Thursday, 19 July 2012

The IMF’s full report on the UK


                When the IMF undertakes an Article IV mission, they publish a preliminary report at the end of their visit, and a full report a couple of months later. I wrote about their preliminary report in May, and today we have the final version. So for the second night running I’ve stayed up too late reading IMF material. While not quite a page-turner, this report is full of good stuff.
                I’ve already mentioned the pessimistic near term outlook for growth. What is just as depressing is their view that “the output gap is projected to remain large for an extended period and not close until 2018.” What is more, they are quite clear that “the risks to the baseline are predominately to the downside” – that means their assessment is more likely to be too optimistic rather than too pessimistic. As a result, they conclude “A more supportive macroeconomic policy stance is hence essential”, with none of the usual ifs and buts.
                Their recommendations of monetary policy are extensive and detailed. They note that “monetary and credit conditions remain tight due to elevated risk aversion and rising bank funding costs”. They recommend reducing interest rates from 0.5% to 0.25%. They note that “standard rules-of-thumb suggest that cutting the policy rate by 25 basis points could boost growth by 0.1-0.2 percentage points—perhaps equivalent to fiscal stimulus of 0.2-0.4 percent of GDP”, but they suggest that may be an underestimate in current circumstances.
                Their final paragraph on monetary policy is worth quoting in full. “The government has also announced that it is considering expanding government guarantees (for a fee) to fund large, privately operated infrastructure projects. Boosting infrastructure spending would support growth, given its high multiplier and ability to increase productive capacity. However, it is important that the choice of projects and the modalities of their operation (public versus private) and financing (e.g., issuing public debt versus guarantees) be based on efforts to use public funds as efficiently as possible. Such decisions should not be affected by artificial attempts to limit government gross debt or near-term expenditure by transforming costs into contingent liabilities that might be realized only later.” I couldn’t agree more.
                The IMF estimate that fiscal “consolidation has so far reduced GDP by a cumulative 2½ percent.” Their multipliers look a little low to me, but its good to have some numbers out there. They note that the government has over the last year tried to change the fiscal mix to promote growth, but “the macroeconomic impact of such measures is likely to be modest”, and it recommends that more should be done.
                The report is quite clear that if growth does not pick up, the Chancellor’s deficit reduction plan should be abandoned.  Jonathan Portes has already highlighted why the IMF believes this would not lead to adverse market reaction. It also raises the question about why they do not recommend short term fiscal stimulus under their baseline, which is hardly rosy. The answer may lie in Annex 3, which simulates exactly this under various different assumptions on hysteresis and multipliers. How they do this looks slightly odd to me, but hopefully I can investigate this further at a later stage.
                There is much more interesting detail in the report, such as an expectation of further significant falls in house prices, and a view that Sterling is modestly overvalued at present. But the main message is pretty clear. They say “unemployment is still too high. Activity is expected to gain
modest momentum going forward, but additional macroeconomic easing is needed to close the
output gap faster, reduce the risks of hysteresis, and insure against the predominance of downside
risks.”

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