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2 August 2011

The IMF’s warnings to Osborne

Tax cuts and further QE will be needed if growth remains weak, says the IMF.

By George Eaton

The IMF’s latest assessment of the British economy is in and although the body has once again endorsed Osborne’s Plan A, it does so with several notable caveats. Ajai Chopra, the IMF mission chief to the UK, writes in a blog that the government should respond quickly with “further quantitative easing” and “temporary tax cuts” if it looks as though the economy is headed for a “prolonged period of weak growth, high unemployment and subdued inflation.” It’s important to add that the IMF says it currently doesn’t expect this happen but Vince Cable – who has called for “more radical” forms of QE – may have found an ally.

Then there’s the fact that the body says Osborne could miss his target of eradicating the structural deficit by the end of this Parliament. It forecasts that “the cyclically-adjusted current budget” will “just reach balance” in 2015-16 (a year later than Osborne expects) but adds that there is “little margin for error”.

In perhaps the most important passage in the document, the IMF notes that “consolidation has so far relied heavily on tax hikes and the phase-out of stimulus. As consolidation becomes more reliant on structural spending cuts going forward, implementation challenges may rise.” In other words, deficit reduction could become even harder as the cuts come to dominate (Osborne split the pain 73:27 between cuts and tax rises).

But what of the implications for growth? It’s worth highlighting another IMF study which found that, contrary to neoliberal wisdom, austerity programmes invariably lead to reduced output. The body looked at 170 examples of fiscal policy stretching back to the 1930s and concluded: “Our estimates suggest fiscal consolidation has contractionary effects on private domestic demand and GDP.”

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George Osborne has consistently argued that the cuts will increase confidence and that excessive state spending is “crowding out” private investment. But the IMF’s conclusions suggest that “expansionary fiscal contraction” is, in the words of Larry Summers, “every bit as oxymoronic as it sounds”.