Union Jack: Be Nimble, Be Quick
IMF Blog, August 1, 2011
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- Authors: Ajai Chopra
- Published: August 1, 2011
Near-term outlook and central message
- The U.K. government should be nimble in its policy response if it looks as though the economy is headed for a prolonged period of weak growth, high unemployment, and subdued inflation.
- Currently, the IMF does not expect this prolonged-slump scenario to happen.
- If signs of such a prolonged slump appear, the IMF recommends responding quickly with some combination of further quantitative easing by the Bank of England and temporary tax cuts.
- The most likely scenario is that the U.K. economy will gradually recover, despite headwinds from:
- a soft housing market,
- household and financial sector deleveraging, and
- ongoing consolidation of the budget.
- Offsetting forces include:
- a push from private investment,
- an increase in exports driven by the global recovery, and
- a possible rebound in labor productivity that could improve competitiveness.
- The IMF is expecting a bumpy and uneven recovery in the U.K.; an updated near-term growth forecast, taking into account the recent GDP release for the second quarter, will be published with the September World Economic Outlook.
- Over the medium term, the IMF expects growth to accelerate gradually to about 2½ percent.
- Volatile commodity prices, the uncertain magnitude of fiscal headwinds, and problems in the eurozone add substantial uncertainty to the outlook.
Scenarios presented
- Stronger growth and higher inflation.
- If growth and inflationary pressures are stronger than expected, monetary tightening will need to accelerate, and all fiscal windfalls should be saved.
- Prolonged slump and subdued inflation.
- If there are signs the economy is entering a prolonged period of weak growth, high unemployment, and subdued inflation, rapid action may be needed to kick-start growth and avoid an entrenched slump.
- The IMF warns that productive capacity could be permanently lost as temporary job losses morph into long-term unemployment from skill loss and labor-market dropout.
- Possible measures to kick-start growth could include a combination of expanded asset purchases by the Bank of England and temporary tax cuts, combined with further reforms of pension and other entitlement programs to safeguard fiscal sustainability and market confidence.
- Weak growth and high inflation.
- If weak growth coincides with high inflation, the appropriate response depends on the root cause:
- If volatile commodity prices are the main driver and there is little evidence of persistent price pressures, policy need not respond.
- If labor and skills shortages are causing rapid wage growth (driving weak growth and high inflation), policymakers would need to tighten monetary policy.
- A narrower output gap would imply a higher structural deficit and therefore require more fiscal adjustment over the medium term.
Policy guidance and priorities
- The government’s foremost requirement is to stay nimble and be ready to alter course should any of the outlined scenarios manifest.
- For now, the IMF views staying the course and implementing the wide-ranging policy program agreed last year as the appropriate stance.
- If a prolonged slump emerges, the recommended rapid-response toolkit includes:
- expanded asset purchases (quantitative easing) by the Bank of England, and
- temporary tax cuts,
- together with continued reforms of pension and entitlement programs to maintain fiscal sustainability and market confidence.
Source: Union Jack: Be Nimble, Be Quick — Ajai Chopra, August 1, 2011; https://www.imf.org/en/blogs/articles/2011/08/01/union-jack-be-nimble-be-quick
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