Transcript of a Conference Call on the Release of the 2011 IMF Article IV Consultation with the United Kingdom

Ajai Chopra, Deputy Director, European Department
Kevin Fletcher, Deputy Division Chief, European Department
Ceyla Pazarbasioglu, Assistant Director, Monetary and Capital Market Department
Isabelle Mateos y Lago, Advisor, Strategy, Policy, and Review Department
Moderated by Simonetta Nardin, External Relations Department
August 1, 2011

MS. NARDIN: Good morning, thank you all for joining this conference call on the 2011 Article IV Consultation with the United Kingdom. Together with the Staff Report on the Article IV, we are also releasing the Spillover Report and the Financial Systems Stability Assessment for the U.K. To help us with all these documents, we have here with me a number of speakers. Mr. Chopra will first say a few words, followed by the other speakers.

MR. CHOPRA: Thank you very much, Simonetta. We have an unusually heavy set of documentation for this year's Article IV. I just want to alert you that in addition to the reports that were put on the Web today, in a few days we expect to put on a number of additional background papers for the Financial Stability Assessment, the FSAP. There is going to be a number of detailed papers on the individual assessments and some technical notes. Now, just talking on the macroeconomic side, I have three points that I would like to make. First, dealing with the outlook. It is clear that the recovery has stalled over the last three quarters. Inflation remains elevated, and unemployment is high. But although growth and inflation have been less than expected in recent quarters, we see the deviations from earlier projections as largely temporary. And both growth and inflation are projected to improve over time. But we do see that the pace of recovery will be moderate. Headwinds from fiscal consolidation, a soft housing market, and the ongoing process of household and bank balance sheet repair continue to weigh on growth. Technically, on macroeconomic policy setting, in the central scenario that I have just outlined we see the current settings of fiscal and monetary policy as remaining appropriate. The overall macroeconomic policy stance balances the downside risks to growth, and the upside risks to inflation. Further, the mix of tight fiscal and accommodative monetary policy will support economic rebalancing to a more sustainable equilibrium by keeping real interest rates low and sterling competitive. Third, in this year's consultation we outlined a number of risk scenarios. The basic point is that the central scenario is subject to large risks. And policy flexibility will be essential to respond to shocks. The appropriate policy response will depend on the nature of the shock. Thank you.

MS. NARDIN: Thank you very much, Ajai. Ceyla, if you can now say a few words about the Financial System Stability Assessment?

MS. PAZARBASIOGLU: The U.K. financial sector, as you all know, is very complex. It's an equally important home and equally important host country. And thus, it's a major challenge to effectively regulate, supervise, and to resolve. Following the crisis, the authorities decided to overhaul the financial regulatory infrastructure, called the Triple Peak Model with both microprudential and macroprudential policies. This is a significant innovation, however, it is critical that the process does not divert attention from recent efforts to enhance financial sector supervision. This is particularly important as the financial sector remains in a recovery phase, despite strengthening of capital and liquidity positions of the U.K. institutions over the past year. Requiring financial institutions, as has been done by the FSA, to build up their capital and liquidity buffers is, thus, very important and necessary. The U.K. is also making process in dealing with systemic risks and resolvability. But little will be achieved regarding this issue without progress on cross-border resolution. And this essentially requires international consultation and high level of political commitment. The U.K. has been leading the agenda, and we encourage the authorities to continue doing so.

MS. NARDIN: Thank you very much, Ceyla. Also as mentioned, we had this year a Spillover Report on the U.K. Isabelle will now say a few words about that.

MS. MATEOS Y LAGO: The Spillover Report is a new type of product that looks at cross border effects of developments and policies in the country. This was undertaken as part of a pilot on the five top systemic economies. In the U.K., it focused on the financial sector and associated policies. The key finding is that the UK financial sector is a key node in the global financial system, whether one looks at it in terms of global banks, markets, or critical financial infrastructure. What we've found is that this means the financial sector has a very large potential to originate global shocks as well as to transmit them. And, indeed, as we've seen in the recent crisis, to amplify them both in the upswing and in the downswing.

As a result, it is critically important for global financial stability to have top-notch regulation and supervision in the U.K. And, of course, the way these policies are implemented needs to be closely coordinated with the broader international and European agenda to maximize their effectiveness.

Lastly, this positioning of the U.K. financial sector really gives the U.K. authorities a unique lens to look at developments and risks, in particular, in the global financial system. And, therefore, gives them the opportunity to contribute significantly to global systemic surveillance. In the report, we encourage the authorities to use that positioning.

QUESTION: Mr. Chopra, I wanted to follow up on your blog and on the advice about what to do in case the various risk scenarios come into play. I wonder how close the U.K., from your point of view or from the point of view of the IMF, is to a scenario where you could talk about a prolonged period of weak growth. You've mentioned that the recovery has stalled for three quarters. But for how long does this need to go on so you would see the need for policy action, which you have described as tax cuts being the ideal version? Maybe you could comment on that, how close we are to such a scenario and the need for policy action.

MR. CHOPRA: Okay, sure. Happy to take that question. The first point I want to make is to underscore something that First Deputy Managing Director John Lipsky said in London when we finished the Article IV discussions. This was on June 6. And the transcript of that press conference is on the Web. What he said then was that it's best not to get involved in any false precision on definitions and thresholds as to when it might be necessary to start implementing contingency plans. I think that view remains. The key point in addition to that is that a lot of the slowdown and the change in our forecasts over these last several months can be explained by the unexpected spikes in commodity prices and other transitory factors. Now, once we take that into account we need to keep in mind that policymaking always has to be forward looking. So it's very difficult to discuss things in a concrete way without knowing what exactly the shock is or what might be the reasons for a slowdown. So the tough economic judgment that we face and that the U.K. authorities face is to determine whether expected growth is likely to be weak enough to require a policy response. And here our answer is that we do expect growth to pick up a bit in the coming quarters, and over the medium term we expect growth to reach 2.5 percent or thereabouts. This sort of growth projection, which is not unique to the IMF or the authorities, I think it's very much in line with the consensus forecasts going forward. At this point, we do not see a need to implement any contingency plans. As I said, much of the unexpected weakness in growth has been due to supply side factors. And these cannot be addressed with conventional demand management.

QUESTION: Good morning. In the Staff Report you have a box on the output gap. And then you have some fiscal projections which show that by 2015/16 the government meeting its ambition by the slimmest possible margins, I think it's 0.1 percent of GDP. And most of the deterioration in the fiscal projection seems to be on the structural side rather than in the raw figures. Can you explain a little bit what's going on there? Or, what it is that you think -- because the numbers are quite different from the government's projections -- why the fiscal position you think is worse than the government?

MR. CHOPRA: I think the key point here is that there's a range of estimates that one can have for the output gap. The precision with which we can specify an output gap should not be overstated. I think we go through a range of approaches to specify the output gap. This time, we've looked a little bit more at using Okun's Law, as you point out, in the box that we have in the Staff Report. And when we come out with what we see as a, you know, a plausible estimate of the output gap, it does show that the mandate is met with a very slim margin. But this does not mean that at this point we see any particular need to adjust fiscal policy because the mandate is specified for the medium term. I think we'll have additional opportunities in the years to come to look at how the economy is evolving, how much spare capacity there is, whether we need to adjust our estimates of the output gap. And on that basis, we can decide whether there's a need to take offsetting discretionary fiscal action in order to meet the government's mandate.

MR. FLETCHER: I would just add to what Mr. Chopra said. There are two main elements where our estimates of potential output differ slightly from the authorities. As you noticed, we project a slightly narrower output gap currently. Our estimate is based on a number of methodologies as discussed in the box, and so it's difficult to pin down precisely all of the reasons why this differs from the authorities' estimates. But I would note that as discussed in the box, we have a somewhat higher estimate for structural unemployment based on filtering methodologies and average unemployment over the last business cycle. And again, this is discussed in detail in the box on how we come to our estimate for structural unemployment, which is slightly higher than the authorities and, therefore, implies a narrower output gap now. Also, although our long-term projections for productivity growth are very similar to the authorities, in the near-term, we have about a quarter percent slower projection for potential growth. And that reflects our view that the lingering effects of the crisis on, for example, skill erosion among the long-term unemployed will in the near-term cause potential growth to be slightly lower than its historical average.

Ms. NARDIN: This concludes our call, thank you all for participating.



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