IMF Urges UK To Tighten Fiscal Policy

by Robin Pilgrim, LawAndTax-News.com, London

08 August 2008

On 30th July, 2008 the Executive Board of the International Monetary Fund (IMF) concluded its Article IV consultation with the United Kingdom.

Beginning their conclusions, the Directors observed that, following a decade of sustained strong economic performance, including stable economic growth and low inflation, the UK economy is now facing several concomitant shocks.

The strong policy frameworks and structural reforms that have underpinned economic performance will be tested by lower growth, higher inflation from food and fuel price increases, ongoing strains in financial markets, rapid housing price reversals, and medium-term external imbalances. Financial sector strains have also triggered a broad-based effort to reform the financial stability framework.

In this difficult context, Directors noted that the authorities' inflation target of 2% will be exceeded for an extended period. In addition, the public net debt ceiling of 40% of GDP is likely to be breached. Rising long-term inflation expectations have added to the importance for fiscal and monetary policies to play their part in safeguarding the credibility of the nominal framework.

Directors welcomed the commitment made in the 2008 budget to tighten fiscal policy in the coming two years.

Directors saw no room for slippages in the current fiscal year. A number of Directors recommended a stronger-than-planned fiscal stance for 2009 and beyond to support medium-term fiscal sustainability and help build headroom for full operation of automatic stabilizers. A stronger fiscal stance would also help address external imbalances.

Some Directors favored a somewhat more gradual adjustment as planned given short-term output concerns.

Directors generally considered that any revision to the fiscal framework should enhance its credibility. They recommended that the net public debt ceiling of 40% of GDP be retained. Should it be breached, they called for concrete and frontloaded plans to bring debt back below the ceiling.

Some Directors argued that the elevation of the status of nominal expenditure ceilings within the current fiscal framework would enhance its credibility. Some Directors suggested that any revision of the fiscal rules should strengthen consistency with the Stability and Growth Pact.

In addition, some Directors agreed that monetary policy has been appropriately focused on stemming second-round effects from the food and fuel terms of trade shocks. Given the outlook for inflation and the stance of fiscal policy, Directors saw little scope for monetary easing at present.

Directors considered that the current inflation-targeting framework contains sufficient flexibility in the target horizon and definition to accommodate the ongoing terms of trade shocks.

Directors noted that sterling has moved towards its equilibrium value, but remains on the strong side.

This could adversely affect export growth, and underscores the case for improving the mix of policies to rebalance demand toward the external sector. Some Directors also stressed the need to enhance productivity. Directors welcomed the ongoing efforts to stabilize financial markets, including the introduction of the Special Liquidity Scheme.

They noted that further capital-raising and information disclosure initiatives by financial institutions would boost confidence in the financial system. With regard to the financial stability framework, Directors praised the thoroughness of efforts to diagnose and resolve the problems illuminated by recent market tension.

They welcomed the close tripartite cooperation among the Bank of England, the Financial Services Authority, and the Treasury, and the openness of the consultation process.

This process has correctly highlighted the need for a special bank resolution regime, a statutory role of the Bank of England in the financial stability framework, and strengthened operations of the Financial Services Authority.

Finally, Directors agreed that success of the special resolution regime will require full clarity and accountability within the tripartite structure.

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