Duncan’s Economic Blog

An important intervention from the IMF

Posted in Uncategorized by duncanseconomicblog on August 16, 2011

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.



8 Responses

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  1. Dave Holden said, on August 16, 2011 at 9:43 am

    “accepts that spending cuts mean lower growth & higher unemployment”

    I agree with this but I think it should have the modifier “in the short to medium term”.

    On stimulus, it’s clear that it will improve GDP just by dint of the accounting identity but for it to be beneficial to the real economy both in the short and medium term, and not just rich peoples stock options) it has to be the right type of stimulus. I’m not sure what that is but I’m pretty sure it’s not QE or a VAT cut.

    • JakeS said, on August 17, 2011 at 3:56 pm

      QE isn’t stimulus, it’s market making of last resort.

      VAT cuts are not bad as tax cuts go, but actual spending on actually useful projects (rail upgrades, power plants, upskilling your workforce, etc.) would be better.

      – Jake

    • Mike said, on August 17, 2011 at 9:42 pm

      Why the qualifier? Shifting the tax burden back to companies and the wealthy increases tax revenues for minimal reduction in growth. Spending (or investment) can be maintained without increasing debt.
      Someone has to invest constructively. Private investment is aimed at short term gain, artificially raising stock markets and house prices.
      Technology industry is looking to the Government for subsidy. It’s not that industry wants the Government to spend less per se, it’s that it wants more of the money itself.

  2. […] The ever alert Duncan Weldon. Share | Permalink | Leave a comment Comments > […]

  3. nikostratos said, on August 16, 2011 at 12:59 pm

    yeah well she obviously reads your blog

  4. jomiku said, on August 16, 2011 at 1:23 pm

    A main point about austerity, which is made in her article, though too softly, is that the markets punish countries whose economies falter because of debt. The odd thing is this idea has now been extended way past that sensible point so then it becomes necessary to point out that markets care about economic performance – as though they usually care about debt as the primary thing, which simply isn’t true. Markets always care about economic performance; it’s what they’re interested in, along with prospects for the same. The austerity movement in non-distressed countries has turned that on its head and people leaped to the idea that markets would reward bigger short run debt reduction for the sake of it. These people have seized on a couple of academic works, not market responses but papers presenting arguable conclusions, to justify something that markets have never said. Markets reward debt reduction when the debtor nation is teetering on the edge of the abyss and financial consolidation is necessary for the country to remain viable. Markets reward the end of hyperinflation. They reward the restructuring of debt that has become too large to be paid. This has happened many times over my life. Markets reward “prudence” but the definition of that would be to reduce debt more slowly so the reductions don’t harm the performance the markets judge.

  5. Dave Holden said, on August 16, 2011 at 2:08 pm

    Two excellent articles today, in a lot of ways saying the same thing about the state of “markets”




    From the Hussman piece:

    “The way to expand the economic wealth of a nation is not simply to “stimulate demand” with fiscal policy, nor is it to distort financial markets with monetary policy. Rather, the way to achieve better economic performance is to focus on policies that expand innovation and productive capacity, particularly in sectors of the economy where there is likely to be latent demand (which may include infrastructure).

    Presently, we should not judge policy actions by their ability to punish saving, indiscriminately promote spending, relieve fear by making bad debt whole, or promote credit for its own sake. Instead, we should judge each policy action by its ability to reallocate resources toward productive uses, and to accelerate the restructuring of hopelessly bad debt that was carelessly extended in the first place. Many “standard” elements of economic policy can be crafted toward these ends, including infrastructure spending, R&D credits, unemployment compensation, funding of NIH and other basic research, and so on.”

  6. […] an effective short-term stimulus now necessarily means deeper austerity later. As new IMF director Christine Lagarde argued yesterday, the right policy mix for most states is a short-term stimulus to get growth moving coupled with a […]

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