IMF backs Osborne on deficit reduction

George Osborne said he had been vindicated in a debate over spending cuts after the International Monetary Fund on Monday unequivocally backed his austerity measures.

The fund was forced to downgrade its assessment of the UK’s 2011 growth prospects for the third time in a year but John Lipsky, IMF acting managing director, said these deviations from previous forecasts were ”largely temporary”.

The IMF’s judgment came at a welcome moment for the coalition, whose austerity programme has suffered criticism amid weakening economic data.

But there are increasing signs that the Treasury is considering some form of contingency plan should the recovery disappoint, even if there is little chance it will take the form of limiting spending cuts or postponing tax increases.

Treasury officials were pointing on Monday to elements of flexibility built into its mandate to eliminate the structural deficit.

Mr Osborne could scarcely have written a more favourable IMF report if the fund had allowed his special advisers to pen it. The IMF said “strong fiscal consolidation was under way and remained essential to achieve a more sustainable budgetary position, thus reducing fiscal risks”.

Launching the fund’s annual assessment at the Treasury, Mr Osborne appeared to revel in the verdict.

“The IMF have publicly asked themselves the question of whether it is time to adjust macroeconomic policies – in other words, ‘is it time to change course?’,” he said. “They have concluded definitively that the answer is no.’’

The IMF said high energy and commodity prices explained both the weakness in growth and the strength of UK inflation compared with its previous forecasts. It recognised consumption growth had been flat but judged that the spending cuts and tax increases implemented or planned would help rebalance the economy, from consumption growth to rising investment and net exports. “Tight fiscal and accommodative monetary policy will help keep real interest rates low and sterling competitive,” the fund concluded. As far as a plan B was concerned, the fund said only in the event of a “prolonged period of weak growth and high unemployment” should the government allow borrowing to fall more slowly than it had planned by accepting lower tax revenues and higher spending on social security.

Although the IMF was less than specific on Monday about what constituted prolonged stagnation, it already envisaged use of these ”fiscal automatic stabilisers” in its central forecast. Its medium term forecast for growth was significantly lower than that of the Office for Budget Responsibility. By 2015, Financial Times estimates, based on its assessment, suggest that the fund expects the level of output to be almost 2 per cent lower than that forecast by the OBR, with higher projected borrowing by the end of the parliament.

Given the likelihood that slower growth will raise borrowing, Mr Osborne acknowledged that there was some “flexibility” in his plans on Monday. Speaking to BBC radio, he made it clear that his plan was to eliminate the current structural deficit by 2014-15, giving him leeway in two areas.

First, if growth came in below expected levels and the actual deficit did not fall quickly, so long as the OBR said the structural, or underlying, deficit was on track to be wiped out, he would be under no pressure to announce a change of course. Second, his fiscal rule calls for the structural deficit to be eliminated by 2015-16, so he has a year of wiggle room should the underlying deficit not fall as fast as he would like.

However, Treasury advisers were also pointing to a potential third element of flexibility on Monday. The fiscal rule says the structural deficit elimination should happen on a rolling five-year basis, so unless Mr Osborne tells the OBR that he is willing to stick to the 2015-16 date of deficit elimination, the OBR will assess his plans against a 2016-17 target at the time of the next Budget.

The Treasury had indicated that it was minded to stick to the 2015-16 timetable and not allow the five-year rolling time frame to apply. The March Budget said: “Once the public finances are closer to balance, the period over which cyclically adjusted current balance must be achieved could safely be shortened to create a tighter constraint.”

Any postponement of the target would mark a significant step towards a plan B.

The additional wiggle room the chancellor seeks for himself will not, however, defuse the political row over fiscal consolidation. Far from finding any crumbs of comfort in the IMF assessment, Ed Balls, shadow chancellor, launched an attack on the institution’s advice.

“However much George Osborne and the IMF hope this is just a temporary blip, the cautious thing to do is not to wait and see and hope for the best, but get a plan B now. We need a balanced deficit plan that puts jobs and growth first, not a rash and extreme plan that increasingly looks like it isn’t working,” Mr Balls said.

The chief economist of the Organisation for Economic Co-operation and Development suggested last month that the pace of spending cuts needed to be slowed .