August 8, 2008 | posted by Michael Baxter in UK economy |

Prepare to groan – bad joke coming up. The IMF used to have trouble making up its mind; now it is just not sure.

Three weeks ago, this influential and much respected financial institution, upgraded its projections for economic growth for the UK. Well, that was July. Clearly, things must look very different in August, because now it has changed its projections again, this time, downgrading them, and by quite a bit too.

It now expects the UK to grow by 1.4 per cent this year. This contrasts with its previous projection of 1.8 per cent, and the projection before that of 1.6 per cent. So far this year the UK has expanded by 0.4 per cent in Q1, and 0.2 per cent in Q2, so if the IMF is right, the second half of the year will be slightly worse than the first half.

As for 2009, it now expects growth of 1.1 per cent. This compares with its previous projection of 1.7 per cent, and prior to that it projected 1.6 per cent.

All in all, then, the latest IMF forecasts are by far the worst to date. In fact, actually, a growth of 1.1 per cent for 2009 is barely above recession pace. Remember, a recession is defined as two successive quarters of negative growth – which could easily be contained within a 1.1 per cent annual growth rate.

Also of interest from the latest IMF report, it turned its attention on inflation and the fiscal deficit.

It said: “Inflation rose to 3.8 per cent in June, on account of food and fuel price developments. And while there is scant evidence of second-round effects, as wages remain subdued, indicators of long-run inflation expectations have risen further.”

On the fiscal deficit it said it recommended: “… that the net public debt ceiling of 40 per cent of GDP be retained. Should it be breached,” the IMF said, “concrete and frontloaded plans” should be introduced “to bring debt back below the ceiling.”

Its comments about inflation seem to be about right. There are good reasons to expect inflation to fall, but, unfortunately, the UK public don’t seem to agree; they expect inflation to stay up. How serious this is depends on your point of view. If you believe inflation is determined by expectations, then the high level of expectations in the UK is worrying. On the other hand, economic theory often seems to assume we are a lot cleverer than we really are. Quite frankly, most of us tend to assume the next few quarters will be like the ones just past. So, inflation rose yesterday, and is still up today; we assume it will be high tomorrow.

And in a way, that aspect of human nature says a lot about why we have economic cycles. Most people refused to believe house prices could ever crash, because they assumed the economic conditions would not change. They said: “Look at how low interest rates are, and how plentiful credit is.” They did not factor in the fact that both these variables could change. That is just one example; go back through economic history and you will see this aspect of human nature behind many of the booms and busts.

It often seems economic theory is quite flawed in the way it assumes some kind of all-knowing aspect to human nature.

The reality is that since our expectations are determined by the recent past, our expectations for inflation will always be behind the curve. Actually, if you look beneath the surface, there are good reasons for thinking inflation will reduce quite sharply, and may even go negative towards the end of next year. It seems unlikely many of us have factored the deep forces at work when we are asked our expectations.

As for the IMF’s comments on public debt – it is worth noting the IMF has a thing about low public debt. It always wants countries to cut this. In 1997, it practically forced reductions in debt in the economies of East Asia – and in 1998 it did the same with Russia. In both cases, the result was a very nasty and avoidable recession.

The UK can not possibly keep net debt below 40 per cent of GDP; to attempt to do that right now would be tantamount to forcing a recession. As we have argued before, the government should in fact allow its net debt to rise, and spend some of the proceeds on tax cuts, especially aimed at the lower end of the income scale, and in the process increase incentives to work over claiming benefit.