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Transcript of a Conference Call with Susan Schadler, Deputy Director in the European Department of the International Monetary Fund, on the 2005 Article IV Consultation Report for the U.K.
March 3, 2006
MS. MBOTO FOUDA: Good morning everyone, and thanks for joining us. I'm Lucie Mboto Fouda, Senior Press Officer with the IMF and I would like to welcome all the participants to this conference call of Susan Schadler. Susan is, as you may know, Deputy Director in the IMF's European Department and Mission Chief for the U.K. We also have with us here today James Morsink, who is Division Chief in the same Department, the Division in charge of the U.K.
Susan and Jim are here today to discuss the 2005 Article IV Consultation Report for the U.K., which as some of you may know was discussed by the IMF's Executive Board on Wednesday, March 1, 2006. The Public Information Notice summarizing the Board's discussion was sent out under embargo a while ago.
Before we begin, let me go briefly over some ground rules. This is an on-the-record conference call. Susan's remarks as well as the Public Information Notice are embargoed until 11 o'clock a.m. Washington time. At that time we will also post on our website the supporting documents, namely, the Staff Report and the Selected Issues Paper.
Susan, you may now take the floor for your opening remarks.
MS. SCHADLER: Thank you, Lucie, and good afternoon to those of you in London. As you've just heard, we've just reached the end of our annual consultation cycle. This began with a two-week visit of the staff team to London in December, after which we issued a statement of our conclusions. On our return we prepared a report and an appraisal of the situation in the U.K. This report was discussed at the Executive Board of the IMF on Wednesday. I believe you now have a concluding statement from that meeting which summarizes the views of the Executive Directors.
The report has a wealth of analysis focusing principally on near-term developments and policies. In addition, this year we took a more in-depth look at several questions, the effects of energy price increases on output in the United Kingdom, the effects of deceleration in house prices on private consumption, and some longer-term fiscal issues in part on the health spending side. On the financial sector, we've taken a closer look at the rapid development of credit risk transfer instruments.
Today I'd like to comment on what I see as a few broad themes of the report, and I hope that you will read the reports for the more in-depth analysis. On the broad themes I'd like to point to two issues.
First of all, perspective is very important. We're looking at recent and near-term developments from the perspective of an economic performance over the past decade that has been strong and steady. In fact, by G7 standards, the average per capita growth in the United Kingdom during the past decade has been stronger and less variable than in any other country. There are undoubtedly many factors behind this enviable performance, but certainly the strong policy framework for monetary and for fiscal policy and the generally sound implementation of both were major assets. I want to emphasize therefore that we view the U.K. policy framework as an example for the rest of the world. Executive Directors endorsed this view in their meeting on Wednesday.
The second major theme of the work that we've done on the U.K. this year is that the stress of the past year has subjected the frameworks to about their toughest test to date. A combination of rising energy prices and the sharp deceleration of house prices presented a challenging environment for policy makers. So it's a good time to review how they have coped with this. Generally I would say the conclusion of the report is that they've done very well. Looking ahead, both because of the policy response in this environment and the expected waning of the effects of the shocks, we expect growth to move back to trend of about 2-1/2 percent in 2006, with inflation very close to the 2 percent target.
What do I mean when I say that policies have coped very well? Let me just highlight four areas where I think that policies have come under stress and comment briefly on the response.
First, monetary policy has appropriately focused recently on containing the second-round effects of the energy price increase. As evidence gathers that these potential second-round effects are well restrained, the key question will become the effect of any output gap on inflation.
Second, on fiscal policy as you know, we have for years pointed to the need for a modest policy effort to reduce the fiscal deficit. Our position has been guided by the objective of ensuring that fiscal positions remain consistent with the debt limit (40 percent of GDP) and with achieving current structural balance. This year, 2005-2006, some of the adjustment that we have been advocating for some time seems likely to have occurred. The important influences have been higher tax receipts from North Sea oil and from the financial sector. Looking ahead, the government has plans to accomplish the remaining adjustment that we have been advocating. Its plan is to do this through a combination of fiscal drag, higher taxes on North Sea oil production, and, with the next Comprehensive Spending Review, restraint on spending increases. We and the Executive Board endorse the plan. By our projections, this plan should be consistent with a sustainable fiscal position.
A third broad area of stress is evident in the active debate we've seen in recent years on the U.K. pension system. We note that the results of the Pension Commission indicate that many middle-income earners are not saving enough to meet likely retirement income expectations and we see the Pension Commission report as an important first step in building a consensus on this issue and how to deal with it. We look forward to the government's report on it. The Commission, we feel, has made a rather compelling case for strengthening incentives for private savings and increasing the state pensionable age. But any of these changes must recognize that increasing the generosity of the pension system would come at the cost of other public expenditure.
A fourth broad area where stresses are every year assessed is the financial sector. Our general assessment here is that financial supervisors are meeting the challenge of overseeing a global financial center very skillfully. We share the authorities' concerns expressed in the Financial Stability Report of December that markets may be underpricing risk, particularly given the concerns that we all have about global imbalances. The rapid growth of the credit risk transfer market, which is providing an important source of diversification, may also be creating some risks. But banks appear to be well positioned to absorb the most likely types of financial market disturbances and we commend the authorities on their continuing vigilance in assessing and improving the framework for financial sector supervision.
I'm going to stop there, and Mr. Morsink and I will take questions.
QUESTION: Hello and good morning. I was wondering if I could ask two related questions on fiscal policy. I'm very grateful for your clear explanation of the IMF's view. One was a very quick one which is to ask whether this is the first time that you are now content to say that you feel that the fiscal position is sustainable. The other was, right at the end of the report that there's talk about the need for sort of a new fiscal policy that is forward looking in order to attain current balance over a set number of years. I have to be honest to say I was out of the country when you produced the first version of this in December, so this may not be new. But in any event, I was just wondering if you could elaborate on how you think that might work.
MS. SCHADLER: Briefly on your first question, is this the first time that we could say we think the fiscal position is sustainable? I think what we have said is that we see a plan in train that the government has articulated to make the fiscal position sustainable. As I said, there are three components looking ahead that in our view, represent the appropriate fiscal adjustment: relying on fiscal drag, on an increase in taxation of North Sea oil production, and on expenditure restraint that the government has committed itself to for the period of FY2008/09 to FY2010/11. Our endorsement is for the plan that the government has for addressing what we still see as the need for a modest fiscal adjustment.
On the new fiscal policy, I first want to emphasize that we are strongly advocating that the government stick to the broad framework that it has. It is a very strong framework. There are some specific questions about the interpretation of certain parts of the framework, in particular, the Golden Rule over the cycle. There we strongly endorse the idea (to which the government is committed) to bring the current structural position back to balance during the course of this cycle. We think that's very important. After that, we think that there is some scope for considering an interpretation of the Golden Rule that is somewhat more forward looking. As you said, for example, this may take the form of aiming for a current balance at the end of a set number of years. At this stage, this is just a suggestion for consideration. We aren't making a concrete proposal. But in an economy like the United Kingdom, where the cyclical variation is becoming very muted, it may be difficult to define cycles and it may be better to have a forward-looking fiscal rule replacing the definition of the cycle.
QUESTION: Hello, everyone. Yes, I had a quick question on the health side of things. You mentioned something about the outlook for health, that you'd done some work on that and I'm wondering what your work was leading to on this area. And also on the pension side of things, obviously pension spending is going to have to go up in the future. What kind of impact do you anticipate that will have on the fiscal position on the economy?
MR. MORSINK: I'll take those two questions. On health spending, the government already projects an increase in the share of health spending as a share of GDP at about 1-1/2 percentage points between now and the year 2050. The work in the Selected Issues Paper on this topic shows that the increase in health spending over this period could well be considerably larger than that. In what we consider a reasonable scenario, this could well be of the order of 6 percentage points of GDP.
The key point is that there are important uncertainties in the outlook for health spending. Demographic changes are not the only factors driving health spending. Importantly, changes in the cost of health services and the mix of products that are offered also tend to drive up health spending. We're suggesting that the government, which already produces a wealth of information on its long-term fiscal projections, be even more forthright in describing the underlying uncertainties and the upside risks to health spending over this period.
Regarding your question on pensions, that's also an area where spending is projected to rise over the next few decades. This year, we focused on the recommendations of the Pensions Commission. As Susan mentioned, there are three main elements. One is the introduction of a national defined contribution system for voluntary saving that would have low costs and automatic enrollment. We feel this would be important in addressing low private saving. This would be accompanied by changes in the state pension system to strengthen incentives for private saving, and an increase in the retirement age to help pay for a more generous state pension system.
Altogether, these changes imply an increase in pension spending relative to what is currently projected. The increase starts in 2010 and goes up to about half a percentage point of GDP by 2020. Any increase in the generosity of the state pension system would need to be offset by reduced expenditure in other areas of public spending.
Question: Good morning. You talk about the Bank of England's finely balanced monetary policy. Can you tell us how concerned you are or how concerned the Bank of England should be about the reacceleration in house prices this year?
MR. MORSINK: I think that's a very good question. For a long time we've been concerned about the weakness of private consumption. We're happy to see that private consumption picked up in the second half of 2005. It is now running at roughly trend or slightly below trend growth.
We have some very interesting work on consumption in another Selected Issues Paper. This work shows a strong correlation between house price growth and the growth of private consumption. Looking forward, the Bank of England will need to remain vigilant with regard to the impact of any reacceleration in house prices on the growth of private consumption.
QUESTION: I'm interested in what you're talking about, the possible effects of immigration on aggregate supply and demand, but at the same time you also commend the U.K. on giving new E.U. members full access to the labor market. Could you please elaborate on this?
MS. SCHADLER: First of all, on the U.K. immigration policy, particularly vis-à-vis the new members of the European Union, we and the Executive Board strongly commend the U.K. for being one of the three countries in the E.U. that has opened its borders to immigration from the new members.
Second, I'm not sure I understand completely your question because it suggests you think there is some tension between that position and favorable growth prospects going ahead. We would see immigration as contributing to favorable growth prospects. This is still a very young issue in the sense that the enlargement took place in mid-2004, so we haven't had much time to assess what the effects of immigration have been. But we would strongly expect that the immigration will have favorable effects on the supply side of the economy by potentially relieving any skill shortages in the economy and by making the economy more competitive.
I think that this is an area that we'll look at in more depth in future Article IV consultations and be able to give more detailed analytical answers at that stage. But our expectation at the moment is that this is a policy that will serve the U.K. economy extremely well.
QUESTION: Thanks for letting me come back. I had another one. In the past, your work on the U.K. has been taken to imply that you think that tax rises are going to be necessary to balance the books. Are you basically saying that's no longer going to be necessary? Is that gist of what you're saying, that it's not going to be necessary because of the plans outlined by the U.K.?
And in terms of the revenue pick-ups, obviously a lot of the improvement in the fiscal balance depends on a strong improvement in revenue receipts. Are you in line with what the U.K. government is in terms of the greater pick-up in revenue growth coming through in the next few years? MS. SCHADLER: First of all, on tax increases, I think you suggest in the past we've said tax increases will be necessary. That's not an entirely accurate statement. In the past we've said that some measures are needed to achieve a modest adjustment of the fiscal position. I did read somewhere in the last couple of days that someone in the British press said whenever the IMF says measures, read tax increases. That is certainly not true because the measure that we would prefer in the case of the United Kingdom is spending restraint. We would like to see spending increases at a slightly lower pace than nominal GDP growth for a short period of time in order to achieve the needed adjustment in that way. That's the first best policy from our perspective. However, spending restraint is not always easy to do and as a second-best option, tax increases would be the obvious answer.
Are we are now saying that it's not necessary to have these measures (and by measures I mean either on the expenditure or the tax side)? No, absolutely not. We're saying that the government's plan seems to us to be a good one. Part of that plan has already been announced as an increase in the taxation on North Sea oil. Another part of that plan, however, is to implement spending restraint following the next Comprehensive Spending Review. That will be an absolutely critical part of the adjustment that we see as necessary. The answer to your question then, is that we see that the government has a plan and we strongly support that they implement the plan as laid out.
The second question was on revenue growth. We do have somewhat more conservative estimates on revenue growth than what the government does. I think those will be obvious to you when the reports are released and you can see the tables. We are slightly more conservative on the increase in revenues that will come as the economy moves back to trend, and also on revenues that will come from the financial sector.
MS. MBOTO FOUDA: If we have no further questions, I believe we can conclude the call at this point. I would like once again to thank all of the participants for joining us today and for discussing with Susan and Jim. We hope to be able to do this again next year. Thanks again.
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