Transcript of a Conference Call on the 2012 Article IV Consultations with the United KingdomWith Ajai Chopra, Deputy Director, European Department
Kevin Fletcher, Deputy Division Chief, European Department
Olga Stankova, Senior External Relations Officer, External Relations Department
Wednesday, July 19, 2012
MS. STANKOVA: Good morning to everybody. This is Olga Stankova and we are holding a conference call now with the press on the release of the Article IV Consultation discussions with the United Kingdom. This conference call is under embargo until 10 a.m. D.C. time and 3 p.m. London time.
With that brief introduction, I will turn on the microphone to Ajai Chopra, Deputy Director in the IMF’s European Department, who will hold the call. We also have his colleague, Kevin Fletcher, with us. Ajai may turn the floor over to Kevin if so they decide.
MR. CHOPRA: Thank you, Olga. The UK economy has been flat for nearly two years at this point. Looking ahead we expect the economy to grow only modestly, slowed by weak demand because of low confidence, high uncertainty due to tensions in the euro area, tight credit conditions, and headwinds from fiscal consolidation and private-sector deleveraging. As a result, the significant slack in the economy would persist, putting downward pressure on inflation.
I’d like to draw your attention to some of the analysis in our report. We have an annex that looks at the estimation of hysteresis effects. And what we show in our report is that a large and persistent output gap raises the danger that a cyclical downturn would reduce the economy’s productive capacity and permanently depress potential output.
Given this, our report this year and our discussions with the UK authorities focused on the dangers that a continued tepid recovery would create and how macroeconomic policies should be adapted to provide additional support. And what we outlined in our report, which is essentially the same as what we said in our May concluding statement, is that more expansionary demand policies would help close the output gap faster, reduce the risks of hysteresis, and ensure against the predominance of downside risks.
So how should such demand stimulus be provided? In our report we discussed the case for additional monetary stimulus via quantitative easing and possibly cutting the policy rate. And we have a supplement that notes that the Bank of England has already embarked on another round of gilt purchases.
We also put emphasis on credit-easing measures. And again, we have a staff statement, which is in the bundle that you’ve received, that looks at the recently announced Funding for Lending Scheme. We judge that it could be more successful in boosting bank lending than previous measures. We also point out that an important innovation of this scheme is that pricing is designed to encourage an expansion of net lending, consistent with the advice that we provided at the time of the consultation. But we also note that at this point it is unclear as to what the final effects of this scheme will be on demand and, hence, this will need to be kept under review.
On the fiscal side, we made recommendations about budget-neutral reallocations that could be undertaken to make room to increase government spending on items with high multipliers.
And finally, we also discussed how fiscal policy might need to respond if the recovery fails to take off even after additional monetary stimulus and strong credit-easing measures.
Our report also looks at the health of the UK banking system and the steps that are still needed to help fortify financial sector stability. We discussed the need to strengthen bank balance sheets by building capital rather than reducing assets. We also discuss issues related to “too big to fail” and the upcoming legislative reforms proposed by the Vickers Commission. We talk about the importance of intensifying supervision, and we also look at issues related to the macroprudential toolkit. And again here I want to draw your attention to the supplement in our report, which provides our views on the recent Financial Policy Committee meeting.
Coming back, I want to also draw your attention to some of the analytical work that we’ve done in our report on alternative fiscal scenarios that look at the effects of delaying consolidation in the presence of hysteresis. Here the team has extended the recent influential work by Brad DeLong and Larry Summers to show that in the presence of hysteresis effects the gains in terms of cumulative GDP from delaying fiscal consolidation could be larger because multipliers are estimated to move inversely with growth and the effectiveness of monetary policy. I think I’ll stop there. Thank you.
MS. STANKOVA: Thank you, Ajai. And with that, we will take your questions. Please identify yourself and your affiliation when asking a question.
QUESTIONER: Hi there, guys. Thanks very much. Could I just start off by asking what scale of monetary policy expansion does the IMF think is required? At the moment, the Bank of England’s quantitative easing program is at 375 billion pounds. What would it need to go up to to satisfy measures to start closing the output gap do you think?
MR. CHOPRA: I’ll start off with an answer and then perhaps my colleague, Kevin, if he wants to add to it, he’s pleased to do so.
Look, we do not have a precise figure in mind. We think that what the Bank of England did on July 5th was a meaningful increase in the quantity of gilt purchases that are to be undertaken over the next four months. We’ve seen that the Funding for Lending Scheme is soon to go into effect. It’s going to be difficult to assess. The impact needs to be assessed as a package, and we do expect that the Funding for Lending Scheme will also help support the outlook, but it’s too early to assess the adequacy of the total package until we see how the Funding for Lending Scheme is being utilized by banks and how it’s evolving.
A key point I would make here is that we see the importance of policy diversification because there is quite a debate about the effectiveness of quantitative easing. We’d have to agree that the magnitude of the effect is uncertain, but we do expect it to be stimulative and clearly the Bank of England expects it to be stimulative as well. But we’ll be able to assess this only as a package once we’ve seen the impact of the Funding for Lending Scheme.
QUESTIONER: Could I then, just as a quick follow-up, in terms of the effectiveness, do you think an expansion of quantitative easing would be more effective or a reduction in the policy rate?
MR. CHOPRA: What we’ve tried to do is we have encouraged the MPC to look carefully at the costs and benefits of reducing the policy rate and whether there are any adjustments that they need to make. Kevin can give you more perspective as to why we see it is as important to assess these costs and benefits in the current environment. Kevin?
MR. FLETCHER: On the policy rate, as we discuss in the report, one thing that has changed substantially over the last year is that the yield curve has flattened substantially, which indicates that markets expect the short-term rate to be stuck at the current policy rate, or even a bit below, for a long period. This means that the lower bound that is effectively established by the MPC will matter for some time. And, therefore, if they reduce that by cutting the policy rate, it’s reasonable to expect that it could have more-or-less one-for-one effects on interest rates well out into the yield curve, whereas in normal times you would expect changes in the policy rate mainly to have such effects only at the shorter end of the yield curve.
For this reason, we think that conditions have changed over the last year or so in favor of cutting the policy rate. However, against that, there are still the arguments that the MPC has noted before about potential adverse effects on net interest margins for banks, which could have adverse effects on financial stability, and also effects on the money market.
In assessing the reaction of banks and the effects on their balance sheets, the MPC is in a better position than us, given their more detailed data. So, as Ajai says, our recommendation has been phrased in terms of a recommendation to consider this carefully and to keep it under review.
The only other thing I would add is that it is true that, if there is a decision that more stimulus is needed, that this could come from a number of avenues. It could be most productive to do it through standard QE. Or it could be a cut in the policy rate. Or there could be an expansion of current credit easing measures, or new measures. At this stage, it’s too early to say which would be the best route to go until we’ve seen more experience with the recently announced measures.
QUESTIONER: Hello, good afternoon or it’s morning in the United States. I was wanting to follow up a little bit more on what you were saying in paragraph 47 of the report about sort of changes to the pace of fiscal tightening. In particular, you were talking about the fact that the pace of fiscal tightening may need to ease before the fiscal year of 2013/2014 if the outlook deteriorates sharply before then. And I was wondering sort of what you could say would sort of count as the outlook deteriorating sharply.
MR. CHOPRA: It’s impossible to put any precision on this. These statements naturally have to be kept quite general because it would depend on the nature of the shock, including how long-lasting the shock might be. So it’s good to depend on an assessment of all the risks and a careful assessment of the outlook when such a decision needs to be made. It’s not possible for us to specify any precise triggers in this regard.
QUESTIONER: Sorry, I don’t know if you can hear, but sort of would you say the kind of downgrade that you gave to growth sort of earlier this week, a 0.6 percent reduction in the UK’s outlook, would a further sort of reduction at that kind of scale be the type of sharp sort of deterioration you have in mind or is it something much more dramatic than that which would require a sort of more immediate fiscal adjustment?
MR. CHOPRA: Again, we cannot put any figures on this. This will need to be a judgment that is made at the time based on all of the information, including about the effectiveness of other policies.
QUESTIONER: Thank you.
QUESTIONER: Thanks very much. I actually wanted to pursue paragraph 47 as well, you probably won’t be surprised to hear.
I mean, the first part of that talking about the need to scale back fiscal adjustment if growth does not build momentum by early 2013, from that it sounds like you’re kind of honing in on budget 2013 in March as being the turning point effectively. Are you saying that if growth fails to pick up in line with your newly downgraded forecast for 2013 of 1.4 percent, is that effectively the hurdle that you’re assessing there?
MR. CHOPRA: No. Again, I think the answer is very similar to what the previous gentleman asked. But let me just be clear here that we see a sequential approach. As I said earlier, we think it’s important to start with additional monetary easing and with credit easing policies first. That’s something that we put forward in May in our concluding statement. Encouragingly, both are now in train. We need to see how those will affect the economy.
The point that we were trying to make in this paragraph is that, firstly, we need to note that the degree of structural adjustment planned for next year picks up relative to this year, so there’s an additional fiscal drag that will be put on the economy next year based on current plans. We also wanted to point out that an annual budget is the biggest annual macroeconomic policy event in the country and that would be a natural time to look at the condition of the economy and at policy responses, not just on the fiscal side, but on the entire macroeconomic side. That would be a natural point to assess these policies.
QUESTIONER: Thanks very much. One other question, if I may, just following up on your discussion of the infrastructure plans unveiled this week.
You slightly obliquely refer to wanting to avoid this sort of thing being driven by keeping the debt off the balance sheets through artificial measures. Are you suggesting, therefore, that this could be construed as a policy driven by a desire to effectively disguise debt from the public balance sheet? Thanks.
MR. CHOPRA: I’m going to let Kevin answer this. I’m actually on the road, so I haven’t had the chance to look at what has been announced this week. Kevin?
QUESTIONER: You’re referring, I think, to the discussion in paragraph 37 of the staff report. There, we’re simply trying to make the point that the choice of public investment projects and the choice of how to finance them should be driven by maximizing the value for money for public funds. In some cases, that might mean that private sector involvement could be a more efficient way to do it. In other cases, it may be more efficient for the government to do it directly. The point is that the choice should be driven by value maximization and not by whether liabilities show up as a contingent guarantee or as debt on the balance sheet or by effects on near-term expenditure.
QUESTIONER: So are you satisfied having looked at what’s been announced this week that that choice is being correctly made?
MR. FLETCHER: In order to apply this principle, you would have to go basically almost project-by-project and say, “In this particular project, has the choice of the project and the financing choices been made in a way that is the most efficient way to achieve the objective?” That is something that we’re not in a position to do.
QUESTIONER: Okay. Thanks very much.
MR. FLETCHER: But we emphasize the general principle.
QUESTIONER: Hello. In paragraph 40 you say that because of your weaker growth forecast that the government is not on target to meet its net debt reduction target and that it’ll be a year late. You say that if the OBR agrees with your forecast, then the government should accommodate this rather than presumably cutting to make sure it hits it. I just want to confirm, are you saying that the government should jettison the second part of its fiscal mandate if growth turns out along the path you expect? Or would it be acceptable for the government to simply massage down the net debt figures for that particular year before seeing them rise again?
MR. CHOPRA: Kevin, can you take this one, please?
MR. FLETCHER: An important principle is that automatic stabilizers should be allowed to operate freely. One feature of the net debt target is that if growth is lower—perhaps purely due to a cyclical reduction in growth that doesn’t affect potential GDP or the structural deficit—if there is a reduction in cyclical growth in the near term, this could cause the net debt target not to be met. And in this case we think the correct policy reaction would be to delay the meeting of the target for a year, or for whatever is necessary, to allow automatic stabilizers to operate freely.
QUESTIONER: And would you say that, therefore, it was an unwise target to set?
MR. CHOPRA: No, the point that we need to make here is that these are interim fiscal mandates that the government set. They were right to set these mandates to provide an anchor at the time that they were putting forward their fiscal policy when they took office. We said in the consultation a couple of years ago that, in time, these mandates will need to be replaced with more robust fiscal rules. In the consultation report a year or two ago, we had a paper on this. So these are interim targets. This is an interim fiscal mandate that will, in time, need to be replaced with a more robust fiscal framework. And in the current circumstances, we put a greater emphasis on allowing automatic stabilizers to work.
QUESTIONER: Okay. Thank you very much.
QUESTIONER: I’m wondering whether or not you think the recent LIBOR scandal has undermined the trust in the UK financial system and whether or not you have a preferred alternative to LIBOR.
MR. CHOPRA: Here I would draw your attention to the supplement that was part of the package that we are publishing. In that supplement, we take note that the chancellor has announced an inquiry to examine whether the setting of LIBOR should become a regulated activity and whether actual trade data could be used to set the benchmark. We’ve also taken note of the parliamentary investigation into the attempted manipulation and that both of these could feed into the Financial Services Bill and into the reforms proposed by the Independent Commission on Banking. We need to let that process work and, at this point, we have nothing to add to what we’ve said in the supplement.
QUESTIONER: Thank you.
MS. STANKOVA: No more questions. Thank you for joining us today. And with that, we will conclude the conference call.