Murnaghan 19.05.13 Interview with Sir Mervyn King, Governor of the Bank of England

May 19, 2013



Now we’ve almost forgotten what it’s like to hear good news from the Bank of England but last week we remembered. The Governor, Sir Mervyn King, announced a welcome change for the economic outlook for the UK and predicted that growth would pick up in the second quarter of this year. Well I spoke to Sir Mervyn in an exclusive interview after that announcement and in a moment you can hear his thoughts on the UK economy, on Europe, banker bashing and find out what he really thinks about his successor, Mark Carney. Well when I spoke to Sir Mervyn this week, I started by asking him what it felt like to leave after finally delivering some better news.


  MERVYN KING: Well it was very nice to be able to report for the first time since the crisis started that growth was likely to be a bit higher and inflation a bit lower than we had thought three months ago so in that sense yes, it was nice to report a somewhat better outlook than we had been reporting for a while.   DERMOT MURNAGHAN: But how far can we push that? Have we turned a corner, are we out of the woods yet?   MK: Well we are seeing a recovery, it is only a modest recovery and we certainly can’t be satisfied with it, we will need to do more to use up the spare capacity and to get back to a healthy growing economy but we are in a recovery period now I think, yes.   DM: And how well rooted is it? What are the risks in other words?   MK: I think the single biggest risk is that the euro area continues to grow very slowly or, as it is in now, in a recession and it is very difficult to see that they will be growing quickly for a long while and that downward drag on exports from the UK to Europe, they account for almost half of our exports, and the fact that our banks still have some exposure to the euro here is undoubtedly the single biggest factor dragging down on our economy.   DM: So in a sense is our fate out of our own hands? We can do what we do and the Bank can do what it does within the confines of the United Kingdom but given the trading nation we are, what happens elsewhere is the biggest determinant?   MK: Well it’s a very important determinant and I think we’re not the only country in the same boat. Almost all the economies in the world are being affected by what is happening elsewhere and certainly we are being very heavily affected by what’s happening in Europe.   DM: Where do you stand in the argument about the role of deficit reduction and its relationship to growth? As an economist do you see the current course as being a driver of growth or something that’s hindering it?   MK: Well I think the whole debate about fiscal policy has really got overblown to some extent.   I think everyone agrees on the following propositions: first that we do need a credible medium term plan to get the public finances back into order and secondly, that we should allow the automatic stabilisers, that is when the economy is weak if tax revenues fall you don’t cut spending elsewhere to make up for it, you allow the deficit to adjust for the state of the economy, you allow these automatic stabilisers to work. Those two principles, a credible medium term plan and flexibility, is the right way to go. Now of course there is always room for debate about the precise parameters involved but by and large that overall view is the right way to go and I think to throw it overboard wouldn’t really make a great deal of sense.   DM: But you must have watched with interest what is happening in some of those eurozone countries, particularly in the south, in Spain, in Greece of course, in Italy. Doesn’t the jury seem to have returned and says really the austerity is being overdone there, it is affecting growth to such a great extent we can’t see you ever getting out of that spiral?   MK: Well it certainly is a major problem for them but there are two enormous differences between their economies and ours. The first is that we have our own currency, we have seen that currency go down in value. Now that has a cost in terms of pushing inflation up but has a great benefit in terms of stimulating our exports and our manufacturing exports have risen a lot since sterling went down a few years ago. The second difference is that we can apply our fiscal plan flexibly, so we are allowing the automatic stabilisers to work. They are trying not to do that, they are trying to hit fixed targets for their deficit and that has been a mistake and it is the reason why their economies are still, some of them, in a downward spiral.   DM: But can you ever see the UK joining the euro after the experience it’s been through and the experience we’ve been through?   MK: This clearly isn’t a matter for the short or even the medium term. What happens fifty or a hundred years from now I certainly wouldn’t want to predict, that will depend on a whole series of factors but I think the big mistake that was made was going to monetary union before they had developed sufficient political union to make the project easily feasible and that’s a problem that they are now struggling to deal with. There are many ways they could try to get through this but there isn’t any easy answer for them and that is why growth there is low and it is likely to stay low for some while.   DM: So you’ve talked about the advantages of not being in the euro, would it be an advantage for Britain not to be in the European Union?   MK: That’s not for me to judge, that’s a different question altogether, that’s a political question and it is very important the Bank of England doesn’t get involved in these political issues.   DM: Let me talk to you about the growth that we are just seeing a glimmer of, can I phrase it this way, is it the right kind of growth because we talked an awful lot, didn’t we, in 2010, in the aftermath of the whole financial and banking crisis of rebalancing the economy away from financial services toward manufacturing, the march of the makers. Have we got that yet, is that what’s showing up in these growth figures or are we going down the same old path again?   MK: We have some of the right kind of growth, to use your phrase, not enough of it but some of it and I think the underlying momentum to growth last year was stronger than the headline figures would suggest. North Sea oil output was particularly weak last year, partly because of tax changes that were made in the past that diminished investment, that’s now been reversed and we have good reason to believe North Sea oil output will recover over the next couple of years but what that meant was that not just was the economy a bit weak last year as the underlying position would have shown, but the trade deficit looked worse because we weren’t exporting oil and gas to the same extent. If you try to look at the figures adjusted for the North Sea production, then you can see an improvement in the trade deficit and you can see we are beginning to come out of the downturn and seeing some positive momentum in terms of economic growth.   DM: But we are still a long way from that rebalancing, it’s not manufacturing, it’s not making things and exporting them.   MK: When I go round the country on regional visits all the time I see a lot of very impressive medium sized engineering companies for example exporting around the world. I don't think we should worry about our ability to do it, what we should worry about is that demand in the rest of the world, particularly in Europe, is very weak and that the situation overseas is a very difficult one in which to rebalance our economy. If the rest of the world were growing at its average historical rate, growing as normal, we’d be in a pretty strong position by now. But it’s not so we’re not growing particularly rapidly and I think this is a very important factor in what’s happening to our economy today.   DM: But have we in this country almost reverted to type when it comes to growth, given what’s happened internationally, particularly within mainland Europe? We’ve gone then for assets, for housing, do you have concerns about another asset bubble building then, in particular fuelled by this Help to Buy Scheme?   MK: Well we are always looking very carefully at what is happening to asset prices and whether we’re pushing them up but of course the very low level of interest rates around the world, and we can’t insulate ourselves from that, so interest rates are low right across the world and that inevitably pushes up asset prices but let’s remember that house prices are still 14% below where they were at the peak. Fortunately we’ve had neither the collapse in house prices which was seen in the United States and especially in Spain and Ireland, equally we haven’t seen house prices rising rapidly, we’ve been remarkably stable for the last few years. That’s not a bad position to be in.   DM: But you did warn before the bust, before the crisis, I mean you were warning as early as 2004 and 5 when house prices were below these levels that an asset bubble was building.   MK: I said people should be very careful about how much they borrowed, yes, and we will continue to try to warn people and to explain and to see whether we can prevent undesirable increases in asset prices but in the end we will set the level of interest rates at the level that will ensure both adequate economic growth and, most importantly of all, to bring inflation back to the target because the one thing that we have achieved over the last 20 years is to get away from the period that many people may never have experienced and some can just remember the 1970s when inflation got to 27% in one year and in the 1970s it averaged over 13% a year right through the whole decade. That was devastating to our economy and we must never go back to that.   DM: Just on the Help to Buy Scheme, my understanding of it is that the Bank of England is effectively the ultimate guarantor. Doesn’t it have to call the end of that scheme where suddenly people have to bear responsibility for the loans that they’ve taken out? When and how will the Bank decide to pull that rug?   MK: Well I’m sure that there is no place in the long run for a scheme of this kind, this scheme is a little too close for comfort to a general scheme to guarantee mortgages. We had a very healthy mortgage market with competing lenders attracting borrowers before the crisis and we need to get back to that healthy mortgage market. We do not want what the United States have which is a government guaranteed mortgage market and they are desperately trying to find a way out of that position so we mustn’t let this scheme turn into a permanent scheme. Now when is the right moment to terminate it will depend on economic conditions at the time and as you say, the Bank’s Financial Policy Committee will give a view on that. Ultimately the government will have to decide but the Bank of England’s Financial Policy Committee will give a judgement as to whether it thinks the scheme should now come to an end. I can’t pre-judge when that will be but what I do know is that it shouldn’t become a permanent feature of our financial landscape.   MK: I think we’ve seen an enormous change in our banking system. Obviously we are not seeing the lending that we’d like to see, there are many factors behind that but let’s remember that when the crisis started we had a very small number of banks which had become much too big, expanded their balance sheets, they were very fragile, they had very thin levels of capital which meant they couldn’t absorb any losses that came along and many of them got into deep trouble and the taxpayer had to bail them out. We’re moving a long way from that now, we have a completely new regulatory system with the Bank of England back again in charge of regulating banks and I’m very impressed with what I’ve seen of the Prudential Regulation Authority now, the colleagues I have on the board are doing an excellent job there, we have a Financial Policy Committee to set the parameters and the framework within which our new regulators will work, we’ve got the Vickers proposals to split the different types of activities of banks so that the normal commercial banks will be behind what is called a ring fence and the more risky investment banking will be outside it, higher capital requirements for the banks that we need to keep going and can’t afford to let fail. We’ve got higher capital in all our banks and we are dealing with the banks that are in the state sector.   If we can get to the end of this process then we will have a revolution in the way in which banking is handled and we will be able to be proud again of British banking. We have a bit further to go but we are not far from it and in the next one to two years we’ll get there.   DM: It’s interesting what you say there about pride again in British banking because Governor, as you know, we’re a long way from it, certainly in the public mood about bankers. Are the public right though to blame the bankers primarily for what happened in 2007 and 2008 or have they got it slightly wrong?   MK: Well there are two things I’d say about that, first is that what bankers did is not the only explanation of the crisis that we had. What we had was a world in which interest rates had become very low, investors of all kinds – not just banks – were desperately searching for ways in which they could earn more return and so they took big risks and some of those risks went wrong. Where the banks contributed to the problem was that they themselves had taken too many risks on their balance sheet and they simply didn’t have enough capital to absorb the losses that were likely to come along and people took fright, they lost confidence in the banks, they didn’t provide money to the banks so the banks couldn’t lend to businesses or households. I would say to people though, don’t demonise individuals here. This wasn’t a problem of individuals, this was a problem of failure of a system. We collectively allowed the banking system to become too big, we gave them far too much status and standing in society and we didn’t regulate it adequately by ensuring it had enough capital. We have to put that right and …   DM: Is that a source of personal regret for you because as I mentioned earlier, you warned about asset bubbles, you warned about lending in the mid noughties, I mean is that a source of regret for you that you didn’t do something about that?   MK: We warned about it, many other people warned about it. In the end what matters is that we learn the lessons from what went wrong and actually make sure that we change the system so that it doesn’t happen again and we are changing the system. The last government introduced a new scheme for deposit insurance and for resolution of banks, we can deal with failing banks. This government has introduced the Vickers reforms and that is going to deal with the state owned banks and has supported proposals through the Financial Policy Committee to ensure our banks are adequately capitalised. We are moving a long way I believe but in a couple of years’ time we could if we carry on the right path get to a point where we would be best practice in the regulation and structure of our banking system and then instead of people trying to mock British banking, as they did in 2007/8 when things went wrong, they will actually look and say, well actually they did learn the lessons and they put in place a system that we could learn from ourselves.   DM: Well that’s explained, very cogently may I say, the role of bankers and where we should place them within that financial crisis. Just let me put to you though, some people who definitely didn’t cause it and seem to be paying for it, which of course are savers. Interest rates are so low, and I’ve heard you talk about it before, interest rates so, so low and of course inflation eroding their savings, they really are the ones who are getting it in the neck.   MK: Absolutely and it’s not just elderly savers, people like myself, it’s younger savers who now find that the cost of providing for a pension is very high so it is very important that we try to get back as quickly as we can to a healthy normal economy with positive interest rates and that’s what we are trying to do. But to state that, it doesn’t follow that the best way to get there is just to push up interest rates tomorrow because that would turn the economy down into a deeper recession and make unemployment worse and make the problems of savers worse too. We have a difficult problem of navigating our way back to a healthy economy and my view is that no one economy on its own will find it easy to do it. This is where we do need international co-operation to make sure that we can rebalance the world economy so that we can grow more by relying on exports and less on consumer spending and economies like China and Germany rely less on exports and more consumer spending and that rebalancing is going to be the key to all our economies growing more quickly.   DM: Is it also another worry about getting that timing right, when interest rates have to go back up again because you obviously have to anticipate what happens. Now there is an unprecedented amount of money sloshing around there in the economy through quantitative easing and what is it, five and a quarter times as much as there was in 2007, if the economy turned very quickly it would be impossible for the bank to react wouldn’t it?   MK: Well I think for inflation to rise very rapidly would require extraordinary expansion of lending by the banks and the creation of deposits in bank accounts and we see no sign of that yet and I think we would get enough time to be able to raise interest rates or take other measures to prevent that turning into a rapid upward push on bank lending and inflation, I think we will get time to see it. It doesn’t mean to say that the judgements would be easy because there are lags between when we take action and their impact on spending and ultimately inflation but I don't think the fact that we have had to increase the amount of reserves that the banking system has is going inevitably to make life impossible for us. After all at present we are still struggling to get enough lending and activity in the economy and I think we have to get to a point where we can see more sign of a recovery but the Bank will need to be prepared to move quickly when necessary, you are absolutely right and I would very much hope that sooner rather than later that savers will see that returns on their savings in safe form, not by taking wild risks but in safe form, will be back at levels that will earn them an income that they can rely on for the future.   DM: On that, looking to the future, your successor, I know you know him very well, Mark Carney, is that very much the hymn sheet that he is singing from too?   MK: Mark is a very smart person, the country is fortunate to have someone like Mark coming in. I think everyone will admire what he will achieve, he will work with the rest of the Monetary Policy Committee, it’s not a one man show, there is a very strong team of people here in the Bank of England which I’ve built up over 20 years and I’m very proud of the team I am leaving behind. They will work with Mark and I have total confidence that they will make the right judgements. What none of us can know of course is what the right decisions will be down the road. They will have to be made month by month according to how the economy develops but I’m sure they will make the right decisions.   DM: But it is a bit of history in the making isn’t it? Bank of England and he’s Canadian.   MK: Well I can’t see any reason at all why we should be remotely apologetic about saying let’s look around the world and appoint the best person to the job. One of the things that’s fascinating to me in talking to my central bank colleagues around the world, they often start by thinking of Britain as a rather insular country. Not one of them, not one of them would have the courage to appoint a foreigner to be Governor of the Bank of England. If he is the best candidate, why not appoint him?   DM: Let me ask you, we’re getting towards the end here, about something you mentioned, I mean you mentioned it as a joke in your last quarterly inflation report when you talked to the Slovenian and said you should come and join the sterling zone and that went down very well but of course Mark Carney or someone else might face the very real possibility of a foreign country wanting to join sterling, you know what I’m referring to here, if Scotland votes to leave the United Kingdom. How would that work in your view?   MK: I think it’s quite simple on one level in that the decisions on that would not be for the Bank of England, they would be for the Westminster parliament and the Westminster parliament no doubt would discuss with the Scottish parliament a way forward depending on the result of the referendum. What’s important is that whatever comes out of that, the Bank of England will still have continuing responsibilities, it mustn’t take sides in this debate, we’re not going to but the Westminster parliament will determine the marching orders for the Bank of England and then we’ll do our best to …   DM: But I mean it’s just the mechanisms of managing the monetary of a foreign company, currency … foreign country which may have different rates of growth, different rates of inflation, different rates of employment. How would that work?   MK: Well it’s very similar to the problems we face now in managing monetary policy for the United Kingdom where there are differing growth rates and rates of unemployment in different parts of the United Kingdom so I don’t think the underlying issues are particularly different but what we would do would be given to us by the Westminster parliament, these are decisions for the electorate in the first place in the referendum and then for elected politicians to decide how to respond to the results of that referendum. It’s for the Bank of England to serve the Westminster parliament in that sense.   DM: I just wanted to ask you about the currency, the notes. You’re leaving the Bank with plans for the Winnie, the five pound note with Winston Churchill, Sir Winston Churchill, on them. I think that will be very popular but I suppose the quid pro quo for that – excuse the pun – is that we now will have no women on our bank notes.    MK: Well with respect they all have a woman, the Queen. We’ve had fifteen figures on our bank notes, two have been women. We have a list of candidates from whom we choose, any member of the public can make a nomination and we put the list of nominees on our website and I’m sure that all people, male or female, would be treated equally when it comes to a judgment about who is appropriate to place on our bank notes and we’ll do that on the basis of choosing the right person and not on the basis of an artificial distinction by gender, but I’m sure there’ll be women on our bank notes in the future as there have been in the past.   DM: And tell me about your future, what happens when you leave the Bank? Someone tells me, you’re leaving at the same time as Sir Alex Ferguson is standing down, now we know he is going to be around Old Trafford in an advisory role, will you still be available to your colleagues here at the Bank of England or once the door shuts, that’s it, you’re gone?   MK: Well I shall not be in the Bank giving advice, no. Obviously if anyone wants to call me, if they can get me on the phone I will be happy to give advice but I shall be leaving, making a clean break. We have a wonderfully talented successor coming in and I am going to take a complete break for a while.   DM: I mean you talked about handing on to that next generation, you’ve just mentioned it again, what about all of us who are looking to the next generation, I was thinking about this as I came in here to do this interview, we’re leaving youngsters if they’ve been to university with a huge amount of debt, an uncertain jobs market, an uncertain growth outlook, it’s all very different from when people like you and I left university.    MK: It is and that’s one reason why I think those of us of the elder echelons of the Bank feel very strongly that we must do what we can to get out of this crisis, to get a banking system that will serve the country well in the future, to get interest rates back up to more normal levels and to ensure that young people can buy houses, can save for a pension and that their prospects are as good as the ones that we faced.   DM: Sir Mervyn King, thank you very much indeed for your time.   MK: Thank you. 

On Twitter