Extracts from Uncorrected Transcript of Lords Economic Affairs committee session with Dr Mark Carney - Mar 5

Q10            Lord Burns: Governor, when you were here a year or so ago, we had a discussion about problems with the RPI and how we might deal with some of those problems. 

Since then, we have taken quite a lot of evidence on this, and of course published a report. The Committee would be very interested to know the extent to which you agree or disagree with the report and the Committee’s suggestion that we need to resuscitate the RPI, relative to the condition that it seems to have reached, to try to deal with some of its problems and, in time, move to a single reliable measure of inflation. 

We raised a number of individual points, but maybe we could begin with the general issue. 

Dr Mark Carney: First, I very much welcome the report and the work that went into it. It is another example of this Committee’s service. It is an important issue that was in some danger of becoming intractable. I forget your exact terminology, Chair, but I think it was about a “ridiculous dance” or words to that effect. 

The Chairman: I am much less diplomatic than you imply. 

Dr Mark Carney: That is how it was translated. The nettle does needs to be grasped and, although it is for others to decide, I suspect the report will make that happen. 

The question then becomes a practical matter of what gets done; there are decisions for others. The move to a single or preferred measure of consumer prices is highly desirable. The path by which we get to that remains to be determined. Transition is important, but transition with a sense of the end objective. As you are well aware, there is a huge range of stakeholders in this. It starts with the gilt-holders of RPI-indexed bonds but extends to pension-holders, both indexed RPI and increasingly CPI, and to those on either side of PFI contracts indexed to RPI and of course student loans indexed to RPI.

I want to say one other thing by way of introduction. Given our mandate and remit, it will not surprise you to hear that we have a particular interest in CPI and the role of CPI. We will of course target whatever Parliament decides we should, but we think CPI serves us well. We think that the ONS’s development of CPIH in the current iteration is promising; its track record is lengthening and it bears consideration with respect to the final determination.

Lord Burns: I have two supplementary questions. First, on the measure of housing costs, do you have a view on which will be the best direction to take? 

Secondly, we had quite a lot of disagreement among our witnesses, and indeed with the Committee, about the question of whether the Government should be issuing CPI-linked gilts. There was one view that this could lead to market fragmentation and could be disadvantageous, whereas the Committee’s view was that we should be moving in this direction. If this is where the overall preference is going to develop for a single measure of inflation, why would we continue with RPI-linked gilts?

Dr Mark Carney: I will focus on the core issues. We favour the rental equivalent approach for housing used in CPIH. Consistent with everything else in the CPI, it is about trying to measure our consumption of housing and not conflating it with other costs associated with housing prices and housing transactions. That means not having housing transaction costs or directly mortgage interest payments in there. Those are two examples.

So we like the approach in CPIH. As I said a moment ago, we think that it is tracking well from what we can see, with respect to rental equivalence and other cross-checks. In addition, the ONS’s broader powers—“broader information set” is probably a better way to put it—following the 2016 reforms adds further credibility to that.

It probably needs a bit more of a track record and a bit more study—one would hope there would be a broader study before moving to the next phase of adjustment—to confirm the appropriateness of that measure. But it is the most promising option in my personal view and, more importantly, from the perspective of the experts in the Bank of England. 

One of the big issues is whether the Government should issue CPI-linked debt. There are a few considerations here. My perspective is that the thinking is about starting a new market rather than fragmenting an existing one. So are the conditions in place for starting a new market for CPI-linked debt? 

First, there is natural demand for the product. Going back more than five years, the estimate is of somewhere between £250 billion and £400 billion in CPI-indexed pensions. Obviously there is a natural macroeconomic interest, since it is the variable we target and it is the most prominent measure of inflation. While there is a very small CPI-indexed inflation swaps market at present, one would expect that to develop pretty substantially with the underlying cash flow. There has also been private issuance; we have seen that over the course of the last couple of years of CPI-indexed debt.

All the signs that a market can develop are there. We should not put the cart before the horse, and I know that you are not suggesting that, but if a decision were taken tomove to CPI indexing and that RPI would become a legacy and eventually a distant memory, then in the fullness of time, after a reasonable transition, the demand will absolutely be there, in my judgment, and that market will develop.

The Chairman: There was one issue about RPI that we found a bit puzzling—you have seen the Committee’s report. While RPI continues to exist as a measure, we could not understand why the statisticians were not prepared to update it and make it relevant. Do you have a view on that?

Dr Mark Carney: That is best answered by the statisticians. 

The Chairman: Yes, but I am trying to put some pressure on them.

Dr Mark Carney: To be absolutely clear, the UKSA and the ONS are committed to the highest quality statistics, as you know. They have taken that position; they have signalled delisting it as a national statistic, calling it a legacy statistic, and drawing attention to its deficiencies.

I apologise, but to go back to your “ridiculous dance”, they are in a situation where they cannot change it. They can recommend changes to it, but we have a formal responsibility, as you know, to judge whether there would be a detriment to specific bond-holders and to give that advice to the Chancellor, who would then make the decision. 

The chicken and egg-type situation is that, if they recommended something that were to improve the measurement errors—as your report and the evidence you have received indicates, the tracking error relative to CPI is somewhere between 70 and 100 basis points, and fixing the Carli formula gets you most of the way there—those orders of magnitude mean that it is hard to image with a long-dated bond that that is not at least detrimental to those bond holders; but that is not a formal judgment. In which case, that is a very tough decision for a former Chancellor who has just left the building, and it is probably what the current Chancellor might do if we were having this conversation. It is a difficult decision. My suspicion is that the issue gets deferred, because one can anticipate the answer at a given time.

This Committee has done a very thoughtful and comprehensive analysis of the situation. It has brought the facts together and, in effect, posed the question. The ball is in the court of the relevant authorities. I have every reason to believe that your analysis and challenge is being given all the seriousness it deserves. 

If things were to proceed, the big question would be to decide an appropriate end state. To do that, there would need to be a consultation and serious thought given to a form of transition. Those are complex issues that really have to be dealt with in an open and public manner, I would think.

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