The IMF on UK recovery, mortgage risks and the supply side

Students preparing for unit 4 on Tuesday might spend half an hour or so analysing this report of the IMF’s update on the UK economy. Here are some key points worth noting:

After raising warnings last year that the Chancellor’s austerity policy may be threatening recovery in the UK, this year IMF managing director Christine Lagarde admitted the Fund "got it wrong" in its assessment adding that while the UK's economic recovery began with consumer spending, it was now rebalancing towards an "investment-led recovery".

While they say there are not currently any signs of a credit bubble, the Fund warned that the main risks to recovery now seem to revolve around house prices. The concern is that, with more low-deposit mortgage lending and the ratio of mortgage levels:incomes rising, people are over-stretching their finances and will be vulnerable to shocks from income falling and interest rate rises.

An important point is policy to control the mortgage market no longer depends on base rates. The Bank of England’s Financial Policy Committee has the power to control bank lending; as the Chancellor said in a radio interview yesterday morning "We have given the Bank of England the tools to do the job and they should not hesitate to use those tools if they see these developments turning into a risk for the British economy."

Lloyds and RBS have already announced some limits to mortgage lending.

The IMF also reflected the Bank of England’s concerns about slow growth in productivity – looking at the need for sustainable growth to come from the supply side, as opposed to the demand side. Slack in the economy is estimated to remain at 1-1.5%, and the Bank suggested in February that this reflects underinvestment.

Another quotation from the report gives a great summary of the value of supply-side and productivity growth, which students could do well to study – I have added three asterisks at points where some additional explanation should be added, for really good examination analysis:

Productivity reflects the amount and value of the goods and services produced by an employee of a company. But productivity depends partly on business investment.

"Accelerating productivity growth would spur investment and output * because..., while allowing real wage increases without triggering inflation * as a result of.... If productivity continues to be flat, however, growth will eventually stall * because..."