ECONOMIC HEALTH CHECK
United Kingdom Could Ease Monetary Policy, Credit to Boost Growth
IMF Survey online
May 22, 2012
- With inflation well anchored, there is room to ease monetary policy further
- Budget-neutral infrastructure spending can help economy recover
- Stronger supervision of financial sector a priority
At a time of intensified global uncertainty, the United Kingdom’s approach to reducing debt levels to put the budget on a more sustainable footing has reinforced credibility, the IMF said as it wrapped up its annual check-up of the U.K. economy.
The government is implementing strong fiscal consolidation to reduce budgetary risks. The IMF said the Bank of England has been nimble in easing monetary policy to support growth. This policy mix helps rebalance the economy toward investment and external demand.
With inflation well anchored, the United Kingdom has room to cut the interest rate set by the central bank and embark on further injection of money into the economy by the central bank by buying assets, a process known as quantitative easing.
The IMF said more monetary and credit easing and improvements in the quality of the fiscal adjustment may be needed to close the output gap faster and reduce the risk of a permanent loss of output.
While the island nation and financial powerhouse of Europe has made progress to rebalance its economy to create more investment and external demand, business and consumer confidence remain weak, the IMF said.
“If the economy fails to strengthen, fiscal easing should be considered,” said IMF chief Christine Lagarde during a press conference in London. “The measures would have to focus on supporting growth and encouraging employment. A delay in fiscal consolidation in these circumstances would be a good use of the hard-won credibility of fiscal policy and institutions in the United Kingdom.”
Jobs, jobs, jobs
While labor markets have improved, and despite falling in recent months, unemployment is still too high at 8.2 percent, with a large number of youth without a job the IMF said.
The IMF projects growth will pick up in the second half of 2012, premised on fewer commodity price shocks and an easing of the strains in the euro area.
To support the economic recovery, financial sector policies should focus on strengthening bank balance sheets by building capital rather than reducing assets.
The government has recently adopted measures to ease credit constraints for both small and medium-sized enterprises and households. The government has announced that it intends to further boost credit for business, housing and infrastructure, which the IMF welcomed.
The slower pace to reduce government debts and deficits this year and next makes sense given low growth in the United Kingdom. The government has taken steps over the past year to make the reduction of debts and deficits more conducive to growth through restraint on public employee wages, to create room for higher spending on infrastructure.
Fiscal space for further growth-enhancing measures could be generated by property tax reform, restraint of public employee compensation growth, and better targeting of social spending to those in need.
If growth does not build momentum and is significantly below forecasts even after additional monetary stimulus and further credit easing measures, planned fiscal adjustment would need to be reconsidered. More government spending should be considered if the recovery fails to take off.
To preserve the United Kingdom’s strong fiscal credibility, any changes in spending should be part of a multi-year plan focused on further reducing the country’s large structural fiscal deficit when the economy is stronger.
Stronger supervision of financial markets
The rebuilding of banks’ capital over the last few years has been valuable given volatile financial markets and heightened risks from the euro zone crisis. The government’s focus on banks raising capital and limiting payouts of bonuses and dividends rather than selling off assets and hindering capital is appropriate, the IMF said.
Stronger financial supervision and authority that casts a wider net over financial institutions is a priority. As the IMF said in its 2011 financial sector assessment of the United Kingdom, high-quality supervision is key to the success of the new government structure that will oversee the country’s financial system.
With London a major player in financial markets, policies have encouraged raising capital, financial oversight and supervision has been strengthened, and work is under way to enhance the capacity to deal with financial institutions that are considered “too important to fail.” Robust regulation and supervision for a global financial hub such as the United Kingdom, whose stability and soundness is a global public good, is essential.
The IMF said the United Kingdom also needs more tools to address risks within the financial system as a whole, known as macroprudential policy.
The IMF’s full report on the United Kingdom’s economy is expected to be discussed by the institution’s Executive Board in July.