Treasury Committee
Oral evidence: Appointment of Clare Lombardelli as Deputy Governor for Monetary Policy, Bank of England, HC 687
Tuesday 16 April 2024
Ordered by the House of Commons to be published on 16 April 2024.
Members present: Dame Harriett Baldwin (Chair); Mr John Baron; Dr Thérèse Coffey; Dame Angela Eagle; Stephen Hammond; Keir Mather.
Questions 1-56
Witness
I: Clare Lombardelli, appointee as Deputy Governor for Monetary Policy, Bank of England.
Witness: Clare Lombardelli.
Q1 Chair: Welcome to this Treasury Committee evidence session. We will hear from Clare Lombardelli, the new appointee as Deputy Governor for Monetary Policy at the Bank of England, before she takes up her role on 1 July this year. Ms Lombardelli, we have seen your CV, and we are publishing the response to the questionnaire simultaneous to this session. I will start by asking you to introduce yourself for the record.
Clare Lombardelli: Hello, I’m Clare Lombardelli. I am currently the chief economist at the OECD, and I will be Deputy Governor for Monetary Policy from 1 July.
Q2 Chair: Congratulations on your nomination to the role. It looks like you will have your hands full, because the Bernanke review, which was published last week, said that the Bank of England’s forecasts have deteriorated significantly. You are currently the chief economist at the OECD. Why have the Bank of England’s forecasts deteriorated significantly?
Clare Lombardelli: Let me start by saying that I think the Bernanke review is a fantastic thing to have undertaken. Clearly, central banks around the world, particularly in advanced economies, have really had to deal with a number of shocks that have been very large and quite unusual in nature over the last few years. When you look at the performance of central bank forecasting in terms of how it is compiled and how the estimates have compared with the outturns, we have seen very large errors across all advanced economies’ central banks. Actually, the Bank of England’s forecasts are in line with that, as you would expect, really. All central banks, in some ways, use similar tools and approaches in the way that they do forecasting.
The nature of the shocks that have hit the global economy over the last few years, if you think in particular of the covid pandemic, the energy price shock, the cost of living and the impact of inflation on that, has been difficult for standard economic models and forecasts to handle and deal with. That is why we have seen these very large errors across the piece. It is a good thing that the Bank has opened up this process and had this review. In bringing in Dr Bernanke, they have obviously brought in someone of outstanding ability and judgment on these things, so that is very valuable. However, for all central banks it is ultimately really around the scale of the shocks and, in a sense, the inability of the usual models and techniques to be able to understand how these relationships have changed in the economy in response to those shocks and some of the structural changes that we also see going on. That would be why we have seen these big errors.
Q3 Chair: What I think I am hearing you say is that you think there has been too much reliance on models and that these models have turned out to have significant shortcomings. This Committee was able to observe in real time, without the benefit of hindsight, the inflationary pressures that existed coming out of the pandemic, and the Bank felt that they were transitory because the models said that they would be transitory. Now that these models have been shown to have significant shortcomings, do you think that the whole process is too reliant on models?
Clare Lombardelli: Actually, I am not sure I would necessarily agree that the process was too reliant on models. What has happened in a sense is that these models could not cope with, or were not providing very reliable estimates of, what the impacts of these shocks would be. What you actually saw in policymaking around the world—and I think this is also true of the Bank—is that because the models were not providing hugely reliable forecasts in some instances, increasingly policymakers were using judgment and other forms of data and analysis to try to estimate other parts of models and look at relationships in a slightly different way. In a way, perhaps less weight was being put on the models because they were struggling, if you like, in this environment.
I do not know individual policymakers on the Monetary Policy Committee and what weight they were personally putting on models versus data analysis and the information coming in from agent surveys and the like. I suspect that that will have changed over the course of the last two years. However, it is definitely the case that we need to understand that models add a huge amount of value and can do a lot in economics but also have their limitations. I experienced that very much when we were going through the covid pandemic, in my role in the Treasury, and I have talked about this before. There is a wealth of models and they are very important; they can add a lot of value and can really help you think about the relationships in an economy. You can use them and compare that to what you are seeing in the real world. That helps you understand, but you cannot be overly reliant on them. Ultimately, the economy is an incredibly complicated thing and no one model is ever going to be able to replicate that and help you there.
Q4 Chair: In your role, as I understand it, you are going to be the person responsible for implementing the 12 recommendations that Dr Bernanke has outlined in his report. One of them is that the software itself is just horribly out of date. He did not hold back in his criticisms of the software. Are those software shortcomings something that, through your role at the OECD, you feel confident that you would be able to address?
Clare Lombardelli: I am hugely excited to be taking on the opportunity of reforming the modelling and how those models are used in the Bank of England. I think it is a great opportunity for us to improve policymaking and communication.
In terms of the software, I have to be honest, I am not yet close to the detail of the precise software the Bank is using, the reliability and state of it, and its suitability for the modelling. As you said, I do not take up my role until 1 July. I understand that the Bank has plans to improve its software, and that will be a core part of the response to the Bernanke review. I am confident that we will have the resources and the capability to do that.
In terms of what I have seen from the OECD and modelling there, we do our modelling in quite a different way and we use, in a sense, less data per country but more data around the world. So we get less into some of the country-specific details but we do, for example, have an awful lot of data and analysis that we do on some of the global issues. For example, we have very sophisticated trade data that comes from an awful lot of information, modelling and data collection. A huge amount of resource goes into that, and it can be time-consuming and difficult. These sorts of infrastructure issues are really important; they can seem quite boring and unexciting in terms of how much resource you put into them—
Chair: They are really important.
Clare Lombardelli: They are absolutely critical. I can tell you from my experience at the OECD that the amount of resource we put into those sorts of things is high, and that is necessary to provide this information.
Q5 Chair: You do have some experience, then, of building and designing those kinds of forecasting frameworks, from your time at the OECD.
Clare Lombardelli: I have a lot of experience. I do not build the models; there are teams of people there that build these models, and my role is to talk to them about it, interrogate it and discuss with them the way in which it is done, and to challenge, test and those sorts of things. I do not build the models; that tends to be a team operation, and there are some real specialisms there. That is important. I think Dr Bernanke talked about that as well in his report—the importance around maintaining and incentivising the building of these skills and capability.
Q6 Chair: He has made some significant recommendations in terms of the staffing. You will be directly responsible for that as well, will you?
Clare Lombardelli: Yes.
Chair: I think we will have quite a lot of other questions on some of the detail of your role, but that is it from me. I will ask John to ask the next set of questions.
Q7 Mr Baron: Thanks, Chair. I will come to the issue of group-think within the Bank, but before I do, I will follow on from what the Chair was asking about forecasting. You have made it clear both in your questionnaire and your response this morning that you are defending the model, in the sense that, given the extent of the external shocks, all models struggled and the Bank of England’s forecasts were not that wayward compared with those of many other central banks. However, I put it to you—and the Committee has raised this issue several times with the individuals responsible—that there is a consensus that the Bank was well and truly behind the curve when it came to inflation. Probably the most extreme example is that just before Ukraine, which is probably one of the largest external shocks, inflation was running at 6% and rising steeply, and still the Bank of England’s forecasts were 0.5%, so well behind the curve. I am trying to put to you that the Bank was well behind the curve before one of the biggest external shocks. You can’t defend that, can you?
Clare Lombardelli: If you take yourself back to the autumn of 2021, in the lead-up to the Ukraine war, which is the period you are talking about, at the time there was a huge amount of uncertainty around what was happening in the UK economy and in all advanced economies. As you say, we were seeing higher rates of inflation. This was a period where the covid pandemic was still with us, and we were coming out of that and recovering from it. The inflation that we were seeing then was very much driven by a rebalancing—well, a combination of the bounce-back in demand that came as those restrictions ended and then a rebalancing of demand from services to goods, and the real bottlenecks that we were seeing in supply, with very strong demand from the US, for example. So you had that on the one side, and what was very difficult to predict was how long that would last and what the implications would be.
If you think back, the other side, which I was thinking about a lot, was what was going on in the labour market. That was really difficult to judge because the furlough scheme had come to an end in that autumn. What was going to happen to the people who had been on furlough was very unknown. There were over 1 million people. Would they re-enter the labour market? Would they go back to their jobs? Would there be a rise in unemployment? So you can see that there were these conflicting pressures, risks—
Q8 Mr Baron: I hear what you said but, if I may, could I just put it to you that, even so, the Bank was so far behind the curve? This wasn’t just the fact that inflation was hitting 6%; it was rising steeply. We had money supply figures clearly showing, some 12 months earlier, a steep increase, and yet the Bank does not pay much attention to money supply figures as a precursor to inflation or deflation. The bottom line is: well behind the curve, inflation rising steeply, and then Ukraine hits, when inflation had already hit 6%.
The reason I raise this is that it worries me when we hear from the Bank that it was the modelling and that the modelling performs like most other models, and you defend the modelling system. We agree with you that the Bernanke review is positive, but I struggle—this will lead me on to group-think in a minute—with your defence of the scenario.
I would have felt much more comfortable had you come in and said, “Yes, mistakes were made. We were a bit behind the curve. The evidence clearly suggests that.” The City knows that the Bank was behind the curve—so far behind the curve that we had 14 consecutive increases in a rapid time, and the fastest in the Bank’s history outside of wartime.
We are looking for fresh thinking here, but I am not getting that sense from you, if you will excuse me.
Clare Lombardelli: Where I would challenge that is that I don’t think this was an issue about the models. The models clearly were struggling, but I do think there is a risk that people over-interpret how all economic policymakers, whether they are monetary policymakers or others, use models. There is a really important role for models, and particularly the forecast itself plays a huge role in communications, but I think that part of the science and the craft of economics is knowing what models to use and when, as well as understanding when they are struggling and, at that point, saying, “Well, what else do we need to be do doing?”
You are always looking at huge amounts of data. There are times when you know models are struggling or when things are happening that are outside the sample. You look more broadly then: you talk to people, you go round, you listen to what businesses are saying and you think about how all these bits of information fit together.
Q9 Mr Baron: So what you are saying, in effect, is that before Ukraine—before that big external shock—you don’t think the Bank was behind the curve?
Clare Lombardelli: I wasn’t a monetary policymaker at the time. I understand that there were these competing risks at the time that all central banks were struggling with—this balance between what is going to happen to activity and what is going to happen to inflation. The decisions that were made were reasonable, given the balance of those risks at the time.
Q10 Mr Baron: In short, you do not think the Bank was behind the curve?
Clare Lombardelli: I think it is perfectly understandable that the balance of risks at the time was interpreted the way it was.
Q11 Mr Baron: You appreciate the importance of this line of questioning, because this affects everything, including interest rates in the real economy and the borrowing rates—people’s livelihoods depend on the Bank’s meeting its mandate of keeping on top of inflation. I would suggest to you that it was well behind the curve even before Ukraine, but let’s move on.
Your appointment as Deputy Governor means you join your predecessor as chief economic adviser to the Treasury, Sir Dave Ramsden, at the Bank’s top table. You will also know that Sir Jon Cunliffe also spent the bulk of his career at the Treasury, and he only recently departed. Does this apparent trend risk blurring the line between the Treasury and the Bank—and, if you think it does, how do you intend to counter it?
Clare Lombardelli: I don’t think it does. With my appointment, you will have two people on the Monetary Policy Committee—two out of nine—who have previously worked at the Treasury. That is not particularly unusual, if you look back at what has happened over the composition of the Monetary Policy Committee. I would also say that it is not unusual if you look internationally either. It is understandable that having experience of policymaking in a more fiscal policy environment, and the economics and economic analysis that go into that, gives you a lot of skills and experience that are relevant and highly useful for monetary policymaking. That is why across the world we see quite a lot of overlap here.
A real strength of the MPC process and the MPC structure is that it has this quite unusual nine-member committee, of which four are external appointments. They can and do come from all sorts of different backgrounds, and we have a real range of people with market experience, academics, people who are internal and who have built their careers at the Bank, and people who are external and have other experience, including from the Treasury.
You will have two of nine, as you say, but I don’t think that is either surprising or worrying or in any way a challenge to the operational independence of the Bank of England. The system there is set up in such a way—and the macro framework in the UK is completely clear on this, and completely sound—that I don’t think the fact that I used to work at the Treasury and will now work at the Bank is in any way a threat to its independence.
Q12 Mr Baron: You will understand the importance of the operational independence of the Bank. That leads me into a further question about group-think. You replace Ben Broadbent, the only serving Deputy Governor who had spent a significant part of their career outside the Treasury, the FCA or the Bank. Does that raise concerns for you about group-think and the lack of diversity of experience at the Bank’s top table?
Clare Lombardelli: There is a diversity of experience at the committee; as I say, you have a whole range of different expertise and backgrounds there, and there have been periods when you have had more or fewer people with direct financial market experience. We also have Catherine Mann on the Monetary Policy Committee, who worked at an investment bank before this role, so we do have people with market experience. The Bank also has a huge amount of markets experience.
The broader question of group-think, I agree, is incredibly important. It is about how you make sure that you are thinking about things in a way that brings a range ideas and perspectives. I take this question in two parts. There are the votes of the committee themselves, and the nine people on that and their background—and it is built into the structure of the MPC that you have this diversity and these people with outside experience. Who that is and what experience they bring has varied over time, but all of us around that committee will bring different thoughts. From what I have seen as the Government representative, there is a very rigorous debate and discussion that happens there.
The other side of it is also really important: how do you build different ways of thinking and challenge into the processes by which you do the analysis and the modelling, and have the discussions internally in the Bank around those things? That is also really important. What data are you using? What is it telling you? Are the internal discussions a comfortable environment for people to raise different views? What is the culture around that challenge?
That is a challenge for the entire economics profession, if I’m honest, but it is something where you can make progress; you can structure things to ensure that you are building that into your processes. That is something I have done before, at the Treasury and at the OECD, and I would look forward to doing again. I think it is a really important part because, as you say, these are decisions that affect millions of people and there is a lot of uncertainty around the decisions. That is why you want a whole range of views, perspectives and challenge built in throughout.
Q13 Mr Baron: I am pleased to hear what you have to say about re-examining the processes, but I hope you also accept that one’s thinking sometimes can be very much shaped by one’s background and the experiences you have had prior to going to the Bank. There is a concern, when it comes to group-think, that we do not have enough people sitting at the MPC table who are willing to think outside the box and willing to challenge. That, in many respects, was shown in the lead-up to Ukraine, when we felt that the Bank was well behind the curve on inflation, letting inflation rip.
Can you assure us, when looking at those processes and at what Ben Bernanke has had to say, that there will be a bit of a shake-up here? When looking from outside, group-think still prevails if you look at the background of all or certainly the Governors and Deputy Governors who sit on the MPC, because there is that very close link between the Treasury and the Bank. That is one aspect of group-think that we are concerned about, because it brings into slight question, at the very least—I am probably being charitable—the operational independence of the Bank.
Clare Lombardelli: I really don’t agree that it brings into question the operational independence of the Bank. That is set out very clearly in the macro framework that the UK operates and—
Q14 Mr Baron: But that sort of background does encourage group-think.
Clare Lombardelli: Look, I agree with you: everyone brings their personal experience to the decisions that they make. I would say also that not everyone from the Treasury is the same; not everyone from the Bank is the same. We all have very different personal experiences. Being honest, I can tell you as a woman who has worked for 20 or 25 years in economics, I am not like your average economist in lots of ways. We all bring our personal experience to those decisions.
The other thing that you asked is: can I assure you there is going to be a shake-up in response to Bernanke? Absolutely. This is a fantastic opportunity. One of the reasons I am so pleased to be taking on this job now is the scale of the opportunity here to really look at radically reforming what we do, taking a fundamental look at it and being honest with ourselves: what are the ways to do this better?
I would say, with my OECD hat on and where I started, I think this is a great opportunity, and I would encourage other countries to think about doing it as well, because there is a huge amount that we can all learn from what has happened over the last couple of years. It has been an extraordinary period, and extraordinarily painful for people. There is a huge amount there, so yes, I can assure you this is going to look and feel very different in the future.
Mr Baron: Thank you.
Q15 Dr Coffey: Ms Lombardelli, the OECD’s February economic outlook, which you oversaw, warns that “Monetary policy needs to remain prudent” but adds that “Scope exists to start lowering nominal policy rates provided inflation continues to ease”. We are seeing inflation ease. When do you expect to see interest rates cut in the UK?
Clare Lombardelli: I should be clear that the interim economic outlook you quote is a global forecast and that policy advice is policy advice that we put out to all countries.
In terms of the UK, I will join the committee in July and my first vote will be the August vote. The issue at the moment in the UK is actually not unusual. What we are seeing is headline inflation falling quite quickly, but if you look at the composition of inflation and what is driving inflationary pressure, we are seeing more of inflation being driven by things that you might think are or could be persistent—services prices, labour markets and those sorts of effects—whereas the falls we have seen have been the changes to goods and energy prices that drove it on the way up.
On the one hand, you have this question about how persistent inflation is going to be. What are these forces that are driving it up? You saw today, with the labour market, private sector wages at 6%; that is much higher than the Bank’s target. On the one hand you have that question, and then on the other side we are seeing that activity is being impacted by monetary policy. We are seeing some loosening in the labour market, with fewer vacancies and those sorts of issues.
The question is really how you balance those two risks, and what is the future for that. I am not going to put a date on when I expect the UK to start the process of loosening monetary policy, but it clearly is the case that that will be the direction of travel, certainly for European economies.
Q16 Dr Coffey: Mr Baron has gone on about whether the Bank was too slow. I know that members of this Committee have also asked whether we are being too slow in cutting. The reason I would go further is that I am just trying to understand. I think the OECD suggested that the US and euro area would be the first to cut rates. I appreciate that you are not on that committee yet, but one of the things that has been part of the issue is that the Governor has been quite clear that he does not want to see such high wage rises, and yet we are seeing that.
It feels like we are in an odd situation—probably not helped by the electoral cycle in that regard—where the Bank’s Governor leads on deciding what interest rates we are going to have and yet does not want wages to go up. He is almost blaming wage rises, as opposed to what the market is deciding needs to happen, despite the fact that unemployment unfortunately does seem to have gone up this month. Trying to balance those risks, what will to be your key determinations in how you come to that conclusion, when it comes to your monthly votes?
Clare Lombardelli: I would say that quite a lot has changed since those February projections. In particular, we have seen quite a lot of news from the US and much more strength in the US economy, both on the growth and the inflation sides. That picture is quite changed; the relative views of the economy have seen quite a big difference between European economies and the US economy.
On your question of what I would be looking to see, it is the data and analysis around these issues of persistence—the things that we think could make inflation persistent. In particular, it is about looking at things like what is happening to services price inflation, which is a much more domestically generated form of inflation. What are we seeing there? The labour market is obviously absolutely critical, as you have said, as is what we are seeing on wages and quantities in the labour market.
It is quite difficult at the moment, and there are a few issues with the data, but it is about looking at those measures and at the real activity we are seeing in the economy and how much that is being affected. In particular, if you look at what is happening in Europe at the moment, you will see quite a big impact on credit from monetary policies. I will be interested in that. I am not deep in the weeds of the UK data at the moment, but those are the sorts of issues I will be getting into and thinking about.
Q17 Dr Coffey: From what we have learned about monetary policy translation during this hiking cycle—we have had the covid aftershock and the energy shock with the invasion by Russia of Ukraine—have high interest rates actually had any impact on inflation at all, or has it been factors beyond interest rates that have brought down inflation?
Clare Lombardelli: You can see the impact of monetary policy tightening; tighter monetary conditions mean tighter credit conditions. You can see an impact from that activity. Again, I am talking more broadly about Europe rather than just the UK, but I think the UK data is consistent with this. You can see impacts on demand and an effect in the labour market.
However, I would note that the labour market has proven to be incredibly strong and resilient, which is a very good thing. If we look back to what people were expecting or forecasting a year or 18 months ago, there was a lot of concern about what would happen to unemployment and the labour market. The strength of the labour markets that we are seeing across advanced economies is a huge relief and a very good thing.
You can see some impact on activity, but there is no doubt that a large chunk of the fall in inflation is because of those shocks that we saw to external prices, and then them falling away. For example, this month the energy price in the UK will change, and that will have a big impact on inflation.
Q18 Dr Coffey: Looking ahead with growth—by the way, I used to run the Department for Work and Pensions, so I always thought the forecasts were nonsense, because I knew our policies would work—there is quite a big difference between the Bank of England’s viewpoint on growth for the UK and the OECD’s. What is the big differing factor between the two?
Clare Lombardelli: You are right—there is. I think the OECD number is actually much closer to where, say the Office for Budget Responsibility is. I should say that the OECD will revise those numbers in May.
I think the difference is around the judgment on the strength of the supply side of the economy. I am not close to and have not got into the weeds of the Bank’s supply side judgment. However, they have talked about this before and I think that they see a lot of reasons in the data to be concerned about supply-side growth there.
The OECD is a bit more positive about the scale of supply in the UK. The OECD does quite a lot of looking at and thinking about factors that affect multiple economies. One of the examples that the OECD will think about is migration, which has been high in the UK, and that obviously drives up the headline growth rate.
I think the supply side and what is going on there drive much of this difference, although I should say that the forecasts are done in quite a different way. There will also be a whole set of methodological and conditioning assumptions and all that, which drive the difference there.
Dr Coffey: Thank you. I will come back to other stuff later.
Q19 Keir Mather: Just following on from those questions regarding growth, the Government’s 2018 modelling of the impacts of Brexit, which I believe you were overseeing at the time as the head of the Government Economic Service, found that an EU FTA would reduce UK GDP per capita by 5% in the long run. Do you stand by that analysis now?
Clare Lombardelli: That particular analysis took a very long-run view of the impact; it looked at that and made some estimates there. And it looked at a series of scenarios, if you like, one of which was the free trade agreement that you described. If all the conditions in those scenarios held, then it was a perfectly plausible estimate of the impact. Of course, how the relationship has evolved is not actually aligned with any of those scenarios, nor would you expect it to be.
Do I stand by it? It was a piece of sound and rigorous analysis that showed, if you make these assumptions, what outcome you get. Yes. That was reasonable; it is not out of line with many, many other studies and analyses that people did at the time.
It is very hard now. That was in 2018; the referendum was in 2016. Obviously, what has happened to the global economy since then has just been huge, so you cannot really disentangle any of these effects. But as a piece of economic analysis? Sure.
Q20 Keir Mather: Looping back to Dr Coffey’s question, you noted in your questionnaire that the largest difference between these forecasts from the OECD and from the Bank is likely due to the OECD taking a more positive view about potential supply growth. Why do you think that difference exists between the two forecasting models?
Clare Lombardelli: As I say, I am not close to the Bank. The Bank puts a lot of effort into its supply judgment, and I am looking forward to getting into that. I think the differences will be, as I say, a number of things. I suspect that migration might play a role in it—the very high numbers and the large impact, if you like, from the numbers that you have seen there.
Also, the OECD focuses a lot on supply-side analysis and what we call structural reforms, so it will have considered a lot of the reforms that have been put in place in that area. I do not know the precise detail as to why the Bank’s number is lower, but it is the sort of issue that I am looking forward to getting into.
Q21 Keir Mather: Sure. When the Bernanke review suggests that the Bank could benefit from an increased focus on issues to do with productivity, trade and labour market activity when it comes to forecasting, do you think there are lessons to learn from the way the OECD produces some of these projections that the Bank could potentially take forward?
Clare Lombardelli: Yes. You might expect me to say this, but I think the OECD can provide a huge amount of analysis and information on what we call the structure side—the productivity issues, the trade issues that you allude to and those sorts of things. That is where its real expertise is; it is particularly in these issues that we think affect growth in the medium and long term. There is a lot of opportunity there for us to think about and for me to bring some of that knowledge and expertise into this process.
A lot of these issues around productivity are very long term. While they do affect short-term forecasts in some way—the monetary policy horizon tends to be a bit shorter—there is certainly a lot we can learn about the supply side. An issue that economists across the board are thinking about much more is the supply side of the economy. One thing we have learned a lot about from the shocks that have happened is that actually what happens on the supply side of the economy is very important.
We need to understand it a bit better and think about it a bit more, both in terms of what the data is—what is going on and what it means when you go around and talk to people about their businesses and their choices—and the analysis, modelling and the more technical work. But yes, I think there is a good opportunity there.
Q22 Keir Mather: I was wondering if you had a view on whether the Bank publishing its own forecasts for interest rates in the longer term might allow it to make more accurate forecasts as to the concurrent growth rate.
Clare Lombardelli: This is a really important question, and I am really glad that Dr Bernanke raised it and opened it up. I’ll be honest: I have not come to a decision on what I think about it. I only read the review over the weekend, and I have not talked to Dr Bernanke, the staff, market participants or others about this. I would like to do that and listen to what people think before I take a firm view on it.
I can see that there are advantages around this: it might allow you consistency with what you are doing, and it would provide some clarity. There are also challenges to doing it around what that does to expectations. It is interesting that, if you look around the world, some central banks do this, and some do not. There is not really a consensus view and there is not an obvious best way of doing this. That is the sort of thing that I look forward to getting into. It is quite a complicated issue, and it needs quite careful thought. Apologies, I will come back to you on it.
Q23 Keir Mather: Moving quickly to QE and QT, you were chief economic adviser at the Treasury during the pandemic when the Bank carried out £450 billion-worth of QE. Did you take a view on its effectiveness then and do you have a view on its effectiveness now?
Clare Lombardelli: I did not, in the sense that it is for the Bank to set monetary policy independently. It was the judgment of the MPC that this was necessary. The Treasury has an important role in the governance around the indemnity. The Bank took that decision for a set of reasons. You look back at what was going on through that period in 2020 and the covid pandemic—it was an incredibly challenging time for the economy. It is perfectly understandable that that policy lever was used in the way it was. I can completely understand that, and it makes total sense that they would choose to use it. From the Treasury point of view, we were comfortable to indemnify that use.
Q24 Keir Mather: In your questionnaire response on quantitative tightening, you said that it had had a limited economic and financial impact, but warned that “we should not assume that the economic effects of QT in future be the same as we have observed to date…it will be important to continue to monitor the impacts.” Does that hint of concern or potential scepticism about the future efficacy of the impact of QT?
Clare Lombardelli: No, it hints at or reveals my view that this is quite new territory, and it is quite uncertain. I do not have specific concerns about it. I just think that this is quite a big change to economics and the markets, and we have to think about that. The data that we have so far on the impact of QT is very early.
The way in which QT is being implemented by all central banks is specifically designed to have very limited effects—this idea that it goes on in the background and the interest rate is the main lever. That is almost designed not to give us very much data on how effective it is, but, to be clear, that is the right thing to do. The careful and considerate approach that everyone is taking of doing this slowly, with a lot of transparency around what is happening, is the right one. But it does mean that we do not have a very wide dataset to go on.
That is why this is one of those areas where I suspect there will be a lot more research in the future, and there should be, as different countries do it in slightly different ways and they have different circumstances. Also, the economic environment will change. We are doing it now in this environment, but in future other things will happen. I think it is an area where, because it is quite new and we have limited information at the moment, it is good and important for more research and analysis to be done. It is important that we keep on top of that and ensure that we are feeding what we are learning from that into the decisions that we are making.
Q25 Stephen Hammond: Good morning and thank you for coming to give evidence this morning. In your response to question 10 of the written questionnaire, you said: “Inflationary pressures started to mount, globally and in the UK, in the second half of 2021”. You also noted that UK “CPI inflation rose continuously from 2% in summer 2021”. I am sorry to go back to this, but it is key: why was it that the Bank did not move rates until inflation was at 5% much later in the year? There were two major concerns: first, that it was slow on the way up and therefore may be slow on the way down, as you will understand. Secondly, in your response to question 15, you talk about the transmission mechanism, which I want to come back to in a moment. But if the argument from the Bank—as it was at the time—was that this was transitory inflation, and given you say the transmission mechanism is 18 to 24 months, if you really believed it was transitory, why do anything at all?
Clare Lombardelli: I think you are getting to the heart of this. The Bank and the decision makers at the time are the people to ask but, from my perspective, the inflation at the time was of a particular nature because of what was driving it. It was being driven by these changes to goods prices and energy prices and the impact of that. So you were seeing those changes. There were reasons to think that that might be temporary. We were seeing this huge rebalancing of demand across the world and the reopening of economies, and you would expect patterns of economic activity to adjust to that and, therefore, where prices are going up, more activity to supply—
Q26 Stephen Hammond: But it was a surge of pent-up demand from restraint that was adding to the supply-side shock, which was making the whole argument about whether it was transitory or being embedded in the system.
Clare Lombardelli: There was a huge amount of uncertainty at the time. There was clearly pent-up demand because of the end of the lockdowns. There was also a lot of uncertainty about supply because those lockdowns were affecting supply, particularly if you think about China, which is a huge supplier of goods to the world economy and was in lockdown for much longer. But it was not clear how long that pent-up demand would last. Once all the covid restrictions lifted, would people go back to their previous behaviour, or were we seeing structural changes to the patterns of consumption? It turns out that we have seen a bit of both, but it was very hard to know. There was a lot of discussion at the time about whether we were totally changing the way we do leisure, work and all of those sorts of things.
On the one hand, the judgment taken was about the transitory nature of inflation—would it be or wouldn’t it be?—and then on the other side there was this question about the risk to economic activity and employment and those sorts of issues, where, again, there was a lot of uncertainty. There was uncertainty around all these things. The Bank took a series of judgments at that time. If you think about what was going on in economies, that was a perfectly reasonable series of judgments, and they were ones that a lot of people—other countries around the world, and other economic forecasters and commentators—were taking.
Q27 Stephen Hammond: But I think you understand that there is real concern from any number of other economic experts that the delay in moving rates at that stage is causing other problems.
Clare Lombardelli: Sorry, the delay in moving rates in 2021—
Stephen Hammond: In 2021.
Clare Lombardelli: Unemployment was obviously rising at the time, but if you think about some of the uncertainties, particularly around the end of the furlough scheme, it was very unknown what was going to happen. Actually, the labour market proved to be more resilient than some people feared.
Q28 Stephen Hammond: Can we move on to the labour market? The FT recently quoted you as saying, in your current role, that the UK has a “particular issue about the labour market”, which is exacerbating inflation. Could you set out the rationale for that view?
Clare Lombardelli: All advanced economies are seeing changes to the labour market. We have a lot of structural change going on. In particular, labour markets are incredibly tight; there is a lot of demand for labour at the moment. As I say, that is very good. We had a very slow economic period around the world, particularly across European economies, over 2023. That was not accompanied by the rise in unemployment that we might sometimes see, which is a huge relief. On the question about labour supply and participation, we have seen a fall in participation rates in a lot of countries, but it looks like it is greater in the UK. It is a greater issue in Germany as well.
Q29 Stephen Hammond: This is an extraordinary structural move. Do you see any evidence that participation rates are likely to increase over the next two years?
Clare Lombardelli: I will be honest: I haven’t looked in detail at the latest UK-specific data. A number of measures have been taken in this space in Budgets while I have been away. The Government have actively focused on this issue and trying to address some of it, and the OBR has done estimates on the impact of that. This is the right issue to be focused on. Labour participation is hugely important. With my monetary hat on, I would say it is important because it is a constraint and a pressure on inflation. With my broader economics hat on, I would say it is also a huge economic issue, and a really important one if we think about not just people’s economic prospects but their welfare and wellbeing.
Increasing participation is very important, and also an important part of what a lot of countries need to think about in terms of demography, which is another issue that is having an increasing impact on labour markets. Participation is the right thing to focus on. The Government have taken some measures. I don’t have personal estimates of the impact of that, but I know that the OBR has done that. It is the right thing to be focused on, for sure.
Q30 Stephen Hammond: In, I think, your most recent economic outlook, the OECD talked about concern about inflationary pressures from companies increasing margins and expectations of increasing wage rates. You called it “greedflation” and mentioned the need to remain vigilant. Is there any evidence that we haven’t seen that increasing company margins as yet? Do you think we still need to be as vigilant as you were suggesting in February?
Clare Lombardelli: Actually, the work that you are referring to was earlier; it was about a year ago that we were doing this analysis on the margins—the increase in wages and the increase in prices. What that showed, across most economies, was initially a rise in margins in response to inflation and less of that going to wages, and then, over time, wages making up a larger component of it. That is what you might expect if you think about how prices and wages adjust. Prices tend to go up quite quickly while for wages, particularly in a lot of European economies, you have a much slower bargaining process or they adjust over time. We did see at the start of the inflationary period a smaller component of this being about wages, and that is now adjusting. You can see that in the real wage data. We are now seeing rises in real wages as people begin to recover some of that.
Q31 Stephen Hammond: And the UK isn’t particularly different from any of the G7 in that.
Clare Lombardelli: Not particularly, no. There are slightly different dynamics in Japan.
Q32 Stephen Hammond: One final question. In your February forecast—I think it was February this time—you said that you thought the US and the euro area would be the first to cut rates and that the UK might be slighter slower, cutting rates in the fourth quarter of this year rather than the second or third quarter. Given that the UK is broadly in line with the rest of the G7, is there any revision to the view about when it should start cutting rates? Is there a change in the chronology?
Clare Lombardelli: I wouldn’t overweight a judgment in February about prospective interest rate changes and when they may be. The big change is the further divergence between the US and European economies. The outlook for US interest rates and US inflation and growth is quite markedly changed now. That comparison is different, and the general market expectation now is that you will see European economies potentially moving sooner than the US, which reflects the growth in the inflation data.
Stephen Hammond: I have used my time up.
Chair: If you have another question to ask, feel free.
Q33 Stephen Hammond: May I go back to the transmission mechanism, because that is key to the efficacy of monetary policy in terms of rates? Do you still see that as 18 to 24 months? That is quite an increase as against traditional, classic economics. It might well fit modern-day scenarios, but with the structure of labour markets and of mortgage markets, if it is taking 18 to 24 months to work through, the impact of rising rates now might be having an impact later in the cycle, when other things have changed quite markedly.
Clare Lombardelli: Clearly, there are lags in the transmission mechanism. I have not seen the latest estimates around it. I have not seen evidence that would make me think that it has definitely changed from 18 to 24 months. I think that we need to be very cognisant of the fact that there is quite a lot of structural change going on in economies at the moment. You want to think about that and come with quite an open mind to these sorts of things. Also, we will have learned quite a lot from the shocks that we have had and the way that they have fed through the economy. I have not seen any evidence or reason for me to move away from that in one direction or the other, but I do think it is worth us making sure that we learn everything that there is to learn from the recent experience and from the structural changes that we are seeing in labour markets, as you mentioned, but also quite a lot in how mortgages and other corporate borrowing rates transmit through.
Q34 Dame Angela Eagle: Ms Lombardelli, I want to talk a little about financial stability, and about non-bank financial intermediation and the problem that that might cause. First, we have had fairly reasonable political agreement for a while on the structures of central bank independence, the Monetary Policy Committee and how that works, but I sense that that is beginning to break down. Do you think that we have got the right kind of structure?
Clare Lombardelli: I wouldn’t recognise the description of it as breaking down. I think that the macroeconomic framework in the UK is very clear and very stable, and it has proved to be—certainly through all my time at the Treasury—a system that has operated with complete commitment to it from all sides.
Q35 Dame Angela Eagle: The breakdown is coming politically. Only yesterday, we had former Prime Minister Liz Truss saying that the Governor should have been sacked for what happened in the aftermath of the changes she made in her mini-Budget in September 2022. Is that a sign of widespread agreement about the structures? She is calling for the Governor to be sacked.
Clare Lombardelli: I do think there is widespread support for this structure. Obviously, individuals will have different views on this, but—
Q36 Dame Angela Eagle: She wants an inquiry into what happened in the aftermath of her catastrophic mini-Budget. She has been touring the TV studios blaming absolutely everybody but herself for what happened.
Clare Lombardelli: The events of September and October 2022 were examined by this Committee. A lot of evidence was provided, and some of your questions provided transparency around that event, so I think there is quite a lot of information about what happened at that time. A lot of evidence was provided to this Committee and other Committees.
Q37 Dame Angela Eagle: She thinks that the OBR should be abolished. Do you think that the OBR should be abolished?
Clare Lombardelli: No, I am a big fan of the OBR. I worked work with it and saw the benefit of its role over many years. It is very valuable to have that independent expert judgment on fiscal policy.
Q38 Dame Angela Eagle: What signal do you think was given to the markets by the sacking of the permanent secretary at the Treasury, who was responsible for financial stability, prior to the catastrophic mini-Budget?
Clare Lombardelli: This is all well-trodden territory in other circumstances.
Q39 Dame Angela Eagle: The measures announced in the mini-Budget took the Bank by surprise in 2022. What scope is there for any improvement in the communication channels between the Bank and the Treasury? I suppose it helps if the Prime Minister actually believes she should share this information.
Clare Lombardelli: There were challenges. It was a very unusual process that ran through that period, although not around the MPC; the MPC processes were as they were. I attended as the Government’s representative, and I shared the information that was available. There were two things that were unusual: the speed with which that fiscal event was put together, given the size of the changes in it—it was a large fiscal event—and the lack of an OBR forecast, which changed the process.
An OBR forecast does two things. First, it changes the timetable by which you are operating because the OBR needs information about what is in the fiscal event in time for it to do its analysis and calculations. That means that the package of measures is settled well before it is announced so the OBR can do that analysis. Secondly, that analysis provides a lot of information about the fiscal impact of the measures. That was missing from this event, and that meant less information was available.
Q40 Dame Angela Eagle: Why do you think the markets reacted the way they did?
Clare Lombardelli: It seems that they were also surprised by the content, and perhaps the approach. It was an unusual process. You asked how it can be changed, but operating the normal process with the OBR doesn’t raise these problems.
Q41 Dame Angela Eagle: The Governor said that he did not know what was in the Budget, and then he had to deal with what happened in the LDI markets. Do you think that is any kind of way to try to get co-operation between the different bodies that are responsible for running financial policymaking and fiscal events?
Clare Lombardelli: As I say, there are actually very good working relations between the Treasury and the Bank at all levels on these events. The processes are very clear. They are in place and they work.
Q42 Dame Angela Eagle: Was this the deep state at work?
Clare Lombardelli: I think these events have been well covered in other inquiries and hearings. People were doing their job, whether at the Bank, with an eye to thinking about financial and monetary stability, or elsewhere.
Q43 Dame Angela Eagle: So you would like the structural parts of the system—central bank independence, the OBR and the way the Monetary Policy Committee works—to remain pretty broadly as they are, even if policies or the way that financial models are designed might change. You think that that is a reasonable structure within which to operate fiscal and monetary policy.
Clare Lombardelli: It is for the Government to set out the macro framework. It is certainly not for me, in this upcoming role, to do that. Those are decisions for a democratically elected Government with scrutiny from you and others. The arrangements that are currently in place, and have been in place since 2010 for the OBR and 1997 for the operational independence of the Bank of England, have served the UK well by providing a stable environment for decision making.
Q44 Dame Angela Eagle: Thank you very much. Looking forward to potential future issues, the Bank’s December 2023 financial stability report states that “the underlying vulnerabilities in the system of” market-based finance “remain largely unaddressed”. How can the current situation be changed?
Clare Lombardelli: The Bank is undertaking a lot of work in this space. There is no doubt that the increasing complexity of financial systems, and the increasing use of non-bank financial intermediaries, is changing the nature of risks and the landscape, and this is an example of that. The Bank does a lot in this space and continues to do so, such as with different stress tests. It has the system-wide exploratory scenario, for example, that it is undertaking at the moment. That looks at what happens to a whole range of not just banks, but beyond, in terms of what happens if you stress the system. That will reveal a lot of information about where vulnerabilities are. One of the challenges in a lot of this space is around information and transparency. The Bank is undertaking quite a lot in this space. That is an important programme of work that the FPC will continue to work on.
Q45 Dame Angela Eagle: In the aftermath of the financial crisis, when, by definition, part of the response was to have greater supervision of banks and increased requirements for deposits and the rest of it to make them safer, we seem to have created a situation where the shadow banking system is booming and growing far faster than the banking system itself, yet it is directly connected, by non-bank financial intermediation, to the potential stability of the regulated sector. In your view, what is the right balance between the non-bank shadow sector and the regulated sector? Is the growth in the non-bank sector just a way of getting around the rules in the regulated sector? Does it therefore present increasing risk in terms of financial stability?
Clare Lombardelli: The growth in the non-bank sector is not driven by regulation in the banking sector. If you think about what it is, it is a whole range of very different and diverse financial markets. There is a big difference between an insurance firm and a hedge fund and so on, so you have a very diverse landscape. It is not driven by regulation of the banking system; it is driven by the preferences and demand for different financial services. That is evolving, and it will continue to evolve, including because of technology. You can think about that, but it is definitely growing. It is now a much bigger part of the global financial system than it was around the time of the financial crisis. That does create risks because of the interactions between the two, as you say, but also risks in these non-bank financial institutions themselves. The right approach to that is to have appropriate regulation across the board for the banking system and the non-bank system. More is being done in the non-bank system to deliver that. There is a lot of work going on internationally, and that is actually—
Q46 Dame Angela Eagle: Are you in favour of regulating the shadow banking sector?
Clare Lombardelli: I am in favour of regulation for different financial institutions as is appropriate to make sure that you have a safe financial system across the board. Clearly, we need to ensure that we have financial stability.
Q47 Dame Angela Eagle: To what extent can transparency be mandated? A lot of the dangers in this area come from risky interconnections that might not be obvious. Obviously, that kind of thing is what caused the financial crisis as well. What can we do to mandate transparency and to try to pull these hidden connections more into the light?
Clare Lombardelli: It is a good question. Transparency is obviously incredibly important, because you don’t really know what you are dealing with unless you can see and assess the size of it, but also the interactions between these parts of the financial system. That is why things like the system-wide stress tests are good, because they will expose some of the interconnections that we might not have been aware of otherwise. In terms of transparency, I am afraid that I am not a deep expert in what is possible at an international level in that space, but clearly a lot of these issues are best handled internationally because of their location and the interlinkages across the global economy on them.
Q48 Dame Angela Eagle: The Bank said in its financial stability report last December that a lot of the underlying vulnerabilities “remain largely unaddressed”. When are they going to be addressed?
Clare Lombardelli: I am afraid that I cannot give you a precise answer on that. I was not involved in the drafting of that report, and I haven’t—
Q49 Dame Angela Eagle: But you will be looking for them to be addressed.
Clare Lombardelli: Certainly, and I have no doubt that the Bank is undertaking work at the moment. I am sure that it is in the process of being addressed and that others would be able to update you on that.
Q50 Dame Angela Eagle: We know how slowly international agreement on these things proceeds. Meanwhile, as a country with a large financial sector, we are likely to face more risks than some if they do crystallise. Do you lie awake at night worrying about that?
Clare Lombardelli: Not yet, because I am not deep in the weeds of it.
Dame Angela Eagle: You might once you have seen it.
Clare Lombardelli: What I will say is that it is preferable to take international action because of the international interlinkages of these institutions, but it is not the only option on the table. There have been multiple instances where the Bank has been able to take domestic action to shore up domestic parts of the system. It is not an either/or; you would take a balance of the two approaches. International is better, of course, because it provides greater resilience, but it is not the only option on the table. There are lots of things that the Bank can do. The Bank has a huge number of levers in the financial stability space that it can and would use.
Q51 Dame Angela Eagle: Coming on to those levers in the financial stability space, do you think that the FPC has all the macroprudential tools that it needs to ensure financial stability?
Clare Lombardelli: It has a wide range of tools. There is always work under way on whether those are the right tools and whether more tools are needed. Work is under way at the moment to explore other tools and think about whether there are other backstop interventions that could be put in place, if needed in certain scenarios, to widen the toolkit to include some more nimble or appropriate tools. That work is under way. It is not a fixed picture; it continues to evolve. In particular, some work is under way at the moment on some of them.
Q52 Dame Angela Eagle: Finally, what can we do to enhance global co-operation on non-bank financial institutions to try to make financial stability a greater aim in the whole international financial space, rather than the current willy-nilly growth, with uncrystallised risks growing and hidden in various places, like the liability-driven investment market, which the Bank discovered was a problem in the middle of the mini-Budget aftermath?
Clare Lombardelli: There is a lot of activity on this on the international stage. The Financial Stability Board are the people who lead and co-ordinate this, and the UK is a really big part of that. It is a huge contributor and does a lot in terms of leading the intellectual case, providing analysis and information, and pushing and shaping the agenda. It is a very active member and does a huge amount. This is a big global agenda. You are right that it can take time to reach international agreements, but that is because it is right to build consensus and get agreement on these things.
The UK punches well above its weight in terms of financial markets and regulation. It has a big impact internationally and will continue to do so. We are very respected in terms of the analysis and the work that we do, and obviously we have a very large financial system. We have to continue to push that agenda and work with others internationally to pursue it, but at the same time think about the domestic tools we have in place so that we have a two-pronged approach to this.
Q53 Chair: On liability-driven investment, at the beginning of September 2022 the Committee asked whether the scheduled start date for quantitative tightening could destabilise the gilt market, given that there was a new Government coming in with a clearly expansionary fiscal policy. The stress tests that had been run on LDI in 2018 looked at something like a 1% sudden shift in the long bonds. Is it part of your remit to look at all the stress test assumptions and see whether they are the right assumptions, or whether there could be some bigger moves that might undermine financial stability?
Clare Lombardelli: Yes, that is the sort of thing the Financial Policy Committee would look at. It is for the FPC, but obviously I will be a member of that.
Q54 Chair: Okay, great. But you are not going to be on the Prudential Regulation Authority, although your predecessor Ben Broadbent was. What reasons did the Governor give you for that?
Clare Lombardelli: Look, I am going to have my hands full with the Bernanke review and the implementation of that. This is a huge piece of ongoing reform for the Bank of England. I suspect that I can make a bigger contribution there. I think my time is better spent and invested on that. That has got to be the right choice. This is huge for the Bank and it is huge for monetary policymaking in the UK. I welcome the fact that I can focus on that a little more.
Q55 Chair: All right. Can I ask about the role of artificial intelligence and how you see that being used in terms of the Bank’s decision making or your decision making?
Clare Lombardelli: Yes, sure. This is a fantastic opportunity in terms of artificial intelligence as a new general-purpose technology that we are all seeing enter all aspects of our life. If I may do a quick plug, the OECD is publishing a paper this morning on the economic impacts of artificial intelligence.
In terms of its use within the economics profession and within the Bank, we should distinguish between artificial intelligence and generative artificial intelligence. Artificial intelligence is being used very extensively in the economics profession, particularly around data analysis and those sorts of things, in the same way that it is being used extensively across the financial sector and other sectors. It is quite widespread across the economy.
Generative AI brings a whole new set of opportunities. It is not yet being used very extensively in the economics profession. A lot of people are thinking about it and playing with it. You are seeing it a lot, for example, in coding. People are using it quite extensively there, and of course people may be using it for the things they are writing and the like, but in terms of using it for forecasting, for example, I know some bodies have been playing with it but no one is really using it that extensively yet.
My attitude to AI is that it is very hard to predict now the uses that we are going to put it to. It is clearly going to give a huge amount of power and improvement to how we do things. I would be very surprised if the forecasting that is done in the Bank or elsewhere in 10 years’ time does not look very different because of artificial intelligence and the role that generative AI may play in that, but it is very hard to predict now, in the same way that when the personal computer came out it was very hard to predict the final uses that it would be put to. Frankly, I think that people who try will struggle to be accurate.
I think it is something we will use. I suspect we will use it. We will think about how we use it on the data side, how we use it on the modelling side and how that plays into the forecasting. I think there is a great opportunity there, and we will be looking to and thinking about how others in the profession are using it and what we can learn from that. I do think this is ultimately going to be a transformative technology for the whole economy, and that will affect the Bank as it will affect others.
Q56 Chair: Okay. The final question from me is on Basel 3.1. What is your view on the implementation of that in the UK? Would you be happy if the UK went ahead and implemented it but the US and the EU did not?
Clare Lombardelli: Let me be frank: I am not as up to speed on the Basel 3.1 implementation as I will be when I get my feet under the table at the Bank. I do not feel I am well placed to give you an informed and meaningful answer on that at this time.
Chair: Fair enough. If my colleagues have no further questions, we would just like to thank you for your time. I declare this part of the session over.