Transcript

Washington, D.C.
Monday, July 28, 2014

MR. SILVESTRE: Good morning Washington and good afternoon London. My name is Bruno Silvestre and I'm glad to welcome you to this conference call on the conclusion of the 2014 mission to the United Kingdom.

With me today are Philip Gerson, the Mission Chief of the United Kingdom and Alasdair Scott, also a UK team member. Before I pass the floor to Philip let me remind you of a couple of things. First of all, the embargo is still on for another 55 minutes. Also there will be a transcript available towards the end of the day, Washington Time. This conference call is on the record, and please, when you ask a question, I would appreciate if you would introduce yourself and the media you represent. With that, Phil, you have the floor.

MR. GERSON: Thanks very much, Bruno. Good morning or good afternoon. I wanted to open by giving a very brief discussion of the Staff Report as well as of the selected issues papers that are being released today.

You've all seen the Staff Report by now. Most of you probably also saw the Concluding Statement last month and have noticed that the Staff Report very much follows the Concluding Statement.

Starting with the outlook, we've revised up our projections significantly relative to where we were a year ago. We now project growth of 3.2 percent this year, about double what we expected a year ago, and 2.7 percent next year. Those numbers are identical to what's in the WEO update that was published last week.

That makes the UK projected to be the fastest growing G7 economy over 2014 and '15. Growth has also become more balanced then it was in the past with business investment picking up.

There are two main domestic risks to the projections. The first has to do with productivity growth, which has been low. We project a moderate recovery in productivity going forward. Meaning, the risks related to productivity are both upside and downside. Productivity growth could be faster than we project or it could be slower.

The second domestic risk is the potential for financial risks arising from further rapid growth of house prices, and the associated increase in household indebtedness. External risks relate to a possible disruption from unwinding of unconventional monetary policy in the U.S., a slowdown in the Euro Area and key emerging markets, and geopolitical developments.

On monetary policy we continue to call for policy to remain accommodative for now. But if there are signs that costs are rising faster than productivity, or that slack has been used up, the authorities may need to tighten quickly. When the time comes to tighten policy we think the authorities should raise Bank rate first.

We note the progress that has been made in increasing transparency of monetary policy and point to two challenges going forward. First, reducing the potential for markets to be surprised by interest rate hikes without, at the same time, giving an unwarranted sense of security about the exact path that interest rates might take in the future. Secondly, explaining how macro prudential policies and monetary policy will interact with each other going forward.

On the subject of macro prudential policies, we repeat our view that they should be the first line of defense against financial risks that could arise from the housing market and welcome measures that have been taken. We call for the authorities to keep a close eye on the effects of these measures and stand ready to adjust if necessary. But we also point out that what's driving rapid house price growth is inadequate supply, and that this needs to be addressed through structural measures.

On fiscal we note the progress to date in bringing down the deficit. We find that the deficit reduction plan for this year is appropriate, underscore the need for further deficit reduction to put the debt ratio firmly on a downward path, and call on the authorities to consider both revenue and expenditure measures to do so.

In the financial sector we note the progress that's been made in building a more resilient financial system with initiatives to raise bank capital and provisioning, to institute a broader framework for assessing capital adequacy, to stress test the major banks, and to strengthen liquidity backstops.

We also point to the need to expand monitoring of risks in the shadow banking system, to maintain communication and coordination across regulatory bodies, and to continue to deal with banking culture, and Too Important to Fail reforms.

Finally, given the importance of productivity growth we point to the need to address structural impediments through improvements in infrastructure, education, and immigration policy.

We also released four SIPs today. These are more technical pieces than the Staff Report, but they're work that we draw on in forming our views on many of the issues that are discussed in the Staff Report.

They cover experience with housing and business cycles in the UK, trends in and prospects for business investment in the UK, the experience with macro prudential policies in the advanced economies, and the potential for outward spillovers from the UK in the event of particular global liquidity shocks. This last paper was done as part of the Fund's regular work on spillovers among the major economies.

With that, let me open it up for questions.

QUESTIONER: Could you please comment on the change in the growth outlook you have compared to last year, and the relation to this new policy advice you gave last year? Last year the IMF was very critical about the austerity measures in the United Kingdom. Now, obviously, even with the austerity measures, growth has picked up quite dramatically and rapidly, so could you please comment on that? Do you see any relation that the austerity measures have had a positive effect on the UK economy?

MR. GERSON: Thanks very much. First I’d like to underscore that the growth rate that we project this year, 3.2 percent, is about double what we were projecting a year ago. We see it coming from continued strong growth of private consumption, which reflects both an improvement in bank flows to households and an increase in confidence in households, and also a pick-up in private investment, which shows signs now of accelerating. This is why we're more confident about both the growth rate this year, and about the prospects for growth going forward.

You know, in terms of its relation to the fiscal advice, there are a lot of things going on in the economy, and it's difficult to isolate in real time as it were the contribution of individual things. I would point out that the discussion a year ago was in the context of an assumption that growth was going to be much slower this year. The question that was being discussed is: what's the appropriate fiscal policy for a country that's projected to grow slowly, but also has a large debt and a large deficit?

So the discussion was not about “will growth be faster or slower?” There was broad agreement on what the growth rate would be. The question was: what's the appropriate fiscal policy for a country with a slow growth rate, but high debt? With growth picking up we now believe that the course of fiscal policy and the intended deficit reduction this year and the future are appropriate.

But it's difficult to say that growth has picked up because fiscal policy was tight. There are a number of things that have gone on. The structure of fiscal spending has changed with an increase in capital expenditure and a decrease in current expenditure. The global economy, more generally, there are signs of a stronger global economy. So there's a lot going on and it's hard to isolate what comes from any individual factor.

QUESTIONER: Just a question about your estimate for the output gap. You put that at 1.3 percent of GDP for 2014, if I remember correctly from the report. How does that compare with the Bank of England's range of 1 to 1.5 percent of GDP assessment of amount of spare capacity? Are these two things comparable?

It does sound, correct me if I'm wrong, it does sound like you're quite relaxed about the amount of spare capacity that there is in the UK economy, and you only expect it to be run down gradually. Would that be consistent with, perhaps, a delayed instruction of the first interest rate hikes in the UK, all other things being equal?

MR. GERSON: Thanks very much for the question. Yes, our estimate of 1.3 is comparable to the Bank of England's estimate of 1 to 1.5. In terms of your characterization of us as being relaxed, the Fund's never relaxed about anything.

What we say in the Staff Report is that monetary policy should stay accommodative for now, but the authorities need to be attentive to signs of rapid growth in costs or other signs that spare capacity may be running out. So I wouldn't characterize this as being relaxed.

I think we have a similar view to the Bank of England on what the degree of slack is in the economy right now. We do think monetary policy should be accommodative for now, but we also think that the authorities need to be attentive to signals that spare capacity may be running out, and to act appropriately when those signals arise. We don't have an estimate or any projection about the date when interest rate increases may be necessary.

QUESTIONER: You call on the Bank of England to provide clarity on the operational framework that will deliver the Bank's chart of interest rate in the future. You've also said that an early pronouncement will help sort of curb short-term rate volatility, and you want the Bank to do this soon.

So I was just wondering whether you can elaborate a bit on what it is you would like to see and what soon means, given that rates could potentially go up later this year? Thank you.

MR. GERSON: Let me answer that very quickly. It's a fairly technical matter. The issue is that prior to the crisis the Bank of England had a corridor system. They moved, when the crisis started, to a floor system where reserves were remunerated at Bank rate.

We need now -- what we're hoping for now is clarity as monetary policy moves back to more normal grounds, as interest rates begin to come up. Clarity of what it is that will guide monetary policy going forward. Will they revert to a corridor system? Will they stick with a floor system? So we think clarity on that issue would be helpful.

In terms of when that has to come, you know, the sooner the better. We don't see a rate increase as being imminent. But, obviously, the sooner this can be cleared up before a rate increase becomes warranted the better it would be. So this is something that we see -- we wouldn't describe as being urgent, but we do think that the authorities should clarify before we get too close to the date when a rate increase might be happening.

QUESTIONER: Can I just ask a follow-up on that? Whether they've given any sort of indication whether they will do that? Because it sounds like that would have to be done within months?

MR. SCOTT: The Bank of England's aware that it needs to provide this clarification, but I don't have anything -- they, to my knowledge, haven't provided any commitment. So we're waiting to hear from them as well.

QUESTIONER: My question's related to the last one, actually. I'm also interested in some of these issues.

You describe how the Bank of England might need to drain reserves in order to keep money market functions smoothly. I wonder if you can give us some sense of how big an issue this might be for the Bank of England? Clearly, it's something the Fed is worried about, and they're doing these reverse repos and so on.

But I guess there's a big difference between sterling and dollar markets. Can you give us the Fund's sense of how much of a problem the Bank might have in controlling short-term rates or avoiding disruption in money markets with, like, doing some of these things, I guess?

MR. SCOTT: Thank you. I think you anticipate my answer in the nature of your question. This is simply not as big a deal as it is in the U.S.

just by the nature of the market. In one sense I'm pleased that people are paying attention to this point, but I wouldn't want it to become a headline point.

I think the Bank of England is aware of these issues, and we're just talking about an optimal timing of communication. There are a number of options here and clarity would be appreciated.

QUESTIONER: I'll ask about housing. That's a big issue here in the UK, as I'm sure you know. Do you think the measures that are being taken at the moment would be sufficient to prevent any risk of the housing market overheating in the way that the authorities are worried about?

MR. GERSON: Just to be clear, the point of macro prudential measures is not to control the growth of house prices. It's to control financial risks that may come from developments in the housing market. In terms of what needs to be done to limit the growth of housing prices, as we say in the report, the key issue is that demand far outstrips supply. What really needs to be done to control the growth of housing prices, and to deal with that issue directly, is to increase supply through structural reforms. We talk in the Staff Report about some of the things that have been done in that regard and some of the things that remain to be done.

So the point of macro prudential is not to control house price growth, but to try to contain the risks to financial stability that could arise as a result of rapid house price growth.

In terms of what the authorities have done, we welcome what's been done. The experience in other advanced economies, which is reviewed in one of the Selected Issues Papers being published today, is that often these policies need to be adjusted over time. They're introduced and over time they may need to be strengthened or tightened in order to make them effective because of lags, and how long they take to have an impact. Also because it's not always clear exactly what level they should be set at, and so you need to adjust over time to fine tune, as it were.

So we're very glad that the authorities have moved to introduce these measures. We think they need to keep a careful eye on them over time, and to see whether or not further adjustments are needed. But from the perspective of controlling rapid price growth in housing it's structural reforms that need to be undertaken.

QUESTIONER: I was just wondering quickly about the real GDP figures that you mention being 1.7 percent last year, which is nearly twice the projection, as you note, made in the 2013 Article IV report. Can you expand a bit on why it was sort of wide off the mark, if you will?

MR. GERSON: Sure. If you look at it arithmetically, we under projected the strength of private consumption last year. Private consumption was much stronger than we expected.

That consumption was finance by a decline in household saving. Household saving jumped markedly at the outset of the crisis as households were beginning to deleverage. That saving rate came down to a more moderate level last year.

We think it was a result of a couple of things. We think it was a result of increased confidence about the state of the economy, so household confidence was higher. We think it reflects, also, better flows from the banking system to households as banks had strengthened their balance sheets, so flows to households began to improve. We think it was a combination of those two things that led us to underestimate the strength of private consumption.

This year we see continued strong private consumption. We also see a big pick-up in business investment, which is why growth is even higher this year, and that widening of the base of growth from primarily consumption to a mix of consumption and business investment is a welcome sign because it gives us greater confidence about the sustainability of the recovery going forward.

QUESTIONER: Just on the possibility of increasing taxes to help bring the deficit down further in the years ahead. Forgive me, I don't know if I saw it in the reports, but do you have any suggestions as to what kinds of taxes might be most appropriate in that kind of environment for that kind of purpose?

MR. GERSON: Yes, there is a discussion in the Staff Report. But, you know, essentially one of the things that we find is that the level of tax expenditures in the UK is quite high relative to other advanced economies. The tax expenditures -- I mean, formally it's a type of -- it's something that comes from the tax side that could easily be replicated by a measure on the expenditure side.

So it's things like exemptions under certain kinds of taxes. We think there's a lot of scope for eliminating some of these tax expenditures basically by broadening bases of taxes. There are a lot of arguments for it in terms of revenue. There are a lot of arguments for it in terms of efficiency.

There are opportunities to off-set the impact of that with expenditure items or with means testing or things like that, that could help off-set any negative impact that might have, for example, on income distribution. So we think on the revenue side there's a lot of room to address tax expenditures that exist in the tax system in the UK right now.

MR. SILVESTRE: Since we do not have any further questions, this concludes our conference call on the UK Article IV. I'd like to thank all the participants for being with us. Let me remind you that the embargo is still valid for another 30 minutes until 10:00 a.m. Washington Time. Bye-bye. Thank you.