Transcript of a Conference Call on UK Article IV Consultations with UK Mission Chief Krishna Srinivasan and Deputy Alasdair Scott, July 17, 2013

July 17, 2013

Washington, D.C.
Wednesday, July 17, 2013

ALISTAIR THOMSON: Thanks to all the reporters who dialed into this call. Good morning, or good afternoon, depending on where you are. I'm here in Washington, D.C. with our Mission Chief for the United Kingdom, Krishna Srinivasan, and also his deputy Alasdair Scott. And they'll be able to answer your questions about the Article IV consultation with the UK, which is going to be published at 1 p.m. Washington time today. That's 6 p.m. in London.

So I'd like to introduce Krishna Srinivasan who will make some introductory remarks about those main conclusions of the Article IV for the United Kingdom and then we'll take your questions after that. Krishna.

KRISHNA SRINIVASAN: Hi. I'd just like to underscore a few key messages from the report which you would have seen by now. First, notwithstanding recent developments, the UK economy remains a long way from a strong and sustainable recovery. Even with the improvement in the first half of the year compared with last year, we project growth in 2013 to be less than 1 percent.

I would also note that per capita income is still about 6.5 percent below its pre-crisis peak. It would represent the weakest recovery in recent UK history. Unemployment is still high at about 7.8 percent and youth employment is at 21 percent. Moreover, the economy faces significant headwinds, notably from private sector deleveraging and a weak external outlook.

If growth remains weak, the economy stands to permanently lose productive potential and so the risk of hysteresis is still here. Against this backdrop, we feel that both boosting growth and rebalancing will help contribute to a virtuous cycle and reinforce positive feedback loops. In particular strong growth will restore incomes, help improve the sustainability of public debt and bolster bank balance sheets.

Similarly, rebalancing is crucial for long-term prosperity and resilience against future shocks. The economy has to gradually move away from relying on domestic consumption.

So to secure strong growth and rebalancing, we advocate a package of policies aimed at alleviating both demand and supply constraints that the economy currently faces. No one policy is going to do the trick and if you take one component out of the package, the burden on other policies increases and the outcome could be suboptimal.

For instance, we call for keeping monetary policy accommodative, but underscore that expectation of its effectiveness should be tempered especially in the absence of complementary financial, demand support, and structural policies. We also call for an expeditious repair of bank balance sheets. This is important for the effectiveness of monetary policy, but again for this to have an impact on output and employment we see a need for demand support and structural policies.

We place a lot of emphasis on structural policies, which we think are important to boost the economy's skills base and competitiveness and to anchor expectations of long-term prosperity.

We see our fiscal policy advice as being an integral component of the multipronged strategy. Given significant headwinds to the economy, we don't want fiscal policy to be another source of drag on the economy, especially at a time when you're seeing nascent signs of recovery. So we advocate bringing forward planned capital spending and other growth-friendly measures within the medium-term fiscal framework. This would support near-term demand, boost the economy’s supply potential and come with minimum risks.

We feel this is the kind of spending which the government will have to do anyway and should do more of it for long term prosperity. It can finance it now at record low interest rates, much lower than the financing costs paid by the private sector. We also advocate measures on the revenue side which can over the medium-term offset the impact of bringing forward capital spending.

Well, I'll stop here and I'll be happy to answer any questions.

QUESTIONER: Oh, hello Krishna. When you read the Executive Board press release, it's very clear that the Executive Board didn't support the staff assessments of the fiscal recommendations for the UK, in fact, overturned them. What is your reaction to that and does this change the outlook in any way?

MR. SRINIVASAN: Thanks, good to hear from you. The views in the board were clearly mixed and I would say that, yes, a majority of them did think that the UK should stick with its fiscal plans. Again, staff views are what they are and we feel that notwithstanding some of the recent developments, which are clearly encouraging, this economy faces significant headwinds. In this context we don't want fiscal policy to be another source of drag on the economy. In fact, we would say that fiscal policy should take advantage of the nascent signs of recovery, and that's why our advice is focused on policies which can actually boost both near term demand but, more importantly, improve the economy’s supply potential. So we advocate bringing forward capital spending and other growth friendly measures within the medium-term framework.

We see this as carrying minimum risk. There was a lot of discussion at the Board on the implications for credibility of such action and some felt that deviating from the medium-term fiscal plan could undermine credibility. We see the risks of that being low for the reasons that we have articulated in the staff report.

QUESTIONER: Oh, hi there. A couple of things really -- one was a just a quick one. Just to ask how common it is for the directors to overturn or to reject the staff’s recommendation in this way. The other one is a different question, which is about the banks, and you will no doubt have seen in the UK one of the ways the reports earlier in the year, or the summary, was spun was as encouraging or urging the government to sort of bring forward the privatization of Royal Bank of Scotland (RBS). And I noticed in your blog that you talked about that, but you've also talked about capital-building across the banking sector as a whole and I wondered how urgent you see the privatization of Royal Bank of Scotland, the bailed out Royal Bank of Scotland, as being.

MR. SRINIVASAN: It's not very uncommon for the board to have a view which is different from staff views. Views are mixed. And that's consistent with what we've seen on the UK. You had a question on the bank balance sheet repair. We see bank balance sheet repair as an important element of the policy package, notably because that bears on the effectiveness of monetary policy.

And the recent AQR [asset quality review] by the regulatory authorities identified capital shortfall across a bunch of banks. We feel it's important for the PRA [Prudential Regulation Authority] to make sure that banks fill these capital shortfalls as fast as possible.

In addition, we feel that greater clarity is needed about the future of RBS, including its eventual return to private sector ownership. And so, we see this as part of a strategy to move quite quickly on bank balance sheet repair because that has a bearing on the effectiveness of monetary policy [and] on the economy, more generally.

QUESTIONER: Hello. Yes, I was just really wanting to see if the more recent economic data that we've had since the sort of cutoff dates in the report, which I believe was in May, is leading you towards any slightly different interpretation of the prospects for the economy. Whether you see that there's a sort of slightly rosier outlook and whether this perhaps sort of means that there's less of a need for the fiscal measures that you sort of mentioned six weeks ago and are again promoting now.

MR. SRINIVASAN: Thanks. Again, we do take into account all recent developments. So even though there might be a cutoff in, say, May, we do look at all developments until the paper is issued to the Board. So we are very current on recent developments.

That said, notwithstanding the fact that developments both in Q1 and Q2 were encouraging, we feel that the UK is still as far away from a strong and sustainable recovery. We think policy should take advantage of this nascent recovery by adopting measures which actually help both near-term demand but more importantly also boost the economy's supply potential. So that's where the fiscal policy advice comes in because we see that there is still a need for support to anchor a strong and sustainable recovery because without that the recovery is still very weak. And so we want policy support to continue.

QUESTIONER: Hi, Krishna and Alasdair. I just had a question about monetary policy. You've got a little bit about forward guidance here but I wondered if you could just expand on that. You talk about forward guidance not necessarily being the only tool that could help turn things around in the UK and I just wandered that given there is lots of focus on that here at the moment [whether] you could expand on that. And the second question is, I suppose, similar to the last one, in that we heard at the spending review that there's going to be a big boost in investment. In fact, they were talking about this being largest investment in our railways since the Victorian age. I wonder whether you had heard about this and thought, well, perhaps this is good news and we're encouraged by that, or whether your advice would still remain the same.

MR. SRINIVASAN: Thanks. I'm going to answer the second question and I'm going to ask Alasdair to answer your first question. On the second question, yes we did follow the spending review. We are encouraged by the government's emphasis on capital investment but we think a lot of it can be brought forward. Why wait until '15, '16 if you can bring a bunch of it forward, especially given how low interest rates are. Significantly lower than what the private sector faces. So the question is: this is the kind of investment spending which you have to do for long term prosperity of the UK economy; why push it to the future, why not bring it forward? That's the answer to your second question.

On the first one let me pass it to Alasdair.

MR. SCOTT: Alasdair here. I think when we talk forward guidance it's important to recognize that forward guidance means potentially a lot of different things in different situations. The original conception of forward guidance was very much relating to a situation where nominal policy rates are at zero. It's the threat of disinflation and in that context you're talking about trying to create expectations against disinflation or even of some inflation to try to bring demand forward.

So when academics like Michael Woodford are talking about forward guidance they're really more talking, I think, about the Japan situation, which applies less to the UK. So that's why we say that we don't think forward guidance would do much to actively boost the recovery. But we talk about it in a different sense that it can be very useful and I think this has really proven to be very applicable in the last few weeks. Very useful in terms of reassuring households and investors that rates are not going to rise very quickly, very soon, and you saw an interesting step in the June minutes by the Bank of England’s MPC [Monetary Policy Committee] to take active steps to reassure the private sector along those lines.

So we're very much in favor of forward guidance in that sense and believe that's a valuable contribution.

QUESTIONER: Hi. I've got two questions, one of which is on monetary policy. You say on QE [quantitative easing] the BoE should consider further purchases of gild. I'm just wondering what the rationale is for that, when you go on to say that the transmission mechanism from gilt purchase through to the economy has been weak. And the second question is to do with the housing market and government policy to support the housing market and whether you have any concerns around the latest sort of help to buy scheme and the possibility of sort of further rises in the house prices.

MR. SRINIVASAN: Okay, again let me answer the second question and I'll ask Alasdair to answer the first question. Our view on the housing support policy is very clear in the report. We recognize the motivation behind the help-to-buy policy which is to increase affordability of house purchase. But what we are concerned is that in the absence of a supply response all that you're going to see is an increase in house prices. And recent house prices point to that kind of an effect being quite relevant. So we would want this policy to be strictly temporary. We underscore this in the report.

We also would like to encourage the government to think about fiscal incentives which would increase the supply of housing. So I'll stop there but we have a section in our report on housing policies where is very clear about our concern on this issue.

On your first question, the monetary policy, let me just give it to Al.

MR. SCOTT: We advocate further accommodative monetary policy and we believe that quantitative easing is still effective in the sense that we don't believe that the Bank of England has lost the ability by purchasing gilts to affect the yield curve or to have a broad money effect. However, as you've clearly picked up correctly, we're also saying that to some extent, without fixing other things, it's pushing on string to some degree.

So we're very firm that what also needs to happen as part of the package of policies that we advocate, we need to see measures taken to enhance the monetary transmission and that's where banks come in. Also we're very concerned -- there's an annex in the full staff report -- we're very concerned that there's a fall away in credit demand. There's a phenomenon of deterred borrowers. So that's why we say monetary policy needs to be supported by other forms of demand support, notably fiscal policy, to give people some expectations of higher incomes so they'll actually want to borrow in the first place.

Finally, that's where we recognize the need for structural reforms to boost long-term expectations of incomes and returns on projects. So that's why we emphasize that if we don't, QE is a viable part of monetary policy accommodative stance but it needs to be supported by other measures.

MR. SRINIVASAN: Again we put a lot of emphasis on the package of policies, the multi-pronged strategy because we don't see one policy on its own doing the trick. So it has to be a package of policies which helps to make a strong and sustainable recovery.

MR. THOMSON: All right, well thank you very much to everyone who's taken part in the call. Thank you to Krishna, thanks to Alasdair. The documentation as I say will go live at 1 p.m. Washington time. And we also anticipate that we will post a transcript of this call either later today or tomorrow once we get that finalized. Thank you and good afternoon everybody and look forward to speaking to you again in the future.

MR. SRINIVASAN: Thank you.

MR. SCOTT: Thank you.
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