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What do you think?
In his first interview since joining the Bank of England’s monetary policy committee, Tim Besley talked to Chris Giles and Scheherazade Daneshkhu on January 30
FT: You have developed a reputation as a hawk since joining the Monetary Policy Committee as an external member in September 2006 because of your voting record [Mr Besley dissented in favour of a rate rise in October and formed part of the 5-4 majority in favour of another rise in January]. What have you got to say about that?
Tim Besley: I don’t find the hawk and dove distinction particularly helpful. The notion of being a hawk suggests you bring some extra baggage, which is some predilection to vote in a particular way. I see my job as looking at the trends in the UK economy, looking at the data, formulating a view about where things are going and voting accordingly. And the other point I would make is that the issues that are on the table at the time you join the committee are the issues you’re dealt with. I could imagine joining the committee under entirely different circumstances where my voting record would reflect those circumstances and would be looking entirely different. So on the whole, I think it’s better to get away from these categories and say let’s look at what’s going on, let’s form judgments and I’m reacting to that, I’m reacting to the current scenario.
FT: Okay, so let’s move away from those categories and talk about what it is that triggers a vote to change. You’ve clearly voted quite a lot of times to change in the short time you have been on the committee and you’ve said publicly you don’t see a compelling reason to wait. What is it that is enough to trigger a decision to vote for a change - what is that trigger point?
Mr Besley: That’s a good question, I’m not sure I can answer it very precisely, but I can give you a sense of at least the qualitative components of such a decision. Obviously behind a lot of this is the Bank’s own modelling process. I came in in September when there had been the previous August rate rise, supported by the Bank’s quarterly Inflation Report that was published in August. I took the judgement in October that an additional rate increase, which had been part of the market expectation at that point and therefore in the model, was quite reasonable given that we were going to observe this peak in inflation towards the end of the year with, hopefully, a decline sometime during 2007. So my initial judgement to raise was based very significantly on believing that it was a prudent measure to have an additional modest monetary tightening to keep that inflation path on track. Subsequently, as you know, that was a decision of a large number of the committee members a month later. But I reached that conclusion in October.
Rolling that forward to January, my view was that there was sufficient news on the month - particularly in December - towards the upside in terms of inflation risk: particularly the news from the US economy suggesting that was, perhaps, more robust than we previously believed; generalised concerns about the ability of producers to get through price increases and the general background picture of pretty robust economy, especially in the service sector. For me that added up to sufficient evidence that we really ought to get ahead of the curve and to put through a further rate increase rather than waiting, perhaps, until further down the line when we might have to put up rates even more to secure the same amount of impact.
So I don’t know if I suggested a specific trigger point but what I’m trying to convey is that it’s all about trying to read the trends and how much they are suggesting we still need to tighten. That is the primary basis on which I’m forming that judgement and, of course, the model is at the core of that and the internal analysis, but it’s not the only thing. There are many judgements that go on around that.
FT: Do you think there is a higher hurdle to jump over in a non-Inflation Report month?
Mr Besley: Personally, I wouldn’t want to put it that way. There are two reasons why the Inflation Report month is helpful, one is that, arguably, you can stand back and reflect more with the more detailed analysis. The other is related to that - you can communicate through the Inflation Report what you’ve done. Ultimately it’s about the judgement you form of the right time to move in terms of the inflation profile that might ensue, so I don’t necessarily want to suggest that makes a qualitative difference between the Inflation Report round and other rounds. But that there are always going to be these two reasons I’ve given you, for saying the Inflation Report round is significant.
FT: From the minutes there seems to be a consensus that the upside risks had increased but there was a lot of concern about market reaction to moving in January, vis-à-vis February. To what extend would that influence you? Were you surprised by the degree of market reaction and what’s your general philosophy about this concern that the MPC seems to have about not wanting to surprise the markets - do you think that’s important or not?
Mr Besley: Other things being equal, I clearly would be in the camp of not wanting to surprise the markets, but the “other things being equal” is the key observation. The trade-off is between feeling you’re making the right decision based on the data; I wouldn’t want to be in the business of saying we are going to be surprising markets wholesale the whole of the time but once in a while it may be justified if you feel that there’s sufficient reason to get on with the decision based on the analysis you have about the inflation risks in the economy. But I take very well that we do want to move as predictably as we can within the confines of feeling that we’re doing the right thing.
FT: Do you have a rule of thumb or a heuristic understanding of how much a quarter-point rate rise gives you in terms of lower inflation?
Mr Besley: The model certainly produces such things. Of course it varies from time to time in analysis to analysis. I don’t find it hugely helpful to think in terms of very strict rules of thumb because you can box yourself in to a rather mechanical judgement. I prefer to think about it as identifying the key economic issues at any point in time, how I see those playing out and how I believe, in terms of the transmission mechanisms we have, we can play on those influences and make sure that we are moving back in the direction of target. But I wouldn’t want to commit myself to a rule of thumb, because that would suggest that we could start to do this by numbers rather than by judgement - and judgement is the key in all of this.
FT: Some people think that the MPC moved to raise rates in January precisely to shock the markets - did you think that?
Mr Besley: No, that’s a mischaracterisation, that we were wilfully surprising markets. Obviously you can ask other committee members their view but I don’t recognise the proposition that we were wilfully engaged in shocking the market.
FT: One reason why they think that is because they say that the growth numbers more or less in line with what the MPC had been expecting and the MPC was expecting CPI inflation to fall sharply, so why the hurry to move in January?
Mr Besley: You need to go back a little before the January meeting. As you recall when we testified before the Treasury Select Committee at the end of November, a number of us, even at that point, were willing to share our views that we thought there was an upside risk to inflation. Indeed that was taken on board in a number of reports of those proceedings. Equally the December minutes make clear that there were some members who were concerned about the upside risk to inflation, so I think there was a growing view, which I personally subscribed to, that there was a variety of data and trends emerging to the upside of the November Inflation Report that ultimately led to the decision in January
The interesting thing about December, from my point of view, was there was a drip-feed of information; there was no single number that you can point to as decisive. Very often, especially in the way statistics are reported in the media, people want to see the committee’s decision as somehow influenced by a given statistic or a piece of data. But it wasn’t until I really sat down in January and began to look at the collection of information over the month that I began to see that it was getting to the point where I could justify the move that we made.
FT: Was it a close decision for you?
Mr Besley: I’m not sure I can even conceptualise the notion of a close decision. I suppose one way to think of it is if you had 100 votes, what number of the votes would go in favour or against? I’m not going to give you a quantification of that, but if I use that as a sort of metric, it was a decision I was comfortable with but, as with all these things, one is acting under a great deal of uncertainty. Therefore one’s degree of certainty that one is actually doing the right thing is always tempered by knowing that there are other scenarios, perhaps, other than the one one is contemplating. In that sense it wasn’t done in a situation of total conviction but that’s a decision I was very comfortable with at the time and remain so.
FT: Would you have thought there was a case for moving by half a point in November?
Mr Besley: Well, at the time I didn’t vote to move by half a point and of course hindsight is a wonderful thing. Perhaps, now if I unpick that...but I think it would be unhelpful at this point to be backward-looking and trying to unpick things. I did what I thought was right in November and I’ll stand by that. It’s very easy to take a decision and two months on have a look at the data and reconstruct the decision. I’d rather not get drawn on that, if I’m completely honest with you.
FT:: Do you see yourself voting for changes that are not in the quarter-point range? Or do you think the stability of the economy since 2001, is such that anything bigger than that would be a signal that things were really out of line?
Mr Besley: I will vote for what I think is right at any point in time. It is hard to say I’ve got some predilection for quarters or halves. We’ve enjoyed an incredible period of stability and a lot of the very modest changes in interest rates that have allowed us to keep inflation close to target have been a symptom of that and partly the cause as well. My hope is that we remain in such a world but I wouldn’t want to commit myself either way. My hope is that the world of low inflation and stable growth is the world we still inhabit and I have not abandoned the hope that that is indeed still the case.
FT: Thinking about the inflation outlook more generally, how much weight do you put on the current inflation rate which clearly enters the model as the starting point?
Mr Besley: Let me begin by saying that the headline inflation rate to which we had prior access before the January vote, was not part of the decision I made. When we make adjustments to monetary policy we accept that those will have an impact on the economy with a lag. So we’re really only interested in what’s in the current inflation numbers insofar as they give us important information about what’s going to happen in the future. And I want to disabuse people of the impression that we were somehow - I mean I can speak for my vote, so I’ll just speak for my vote - that somehow we were shocked by 3 per cent into making a decision. The key thing when I look back over the autumn and the inflation numbers coming out, is that we saw things in the inflation numbers to the upside which suggested that, perhaps, there was this slightly greater ability of producers to pass through cost increases into prices. The current inflation numbers are important insofar as they tell us something about the process and therefore the forward-looking component.
FT: Over the past year, the rise in inflation that has been faster than the Bank and pretty much than anyone else predicted. We’ve got diversion between goods and services prices which suggest that domestically-generated inflation has been high in the UK for a long time. Are there things that you can tell from the current inflation rate?
Mr Besley: Let me suggest two stylised views, neither of which I subscribe to directly. One is that we can attribute the current increase in inflation to a series of cost shocks, such as energy prices, that are gradually feeding through into prices. You can tell a story that says inflation is rising in response to those cost shocks and that we can not dismiss, but account for the increases in inflation through a series of idiosyncratic factors, particular cost factors. That’s story one.
Story two is that there are more generalised inflationary pressure in the economy coming from an imbalance between nominal demand and potential supply which is causing generalised, upward pressure on certain prices in the economy.
My view is that we cannot, any longer, simply dismiss the upward movement in inflation, entirely from the first of those sets of factors - the idiosyncratic factors are not all the story. Therefore we need to try and form a judgement on how much of it is more generalised, domestically-generated inflationary pressure. That’s going to be potentially more persistent because when the cost factors subside, we may not observe the kind of easing back in inflationary pressure that we would have had if these are simple reversals of the idiosyncratic factors.
So I come down somewhere in the middle of those two views. The point is a lot of the judgement that we’re making at the minute, or I’m making at the minute, are trying to put weights on which of those is the more relevant story. That would affect my judgement about what to do with monetary policy at this point.
FT: So though inflation will fall because of base effects coming out, it might just be a little bit sticky on the way down- is that one of the things that you’ve saying?
Mr Besley: It’s a concern and I should be careful in what I say at this point because we are currently working on our Inflation Report forecast and I don’t want to prejudge that. But we are going to be offering a consensus time path for inflation in the Inflation Report which will reflect our views of what we think are the forces that might shape that.
FT: Can you restate that concern?
Mr Besley: The generic concern is that there are a set of underlying factors coming through the economy which could be thought of as an imbalance between nominal demand and potential supply, that are going to lead to somewhat more generalised inflationary pressure and, therefore as the idiosyncratic factors become less important, we will not see inflation falling back as fast as it would if we just mechanically took those out of the projection - that’s the generic issue here.
FT: Do you think of the inflation-generating process as a product of spare capacity in the economy?
Mr Besley: The model that the Bank uses is crafted in that way and I find it useful to a point. The key part of that framework which I think I’m less sanguine about, is our understanding of the formation and consequences of the formation of inflationary expectations. Those models tend to put a lot of weight on the fact that because monetary policy is credible, people believe there’ll be a reversion to target. If we had a better grasp of the way in which inflation expectations are formed out there, we might have more reason to believe that that credibility could be relied upon. I think the framework is very credible. It’s been set up with institutions that reinforce credibility such as the accountability through the letter and so forth, but the framework puts a lot of weight on the attraction, if you like, towards the target inflation that’s built through the credibility.
FT: We’ve seen a number of things that might be suggesting that inflation expectations are rising. Are those things behind your wanting to take a more prudential approach to interest rates?
Mr Besley: I look at all the evidence to see whether it shifts my views. You’re right that there does appear to have a tick-up in inflation expectations but those numbers are quite hard to interpret - not least what is the perception of inflation? Is it RPI, CPI and all manner of issues surrounding that? More generally the expectations are driven by a view about the nominal side of the economy and what is driving nominal demand out there. And that’s where I would put some weight - you notice occasionally comments in the minutes - I would subscribe to this view that what’s going on in asset markets may be something that’s influencing people’s perceptions of the nominal side of the economy. After all, they’re observing on one side of the economy very significant increases in particular prices. I would feel more comfortable if I had an underlying systematic view of how expectations are formed, as opposed to just trying to look at numbers in a survey.
FT: Which asset prices are most important for you?
Mr Besley: General asset price inflation is something we’re seeing at the moment, so I’m not sure I need to pick out particular ones. I don’t want to suggest that by looking at the asset prices you perhaps shift your view about the nominal path of the economy, because it’s also what might be driving that underneath. There is a view that it’s a state of available liquidity and other things that could be giving us the kind of message that says the nominal path of the economy is going to proceed in a particular way. So I wouldn’t want to suggest we just look at the outcome. It may be that people are smart enough to see through the process that’s generating the outcome and the information in that process.
FT: One of the things that really is rising very quickly at the moment is various measures of money supply. The history of money supply targets is not necessarily a particularly happy one. What can you really get of looking at measures of money supply these days, do you think?
Mr Besley: Well, it’s something I’ve been asking myself a great deal and at some point, I will write down my thoughts and give a speech on the topic. But let’s just get a couple of things on the table. I’m not of a view that somehow we should be returning to a regime of monetary targeting. I’m pretty convinced that the framework that we have now and the way we conduct inflation-targeting is an essentially sound framework. But what I would like to be able to do is to have a view which allows these nominal things to have a more direct role in the way the inflation process works. That does mean having perhaps a more joined-up view of what’s going on in asset markets with what’s happening in terms of the way the inflation process is worked.
FT: So you think that looking at real variables in the economy is deficient?
Mr Besley: Well, there’s a very clear sense in which it widely acknowledged to be deficient. The way those models essentially work is by saying that we pin down the inflation rate in the model by a credible path of policy. So you’re begging the question of what makes policy credible. It’s just inherent in those models that they build in some assumption about policy rules, policy processes, and the credibility of those to predict even what the rate of inflation is going to be. All I’m suggesting is there is a piece of this that is not fully understood. There are many very talented people who have worked in this area and I wouldn’t deem to be able to make an informed contribution. But it’s something that as a practical monetary policymaker having been asked to do this job, I just like to think I can understand better than I do now.
FT: We’ve seen in the recent decisions to raise interest rates that money growth has been mentioned as a reason. Does money growth send some flashing signals as far as you are concerned?
Mr Besley: Let me be clear. I want to join up money, credit and asset prices. I think people who just look at money per se rather than thinking of money as among a class of assets, whose both relative and absolute prices are being determined and linked back to the process of creation of money through the banking system, so linked to issues of credit. I think it’s a bit risky to pull off just the money part of that and say we’re just going to look at the money part. We have to take a broader view of what’s going on in the financial system driving asset prices in the creation of credit and then how that interacts with the rest of the economy. I’d be really surprised if you were to tell me that issues of credit and asset prices have not been a much more regular feature of the discussion than just money.
FT: One asset price which going in the opposite direction is sterling. To what extent do you think the strength of sterling has a dampening effect through import prices?
Mr Besley: Clearly when sterling rises we get less inflationary pressure through import prices. Certainly one of the reasons why goods price inflation has perhaps been somewhat muted is because of the appreciation of sterling over the period, but we know it’s the not the whole part of the story.
FT: When you look across countries, you’ve seen inflation fall away much quicker than we have in the UK. Is that one of the things that makes you feel that maybe we do have a higher nominal demand versus supply?
Mr Besley: It would be one of the factors I would cite. Certainly [European] inflation versus consumer price inflation here is something that if you look at, it gives you the picture you’ve described. I think it’s only just another way of looking at the point which I talked about earlier, namely there do appear to be some factors that appear to be not purely explicable by idiosyncratic factors.
FT: What’s surprised you since you’ve been on the committee coming as you do from an academic and micro policy background?
Mr Besley: I hadn’t appreciated how much the analysis that the Bank produces contributes towards the decision. I found that perhaps even more helpful than I imagined it might have been before I joined the committee, because as an academic you tend to work pretty much as a sole agent, producing your research, perhaps with a research assistant on occasions, but you don’t have this whole back up process and the Bank is a corporate entity and the MPC is on top of the process. I’ve never worked in an environment where you were part of a kind of broader machine. It is helpful if you’re doing a task like this.
And I’ll cite one other thing, which is that when I was off the committee, I like everyone else would read newspaper articles about the process. In the case of journalistic reports you get the impression that people put a lot of weight on today’s numbers, whatever they are. I quickly learned in the Bank to, not exactly ignore today’s numbers but to realise that the key thing was to look at an array of numbers at the right time and at the appropriate level of reflection and not to be thrown off very quickly by headline numbers on the day they come out. I’m not saying that’s wrong for a journalist to write about it in that way - that’s perfectly understandable, but it’s quite different as an insider to see that we really don’t get very het up about a given number on a given day. It’s much more than we can file these things away and come back to them and say when we’re going to make our decision, we’ll look at that alongside everything else we’ve learned.
FT: Are you trying any way to bring more micro analysis to any areas of thinking on monetary policy where you think it might be really fruitful to get behind the sort of average numbers and the aggregate numbers?
Mr Besley: I’d like to believe so. One area I’m determined that I’ll do more on is pricing decisions. At the end of the day we’re interested in macro-pricing decisions, the price level, but I’d like to understand much better individual pricing decisions. One of the things that’s quite interesting when you come in as a micro economist is how much bottom-up stuff is done, particularly through the agents’ network. I’ve been on two regional visits so far and going around talking just to specific businesses, finding out how things really work on the ground, is a kind of economic anthropology that comes as second nature to a micro economist. I’m completely comfortable with that.
FT: You don’t think it’s too anecdotal?
Mr Besley: Some of it is anecdotal, but what I’m trying to extract is the right way to think about certain processes - how do businesses set their pricing? how do they make investment decisions? which then have more general implications than just one business in one part of the country that happens to have made such a decision in the last couple of weeks. So I view it as intelligence, trying to build towards a better first principles understanding of how the economy works, that then can be aggregated to have a more accurate picture put on top of it.
FT: Another area that you cited as an area of interest is personal debt. Can you talk a little bit about it?
Mr Besley: Yes. I haven’t furthered that yet, but it’s an intellectual interest. I’ve worked on credit markets for a long time and I’ve been interested in the process that leads people to take on debt and the consequences of people taking on debt for some period. It’s an issue for us in the sense that people outside put a lot of weight on this.
FT: And, at the moment, the growth in personal debt is not a cause for concern?
Mr Besley: If the individuals concerned are in difficult circumstances, it’s a major cause for concern and I feel very badly for people if they have got themselves into difficulty. But the issue for MPC is the macro implications and at this point, I wouldn’t say it’s in a sort of range where from a purely macro point of view that it’s something that we care about enormously at the moment.
FT: If you just had to sum up a few areas that you’ll be looking closely in terms of inflationary pressures, what would those be?
Mr Besley: We covered the factors already that I think have been relevant in the last few months. Obviously, understanding the ability of producers to put through price increases and what we can learn about that is a very relevant issue - understanding how prices are set is central to the inflation process.
I don’t think that’s research I’ll be able to conduct in the timeframe that would be relevant for the next few MPC decisions. I view that as more of an issue I’ll be able to investigate in the medium term. I can’t guess what the issues are going to be going forward. Some of the issues have got longer to run, like exactly how the energy price process will follow through the economy, but I wouldn’t want to what will be the next big issue. I think there it’s more a reactive mode, understanding that things will be driven by the challenges that arise from events.