Christine Lagarde, the new IMF director, has written an important article for the FT today. Tellingly it is entitled ‘Don’t Let the Fiscal Brakes Stall Global Recovery’.
The essential points are (i) that markets worry about growth as well as deficits and (ii) that states ‘that are not under market pressure’ and have room for expansion should be looking at slower tightening and/or additional fiscal measures to help growth in the short term.
She is basically arguing for the same postion as IMF’s Chief Economist did last year – the appropriate policy action now by Finance Ministry’s is for short term stimulus coupled with creditable (and meaningful) medium term fiscal tightening.
What is interesting is that her argument explicitly accepts that spending cuts mean lower growth & higher unemployment – something the government (and its cheer leaders) have occasionally denied.
As she notes – markets worry about high deficits BUT they also worry about low or negative growth.
The question then becomes what is the right balance. As I wrote earlier this year:
The Government claim that cutting the debt will lead to ‘expansionary fiscal contraction’ and a ‘rebalancing of the economy towards net exports and investment’. This is unlikely to be correct, the evidence (see this post for example on recent IMF work) suggests that austerity policies lead to weaker growth – especially if interest rates are already low or cannot fall further. I’d have much more time for Osborne if he acknowledged that the cuts will hurt growth but argued that not cutting as fast and deep as he plans would risk a loss of market confidence and problems funding the debt. That’s a justifiable and reasonable position to hold.
We face a trade-off between cutting and hence harming the economy and not cutting and hence risking a loss of bond market confidence. The real debate, away from the shouty world of Westminster, is about the balance of risks.
Taken together I think the UK’s low stock of debt, the low interest rates it attracts and the debt profile outlined above more than offset the high deficit. I think the risk of cutting as fast and deep as the Government intends is far worse than the risk of a loss of confidence. I certainly don’t say that there is no chance the markets would lose faith in a British government that’s adopted a different approach, I just think the balance of risks points towards a less extreme and more growth friendly fiscal package.
It’s nice when the Director of the IMF agrees with you.