“Fiscal easing and further use of the government’s balance sheet should be considered if downside risks materialize and the recovery fails to take off. In particular, 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. Under these circumstances, gains from delaying fiscal consolidation could be larger as multipliers are estimated to move inversely with growth and the effectiveness of monetary policy. To preserve credibility, reconsidering the path of consolidation should be in the context of a multi-year plan focused on further reducing the UK’s large structural fiscal deficit when the economy is stronger and taking into account risks to sovereign borrowing costs. Fiscal easing measures in such a scenario should focus on temporary tax cuts and greater infrastructure spending, as these may be more credibly temporary than increases in current spending.”
The above quote is from the concluding statement of the International Monetary Fund’s mission to the UK for the so-called Article IV Consultation, released on 22 May 2012.
What does this mean? Does it make sense?
What it means, in carefully modulated bureaucratic prose, is that the economy is not doing at all well.
Indeed, in the second paragraph of the statement, the IMF staff writes that:
“The hand-off from public to private demand-led growth has not fully materialized. Much of this underperformance relative to earlier expectations is due to transitory commodity price shocks and heightened uncertainty following the intensification of stress in the euro area. However, the weak recovery also indicates that the process of unwinding pre-crisis imbalances is likely to be more protracted than previously anticipated, in part due to persistent tight credit conditions. Reflecting these forces, output remains more than 4 percent below its pre-crisis peak.”
The statement continues:
“The projected modest pick up in growth in the second half of 2012 is premised on less drag from budget consolidation this fiscal year, the dissipation of last year’s commodity price shocks, and an assumed easing of strains in the euro area. Over the medium term, economic activity is expected to gain additional momentum, but the continued headwinds from private-sector deleveraging and the need to reduce the structural fiscal deficit will constrain the pace. The output gap is projected to remain sizeable for an extended period, raising the risk of hysteresis as sustained cyclical weakness reduces the economy’s productive capacity.”
Indeed, as I have noted several times, the economy is at best stuck at levels of output 4 per cent below the pre-crisis peak and still shows next to no sign of recovery from the longest and costliest slump (or period below a peak) since the 1920s.
Does the Fund Staff’s call for a possible rethink on fiscal policy make sense? The answers are: yes and no.
Yes. There is no question that, if further monetary and credit-easing measures fail to push the economy out of its rut (which is all too likely, given the weak impact of monetary policy so far, the difficulty of making “credit-easing” work swiftly, and the dire news from the eurozone, much), then present fiscal policy must be reconsidered. The specific suggestions, moreover, of temporary tax cuts and greater infrastructure spending (or use of the public sector’s balance sheet in support of such spending) are ones I have made. It is easier to make tax cuts and infrastructure spending credibly temporary. For a government obsessed with credibility (indeed, over-obsessed), that must be attractive.
No. There is no case for further delay, as soon as one accepts the argument that the economy suffers from severe and entrenched weakness of demand. Of course, if you believe that the economy is always in equilibrium or that the stagnation is a proper punishment for past evil, even if it is the innocent who are suffering, you will not share this view.
If one ignores these views, one sees that the worst of the global financial crisis was almost four years ago (provided the eurozone does not actually melt down) and that the UK economy has been stagnant for almost two years.
How long then is a change in policy supposed to wait?
I find it hard to believe that the Fund staff disagree that action is needed right now. It is far more likely that they (and, not least, the IMF’s Managing Director, Christine Lagarde) felt unable to take on the government of what remains an important member country. That is also what the BBC’s Stephanie Flanders suggests in her excellent post, “IMF: ‘Great Policies: Shame about the Economy’.”
The time for aggressive fiscal consolidation is when the economy – by which I mean spending by the private sector – is strong, not weak, as it is now. What, then, is the argument against using fiscal policy more aggressively, to support the economy now? As Jonathan Portes, director of the National Institute for Economic and Social Research, notes, it is very hard to make one.
The principal argument against any fiscal action now, apart from the hope against implausible hope that monetary policy is going to do the job, even though interest rates are almost zero and the Bank of England has indulged in substantial “quantitative easing”, is that it will destroy the government’s credibility, lead to a rapid spike in interest rates and so weaken the economy, rather than strengthen it.
The question is whether this argument has any plausibility or offers a bogey man, instead.
I intend to argue it is the latter in my next post.
