Sunday, February 05, 2006
Shadow MPC in three-way split
Posted by David Smith at 10:59 AM
Category: Independently-submitted research

The results of the latest Shadow Monetary Policy Committee (SMPC) quarterly meeting and supplementary e-mail poll for the Sunday Times are set out below.

The rate recommendations are made ahead of the Monetary Policy Committee (MPC) rate decision to be announced on Thursday 9 February. On this occasion, four SMPC members voted to hold rates on 9 February, three voted for a ¼% reduction, and two voted for a ¼% rise.

The SMPC itself is a group of independent economists drawn from academia, the City and elsewhere, which gathers once a quarter at the Institute of Economic Affairs (IEA) in Westminster, to monitor UK monetary policy. The inaugural SMPC meeting was held in July 1997, two months after the Bank of England was granted operational independence, and the Committee has met almost every quarter since.

The Secretary of the SMPC is Professor Kent Matthews of Cardiff Business School, Cardiff University, and its present Acting Chairman is David B Smith (Williams de Broë Plc and University of Derby).

Other current members of the Committee include: Professor Patrick Minford (Cardiff Business School, Cardiff University), Professor Tim Congdon (Founder, Lombard Street Research), Professor Gordon Pepper (Lombard Street Research and Cass Business School), Professor Anne Sibert (Birkbeck College), Dr Peter Warburton (Economic Perspectives Ltd), Professor Roger Bootle (Deloitte and Capital Economics Ltd), John Greenwood (AMVESCAP), Professor Peter Spencer (University of York), Dr Andrew Lilico (Europe Economics), and Dr Ruth Lea (Director, Centre for Policy Studies and Non-Executive Director, Arbuthnot Banking Group).

Professor Philip Booth (Cass Business School and IEA), who also attends physical SMPC meetings, is technically a non-voting IEA observer. However, he is awarded a vote on occasion to ensure that exactly nine votes are cast.

The IEA’s Shadow Monetary Policy Committee, a group of leading monetary economists drawn from academia and the City, voted to keep interest rates unchanged at its latest meeting. A vote to raise rates was defeated by seven votes to two and a vote to lower rates was defeated by six votes to three. The evidence presented to the committee about the UK economy contained conflicting signals, and this explained the unusually divergent views on the committee. The largest number of members believed it was appropriate to wait for more evidence before changing interest rates.

In the presentation of the international economic situation, concerns were expressed for international inflation. Across the world, the rate of broad money has been increasing to a level incompatible with current inflation levels. Future interest rate increases were likely in the Euro-zone and in the United States.

The picture was less clear in the UK. There has been a slowdown in the UK economy, but this was a result of factors such as increased taxation and reduced consumer spending, rather than as a result of monetary policy. Money supply growth is still strong. One member, Gordon Pepper, was particularly concerned about the way in which broad money growth was working its way into asset price inflation and other members expressed concern about rapid money supply growth and the prospects for inflation.

However, other members, including Dr Peter Warburton, who had delivered a briefing on the Economic Situation to the meeting, believed that the risks of undershooting the inflation target were greater than the risks of overshooting and that, as a result, interest rates should be cut.

Comment by Professor Philip Booth
(Cass Business School and Institute for Economic Affairs)
Vote: Raise by 0.25%

Money supply growth warranted a hike

Philip Booth said that money supply growth has been far too high and was not compatible with the target rate of inflation. He recommended that rates should be raised by ¼%. He also commented that monetary policy should not be used to achieve other economic policy objectives, such as counteracting weakness in the economy arising as a result of the government’s tax and public spending policies.

Comment by John Greenwood (Chief Economist, AMVESCAP)
Vote: No change

No need to tighten so far

John Greenwood said that the economy has shown some signs of improvement in housing and the retail sector. Growth is now more balanced. The yield curve is flat and the economy is growing moderately at below potential after a period of growing above its long-run potential. There is no need at present to tighten. He voted to keep interest rates on hold.

Comment by Dr Ruth Lea (Director, Centre for Policy Studies and Non-Executive Director, Arbuthnot Banking Group)
Vote: No change

Mixed picture suggests leaving rates on hold

Ruth Lea said that the economy has no spare capacity. Inflation is under control. Wage inflation is moderate. Therefore, there is no pressing need to cut or to raise. She voted for rates to stay on hold.

Comment by Professor Kent Matthews
(Cardiff Business School, Cardiff University)
Vote: No change

Liquidity trap analogy

Kent Matthews said that the growth in broad money is not consistent with the current rate of inflation and those grounds would warrant a rise in the rate of interest. However, he was impressed by Peter Warburton’s argument that retail money growth had remained stable and that households were holding money for savings purposes, not unlike the liquidity trap. He also recognised that the economy was at capacity and that there had been an improvement in demand on the retail side, which did not support a rate cut. He voted to keep rates on hold.

Comment by Professor Gordon Pepper
(Lombard Street Research and Cass Business School)
Vote: Raise by 0.25%

Raise rates to forestall financial instability

Gordon Pepper said that if asset prices were expected to rise more rapidly than product prices, the expected real rate of interest for purchasing assets was lower than that for goods and services. When this was happening, rates could not be raised sufficiently to moderate asset-price inflation without causing a recession. At the moment, the expectations of inflation were roughly the same and the problem did not arise. Because asset prices were already very high - witness the incredibly low yield on index-linked gilt-edged stock - he was in favour of ¼% rise in rates to discourage a further increase. The reasoning for a rate rise was to forestall financial instability and not to control goods price inflation.

Comment by David B Smith
(Chief Economist, Williams de Broë and University of Derby)
Vote: No change

Risks arising from a rate cut seem worse than would stem from a hold or a rise

David Smith said that he had no strong views either way, but thought that a rate cut was more likely to lead to longer-term problems than an increase. In particular, the British economy seems to have acted a bit like the bouncing bomb in the film The Dam Busters: it hit the surface last autumn, but did not sink, and now seems to be rebounding again. In particular, there are signs of a pick-up in the housing market, retail sales and in industrial surveys. Recent GDP figures seem weaker than one would expect from independent surveys and could be revised upwards.

Total national output has also been reduced by a tax-induced (?) run-down in North Sea output and non-oil GDP rose by 1.9% in the year to 2005 Q3. Inflation is not an immediate problem, and the labour market appears genuinely weak, but the CPI figures are slightly higher than one might expect, given the behaviour of retail prices excluding housing items. The rapid growth in its wholesale element, which rose by 18.6% in the year to November, suggests that the M4 figures are being boosted by financial speculation. Retail M4 is chugging along in comparison, but still increased by 9.7% in the twelve months to November.

Global monetary conditions are likely to tighten over the next few months, with a US Federal Reserve rate hike likely on 31 January and an ECB one on 2 March. Sterling could be knocked for six if the MPC cut rates at the same time as the rest of the world tightens. It is not worth risking triggering a portfolio shift out of sterling by cutting the UK REPO rate, and we would have to raise rates if world rates rose anyway. He voted to hold interest rates.

Comment by Peter J Warburton
(Director, Economic Perspectives Ltd)
Vote: Cut by 0.25%

Real rates too high

Peter Warburton said that he remained a cutter, and that real interest rates to the private sector are too high. He voted for a ¼% reduction.

Votes in Absentia

The SMPC sometimes allows a small number of votes to be cast in absentia and adds their written submissions to the record of the meeting, particularly where it avoids the possibility of a tied vote. Two SMPC members who were unable to attend the physical meeting on 17 January cast votes.

Comment by Roger Bootle (Economic Adviser, Deloitte)
Vote: Cut by 0.25%

Difficult time to assess the economy

This is an extremely difficult time of year to assess the economy. As usual, there have been conflicting reports as to what has been going on. By the time of the February MPC meeting there will not be definitive evidence on the New Year period to set against the apparently strong Christmas trading, but the picture should begin to be a little clearer. Moreover, this month coincides with the Bank’s regular forecast reassessment in preparation for the February Inflation Report. With little sign of any pass-through from high oil prices; headline inflation looking as though it is past its peak; and it looking as though economic growth will continue below trend, the Bank should cut interest rates by ¼%. This is what I would do, but it would not surprise me if the Bank waited a little longer for more evidence. I expect rates to fall to 4% this year.

Comment by Professor Anne Sibert (Birkbeck College)
Vote: Cut by 0.25%

Inflation has moderated

The prospects for UK inflation appear to have moderated. Although the average rate of CPI inflation during 2005 was 2.1%, the highest since 1997, CPI inflation peaked in September 2005 at 2.5% and was down to 2.0% in December 2005.

Labour market is slacker

While year-on-year employment still shows growth, during the last few months, employment has declined and inactivity has risen. These signs of labour market weakening are consistent with recent earnings data. Average earnings, excluding bonuses, rose by 3.8% in the year to November 2005, down from 3.9% in October. Including bonuses, average earnings rose by 3.4% in the year to November, down from 3.6% in October. Even with the rather poor underlying productivity growth of the UK economy, it is hard to see much threat to price stability from rapidly rising unit labour costs.

World growth

In the rest of the world, stronger growth in the Euro-zone and in Japan will be supportive of UK exports, but both Euroland and Japan remain fragile. In the United States, the downside risk to activity seems greater than the upside.


With inflation more likely to be below target than above target over the time horizons that the MPC can affect it, I believe a 25 basis points cut is called for.

Policy Response

1) Putting together the seven votes cast at the physical meeting with the two votes cast in absentia revealed that the largest single block of four SMPC members believed that interest rates should remain on hold. However, there were dissensions both ways. In particular:

2) Three members voted to cut rates by ¼%, and:

3) Two members voted for a ¼% rise, with one emphasising the implication for financial stability rather than inflation control.