IMF backs tax and interest rate cuts to dig UK out of recession
International Monetary Fund head Christine Lagarde says, ‘bolster demand before low growth becomes entrenched’
The IMF has urged George Osborne to start preparing an emergency package of tax cuts and spending increases as it called for further interest rate cuts and more electronic money creation from the Bank of England to lift Britain out of its double-dip recession.
Expressing concern about weak growth and high levels of youth unemployment, the IMF said the UK needed swift action from the Bank’s governor, Sir Mervyn King, but that the chancellor should be ready with a plan B for the economy. Such a plan could include temporary cuts to VAT and national insurance, the IMF said.
Labour seized on the findings of the IMF’s latest health check on the UK as evidence that two years of government austerity had killed off Britain’s recovery from the deepest recession since the second world war.
Speaking with Osborne at a news conference in London, Christine Lagarde, the IMF’s managing director, said: “Growth is too slow and unemployment, including youth unemployment, is too high. Policies to bolster demand before low growth becomes entrenched are needed.”
She added: “If the economy turns out to be significantly weaker than forecast, fiscal easing should be considered.”
Ed Balls, Labour’s shadow chancellor, who has urged the chancellor to adopt a five-point recovery plan that includes temporary tax cuts, said: “If we fail to act, and we see years of slow growth and high unemployment being entrenched, Britain will pay a heavy long-term price.”
In its report, the IMF called on the Bank to take the lead with an immediate cut in interest rates and an acceleration of its £325bn programme of printing electronic money, known as quantitative easing.
The case for more QE was strengthened today by a decline in inflation to 3% in April from 3.5% in the previous month. The fall could provide the Bank with scope to inject more funds into the banking system and the wider economy.
However, the IMF and Lagarde were careful to praise Osborne’s approach to cutting the UK’s budget deficit. The report said that deficit reduction was “essential” in the medium term and paid tribute to the “substantial progress” towards a sustainable budget delivered by the government’s austerity programme. “When I think back to May 2010, when the UK deficit was at 11%, and I try to imagine what the situation would be like today if no such fiscal consolidation programme had been decided, I shiver,” said Lagarde.
Osborne said: “The IMF couldn’t be clearer today. Britain has to deal with its debts and the government’s fiscal policy is the appropriate one and an essential part of our road to recovery.”
Lagarde also praised Osborne for relenting on some cuts in his autumn statement last November, but said this fiscal easing may no longer be enough.
The IMF said there was scope for the government to boost growth through higher spending on infrastructure projects, which would increase employment and demand within the economy and could be funded within existing budgets by imposing further public-sector wage restraint or reforming property taxes.
An OECD report also praised Osborne for sticking to his debt reduction plans, but echoed the IMF warning that the economy would struggle to pick up momentum this year. The Paris-based thinktank, which is funded by the world’s most powerful countries, saved most of its criticism for the 17-member eurozone and its lacklustre response to the Greek crisis.
It urged the UK to prepare for the worst as Greece remained on the brink of leaving the euro and the single currency’s protective firewalls to prevent contagion appeared weak.
The IMF, which is supporting financial rescue plans in Ireland, Portugal and Greece, also warned the UK to prepare for an escalation of the eurozone crisis that would deliver a “substantial contractionary shock” to the economy.
Its report identified uncertainty over the future of the euro as the main danger to recovery and warned: “Risks are large and tilted clearly to the downside.”
The UK’s central bank has resisted adopting the European Central Bank’s programme of cheap three-year loans to banks, which has boosted the European banking sector and made borrowing cheaper. It has also been unwilling to buy corporate bonds, which amounts to direct lending to businesses.
Lagarde praised the monetary policy committee’s (MPC) £325bn QE scheme, which she said had proved a key support for the UK economy, but urged it to go further and consider further base rate cuts, more QE and a wider range of credit schemes to boost direct lending. King could make the first move next month if the nine members of the MPC agree to cut interest rates and boost quantitative easing.
Lagarde said policies designed to stimulate growth obviously came with risks, but added: “These risks need to be weighted against the risk of lost years of growth. To this end, further monetary easing is required.”
Osborne said both reports showed that the government was on the right track. “Britain has got to deal with its debts and the government’s fiscal policy is the appropriate one and an essential part of our road to recovery,” he said.
The Treasury is developing schemes to use its historically low borrowing costs to support a wide range of commercial projects, mainly in infrastructure.
Government spending on infrastructure was down by a quarter in the last year and the Treasury is under pressure to devise plans that will increase spending without adding to the UK’s debts. Osborne said schemes to support infrastructure projects and lending to small businesses would be ready over the next few months.