LONDON (MNI) – The following is the full text of the new Bank of
England Monetary Policy Committee member Ian McCafferty’s written
answers to the Treasury Select Committee of the House of Commons on
monetary and economic policy.
D. MONETARY AND ECONOMIC POLICY
11. What do you regard as the major risks to the outlook for the UK
economy?
The continued uncertainty about the outlook for the sovereign debt
and banking crisis in the Eurozone continues to weigh on business
confidence and, with growth rates across the Eurozone slowing, the risk
of a deeper Eurozone recession hitting export demand from the UK (to
what is still our largest single export market) has increased. Serious
financial market disorder or a banking crisis in the Eurozone would have
significant negative effects on the UK economy.
Recently, there have also been signs of a loss of economic momentum
more widely, with both the US and Chinese economies slowing since the
early part of the year. If this were to persist into 2013, the outlook
for the UK would be consequently weaker.
Domestically, the main downside risk lies with the consumer. One of
the key reasons that the economy grew more slowly than had been expected
in 2011 and 2012 was the significant decline in consumer real disposable
income, squeezed by the rise in imported inflation following the sharp
rise in sterlingdenominated energy prices. UK inflation has fallen
sharply, allowing real disposable income growth to start to pick up, and
suggesting that consumer spending should slowly recover towards the end
of this year and into 2013. However, recent increases in the prices of
several raw materials, including crude oil and some agricultural
products, if sustained, may lead to inflation falling rather more slowly
than set out in the Banks August forecast, posing a downside risk to
the rate of UK consumer demand growth. These downside risks are to a
certain extent already built into existing forecasts of the outlook for
the UK. If they do not materialise, or are quickly resolved, growth in
the UK economy may be higher than current projections.
12. What consideration should be given to the exchange rate and to
asset prices, including house prices, within the framework for inflation
targeting? In particular, how should monetary policy react to asset
price bubbles?
Both the level of the exchange rate and movements in asset and
house prices are included in the framework with which the MPC thinks
about the transmission mechanism of monetary policy. Asset and house
prices give important information on the likely path of demand, and the
exchange rate on import price pressures, so both are critical in
considering the appropriate policy stance. This does not imply that
separate or explicit targets for either asset prices or the exchange
rate would be appropriate for the MPC with its current mandate. The
current inflation target has the advantage of simplicity, and with only
a single set of policy tools (the level of short term interest rates and
by extension QE), the MPC would risk being unable to achieve targets for
different policy variables simultaneously, thus damaging its
credibility.
It is, however, now widely accepted that asset prices V and the
avoidance of excessive credit growth – are important to the broader
stability of the economy, above and beyond their impact on the outlook
for inflation, and that policy intervention to influence them directly
may be required. Instruments other than Bank Rate, such as those being
considered by the Financial Policy Committee, will be required if they
are to be specifically targeted.
13. What is your current estimate of the extent of the output gap?
Estimates of the output gap are always uncertain, as we cannot
measure potential output directly, and at times of major adjustment in
the economy, such estimates are more imprecise than normal. At present
different sets of indicators give very different signals about the level
of spare capacity: h Estimates of the current level of GDP, relative to
its pre-crisis trend, suggest that the economy is close to 15% below
where it would have been had the financial crisis not occurred. However,
both the sustainability of the pre-crisis trend in GDP and the current
level of GDP are subject to significant uncertainty, and it is likely to
be some time before this data is sufficiently robust to be used with
full confidence.
Other data suggest that the degree of slack in the economy is
somewhat less than suggested by the GDP analysis. CBI measures of
capacity utilisation, for both the manufacturing sector and the
nonfinancial, non-distribution service sector, are closer to their long
run means, although these often measure the potential to increase output
only in the very short term, without changes to working practices or
shifts. Recent trends in the labour market, and in particular, the
increase in private-sector employment of the past year, also suggest
that the degree of slack in the economy is somewhat lower. Direct
estimates of the output gap, such as those employed by the OBR, suggest
a figure in a range closer to 2.-3%, although these, too, are subject to
significant margins of uncertainty.
On balance, I would estimate that the output gap is probably
slightly greater than the direct estimates would suggest, but well below
that given by the GDP trend analysis. However, at times in which the
economy is undergoing major adjustment, with shifts in the contribution
to total demand from different sectors and shifts in relative prices
underway, a single estimate of the aggregate output gap is not, in
itself, the best predictor of inflation, as the spare capacity is
unlikely to be evenly distributed across the economy. A more
sectorally-disaggregated approach, looking separately at trends in the
labour market and capacity utilisation provides more information in
assessing future inflation pressures.
–London newsroom: 4420 7862 7491; email: drobinson@marketnews.com
[TOPICS: M$$BE$]
