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IMF boss Christine Lagarde backs Osborne in public – but in private?

Lagarde was effusive about Barack Obama’s jobs package and wants UK policy to be ‘nimble’ – how does that square with the chancellor’s hardline ‘no surrender’ approach?

Christine Lagarde is far too much the seasoned diplomat ever to embarrass her host, so it was little surprise that the new managing director of the International Monetary Fund backed George Osborne’s economic strategy when she shared a platform with him in London on Friday.

Whether she is quite so enthusiastic in private about the government’s “no U-turn” approach to cutting the budget deficit is debatable.

After all, she was effusive in her support for Barack Obama’s 7bn (£280bn) growth and employment package announced on Thursday night and it is less than two months since the IMF set the cat among the pigeons in Downing Street when it said temporary tax cuts might be needed were the economy to stall.

The possibility of that is now higher than when the IMF completed its annual health check on the UK in July. As Lagarde noted on Friday, the risk levels to the UK economy are “rising”.

But while stressing that both the Treasury and the Bank of England should be “nimble”, Lagarde avoided calling on Osborne to implement an Obama-style fiscal boost, something that is being urged on the chancellor by his Labour shadow, Ed Balls.

Instead, she described the current stance of policy as appropriate, arguing that help to revive growth could come via more quantitative easing from the Bank and from the operation of what, in the jargon of the economics profession, are known as the automatic fiscal stabilisers. The latter involve the government turning a blind eye to an increase in the budget deficit that results from lower tax revenues and higher welfare payments during a period of temporary economic weakness. In the early stages of the Great Depression, governments reacted to rising budget deficits by cutting spending, sucking even more demand out of the economy, but that has never been part of Osborne’s plans and he said today that the automatic stabilisers ensured flexibility was built into his austerity plans.

The debate about how policymakers should respond to the slowdown in the global economy this summer will re-surface at this weekend’s meeting of G7 finance ministers and central bank governors in Marseille. It will be top of the agenda when the fund holds its annual meeting in Washington later this month. And it will dominate UK domestic politics during the party conference season and well beyond.

Dangerous new phase

There are three key issues. The first is whether the loss of momentum to growth is a short-lived response to rising commodity prices and the turbulence in the eurozone or a more prolonged and deeper retrenchment that will result in higher unemployment and fresh problems for still-vulnerable banks. Clearly, both the IMF and the Organisation for Economic Co-operation and Development fear it may well be the latter. Lagarde said she wanted bold action now to steer the world economy through “this dangerous new phase of the recovery”. The world, she added, was suffering from a crisis of confidence.

Osborne agrees with this analysis. His view is that it was excessive debt that caused the financial crisis in the first place, and it was excessive debt that is hampering the recovery. Both the chancellor and Lagarde agree that the biggest boost to the global economy would come from a resolution of Europe’s sovereign debt crisis, something that currently looks remote.

The second issue is how the international community responds to what is shaping up to be a tough winter. In April 2009, the London G20 summit marked the high point of global co-operation in the face of the most serious downturn since the 1930s, but since then there has been a gradual fragmentation as policymakers in individual countries have gone their own way. Obama’s approach in the US – ease policy now while setting out a longer-term plan to reduce the budget deficit – is in contrast to Osborne’s insistence that changing course would lead to the financial markets losing confidence in the UK, thereby driving up interest rates for homeowners and businesses.

The chancellor says it is different for Obama because the US dollar is the world’s premier reserve currency, so America adopts a more relaxed approach to deficit reduction without being punished by the markets. Neither the IMF nor the OECD see things in quite such stark terms. Both think countries that have credible budget plans and which can borrow cheaply could adopt a more nuanced approach and slow the pace of austerity.

Osborne, clearly, is in no mood to do this. He is betting that a combination of the automatic stabilisers, a bit more electronic money creation from the bank and the boost to consumer spending as oil prices come down will see the economy through its soft patch. The risk is not just that the soft patch proves to be longer than the chancellor expects (and the growth forecasts used by the Treasury have been consistently over-optimistic over the past 16 months) but that he is digging himself deeper into a political hole through his hardline approach. Should Osborne persist in his no-surrender approach throughout the winter only to be forced into cutting taxes along the lines suggested by the IMF in next spring’s budget, he would suffer precisely the loss of market credibility he is so determined to avoid. © 2011 Guardian News and Media Limited or its affiliated companies. All rights reserved. | Use of this content is subject to our Terms & Conditions | More Feeds