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IMF report on UK makes for unhappy reading

Christine Lagarde
IMF chief Christine Largarde: A bleak assessment of the UK economy

The IMF is very worried about the state of the UK recovery and thinks the government should rethink some of its budget cuts if things get any worse - that is the headline from its annual report on the UK, out today.

Some of you will feel you've heard that before. You have. The IMF said exactly the same thing back in May., when the Managing Director Christine Lagarde was here for the end of the UK's annual economic check-up.

Back then, she presented a quick summary of their conclusions. What we got today was the full report from the staff who went on that mission. All 106 pages of it.

And yet, there is news buried in all that detail - some of which will be quite irritating to the government.

For example, the IMF states baldly that the government's tax rises and spending controls since spring 2010 have cut Britain's growth by a cumulative 2.5% of GDP over those two years.

The government will say it has never denied that budget cuts affected growth, but it's not something that the Treasury or the Office for Budget Responsibility have usually put into hard numbers.

Rethink

That is all about the past. What most will find exciting in this report is what it says about the future. Because, for the first time, we have the IMF saying, not just that the government might have to rethink, but when it might have to do it.

Specifically, the staff say that the government ought to rethink the cuts it is planning for next year - the fiscal or tax year beginning April 2013 - if the outlook gets worse between now and then. Here's the key paragraph:

"Fiscal adjustment for FY13/14 would need to be scaled back if growth does not build momentum by early 2013. Current plans envisage structural adjustment accelerating from ½ per cent of GDP in FY12/13 to nearly 1½ per cent of GDP in FY13/14. Such an acceleration may be difficult for the economy to handle if it remains very weak. The planned pace of fiscal tightening may need to ease before FY13/14 if the outlook deteriorates sharply before then."

If this is how things pan out, the IMF says the Chancellor George Osborne would probably have to admit that he was going miss one of his key fiscal targets, which says net debt as a share of GDP must be falling in 2015-16. It would start falling only a year That would only happen a year later.

You can hear the Chancellor now, explaining how damaging this might be for the UK's hard-won fiscal credibility. But, interestingly, the staff think the financial markets would be pretty unbothered, particularly if the loosening came with steps to cut government spending in the longer term - another increase in the state pension age, for example. Here's what they say:

"Would this trigger an adverse market reaction? Such hypotheticals are impossible to answer definitively, but there is little evidence that it would. In particular, fiscal indicators such as deficit and debt levels appear to be weakly related to government bond yields for advanced economies with monetary independence."

To put that in plain English, the Fund is saying that countries with their own currencies (i.e. not in the eurozone) don't have to worry too much about international lenders charging them higher interest rates because of increases in government borrowing and/or debt.

Surprising

That is not to say that the deficit and the debt do not matter for other reasons. As in May, the IMF is quite clear that the government was right, in 2010, to set out clear targets for getting borrowing under control.

But that is a pretty surprising paragraph, all the same. The idea that the government's cost of borrowing is not really related to what happens to the deficit is not, I think, one that Mr Osborne would accept. It's certainly not what he's been telling us for the past two years.

Labour are claiming that the IMF has now all but endorsed their plan for boosting the economy - their "Plan B". That is a stretch.

The IMF wants more monetary easing from the Bank - including, maybe, another rate cut. It also wants the government to make a bigger effort to shift spending around, to be more pro-growth. It would like Mr Osborne, for example, to replace stamp duty with a proper property tax, and get rid of some universal benefits - in order to spend more on public infrastructure. (Good luck with that.)

But, and here we go back to ground we have trodden many times before, the IMF does not want Mr Osborne to ease up this year any more than he already has. If there is going to be a reassessment, the IMF suggests it should come in next year's Budget - and only if the economy is still flat.

You might wonder, for the umpteenth time, why - if things are so bad - the IMF doesn't say temporary tax cuts or public investment would be helpful right now?

Speculative

There are internal political reasons for them to hold off - not least, the fact that the Managing Director doesn't want to hurt Mr Osborne politically. But in a lengthy technical appendix to the report, the staff also offer a kind of economic rationale.

These go through various possible scenarios for fiscal policy, exploring whether, in effect, the shadow chancellor Ed Balls is right to say that the economy would be better off tightening more slowly - ie whether we would get more growth, overall, if we saved some of the cuts for later.

These scenarios are highly speculative - and technical. But the rough conclusion is that you only benefit, long term, from going more slowly if the positive impact of on the economy of easing up right now is bigger than the negative impact on the economy of tightening more than expected in a few years' time. (Or, as an economist would put it, the "multiplier is asymmetric across the business cycle".)

Put it another way, there's no point loosening now to help growth if you are only going to pay just as much - in growth terms - tightening next year, or the year after, instead.

Very very roughly, the scenarios suggest that this might be true - ie Ed Balls might be right - if the economy is actually in a downturn. Then a fiscal stimulus might even be a money-making proposition for the government. The IMF is not certain that's the case right now.

So, the IMF is not saying, today, that the government is wrong and Labour is right. It does not seem to think a big stimulus programme right now would transform our economic prospects. (Though reading some of its other research, on the eurozone, might lead you to that conclusion).

But it is saying our prospects are pretty bleak. And if they haven't improved by the end of the year, the government will have to start coming up with solutions which cost real money.