David Ruffley MP questions Sir Mervyn King on Quantitative Easing

Tuesday, 25 October, 2011

David holds the Governor to account on inflation and QE in a fiery Treasury Committee exchange.

Q75 Mr Ruffley: Governor, with inflation at 5.2%-it is the highest since the early 1990s-do you accept that this is having a crippling effect on household incomes?

Sir Mervyn King: It is the same inflation rate as in 2008, technically true, but I certainly accept that what is happening in the economy now is a very large squeeze on household incomes. Real take-home pay has fallen by more in the past two years than any time in living memory. That is not the result of inflation being high; inflation is the symptom. The causes of that squeeze on living standards are real causes. They are a change in world prices of energy and the utility prices of gas and electricity at home. They are the consequences of higher Value Added Tax, higher food prices in the world, and the consequence of a fall in the real exchange rate, which was necessary to enable us to be able to rebalance our economy in the way that was vital after quite a long period of a relatively overvalued exchange rate. All of these things were inevitable and the only question was, at what inflation rate should we see the squeeze coming? But that squeeze was the result of factors that were real factors, which I donÕt think the UK could have avoided.

Q76 Mr Ruffley: You say they could not have been avoided, but the question this Committee has is, could it have been reasonably forecasted? I just ask you, as Governor, do you feel any responsibility for letting inflation get out of control because we have a lack of price stability now? It is well over 5%, inflation. This is undermining confidence in the British economy, consumers and households. Do you accept any responsibility for it spiralling out of control?

Sir Mervyn King: We certainly accept responsibility for not pushing up interest rates very sharply earlier this year and last year, in order to keep inflation closer to the target, yes. We did that because we were faced with a difficult decision, but we felt it was better, given that the squeeze on real incomes could not be avoided, that the only alternative to doing what we did was to push the economy, quite deliberately, into a deep recession with a high and rising unemployment. I think that would have made a bigger squeeze on real incomes and I am absolutely confident-I think this is the key point for us-that if we had done that and inflation were a little lower today than at the 5.2%, that come next year you would be giving us a very hard time for having got inflation to the point where it suddenly went way below the target once these temporary factors dropped out of the inflation measure. I think then I would have been saying to you, "Well, if you want us to try and keep it as close to 2% as possible all the time then we are going to have a zigzag strategy," and I think we avoided the zigzag. Now it is very uncomfortable and we are not at all happy that inflation is at 5.2%. But as I said last week, I think we do believe this is very close or at the peak, that it will come down sharply next year. It is quite hard to come up with any reasonable argument that would suggest it would do anything other than that. I think then we will be in a position where we can say to you, "Well, we didnÕt push the economy into a very deep recession and end up with inflation well below the target."

Q77 Mr Ruffley: Understood, but we have evidence from you that the first round of QE pushed up inflation, and there is another round of QE that you have just announced. Therefore, could you explain to us the sequence of events, if you would, that will deliver your forecast of 18 to 24 months from now, inflation back at target, because you are forecasting a very significant fall to around 2%? What we would like for you to do is just to explain the sequence of events from now to then.

Sir Mervyn King: The first thing that will happen, as we go into the new year, is that the effect of the increase in VAT last January will disappear from the 12-month window, which is used to calculate inflation. So, inflation is the measure of increase in prices over the previous 12 months. As we move forward in time, some of the price increases that came in this year will drop out of that comparison. We will see that some of the large energy price increases and food prices at world level drop out. Commodity prices have started to fall back. As a whole, energy and commodity prices in the world have fallen about 10% to 20% over the last couple of months. They had been rising at 30% to 40% a year. Once those things start to drop out of the window there will be a further fall back. That will carry on until the end of the year when towards the end of next year, 2012, the increase in gas and electricity tariffs, which came in in the last couple of months, will also drop out. On top of all that, gradually through the next two years, what seems to us a pretty large degree of spare capacity in the economies and still very subdued wage inflation-wage inflation is running at a rate well below the level that we would normally consider consistent with a 2% inflation target. So, as Charlie pointed out earlier, there is a lot of uncertainty as to what will happen to productivity, but given those factors we would see, as the window moves forward, a number of the price increases that have contributed to the 5.2% will be disappearing and they will not be replaced by equally large increases in prices.

Q78 Mr Ruffley: Final question, the-

Chair: There are more colleagues who want to come in and I know that you are pressed for time, so a very quick question and reply.

Mr Ruffley: Just a short one. A lot of us are concerned about the forecasting record of the Bank of England. If you had to score on a scale of 0 to 10, what would you give yourself for the last three years in terms of your forecasting record?

Sir Mervyn King: I am not going to score ourselves. That is for you and the others to do.

Q79 Mr Ruffley: Five, six, seven?

Sir Mervyn King: But I will point out that most of the reasons-

Q80 Mr Ruffley: Go on, Governor, between 0 and 10, how well do you think you are doing?

Sir Mervyn King: No, I am not going to do that. No. It is not my job to examine myself. It is your job to give us-

Q81 Mr Ruffley: You donÕt examine your own decisions?

Chair: We will take that as well as an invitation to take a look at that at a subsequent time.

Sir Mervyn King: Thank you very much. We do have to move to the airport pretty quickly.

Read the full transcript here: