IMF: Cutting the deficit too fast causes higher unemployment

The IMF have published the results of a study of previous episodes of deficit reduction in advanced economies, concluding cutting too quick increases unemployment.

The credibility of the government’s argument that cutting the deficit quickly and aggressively will have no affect on growth and unemployment was already under pressure from recent data showing real GDP has barely increased over the last three quarters and that unemployment is rising once again.

Now IMF economists have published the results of a comprehensive study of previous episodes of deficit reduction in advanced economies – their conclusions are stark:

“Fiscal consolidations that are unduly hasty risk prolonging the jobless recovery in many advanced economies. So countries with the scope to do so should opt for a slower pace of consolidation combined with policies to support growth.”

Furthermore, because short-term interest rates in the UK are just 0.5%, long-term interest rates are near record lows and the exchange rate has already fallen around 25% since the start of the recession, the scope for monetary policy easing to offset the effects of fiscal consolidation are limited and this adds to the risks:

“The reduction in incomes [and increase in unemployment] may be more than twice as large when central banks cannot cut interest rates and when many countries are carrying out consolidations at the same time.”

The government argues that the Monetary Policy Committee has the scope to ease monetary policy further – through an expansion in quantitative easing (QE). And the Bank’s economists believe QE has had a positive impact on growth in the UK. However, much of that impact probably came through easing pressures in money markets.

What is needed now is a spur to private sector spending – though it is less clear more QE has the power to deliver this. More QE should be part of the plan to boost the UK economy, but on its own it might not be enough.

The government also argues the UK is not a country with the scope to slow its pace of fiscal consolidation. This seems nonsensical. The government has never been able to borrow as cheaply as it can do today. It is paying less than 2.5% for 10-year borrowing. If anything, financial markets are telling the government it should be borrowing more, not less.

This might jar with the headline in today’s Financial Times (£), suggesting there is a £12 billion black hole in the government’s plans to cut the deficit. But this conclusion rests wholly on calculations of the amount of spare capacity in the economy – something that is, as the FT readily admits, “little more than an educated guess”.

Even if the FT analysis is right, the wrong conclusion to draw would be that more deficit reduction is needed now. The right one – as the IMF’s analysis shows – is that deficit reduction should be spread out over a longer period and the pace of consolidation should be lessened when economic growth is weak and unemployment is increasing.

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  • Leon Wolfson

    NO ****.

    They’re not going to do anything, though.

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  • Charles

    Why are interest rates so low? Because the government has convinced the markets we’re not at risk of default due to our deficit cutting programme. Begin to borrow more rather than less and our interest rates will increase, not just for government but for private individuals and businesses too.

    We want private sector growth, which means the private sector needs access to cheap credit. Access has been made difficult by the government mandating banks leverage themselves less, so the last thing we need is compound this issue by a) making it more expensive and b) scaring off foreign lenders.

    Due to the global economy, our economy isn’t going to grow as fast as it was thought, because we are cutting the public sector which makes up a large proportion of our economy (too large in my opinion) we may well enter an artificial recession directly caused by cuts, but that doesn’t matter now. Sustaining an illusion of growth at a vast expense to the real economy, isn’t going to achieve anything but make the country financially worse of for an entire generation. Growth figures are an incredibly unhelpful indicator of economic health when an economy is so fundamentally in trouble as our own.

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  • Mathew


    Gilt rates are so low because of the fact the the BoE MPC is not going to raise rates anytime soon due to the stagnation of the economy.

    You have taken demand out of the economy, that is what is causing us to grow so slowly if at all, we were stagnating well before the Global Slowdown.

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  • Leon Wolfson

    @2 – It doesn’t MATTER we’re going into an artificial *depression* caused by austerity?

    We were not previously in nearly that much trouble. We are now, yes, and spending needs to be poured on, on a scale larger than America’s, to get us moving again now.

    Small hits to 20-30 year growth matters little if people’s real wages are eroding at a real rate of over 5% a year, double that at the bottom.

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  • Mr. Sensible

    Osborne is losing support for his austerity plan. Fact.

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  • http://leftfootfwd Rob Andersen

    Your logic is skewed. Rates are low and went to record lows recently when the US and Eurozone debacle came to a head, UK rates even trading lower than Germany’s for a while, this having nothing to do with short end rates (the short end drivers are WAY different to long end). Otherwise do u countenace that germany will grow more slowly that the UK? even if this were so, can u explain the SHIFT cica a month ago, as stockmakerts were crashing around, and peripheral yields sky rocketing, as credit default swap spreads traded all time highs day after day, as equity price earning ratios crashed on companies that had MASSIVE dividend cover and CASH rich after having hugely strengthend balence sheets since 2008, are u saying that as all this was happening the reason UK gilts traded up is that growth in the economy was perceived to be slowing? This is similar to the rubbish that krugman is now pushing, trying to distance himself frrom past failed policies.
    It’s bvery simple, do the exercise for yourself, don’t take my word. plot 5, 10 and 20 yr gilts daily over last month, superimpose equity movt, peripheral debt yields (especially greece, france, italy, spain) then look at daily news. It is there to see black on white.
    I do find it ever so frustrating when so called economists try and re-write history to fit their theories.

  • http://leftfootfwd Rob Andersen

    US came to a head, eurozone more of a realisation that only one workable solution… i meant to say

  • http://leftfootfwd Rob Andersen

    @4- u say ‘we were not nearly in that much trouble’
    deficit deniers include thos e who don’t understand that the 2008 traincrash is the same has today’s. thyis webiste purports to have views put forward based on facts- here we go
    actually this one’s easy. It was debt concernes that led to the credit squeeze in 2008. in fact the cracks first appeared in 2005 when BNP suspended redemptions from 2 of it’s subprime funds, yes as far back as that the elite bankers and politicians were issued warnings. brown chose to ignore and borrow his way to a new victory, but le’s not cry over spilt milk. And when the inevitable happened, morphine was administered to the patient, currently about to run out… so please, best not to confuse stumbling around in a drug induced haze with an economy that was ok/bordering on ok, it’s disingenuous….

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  • john p Reid

    sorry, cutting the defecit decreases debt, which can be plowed back into the country quicker, and look at public services, yes they aren;’t recruiting, but at the same time most of the cuts come from not wasting things on red tape.

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