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George Osborne prepares for battle with the IMF George Osborne prepares for battle with the IMF
(about 1 hour later)
George Osborne likes to slip away at the end of meetings of the International Monetary Fund to visit a civil war battlefield. This year it was the appropriately named Chancellorsville in Virginia, where the confederate general Thomas "Stonewall" Jackson lost his life to friendly fire in 1863. George Osborne likes to slip away at the end of meetings of the International Monetary Fund to visit a civil war battlefield. This year, it was the appropriately named Chancellorsville in Virginia, where the confederate general Thomas "Stonewall" Jackson lost his life to friendly fire in 1863.
It was a relevant choice. Osborne was wounded last week by friendly fire from the IMF and another battle is looming when the Fund sends a team of officials to Britain next month to give the economy its annual inspection. It was a relevant choice. Osborne was wounded last week by friendly fire from the IMF, and another battle is looming when that body sends a team of officials to Britain next month to give the economy its annual inspection. Unless, the next batch of data – starting with the first quarter growth numbers this week – provides strong evidence that the UK has at last started to recover sustainably, the fund will be urging Osborne to provide a boost to demand.
Unless, the next batch of data – starting with the first quarter growth numbers this week – provides strong evidence that the UK has at last started to recover sustainably the Fund will be urging Osborne to provide a boost to demand. This doesn't necessarily mean it will call publicly for the Treasury to abandon its plan to tighten fiscal policy this year. But that is likely to be its recommendation, unless Osborne can find an alternative way of expanding demand.
This doesn't necessarily mean it will call publicly for the Treasury to abandon its plan to tighten fiscal policy this year. But that is likely to be its recommendation unless Osborne can find an alternative way of expanding demand. Unsurprisingly, the chancellor was mightily unhappy that the IMF singled out the UK as a country that needed to rethink its approach to tax and public spending. In part, that was because the fund was initially four-square behind the government's austerity plan. In part, it's because Osborne has a good relationship with Christine Lagarde, the fund's managing director, and was the first finance minister to endorse her when she was running for the job. In part, it's because the chancellor thinks he has already done quite a lot to underpin the economy, including the budget help for the housing market. And in part it's because Osborne believes – quite correctly – that there are other countries more deserving of a kicking from the IMF.
Unsurprisingly, the chancellor was mightily unhappy that the IMF singled out the UK as a country that needed to rethink its approach to tax and public spending. He could certainly have done without its intervention in a week in which that saw unemployment rise, a second credit downgrade and the debunking of the seminal paper by Carmen Reinhart and Ken Rogoff that has been used by fiscal conservatives – including Osborne – to justify austerity. The significance of the now-infamous Reinhart-Rogoff paper was that it struck a chord when it was published in 2010. By arguing that growth rates fell sharply when a nation's debt as a proportion of its annual output reached 90%, it was manna from heaven for those policy makers keen to take immediate and tough action to tighten fiscal policy.
In part, that was because the Fund was initially four-square behind the government's austerity plan. In part, it's because Osborne has a good relationship with the Fund's managing director, Christine Lagarde, and was the first finance minister to endorse her when she was running for the job. In part, it's because the chancellor thinks he has already done quite a lot to underpin the economy, including the budget help for the housing market. And in part it's because Osborne believes – quite correctly – that there are other countries more deserving of a kicking from the IMF. As a result of basic spreadsheet errors in the original calculations, it is now clear that the 90% debt cliff does not exist. Moreover, it has ensured a wider hearing for those economists who have always been sceptical about the R-R thesis. Put simply, the counter argument is that Reinhart and Rogoff have confused cause and effect: countries have high debt levels because they have slow growth rather than having slow growth because they are heavily indebted.
He could certainly have done without the IMF's intervention in a week that saw unemployment rise, a second credit downgrade and the debunking of the seminal paper by Carmen Reinhart and Ken Rogoff that has been used by fiscal conservatives – including Osborne – to justify austerity. This seems logical. Britain's debt to GDP ratio has more than doubled in the past five years and is now close to the 90% level. But it was the collapse of the economy in 2008-09 followed by the most tepid of recoveries that blew a hole in the government finances. There is no indication that servicing this debt is prohibitively expensive: indeed, interest rates on government gilts are close to historic lows. As they are in other countries – such as the US and Germany – that are running debt to GDP ratios of a similar size. The message is a simple one: get economies moving and the debt will look after itself.
The significance of the now infamous R-R paper was that it struck a chord when it was published in 2010. By arguing that growth rates fell sharply when a nation's debt as a proportion of its annual output reached 90%, it was manna from heaven for those policy makers keen to take immediate and tough action to tighten fiscal policy. Unfortunately, there was not the slightest indication in Washington last week that policymakers knew how to do this. Indeed, the spat between Britain and the Fund helped enliven what would otherwise have been a depressing meeting.The IMF's plan involves keeping monetary policy ultra loose while easing back on austerity in those countries where there is scope to do so. But the IMF has a silo-like approach, suggesting policies for individual countries but failing to look at the bigger picture.
As a result of basic spreadsheet errors, it is now clear that the 90% debt cliff does not exist. Moreover, it has ensured a wider hearing for those economists who have always been sceptical about the R-R thesis. Put simply, the counter argument is that R-R have confused cause and effect: countries have high debt levels because they have slow growth rather than having slow growth because they are heavily indebted. Sadly, only a second crisis is likely to rekindle the spirit of collective endeavour evident in 2008 when the global financial system was on the brink of meltdown. For now, policymakers are keeping their fingers crossed that unprecedented monetary policy easing will eventually work while harbouring fears that the aftermath of the Great Recession of 2008-09 could be a low-growth, high unemployment equilibrium of a sort not seen since the 1930s.
This seems logical. Britain's debt to GDP ratio has more than doubled in the past five years and is now close to the 90% level. But it was the collapse in the economy in 2008-09 followed by the most tepid of recoveries that blew a hole in the government finances. There is no indication that servicing this debt is prohibitively expensive: indeed, interest rates on government gilts are close to historic lows. As they are in other countries – such as the US and Germany – that are running debt to GDP ratios of a similar size. The message is a simple one: get economies moving and the debt will look after itself. There was, however, a marked reluctance to voice this fear openly. Despite revising down its forecasts, the IMF said it was encouraged by the improvement in financial market conditions and believed that the global economy was on the mend. Privately, however, it presented two alternative risk scenarios – one in which a faster than expected recovery leads to central banks unwinding their colossal monetary stimulus too quickly, and another in which growth continues to disappoint, leading to rising debt levels for both public and private sectors. As things stand, the second scenario looks the more likely.
Unfortunately, there was not the slightest indication in Washington last week that policy makers knew how to do this. Indeed, the spat between Britain and the Fund helped enliven what would otherwise have been a depressing meeting. All three of the global economy's growth engines have their problems. The US is recovering more quickly than most advanced countries, but by historic standards the 2% growth expected this year is weak. The housing market is on the mend and US banks are in a better state than those in Europe, but budget wrangling between the White House and Congress will stifle activity over the coming months.China looks like an accident about to happen. Growth has been pumped up in recent years by over-investment in new manufacturing capacity and by a real estate bubble. Activity has started to slow and the debts incurred by local government are an unexploded bomb ticking away under the economy.
The IMF's plan involves keeping monetary policy ultra loose while easing back on austerity in those countries where there is scope to do so. But the Fund has a silo-like approach, suggesting policies for individual countries but failing to look at the bigger picture. Finally, of course, there is Europe, the part of the world where the shortcomings of the fund's piecemeal approach are most obvious. Here, a bit of what Keynes called "ruthless truth telling" is in order, because the structural problems of the single currency are big enough to drag down the rest of the global economy. The truth about the eurozone is that there is a massive gap in competitiveness between the rich and poor parts of monetary union that can only be tackled in one of three ways: year after year of austerity, transfers of resources from north to south, or a break-up that will permit devaluation. Instead, ad hoc bailouts are organised each time the debt crisis rolls on to a new country. Slovenia may be next.
Sadly, only a second crisis is likely to rekindle the spirit of collective endeavour evident in 2008 when the global financial system was on the brink of meltdown. For the meantime, policy makers are keeping their fingers crossed that unprecedented monetary policy easing will eventually work while harbouring fears that the aftermath of the Great Recession of 2008-09 could be a low-growth, high unemployment equilibrium of a sort not seen since the 1930s. The economist George Akerlof came up with a metaphor for the state of the global economy at an IMF conference on rethinking macro economics. "The cat is still stuck up the tree and we don't know how to get it down", he said. Keynes would suggest building a bigger ladder. Hayek would wait for the cat to jump down of its own accord. The European approach involves chopping the tree down.
There was, however, a marked reluctance to voice this fear openly. Despite revising down its forecasts, the Fund said it was encouraged by the improvement in financial market conditions and believed that the global economy was on the mend. Privately, however, it presented two alternative risk scenarios – one in which a faster than expected recovery leads to central banks unwinding their colossal monetary stimulus too quickly, and another in which growth continues to disappoint, leading to rising debt levels for both public and private sectors. As things stand, the second scenario looks the more likely.
All three of the global economy's growth engines have their problems. The US is recovering more quickly than most advanced countries but by historic standards the 2% growth expected this year is weak. The housing market is on the mend and US banks are in a better state than those in Europe, but budget wrangling between the White House and Congress will stifle activity over the coming months.
China looks like an accident about to happen. Growth has been pumped up in recent years by over-investment in new manufacturing capacity and by a real estate bubble. Activity has started to slow and the debts incurred by local government are an unexploded bomb ticking away under the economy.
Finally, of course, there is Europe, the part of the world where the shortcomings of the Fund's piecemeal approach are most obvious. Here, a bit of what Keynes called "ruthless truth telling" is in order, because the structural problems of the single currency are big enough to drag down the rest of the global economy. The truth about the eurozone is that there is a massive gap in competitiveness between the rich and poor parts of monetary union that can only be tackled in one of three ways: year after year of austerity, transfers of resources from north to south, or a break up that will permit devaluation. Instead, bail outs are organised on an ad hoc basis each time the debt crisis rolls on to a new country. Slovenia may be next.
The economist George Akerlof came up with a metaphor for the state of the global economy at a Fund conference on re-thinking macro economics. "The cat is still stuck up the tree and we don't know how to get it down", he said. Keynes would suggest building a bigger ladder. Hayek would wait for the cat to jump down of its own accord. The European approach involves chopping the tree down.