity, it would be consistent with the longevity of some of their employees, that they inflation pressures probably no higher and, therefore, gain productivity and they gain skills through working would be a welcome thing. So that was my thinking with individual companies over a longer timeframe, behind continuing to vote for more expansionary which makes employers reluctant to lose those policies. employees, simply because short-term demand cobber Pack: U PL: COE1 [E] Processed: [02-04-2013 16:06] Job: 028182 Unit: PG01 Source: /MILES/PKU/INPUT/028182/028182_o001_th_TC 26.02.13.xml

Ev 18 Treasury Committee: Evidence

26 February 2013 Charles Bean, Paul Tucker, Professor David Miles and Ian McCafferty conditions are less than they would like, or certainly was a long time in the making, and some of the details deficient in this case. So from that point of view I of regulation can affect incentives in the financial think, if you want to call it “labour hoarding”, there sector in a very potent way. But we are trying to is some degree of labour hoarding. It is clear from the design an international regulatory framework—and I statistics that employment growth is relatively strong know that Mark talked about this when he was here— at this stage in the cycle, whereas output growth is that both underpins soundness and unwinds some particularly weak. By definition, therefore, we have to rather unfortunate incentives. have some form of labour hoarding in that sense. It can be explained, as I say, because I think there are Q105 Jesse Norman: Thank you. Mr Bean, you will firm-specific skills that employees can gain that are recall that European Monetary Union was dogged increasingly important in maintaining competitiveness from the outset by an inability to maintain countries for many firms, which leads them to be reluctant to within the framework of the spending and growth lose those employees. Firms are able to maintain their requirements as set by the European Commission. You labour force in this particular recession, which I think have just described, fairly eloquently, why a banking is a contrast to previous recessions, because of the less union that is required to make European monetary difficult financial conditions that they face: the very union work effectively is going to take, at the very low interest rates; the use of QE. The fact that firms least, many more years to implement. Would it not be went into this downturn in a better financial position your view that these should have been foreseeable in than previously means they are able to maintain advance and, therefore, the implementation of EMU employment in a way that firms weren’t in the 1980s has been a fiasco? and the 1990s, for instance. Charles Bean: I think it is fair to say that there were plenty of commentators, academics and the like, who Q103 Chair: You are portraying it as a good thing. did suggest when monetary union was first mooted They are hanging on to people they are going to need that it needs to be associated with a degree of fiscal when the upswing comes and, therefore, you are union and so forth. The route chosen to deal with the partly answering Mr Bean’s question about the yellow fiscal issues was, as you say, the Stability and Growth line in chart A, page 24, by saying you are optimistic Pact, which turned out not to have teeth. Also I think that is going to go in the right direction. insufficient attention was given to the question of how Ian McCafferty: Yes. I think that as the recovery you deal with heterogeneous developments in gains some strength, we will see productivity naturally different parts of the community, and the problems recover as people work more intensively than they are that that might lead to. I don’t think people did realise, having to currently. though, that one of the consequences of monetary union was going to be to encourage capital flows into Q104 Jesse Norman: Mr Tucker, you have raised the the periphery and the build up of financial imbalances very interesting and controversial idea of negative that was obviously connected with the wider interest rates. You are going to write to us, kindly, development in global financial markets. But that about how a floor could be set for such. Could you exposed, I think, the issues in the structure of financial also include in that any thinking you have done on markets, banking union territory, in a way that I think current mechanisms for how it would be it is fair to say most people had not really anticipated. implemented? I am grateful. Although with hindsight you can see the issues. But You remarked about the importance of the banks certainly— staying out of the supply side of the economy, and I hope it would not be facetious to point out that you Q106 Jesse Norman: Greek interest rates falling as have an extraordinarily large influence over one aspect quickly as they did might have encouraged people of the supply side, which is the supply of money. It to— would be nice to think that as the Bank takes over Charles Bean: No. There were people who identified more responsibility—proper responsibility for the that that would have some consequences, but I don’t banking system—it could be gently guiding the large think anybody can really claim to have said, “Oh this banks towards a proper recognition of the function of will lead to a build up of financial imbalances that banks to supply working capital to industry, and to get will eventually unwind in an unhappy way”. out of the business of principal trading and punching their own treasury operation. I hope you will pass that Q107 Jesse Norman: Because I am sweeping up a message on in the supervisory role that you whole bunch of things, I want to keep moving if I increasingly exercise. may, and I take your point. What is your central guess, Paul Tucker: I think that the first step is to gradually Mr Bean, for how long a proper banking system will restore these banks to health. I have talked about that take to put into place; a banking union if you like? on other occasions. The other thing I would say is it Charles Bean: It depends whether you want all of my is not just a matter of exhortation. The changes made five items. and the regulatory regime in Basel, which, for Jesse Norman: You have to have five because you understandable reasons, do not get a huge amount of said they are necessary. prominence here, will tend to tilt the allocation of Charles Bean: I said, for a durable one— capital away from trading towards real economy Jesse Norman: Let us have one that works. How provision of credit, and that process is not yet finished. about that? How long will that take? If you asked me, “How much?”, my answer is I don’t Charles Bean: I suspect you will have the supervisory know because that work is still ongoing. But this crisis mechanism in operation by the beginning of next year. cobber Pack: U PL: COE1 [O] Processed: [02-04-2013 16:06] Job: 028182 Unit: PG01 Source: /MILES/PKU/INPUT/028182/028182_o001_th_TC 26.02.13.xml

Treasury Committee: Evidence Ev 19

26 February 2013 Charles Bean, Paul Tucker, Professor David Miles and Ian McCafferty

That is clearly the roadmap that our European partners competitiveness. I would emphasise the have put out for themselves. The timeframe for the competitiveness part because countries like Italy, resolution— Greece and Spain lost quite a lot of competitiveness Paul Tucker: I hope the directive is done before the relative to Germany in the first years of monetary summer, and then they have they have said that they union, and they now have to get that back and increase will announce their plans for a banking union net exports, as we were discussing earlier. But of resolution authority before the summer. Once the ECB course they can’t do that by changing the exchange have responsibility for supervision, without the other rate. They have to do it either by changing pay levels pieces that Charlie described being in place, they have or somehow bringing about a big improvement in a hell of an incentive to push for further steps. One of productivity. So these are big challenges they still the great lessons for supervisors in this country is that face, and there is a long way to go. being a supervisor without an adequate resolution I think it is fair to say that some of them are making regime is a pretty stupid place to be. I think that we significant steps though, and if you look at a country will find over time that the ECB end up being a voice like Spain, its trade performance has actually been to push along the line that Charlie has described. really quite strong, despite not having access to the Whether they will succeed, I do not have the faintest exchange rate. idea. Professor Miles: I would say one thing which I am sure is a minority view and it is a view that does not Q108 Jesse Norman: Is it five years to get all these affect my thoughts about UK monetary policy. I think five? Is it longer? Some people say it is a decade. the view that you can only make a monetary union What is your best guess? work with fiscal union is profoundly wrong. That is Charles Bean: I do not think you can necessarily my own assessment. I think the reason why there was easily set a time limit because the last two steps are such a problem in the eurozone was that there wasn’t connected with the politics of this and whether there is the will for the north to provide the back stop. a recognition early on that bonds issued by different Paul Tucker: It goes back to Ms Leadsom’s question. entities in the same currency had very different risks. Jesse Norman: I am fully aware of that. People took the view that as long as a bond is issued Paul Tucker: But we think you are better equipped to in the same currency by a Government that was in make judgments on that than us. the eurozone, it had the same risk as the least risky Government in the eurozone. That is a mistake that I Q109 Jesse Norman: In your view at the moment, suspect people will not make again, at least for a very there is no guarantee it will happen at all, is the point long time. you are really making. Nothing, or very little, has Charles Bean: So the challenge is to make no changed in the eurozone economically. That is to say, bailout credible. the European Central Bank is now supplying a limited Paul Tucker: Yes. In a strict sense David is right, but liquidity, but the fundamental economics of you do then need to make the no bailout credible. If productivity imbalances has not really—I think I am it is not credible then you need mechanisms for right in saying—changed. What risk do you think— transfers. any of the panel really, but I suppose in particular Mr Chair: Did you want to say something else, Bean—there is at the moment to a balance of Professor Miles? payments crisis within the eurozone? Professor Miles: No, that was all. Charles Bean: Within the eurozone? Jesse Norman: Either within or without. Q111 Jesse Norman: Dr Carney has noted what he Charles Bean: Personally I think there has been some called an underlying sickness—that is, a balance of improvement relative to where we were in the middle payments crisis within the currency area. Do you think of last year and, in particular, the ECB’s declaration that is a mistake? that it is willing to undertake these so-called outright Paul Tucker: No, that is the imbalances that exist at monetary transactions, buying the short-term debt of the moment. periphery countries in receipt of a support programme. Jesse Norman: That was the question I originally asked. Q110 Jesse Norman: How does that actually Charles Bean: My remarks about competitiveness improve the fundamental economics? The were precisely a response to that. productivity— Charles Bean: I am going to work through this. There certainly has been an improvement there, which has Q112 Jesse Norman: You do not think there is a brought down yields very significantly for countries likelihood of having a balance of payments crisis like Italy and Spain. That means it is easier for them within the currency area? to finance their fiscal deficits. That is a real Charles Bean: There is one within it. improvement. You shouldn’t underestimate that. It is Ian McCafferty: You could say that, yes, there is one. also played more generally in the improvement in Jesse Norman: So there is one. financial markets around the world—a sense that they Paul Tucker: Yes, there is one. It manifests itself as are heading in the right direction. vast balances in the so-called target system where the Where you are absolutely right that there is still a long German banks are effectively lending money via the way to go is in tackling the underlying real problems Bundesbank and the Nederlandsche bank to the of those countries, in terms of indebtedness and southern countries. cobber Pack: U PL: COE1 [E] Processed: [02-04-2013 16:06] Job: 028182 Unit: PG01 Source: /MILES/PKU/INPUT/028182/028182_o001_th_TC 26.02.13.xml

Ev 20 Treasury Committee: Evidence

26 February 2013 Charles Bean, Paul Tucker, Professor David Miles and Ian McCafferty

Q113 Jesse Norman: I think we are where we should about the design of the international monetary system. be, which is, we have a balance of payments crisis in But that is quite separate from questions of a currency the eurozone. That was my original question and we war among the big countries; I do not see that that are now, five minutes later, there. Good; I agree. You need happen. People would have to try quite hard to did not answer the questions put to you, Mr Tucker, make mistakes. about the currency war. What is the actual risk of having a currency war at the moment? Q114 Jesse Norman: You are saying not only does Paul Tucker: If everybody conducts themselves in the it need not happen, but you don’t see any signs of it broad way I have described, I think it is low. actually happening now? Jesse Norman: Yes, but what if they don’t? What Paul Tucker: If you go back a few weeks, I certainly is your— saw signs that the markets were worried about it. I Paul Tucker: They all have domestic price stability think the officials of the G7 and G20 have responded objectives. I don’t see any evidence that any of them in a sensible way. are departing from trying to pursue their own Jesse Norman: Thank you very much. domestic mandates. That is not a recipe for a currency Chair: You have been extremely helpful this morning, war. Where there is a degree of tension is between the which has now become this afternoon. Thank you big G7 countries and other countries who link very much for coming in. We have picked up a great themselves typically to the dollar, and they become deal about your messaging, about some keys facts in concerned about importing US monetary policy and a number of areas; clarity has been brought to policy, the capital flows that go with that, and as those and we will be following up a number of points that economies become bigger that does pose questions you have raised in writing. Thank you very much indeed. cobber Pack: U PL: COE1 [SO] Processed: [02-04-2013 17:44] Job: 028182 Unit: PG02 Source: /MILES/PKU/INPUT/028182/028182_w003_michelle_3.Paul Tucker supp.xml

Treasury Committee: Evidence Ev 21

Written evidence

Report to the Treasury Committee by Paul Tucker, Deputy Governor Financial Stability, Bank of England Voting Record My previous report was 12 months ago. It looked at the time as if, helped by the ECB’s Long Term Repo Operations, the clouds from the euro area might be lifting. That proved short lived. As deep concerns re- emerged about possible exits from the euro area, conditions in bank funding markets deteriorated badly, including for UK banks. Domestic lending conditions tightened, adding to the headwinds facing the UK economy from public and private sector deleveraging. Net exports suffered amid a sharp softening in global demand for manufactured goods, and as safe haven flows drove an appreciation of sterling. Confidence ebbed. The Bank responded with a package of measures. In June we made clear, via the Extended Collateral Term Repo, that we stood ready to provide liquidity to individual banks against a wide range of collateral. As well as helping to forestall a crisis, that enabled the FSA to free up bank balance sheets somewhat by relaxing regulatory requirements on banks’ holdings of liquid assets. The third part of the package was the Funding for Lending Scheme (FLS), which I was strongly behind in order to insulate domestic credit conditions as far as possible from the deterioration in international wholesale markets. And the fourth part was additional QE of £50 billion, taking the total to £375 billion, for which I voted at the MPC’s July meeting. (Later in the year, the Bank also welcomed the Government’s decision to let the “automatic fiscal stabilisers” work as the economy slowed.) There is no doubting that, taking the Bank’s package alongside the ECB’s Outright Monetary Transactions announcement and the FOMC’s QE3, central bank actions had plenty of traction on financial conditions. Gilt yields fell and, as investors adjusted their portfolios, investment grade sterling corporate bond yields fell by more. Bank funding markets reopened. The “war” for retail deposits ended, helping to reduce the cost of credit for borrowers. Credit conditions have started to ease, especially for households and those firms with access to capital markets. In more normal circumstances, those easier financial conditions would have provided a strong stimulus to real spending in the economy, through higher wealth and a lower cost of borrowing for many households and businesses. But during much of 2012 the transmission of policy into spending was dampened by pervasive fears about the international environment and general uncertainty about the recovery. Household saving rose, and firms delayed investment. Output has been flat. The (relative) good news has been the rise in private sector employment—approaching a million over the past year or so—evidencing flexibility in the labour market as the economy rebalances. This has mitigated the social damage of the downturn and the erosion of the economy’s human capital.

The Outlook Strong employment has also meant that, with output flat, productivity has weakened. That may be due in part to the financial crisis impairing the effective supply capacity of the economy, at least in the short run. Balanced recovery will need to include a relative shift in the economy towards the production of tradables and away from sectors that benefitted from an unbalanced composition of demand in the years running up to the crisis. It is possible that the banking system’s continuing challenges are impeding the efficient allocation of capital. Alongside the desirability of wider measures to improve the strength of the economy over the medium term, the prospect of balanced recovery can be helped by the actions of the prudential supervisors, on the Financial Policy Committee’s recommendation, to ensure that banks value their assets prudently and restructure their balance sheets and, separately, to lower barriers to entry into banking. Meanwhile, credit easing, via the FLS, can help to support borrowing conditions in the nearer term. We must keep the effectiveness and terms of the Bank’s schemes under review; particularly their effect on SMEs, given the improvements already underway in the household mortgage market. I would also judge that the existing degree of monetary easing from QE is likely to gain more traction on spending than it had last autumn, given reduced tail risks from the international environment. I remain open to doing more QE depending on the outlook for demand and inflation. If productivity and supply capacity were to recover strongly as and when demand recovers, underlying inflationary pressures should not emerge. Moreover, if output and so prospective incomes were to recover back towards a higher path, that would relieve some of the drag on the economy from the levels of household debt accumulated before the crisis when the outlook seemed rosier. But there is great uncertainty here. The MPC needs to adopt a watchful and probing approach. The existing and prospective rises in administered and regulated prices and the recent depreciation in sterling’s exchange rate are pushing inflation up, and are likely to keep it above the 2% target for the next few years. It is consistent with the MPC’s Remit to look through a period of above target inflation, so as to avoid derailing the recovery, provided that medium term inflation expectations are anchored. Any perception of our cobber Pack: U PL: COE1 [E] Processed: [02-04-2013 17:44] Job: 028182 Unit: PG02 Source: /MILES/PKU/INPUT/028182/028182_w003_michelle_3.Paul Tucker supp.xml

Ev 22 Treasury Committee: Evidence

wavering in our commitment to sound money would undermine our ability to sustain the stimulus otherwise warranted to generate a gradual recovery in activity. As I said at the Committee’s June 2011 hearing and repeated in my annual report a year ago, my position has been that we should not start to withdraw monetary stimulus until we have securely achieved what I called escape velocity: the economy growing, and being set to continue to grow, at a pace that gradually absorbs the slack in the labour market and within firms. As spare capacity is absorbed, we will need to track indicators of domestic inflationary pressure. In particular, recovery needs to be accompanied by unit labour cost growth falling back to be consistent with achieving the inflation target over the medium term.

Explaining Monetary Policy Over the past year I have given eight on the record speeches and published five articles. Three covered monetary policy issues. I have given twenty to thirty off the-record talks on monetary policy and financial stability. I have made four visits to different parts of the UK—Northern Ireland, the East Midlands, Yorkshire and Humber, and the South East. I have had regular meetings with other central bankers, including at the ECB General Council, the BIS, the G20 Financial Stability Board and the European Systemic Risk Board. I have maintained extensive contacts with the business and financial communities here and overseas. February 2013

Report to Treasury Committee by Charles Bean, Deputy Governor Monetary Policy, Bank of England Voting Record In my previous report, in February 2012, I said that I expected underlying growth (ie abstracting from special factors such as the Queen’s Diamond Jubilee) to be subdued in the first half of the year, followed by a gradual strengthening, reflecting an ease in the squeeze on household incomes as inflation fell back towards the target, complemented further out by some recovery in investment. But the headwinds from de-leveraging, tight credit conditions and the fiscal consolidation pointed to a margin of spare capacity persisting for some while to come. My personal judgement was that inflation was likely to be a little higher than the Committee’s best collective judgement at that time. The biggest risk was of disorderly developments in the euro area. Over the course of the past year, the picture generally—yet again—has been one of growth disappointing and inflation turning out higher than expected. Much of the weakness in growth has, however, been down to contraction in three sectors: manufacturing (hit by a slowing in global trade); construction (hit by the fall-off in public construction); and oil and gas extraction (a continuation of a longer-term trend). In contrast, the output of the services sector grew at a moderate pace, and is now back to pre-crisis levels. The labour market has confounded this picture of a very weak recovery in output, however, with employment growing robustly, at rates one would only expect to see when output is growing at historically above-average rates. Inflation has been subject to further adverse shocks, including much larger than expected contributions from university tuition fees and from other “administered and regulated” prices. So far, a disorderly resolution of the indebtedness and competitiveness problems of the euro-area periphery has been avoided. Indeed, the ECB’s announcement of its willingness to buy short-term periphery sovereign debt in order to remove “euro-exit” premia, together with the moves towards a euro-area banking union, has provided a fillip to prospects there. At the time of my previous report, the Committee had just announced further asset purchases—which I supported—taking the total stock to £325 billion by May. At the May meeting, growth seemed to be coming in a little weaker than expected, while the outlook for inflation in the near-term was markedly higher than before. Given that, I considered it appropriate to vote to pause to take stock, recognising that asset purchases could be re-started if conditions dictated. By the time of the July meeting, the news on growth had been distinctly disappointing, while the upside inflation risks appeared to have diminished somewhat. Moreover, the stresses in the euro area, and in financial markets, had intensified significantly (ultimately prompting ECB President Draghi’s “Do whatever it takes” pledge shortly thereafter). The preceding month had seen the Bank announce the Funding for Lending Scheme (FLS) designed to counteract the rise in bank funding costs and provide incentives to banks to increase lending to the real economy, as well as activating the Extended Collateral Term Repo Facility in order to stress that backstop liquidity was available to the banks if required. While those actions should have helped to support UK demand, I judged that it made sense to vote to complement them by undertaking an additional £50 billion of asset purchases. By the November meeting, the stresses in the euro area had moderated significantly, while early indications of the impact of the FLS on bank funding conditions had been encouraging. UK growth was also estimated to have been strong in Q3, though partly reflecting the Olympics. Moreover, the inflation outlook for the next year or two looked substantially worse because of the unexpectedly large prospective contribution from administered and regulated prices. Accordingly I voted for no further asset purchases, and have maintained that stance since. cobber Pack: U PL: COE1 [O] Processed: [02-04-2013 17:44] Job: 028182 Unit: PG02 Source: /MILES/PKU/INPUT/028182/028182_w003_michelle_3.Paul Tucker supp.xml

Treasury Committee: Evidence Ev 23

The Outlook There has been a marked improvement in financial market sentiment in the past few months, though that has yet to be translated into a pickup in the activity indicators. At present, my expectation is that growth will gradually strengthen this year and next on the back of that, a further easing in credit conditions, and an improvement in the global environment. But downside risks remain, especially in the euro area. Inflation now looks likely to remain elevated above the target for longer than we thought. Given the source of that—the unusually large increase in administered and regulated prices—I think there are good reasons to look through it, so long as inflation expectations remain anchored. Prospects hinge heavily on the explanation for the conundrum of weak output growth juxtaposed with strong employment growth. I take the view that part of the associated weak productivity can be expected to unwind if demand picks up, though it is difficult to know precisely how much. But some may be associated with a combination of low interest rates and forbearance by banks, which has allowed some businesses to survive whereas they might have failed in previous downturns when interest rates were higher. Unlike some commentators, I do not believe this is necessarily a bad thing: if a business has problems meeting its loan commitments now, but has a viable long-term business model, then it may be more efficient to keep it going than to liquidate it.

Explaining Monetary Policy Since my previous report in February 2012, I have given three on-the-record speeches on monetary policy issues (one of these also covered the work of the Financial Policy Committee), together with numerous off- the-record presentations to a variety of audiences. I made six regional visits (to Norwich, Thames Valley, Leeds, Cardiff/Caerphilly, Birmingham/Hereford, Manchester) involving various meetings and events with local business people. I also attended a variety of events with journalists, City economists and market participants. Finally, as Deputy Governor for Monetary Policy, I also represent the Bank’s views in a number of international settings, including the G7, G20, and the OECD. February 2013

Supplementary written evidence submitted by Paul Tucker, Deputy Governor, Financial Stability, Bank of England Negative Interest Rates At the Treasury Committee hearing on 26 February you asked me to write to you on the subject of negative interest rates. This letter is a preliminary response to your request (for more details of which see Questions 88 and 104 of the published transcript). It will be followed in due course by a longer paper being prepared for the Monetary Policy Committee (MPC), which will be sent to you by Charlie Bean, the Deputy Governor for Monetary Policy. At the February MPC meeting the Governor invited members of the Committee to review the range of possible monetary policy instruments other than gilt purchases that could, in principle, be deployed should the Committee judge further stimulus to be warranted. The idea was to elicit a range of ideas, rather than to indicate the likely direction of policy. It was in the context of that “blue skies” discussion that we discussed, amongst other things, the possibility of reducing interest rates below zero. By “negative interest rates”, I mean the Bank applying a negative interest rate to some or all of the reserves that the banking system holds with us. In principle that negative rate would become the “marginal” rate in the wholesale money markets. As I said in my evidence to your Committee on 26 February, negative interest rates would be an extraordinary measure. It is not a question of MPC having a plan here. Most obviously, any further stimulus would need to be consistent with the MPC’s remit and commitment to sound money and price stability. Nevertheless, it is incumbent upon us to explore the pros and cons of a wide range of possible instruments. The paper being prepared now will cover a range of prospective risks and costs of negative interest rates. These include the incentives for firms and households to try to hold large quantities of bank notes, bearing a zero nominal rate; the incentives and ability of banks to adjust lending rates to compensate for the cost of holding reserves remunerated at a negative interest rate; and the effect on the incomes and spending of savers in particular. The Bank expects that paper to be ready in the next month or so. March 2013

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