Prepare for Plan B, IMF tells government on economy

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THE Government should prepare a Plan B, featuring temporary tax cuts and increased spending on infrastructure, to support the UK economy in the case of a collapse in the eurozone or the failure of recovery to take off, the International Monetary Fund (IMF) said today.

The Fund said that further easing of monetary policy, by printing money or even cutting the 0.5% base interest rate, was “required” now to inject some vigour into a flat economy. And it said the Government should consider an immediate increase in spending on infrastructure to boost growth and employment.

But it warned of the “large” risk of an escalation in the eurozone crisis, which would deliver a “substantial contractionary shock” to the UK economy.

While reducing Britain’s deficit over the medium term remains essential, a shock in the eurozone - such as the exit of Greece from the single currency - would force the Government to consider delaying plans to balance the books beyond the current target of 2017 and implement short-term measures to shore up growth, said the IMF in an annual report on the state of the UK economy.

“If the economy turns out to be significantly weaker than forecast, fiscal easing should be considered,” said IMF managing director Christine Lagarde. “Measures should be focused on supporting growth and employment.”

Today’s report came as the Organisation for Economic Co-operation and Development (OECD) warned the eurozone was close to “a severe recession” which would have knock-on effects on the rest of the world.

Chancellor George Osborne warned that the eurozone was reaching “a critical point” and confirmed that Britain was preparing to deal with the consequences of a failure in the single currency.

Ms Lagarde acknowledged the “substantial progress” Britain has made towards achieving a more sustainable budget thanks to the coalition Government’s austerity measures and the Bank of England’s “nimble” use of quantitative easing and interest rate cuts.

This had given Britain a “hard-won credibility” with international markets which now allows ministers the scope to take measures to support growth, she said.

But she warned that the UK economy had under-performed and unemployment remained “much too high”. Growth is expected to pick up in the latter half of this year, but much productive capacity could “remain idle for a protracted period”.

“Policies to bolster demand before low growth becomes entrenched are needed,” she said.

The IMF’s assessment, drawn up after a two-week mission to the country by a team of seven economists, found that “further monetary easing is required” now. The Bank should consider another round of QE and “reassess the efficacy” of cutting the base rate below its current historic low.

The report welcomed Government plans for “credit easing” to make lending more accessible to small businesses, and said there was also room for spending on infrastructure projects, which could be kept “budget-neutral” by funding them through restraint on public sector wages or increased property taxes.

But it made clear that more dramatic action will be needed if the economy fails to escape the double-dip recession or is plunged into deeper difficulties by the break-up of the single currency.

Instability in the eurozone is the “key risk” to the UK’s economy, said the IMF report, which added: “Risks are large and tilted clearly to the downside...

“An escalation of stress in the euro area could set off an adverse and self-reinforcing cycle of lower confidence and exports, higher bank funding costs, tighter credit and falling asset values, resulting in a substantial contractionary shock.”

Britain should be ready to consider “fiscal easing and further use of the Government’s balance sheet... if downside risks materialise and the recovery fails to take off”, said the report, naming temporary tax cuts and greater infrastructure spending as the measures most likely to be effective.

To preserve credibility, any relaxation in the Government’s austerity programme would have to be presented as part of a multi-year plan designed to reduce the deficit once the economy is stronger. But the gains from delaying fiscal consolidation might outweigh the cost of tearing up the totemic deficit reduction plan.

“We should recognise that policy options in this regard come with risks,” said Ms Lagarde at a press conference in the Treasury to launch the report. “However, these risks need to be weighted against the risk of lost years of growth.”

Welcoming the report, Mr Osborne said: “The IMF couldn’t be clearer today. Britain has to deal with its debts and the Government’s fiscal policy is the appropriate one and an essential part of our road to recovery.

“I welcome the IMF’s continuing support for the UK deficit reduction plan. They agree that, in their words ‘reducing the high structural deficit remains essential’ and make clear in their statement that they consider the current pace of fiscal consolidation to be appropriate.”

He acknowledged that an escalation in the euro crisis would have an impact on the UK and urged eurozone countries to “stand behind” the single currency.

“It is clear that we are now reaching a critical point for the eurozone,” said Mr Osborne.

“Eurozone countries need to stand behind their currency or face up to the prospect of Greek exit, with all the risks that that could involve.

“The British Government is doing contingency planning for all potential outcomes. It is our responsibility to ensure that while we work for the best, we prepare for something worse. The IMF must also prepare for the consequences if members in Europe don’t follow its advice.”

The IMF said possible candidates for temporary tax reductions in any Plan B would be VAT or payroll contributions, as these could credibly be presented as short-term measures which could swiftly be reversed once economic conditions improve.

Ms Lagarde said she shuddered to think what would have become of the UK economy if no deficit-reduction plan had been implemented in 2010.

“When I think back to May 2010, when the UK deficit was at 11%, and I try to imagine what the situation would be like today if no fiscal consolidation programme had been decided, I shiver,” she said.

The implementation of that deficit-reduction programme had resulted in a boost in the credibility of the UK Government, allowing it to borrow at “extremely favourable rates” to support the economy now.

The Scottish National Party’s Treasury spokesman at Westminster, Stewart Hosie, said: “The UK Government must listen to the IMF and deliver the Plan B that the Scottish Government has been arguing for to boost growth and employment.

“It seems that everyone except the Chancellor recognises the importance of infrastructure spend as a means to promote economic growth.

“The IMF’s assessment is consistent with the Scottish Government’s calls for £300 million capital investment in 30 ‘shovel-ready projects’ to build economic recovery and create jobs across Scotland.

“Every £100 million of capital investment is estimated to support 1,400 jobs, and would provide a much-needed boost to the UK’s stagnating economy.”

Shadow chancellor Ed Balls said: “The IMF is right to call for action to boost the British economy and to stop slow growth and high unemployment causing long-term damage to our economy.

“A year ago, the IMF warned that if economic growth undershot expectations, the Government should boost the economy with temporary tax cuts and greater infrastructure spending - as Labour has called for in our five-point plan for jobs and growth.

“Since then our economy has been pushed into a double-dip recession. How much worse do things have to get before David Cameron and George Osborne finally take action?

“There is no case for delay and there can be no more excuses. Now is the time to act. If we fail to do so, and we see years of slow growth and high unemployment being entrenched, Britain will pay a heavy long-term price.

“We have to get the deficit down but, as Christine Lagarde has warned, the right pace is essential and growth is necessary for fiscal credibility.

“In Britain, cutting spending and raising taxes too far and too fast has backfired, with the resulting slow growth and high unemployment meaning the Government is set to borrow an extra £150 billion and borrowing last month higher than a year ago.”

The Labour-led Welsh Government was today announcing a plan to invest £3.5 billion over the coming three years and £15 billion over the next decade on capital projects, including housing construction, designed to support growth and jobs.

Cardiff’s finance minister Jane Hutt said: “We remain a Government committed to the provision of infrastructure and the creation of jobs, and we want to take every cost-effective opportunity to increase capital investment, despite the severe cuts in our budget, right across Wales.

“As recent data shows, the UK has now slipped back into recession. This makes it even more vital that public investment in capital and infrastructure here in Wales continues.

“Our plan will provide a real, concrete demonstration of how the Welsh Government is helping the Welsh economy grow.”

Joanne Segars, chief executive of the National Association of Pension Funds, said: “If there is to be more QE then the Government needs to do more thinking about the impact on pension funds.

“QE has driven pension funds further into the red and leaves those trying to buy an annuity with a worse deal, which they are then locked into for life.

“We are being told it will all be worth it in the long run, but in the short run pension funds and pensioners are being left to deal with the pain. They need, and deserve, much more support.”