Blanchard: UK economic policy is “playing with fire”

World Economic Outlook

The International Monetary Fund’s chief economist has warned George Osborne that he is “playing with fire” with his fiscal policy.

In an interview with Sky News, Olivier Blanchard also said that the Chancellor should have changed his austerity strategy at the Budget last month. The comments came as the IMF unveiled new forecasts which showed a dramatically weaker outlook for the British economy.

Asked about Britain’s prospects, Mr Blanchard said: “I think conditions have deteriorated. There is no question that the fiscal plan – which was designed a few years back – was assuming that private demand would be stronger than it is. So the question is what do you do. Well the first line of defence is you let the so-called automatic stabilisers play. That has been done, that’s good. But then at some stage you actually have to sit down and say: do we continue?

“The danger of having no growth, or very little growth, for a long time is very high; you get a number of vicious cycles which come into play… The result is that [people] don’t spend, output is low.

“And I think you’re playing with fire when you get to very low growth rates so… if you can decrease the speed of fiscal consolidation maintaining  the credibility (so it’s not a question of whether, it’s a question of when), when growth is close to zero I think yes it’s worth considering.”

Asked whether Mr Osborne had wasted the opportunity of the Budget, Mr Blanchard said: “Well, “waste” is too strong, but they surely could have done more, yes.”

The comments are likely to infuriate the Treasury, which has insisted that its austerity plan is the only sensible course for the UK, and that Mr Blanchard is wrong. The chief economist said his response to this was: “That I think that I am right and they are wrong.”

Here’s the full transcript of our interview with Mr Blanchard, in which I started by asking him about the notion of a “three-speed” world – something he talked about in the World Economic Outlook:

Blanchard: We used to make this distinction between emerging markets and advanced economies. Now you have to make a distinction between emerging markets, which are still doing well, but within advanced economy you seem to have increasingly two groups – the main representative of the first is the US where all the forces of recovery seem to be getting in place. And then you have mostly Europe – particularly the euro area. What worries us is this bifurcation.

Q: Where does the UK fit in there?

A: The UK probably fits closer to the euro area in terms of results. Its growth performance is clearly not very good. But in terms of the flexibility of the country, which is not in a common currency area, and has a different set of tools potentially. So in terms of results, if I had to put them in a box they would be in the European box. But they are clearly different from the problems faced by Spain, Italy and France.

Q: Outlook for the UK not great. Downgraded them more than others. Why?

A: One should not make too much of the size of revisions – it’s true that the UK we’ve revised down by 0.3% where we’ve revised the eurozone by 0.2%. This is small differences within the margin of error, but it’s true that the UK is not doing great. It’s difficult to put your thumb on what exactly it is that is leading to those poor results. you go through the list of all the components of demand and they are all doing a bit worse than you’d hope. It looks as if exports are doing a bit worse – some of that is due to the fact that the world is not doing great. But market share is not improving. Deleveraging by banks seems to be a bit stronger than was assumed and there is some question as to whether the banks are really in as good a state as we thought. So all these things are adding up – I don’t think there is any particular aspect to it. And fiscal consolidation clearly is contributing to this as well.

Q: You’ve said in the past if economic conditions deteriorate the UK needs to consider. You don’t say that about economic conditions this time

A: I think conditions have deteriorated. There is no question that the fiscal plan – which was designed a few years back – was assuming that private demand would be stronger than it is. So the question is what do you do. Well the first line of defence is you let the so-called automatic stabilisers play. That has been done, that’s good. But then at some stage you actually have to sit down and say: do we continue? The danger of having no growth, or very little growth, for a long time is very high. You get a number of vicious cycles which come into play – banks have bad loans. Then they don’t want to give credit because they are not strong. You get people dropping out of the labour force. You get what strikes me – and this is increasingly relevant in many countries – a decrease in confidence. People saying we are never going to get out of it, so I have to be careful with my spending, let’s wait and see if things improve, so I’m going to be very careful with my investments. Banks say in this environment loans are very risky, and in the process of doing this it’s self-fulfilling. The result is that they don’t spend, output is low. And I think you’re playing with fire when you get to very low growth rates so… if you can decrease the speed of fiscal consolidation – maintaining credibility so it’s not a question of whether, it’s a question of when – when growth is close to zero I think yes it’s worth considering.

Q: You talked before the Budget and said it was a good opportunity.

A: Yes

Q: Do you think they wasted that opportunity?

A: Well, “waste” is too strong, but they surely could have done more, yes.

Q: Can you give some indication of how much more [in terms of slowing the fiscal consolidation]?

A: When you get to the numbers, that’s the kind of job that can be done best by our mission which goes there next month sitting down with the authorities and taking

Q: A lot of people would look at forecast and start to think that you’re picking on the UK. Why don’t others, for instance Germany, get the same language about too much fiscal consolidation?

A: Well, ironically, while Germany is very tough they need to do less fiscal consolidation because they were in better shape to start with. They are actually not doing a whole lot: they are doing what’s needed – which is little. So in fact if you’re going to pick on a country you’re not going to pick on Germany. The country you might want to pick on is the US. where again the consolidation is worse as a result of political accidents the US is having a very very strong fiscal consolidation. It’s 1.8% of GDP. Now we argue that that is too strong. But the difference is that this is in an environment in which private demand is strong. It may be that without fiscal consolidation the US would have say 4% growth or 3.5%, and with fiscal it’s going to be around 2%. That’s not good, but 2% is not catastrophic. Once you have strong private demand you can do strong fiscal consolidation. But when you start with very weak private demand and you do fiscal consolidation on top of that – then there is an issue.

Q: And that’s the UK that we’re talking about?

A: That’s the UK.

Q: People within the UK are adamant that they have chosen the right course. They are adamant that they are right and they think that you are wrong. How do you respond to this?

A: That I think that I am right and they are wrong [laughs]. As I’ve explained, comparing it to the US is the wrong comparison because in the US everyone agrees that as a result of this problem between Congress and the President we’re having too much fiscal consolidation so that’s not the benchmark to use.

Q: Cyprus – a sign that the euro crisis is still there, or an aberration?

A: It is a very special case. I don’t think more should be made of it as what happened. What we’ve seen is that it doesn’t lead automatically to contagion – so far not much has happened.  The signal that there should be bail-in when bail-in makes sense is a good signal. It’s unfortunate that it had to fall on uninsured depositors. This would probably not be the case elsewhere because there would be some other debt in wholesale funding. But in the end although it was a messy process – everybody agrees to this – I think we’ve learned that systemic risk may not be enormous, can be contained and we probably have done things reasonably well in the end.