Balancing austerity and recovery

The International Monetary Fund (IMF) has issued a stark warning about the need to balance debt reduction through austerity measures with stimulating economic growth.

In their latest Fiscal Monitor, the IMF explained how all governments face difficult policy choices and suggested that many will need to further develop their plans in response to anxious financial markets.

The IMF Fiscal Monitor is published twice a year, with quarterly updates in January and July. They also published their World Economic Outlook this week, which shows that global economic recovery has weakened.

Growth in developed economies is now forecast at 1.6% this year, with economic growth in developing economies forecast at 6.4%.

Whilst growth is likely to be weaker than previous expected, these latest IMF reports contained some positive news about deficit reductions.

The average deficit for advanced economies now stands at 6.7% of GDP. This is an improvement of 0.4% compared to the previous report in April, and shows that austerity measures are starting to work.

What does all of this mean for the UK economy and global financial markets?

There is often a disconnect between economic recovery and stock market performance. Whilst the two should be correlated over the longer-term, in the shorter-term they can often behave quite independently.

Slower economic growth closer to home is likely to result in a few things happening.

Firstly, interest rates should continue to remain low. The latest minutes from the Bank of England Monetary Policy Committee meeting in September show that all nine members voted to keep the Bank Rate at 0.5%.

Secondly, we are likely to see additional quantitative easing to stimulate economic recovery. Vince Cable, speaking at the Liberal Democrat Conference earlier this week, highlighted the need to stimulate the economy to ensure growth.

Finally, it could result in additional capital expenditure on projects by the government, although the Treasury has denied this week they are considering a £5bn spending boost to infrastructure projects.

Governments need to carefully balance their twin objectives of reducing deficits and ensuring economic growth. Getting the right balance will not be easy, with plenty of critics calling for greater focus on both objectives simultaneously.

Photo credit: Flickr/World Economic Forum