Mind The Gap: Policies To Jump Start Growth in the U.K.
IMF Blog, July 19, 2012
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- Authors: Ajai Chopra
- Published: July 19, 2012
Economic context and risks
- The U.K. economy has been flat for nearly two years.
- Output per capita is "a staggering 14 percent below its precrisis trend and 6 percent below its pre-crisis level."
- Unemployment is "high at 8.1 percent," with youth unemployment "an alarming 22 percent."
- Large and sustained output gaps raise the danger of hysteresis—permanent reductions in potential GDP—through:
- erosion of skills from persistently high long-term unemployment;
- scrapping of idle capital;
- inadequate investment that erodes the capital stock and hinders innovation and the development of new technologies.
Findings from analysis
- Policies that bolster demand will help close the output gap faster, reduce the risk of hysteresis, and insure against the predominance of downside risks.
- Evidence suggests further quantitative easing can continue to support demand by lowering long-term interest rates and improving banks’ liquidity.
- Credit conditions remain tight because elevated bank funding costs have limited the quantity and maturity of lending to the private sector, despite significant monetary easing.
- The recent sharp flattening of the yield curve may have increased the stimulative effect of cutting the policy rate, "possibly outweighing potential negative effects on money markets and financial stability."
- Delaying fiscal consolidation can generate permanent gains if fiscal tightening has a larger negative effect on output during a period of negative or weak growth (extending work by DeLong and Summers).
- If growth remains absent even after additional monetary and credit easing, monetary policy’s ability to mitigate contractionary fiscal effects may be more constrained than currently assumed, implying higher and more asymmetric multipliers when the economy is weak.
- Heightened uncertainty, including concern about tail risks, can deter private-sector borrowing even when credit is significantly cheaper and more easily available.
Policy priorities and recommendations
- Monetary policy
- Provide additional monetary stimulus through further quantitative easing.
- Keep under review the merits of cutting the policy rate.
- Monitor the implications of the recent sharp flattening of the yield curve for policy effectiveness and financial stability.
- Note: "In line with recommendations made in our report, the Bank of England’s Monetary Policy Committee voted on July 5, 2012 to expand further its quantitative easing program."
- Credit easing
- Implement credit easing measures to boost demand and address tight credit conditions caused by elevated bank funding costs.
- Support broader provision of bank funding against collateral with haircuts, including the "funding for lending" program.
- Consider further measures, depending on effectiveness, such as purchases of private-sector assets on secondary markets.
- Public investment and guarantees
- The government could use record-low borrowing costs to provide government guarantees to fund large, privately operated infrastructure projects.
- Ensure choice of projects and modalities (public versus private; financing by issuing public debt versus guarantees) are based on using public funds as efficiently as possible.
- Ensure project choices are not affected by attempts to artificially limit government gross debt or near-term expenditure.
- Fiscal policy sequencing
- If growth does not pick up sufficiently after monetary stimulus and credit easing, slow the pace of fiscal tightening; "delaying fiscal consolidation could yield gains."
- Recalibrate fiscal policy as needed, using the space created by deficit reductions over the last two years.
Scenarios and conditional guidance
- If monetary and credit easing successfully restore growth:
- Resume planned fiscal consolidation once the output gap narrows and downside risks recede.
- If growth remains weak despite additional easing:
- Prioritize delaying fiscal consolidation to avoid larger negative effects on output and permanent damage to potential GDP.
- Recognize higher and more asymmetric fiscal multipliers during periods of weak growth and heightened uncertainty.
Source: Mind The Gap: Policies To Jump Start Growth in the U.K., Ajai Chopra, July 19, 2012.
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