Resilient public finances in a “world of uncertainty”

Good morning from New Economy Brief.

Last week finance ministers from all over the world gathered in Washington DC for the  International Monetary Fund and World Bank’s Annual Meetings. 

This week we give a brief summary of key themes from the meetings and what they mean for the UK government’s upcoming Autumn Budget.

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The IMF Annual Meetings.

To coincide with the meetings, the International Monetary Fund (IMF) has released its latest World Economic Outlook, Global Financial Stability Report and Fiscal Monitor of global developments and how they affect countries’ public finances. The toplines from this autumn’s reports are that the international economy has remained more resilient to the global trade war than the IMF previously expected in their Spring Meetings. Global growth has been revised upwards, and is now projected to hit 3.3% in 2024 before slowing to 3.2% in 2025 and 3.1% in 2026. However, IMF director Kristalina Georgieva warns of growing ‘anxiety’: “From technology to geopolitics to climate to trade, change is unsettling.”

“Global Economy In Flux, Prospects Remain Dim.” Global growth is still fragile, but it is being propped up by the ‘AI mega-boom’, particularly by huge investments from US tech companies. But the IMF warns that this may not last, and Georgieva notes in her speech: “the history of financial market responses to pathbreaking new technologies is a story of overestimation and market correction… The world would be wise to manage such risks.” (Look out for our briefing on the AI bubble in the coming weeks.) The World Economic Outlook also warns of a range of other risks to growth: “Prolonged uncertainty, more protectionism and labour supply shocks could reduce growth. Fiscal vulnerabilities, potential financial market corrections, and erosion of institutions could threaten stability.”

Anxiety over financial instability and public debt. In its Global Financial Stability Report, published on Tuesday, the IMF said markets appeared “complacent” and pointed out three reasons to be anxious: overstretched valuations for tech stocks; pressure in government bond markets as they absorb fast-growing debts; and risks in the shadow banking sector. The IMF is particularly worried about rising public debt in both emerging and advanced economies, with the Fiscal Monitor noting that the already-fragile state of many countries’ finances could make it hard for them to respond to the growing risk of a financial crisis or another shock. 

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What does this mean for the UK?

At the top of the IMF’s list of recommendations for highly indebted governments trying to navigate this new ‘world of uncertainty’ is to repair the public finances with fiscal consolidation. It thinks this is “necessary so they can buffer new shocks and attend to pressing needs without driving up private sector borrowing costs.“ 

Invest to grow. The Fiscal Monitor also makes the case for governments to spend more efficiently to free up funds for more investment in infrastructure, human capital and R&D. This would in turn improve growth, create more jobs, bring in more revenue from taxes and improve resilience and debt sustainability. Here, the IMF’s Director praised the UK for “doing the right thing… They are signalling [to the bond markets]. They have a growth vision and are showing financial responsibility”. (However it is important to note that the UK is still investing less than the OECD average and the ‘capital gap’ with other countries is in the trillions of pounds – so it will take much more ambition to catch up.)

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Looking ahead to the Autumn Budget.

Put simply, the IMF is saying to governments: repair your public finances via fiscal consolidation and grow your economies with public investment. Fiscal consolidation means either tax rises, spending cuts or both. Given the state of UK public services (check out the IfG’s latest Public Sector Performance Tracker for more on this) and the political backlash over the proposed cuts to disability benefits to increase headroom back in the spring, many commentators expect the Chancellor to lean much harder on tax rises in the Autumn Budget. In fact, the Chancellor used last week’s IMF meetings to give her clearest indication yet for increasing taxes on the wealthy and ‘those with the broadest shoulders’. 

Pro-growth tax reform. The IFS’s Green Budget recommended a variety of tax-raising options, but emphasised that reforms should focus on creating a more ‘growth-friendly tax system’. Similarly, economist Jonathan Portes wrote in the FT that the Chancellor needs to explain to markets not just how much tax will be raised but “why it will be good for growth and public services and how pain will be fairly shared”. New polling from Invest in Britain shows that a majority of Labour MPs want Reeves to go beyond ‘fiscal tinkering’ and raising taxes only enough to meet fiscal rules. Instead, they think she should be more ambitious and raise enough for extra spending and investment to boost growth.

More flexibility and firepower in the fiscal framework? The Times’ Mehreen Khan reports that the Chancellor met with the head of the IMF to speak about its “recommendation that the government only has one fiscal forecast measuring its compliance with the budget rules a year." Experts at the Institute for Government say such a reform would promote policy stability and prevent the government being pushed around by adverse economic forecasts. (Read our previous New Economy Brief on this.) 

However, former chief economist at the Bank of England Andy Haldane argues that this reform alone “would not tackle the inflexibility embedded in the system”. He proposes further steps to make fiscal policy more growth-friendly. These include recommending that the Treasury should also take back control of forecasting from the OBR and have the OBR scrutinise it instead (as NEF has recently proposed); allow ‘tolerance bands’ of 1% of GDP around the fiscal rules to “remove the need for a growth-limiting squeeze to boost fiscal headroom”; and assess policies’ impact over a longer period than a single parliament so more of the growth-enhancing benefits of public investment can be taken into account.

Modernising fiscal policy for an unstable world. Any change to the fiscal framework would require updating the Charter for Budget Responsibility – which enshrines the OBR’s mandate, the fiscal rules and how the OBR assesses them – and passing secondary legislation through Parliament. The polling above also shows most Labour MPs think the fiscal framework should focus more on promoting sustainable and inclusive economic growth (76%), resourcing high-quality public services (72%) and responding to geopolitical threats and emergencies (59%). Invest in Britain has published a briefing explaining a variety of wider reforms that could make the fiscal framework more flexible, investment-friendly, and capable of meeting today’s economic, climate and geopolitical challenges. 

In its laser focus on the technical to-and-fro with the OBR or the political ups-and-downs at the Treasury, the UK fiscal debate can easily lose sight of the global context. But looking at other countries – from the IMF’s warnings last week to the ongoing French budget crisis and the government shutdown in the US – it becomes clear that the UK situation is about much more than the hangover from Liz Truss’s mini-budget. Instead, it reflects trends that are putting fiscal policy under strain in even the wealthiest countries, and which will require more systematic solutions than another round of belt-tightening.