Britain's government should cut taxes and the central bank take more steps to pump money into the economy if Britain looks to be heading into a long phase of weak growth, the International Monetary Fund said today.
In its annual report about Britain's economy and policies, the IMF largely echoed the assessment published after its talks with authorities in early June, repeating that the economy should continue to recover and grow by 1.5% this year and 2.3% in 2012.
However, the IMF gave more detailed advice about how the government and the Bank of England should react if the risks stemming from the euro zone crisis, the uncertain impact of the spending cuts and volatile commodiity prices materialise.
'The UK government should be nimble in its policy response if it looks as though the economy is headed for a prolonged period of weak growth, high unemployment, and subdued inflation,' said Ajai Chopra, Deputy Director of the IMF's European department and chief of the mission to Britain.
'Currently, we don't expect this scenario to happen. But if such a scenario appears to be in prospect, we recommend responding quickly with some combination of further quantitative easing by the Bank of England and temporary tax cuts,' he said.
The UK economy has barely grown over the past three quarters. A slew of weak business surveys have indicated a weak start into the third quarter, raising the pressure on finance minister George Osborne to boost growth.
The IMF continued to back the government's austerity plans to balance the budget, which include unprecedented cuts in spending. 'For now, staying the course and implementing the wide-ranging policy programme that was agreed last year seems the right thing to do,' Chopra said.
However, the IMF said should the economy appear likely to experience a prolonged period of weak growth and high unemployment - and inflation ease in consequence - quick action would be important.
The report suggested temporary tax cuts to help low-income households, bolster job creation and boost investment. Solutions could include investment tax credits or cuts to employers' payroll taxes to reduce employment costs, the IMF said.
In addition the Bank of England should expand its asset purchases. However, should growth turn out stronger than expected and inflation remain high, quicker interest rate rises may be necessary, the Fund said.
The Bank of England is widely expected to hold interest rates at their record low of 0.5% well into next year and the sluggish economic recovery has sparked fresh debates about the need for more quanitative easing.
One member of the BoE's Monetary Policy Committee, Adam Posen, has been pushing for several months for the central bank to extend its asset-buying programme by £50 billion, and his colleague Paul Fisher has also said this option remained open.
But many economists don't expect more QE as inflation is still above 4%.
The IMF said that under its main scenario, the case for a gradual rise in interest rates would slowly increase.
The IMF welcomed the creation of the Financial Policy Committee, the new financial risk watchdog housed at the Bank of England, and agreed with the broad thrust of its recommendations.
However, it said more needed to be done to address the too-important-to-fail problem, and sounded lukewarm about proposals from Britain's Independent Commission on Banking to ring-fence banks' retail operations.
It urged Britain to collaborate with its international partners, rather than adopt such a policy alone. A unilateral move, it said, could have 'efficiency and possibly financial stability implications'.
