UK growth: will Osborne listen to Lagarde?
In its latest report on the UK economy, published today, the IMF warns that monetary and fiscal policies will have to change if the economy fails to recover from the recession it was in at the end of 2011 and in early 2012.
The IMF accepts there are risks to easing policy – not least to the credibility of the government’s plans for medium-term fiscal consolidation – but it warns that there are also risks associated with not taking action. In particular, the longer economic growth is weak, the greater the risk to the economy’s long-term potential growth rate.
The IMF wants the Monetary Policy Committee to take immediate action. It says that the scale of quantitative easing should be increased and that consideration should be given to a cut in the bank rate, which is already at an historical low of 0.5 per cent.
The report also suggests that the UK could undertake ‘balanced budget fiscal expansion’. By this the IMF means temporarily increasing tax revenues or cutting spending in ways that will have a relatively small effect on demand, and using the funds to boost public spending in areas where it has a large effect on demand. It suggests smaller increases in public sector pay and better targeting of transfers (which might mean, for example, restricting winter fuel allowances and free travel passes to better-off pensioners) and using the funds to increase infrastructure spending.
Although this would leave its deficit reduction plans intact, there is no sign that the government has any appetite for such a move. If it was going to happen, it would have happened in March’s budget.
For the first time, the IMF goes further when it says ‘if growth does not build momentum and is significantly below forecasts even after substantial additional monetary stimulus and further credit easing measures, planned fiscal adjustment would need to be reconsidered’. In other words, if the economic remains weak, the government should implement temporary tax cuts and a boost to infrastructure spending not offset by cuts elsewhere. This would mean borrowing more in the short-term.
This is a very significant move on the IMF’s part. Except when an economy is in dire straits, like Greece, its reports are almost inevitably couched in language that can be interpreted as supportive of government policy (and the IMF head Christine Lagarde was careful to be complimentary about George Osborne’s deficit reduction plan in her press conference). But, while this comment does not yet say the government has got its policy wrong, it does say – counter to the government’s line – that a point could soon be reached when fiscal policy does need to change.
Given the continuing uncertainty in the euro zone, this time could be sooner rather than later. The OECD’s latest forecast for the UK economy, also published today, suggests growth will be 0.5 per cent in 2012, lower than the last OBR forecast, which was for 0.8 per cent growth. Another round of downgrades could see the growth forecast cut to zero, which would fulfil most reasonable people’s definition of ‘growth not building momentum’.
The question then will be whether, politically, the chancellor and the prime minister feel able to move on fiscal policy. Having persistently ruled out any move to a Plan B and said repeatedly that taking on more debt is not the solution to a crisis caused by debt, it would represent a big shift in their position. Even with the cover of the support of the IMF, it may be too big a move for them to make.