IMF: “A plague on both your houses”

Funded stimulus will take real political leadership to pull off.

Yesterday’s IMF country report for the UK had something for everyone in the debate about fiscal policy and growth.

There were two headline conclusions. The first was that evidence from non-eurozone countries suggests that, in the UK, low Gilt yields are an indicator of weak growth prospects. As Jonathan Portes has long argued, they aren’t a market vote of confidence in the Government’s fiscal strategy. So the benefits of Plan A aren’t nearly as great as the Government likes to claim. Loosening up on Plan A would indeed raise the Government’s cost of borrowing, but only because prospects for growth in the private sector would improve. So much for Plan A fundamentalism.

So Plan B it is then? Well not quite. At the same time as challenging the benefits of Plan A, the report’s second conclusion cast doubt on the gains from easing-up on deficit reduction.

The benefits of slowing the pace of the cuts depend upon your view of how the impact of government spending on output varies with the state of the economy. Does a pound of government spending boost GDP by more when output is below its potential – or in a recession - than it does in normal times? The IMF sets out three scenarios.

First, that the timing of spending makes no difference in the long-run. Plan B would therefore be a prescription for lower-intensity pain for longer, while Plan A is more of a short, sharp shock. But in the long-run, the negative impact on the potential of the UK and its workers would be no different under either plan.

Second, it could be that each pound of spending has more impact when output is below its potential, as it is now. In this case slowing the pace of cuts would be a good idea, saving thousands of people from being permanently disadvantaged in the labour market.

Third, it might be that government spending has its greatest impact when the economy is actually shrinking, and less impact when it’s growing. If slower cuts fed through just as growth picked up, then Plan B might even be worse than Plan A on this view.

So for Plan B to be effective, we need to be in the second of these worlds. And a lot of microeconomic evidence strongly suggests that we are. Yet the IMF casts some doubt on that, citing a study that “finds a weak relationship between the output gap and multipliers in the UK”. For the IMF, if not for most labour market economists, the benefits of Plan B are uncertain for the UK (although you might also argue that there’s nothing to lose from trying it).

So we have a situation where Plan B might not cause a panic, but it might also not help. The risks of both plans may be less than their respective opponents claim, but their benefits too may be oversold. So what to do?

In all this discussion of the impact of government spending on output, the IMF, along with most commentators, generally talks in terms of the average effect of government spending. But one thing we know with more certainty is that spending on things like public infrastructure is far more beneficial for output than, say, fiscal incentives for people to lock money away in a pension for 30 years. As I argued in Osborne’s Choice, the composition of government taxation and spending matters far more than most of the macroeconomic debate suggests. That’s why the only way to reduce the damage wrought by a stagnant economy with any certainty is to rejig spending from low- to high-growth areas. And this is an important part of what the IMF proposed yesterday.

The Fund points out that neither Plan A nor Plan B are free lunches. But in economic terms, a funded stimulus is about the cheapest lunch you can get. The catch is that it takes real political leadership to pull it off. The growth crisis demands nothing less.

Ian Mulheirn is Director of the Social Market Foundation.

Ian Mulheirn is the director of the Social Market Foundation.

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Why Angela Merkel's comments about the UK and US shouldn't be given too much weight

The Chancellor's comments are aimed at a domestic and European audience, and she won't be abandoning Anglo-German relationships just yet.

Angela Merkel’s latest remarks do not seem well-judged but should not be given undue significance. Speaking as part of a rally in Munich for her sister party, the CSU, the German Chancellor claimed “we Europeans must really take our own fate into our hands”.

The comments should be read in the context of September's German elections and Merkel’s determination to restrain the fortune of her main political rival, Martin Schulz – obviously a strong Europhile and a committed Trump critic. Sigmar Gabriel - previously seen as a candidate to lead the left-wing SPD - has for some time been pressing for Germany and Europe to have “enough self-confidence” to stand up to Trump. He called for a “self-confident position, not just on behalf of us Germans but all Europeans”. Merkel is in part responding to this pressure.

Her words were well received by her audience. The beer hall crowd erupted into sustained applause. But taking an implicit pop at Donald Trump is hardly likely to be a divisive tactic at such a gathering. Criticising the UK post-Brexit and the US under Trump is the sort of virtue signalling guaranteed to ensure a good clap.

It’s not clear that the comments represent that much of a new departure, as she herself has since claimed. She said something similar earlier this year. In January, after the publication of Donald Trump’s interview with The Times and Bild, she said that “we Europeans have our fate in our own hands”.

At one level what Merkel said is something of a truism: in two year’s time Britain will no longer be directly deciding the fate of the EU. In future no British Prime Minister will attend the European Council, and British MEPs will leave the Parliament at the next round of European elections in 2019. Yet Merkel’s words “we Europeans”, conflate Europe and the EU, something she has previously rejected. Back in July last year, at a joint press conference with Theresa May, she said: “the UK after all remains part of Europe, if not of the Union”.

At the same press conference, Merkel also confirmed that the EU and the UK would need to continue to work together. At that time she even used the first person plural to include Britain, saying “we have certain missions also to fulfil with the rest of the world” – there the ‘we’ meant Britain and the EU, now the 'we' excludes Britain.

Her comments surely also mark a frustration born of difficulties at the G7 summit over climate change, but Britain and Germany agreed at the meeting in Sicily on the Paris Accord. More broadly, the next few months will be crucial for determining the future relationship between Britain and the EU. There will be many difficult negotiations ahead.

Merkel is widely expected to remain the German Chancellor after this autumn’s election. As the single most powerful individual in the EU27, she is the most crucial person in determining future relations between the UK and the EU. Indeed, to some extent, it was her intransigence during Cameron’s ‘renegotiation’ which precipitated Brexit itself. She also needs to watch with care growing irritation across the EU at the (perceived) extent of German influence and control over the institutions and direction of the European project. Recent reports in the Frankfurter Allgemeine Zeitung which suggested a Merkel plan for Jens Weidmann of the Bundesbank to succeed Mario Draghi at the ECB have not gone down well across southern Europe. For those critics, the hands controlling the fate of Europe are Merkel’s.

Brexit remains a crucial challenge for the EU. How the issue is handled will shape the future of the Union. Many across Europe’s capitals are worried that Brussels risks driving Britain further away than Brexit will require; they are worried lest the Channel becomes metaphorically wider and Britain turns its back on the continent. On the UK side, Theresa May has accepted the EU, and particularly Merkel’s, insistence, that there can be no cherry picking, and therefore she has committed to leaving the single market as well as the EU. May has offered a “deep and special” partnership and a comprehensive free trading arrangement. Merkel should welcome Britain’s clarity. She must work with new French President Emmanuel Macron and others to lead the EU towards a new relationship with Britain – a close partnership which protects free trade, security and the other forms of cooperation which benefit all Europeans.

Henry Newman is the director of Open Europe. He tweets @henrynewman.

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