Abstract
Strengthened macroeconomic and structural policies, underpinned by improved monetary and fiscal policy frameworks, have contributed to the United Kingdom's achievements. Executive Directors commended these developments, and supported the focus of policies to encourage innovation and entrepreneurship, promote research and development, and strengthen the competition in view of the need to foster the New Economy and boost productivity growth in the rest of the economy. They agreed that the banking system is profitable and well capitalized, but stressed the need to be more vigilant.
On February 23, 2001, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with the United Kingdom.1
Background
The United Kingdom is experiencing the longest period of sustained noninflationary output growth in more than 30 years. Output growth has averaged 2.9 percent in 1993–2000, the rate of unemployment is at its lowest level in a quarter century, and inflation has remained at or below 3 percent. Long-term interest rates have declined markedly and private investment has increased reflecting declining risk premia and improved business confidence. These developments have been accompanied by substantial changes in fiscal and monetary policy. The fiscal position tightened significantly with the structural balance improving by almost 9 percentage points of GDP since 1992 and the net public debt declining by more than 12 percentage points of GDP to about 33 percent at end-2000. The authorities adopted inflation targeting in 1992 and granted operational independence to the Bank of England in 1997, with the primary objective of maintaining price stability, defined by an inflation target of 2½ percent.
Notwithstanding these achievements, the productivity performance of the United Kingdom has been weak in comparison with other industrialized countries: labor productivity in manufacturing declined on average 0.3 percent annually in 1995-1998. This performance can be attributed to past low public and private investment in physical capital and to low total factor productivity growth which partly reflects skill deficiencies in the labor force. In the past year and a half, however, overall-economy productivity growth has accelerated, led by strong—albeit still uneven—gains in manufacturing, notably in information and communication technology (ICT) industries, and ICT-intensive services, sparking interest in possible “New Economy” effects.
Output growth in 2000 is estimated at around 3 percent reflecting buoyant domestic demand. Private consumption growth remained strong, underpinned by continued employment gains over several years and sizable increases in earnings, disposable income, and wealth through early-2000. Investment weakened after several years of growth, although it remains at high levels in real terms as a share of GDP. Rising external demand in 2000 improved export performance substantially, but imports also grew rapidly and the current account continued to exert a drag on growth reflecting the strength of sterling. Inflation remained subdued, with the targeted rate (RPIX) hovering around 2 percent. The unemployment rate fell further to 5.3 percent (on a labor force survey basis) while earnings growth moderated to below 4½ percent by year end.
The 1999/00 budget closed with a public sector surplus of 1.7 percent of GDP (on an ESA95 basis), a substantial overperformance relative to the original budget plan of a deficit of 0.5 percent of GDP. Budgetary policies formulated in 2000 envisage sizable spending increases extending over 2001 and beyond—mainly on infrastructure investment, health, education, and social services—as well as targeted tax cuts. The November 2000 Pre-Budget Report introduced, among other measures, a generous pensioner benefits package and a fuel tax freeze while a possible fuel tax cut was proposed for consultation. These would lower the overall surplus from 1.7 percent of GDP in 1999/00 to under 1/2 percent of GDP in 2001/02 and to a deficit of about 1 percent of GDP by 2003/04 on the Government’s projections. A fiscal overperformance is likely in 2000/01 as revenue remains buoyant due to improvements in tax administration and there appear to be delays in implementing spending increases.
The Bank of England kept policy rates unchanged at 6 percent from February 2000 to January 2001 following a 100 basis point tightening cycle that started the previous summer. Continued moderation in wage and inflation pressures, and indications that factors underpinning private demand—such as assets and housing prices and surveys of investment intentions—were plateauing or weakening argued against an increase, even if household consumption and credit remained strong. As concerns over possible inflation pressures and overheating gradually dissipated through the second half of 2000, market expectations of further policy rate hikes faded (turning into expectations of future rate cuts) and short- and medium-term market rates shifted downwards—easing monetary conditions over the year. In February 2001, the Monetary Policy Committee lowered the policy rate by 25 basis points to 5¾ percent to forestall a weakening in economic activity, mainly on account of a deterioration in the external outlook.
Executive Board Assessment
Executive Directors commended the authorities for the continued strong performance of the U.K. economy since the early 1990s, a performance that marks the longest period of sustained output and employment growth and low inflation in more than 30 years. They agreed that sound fiscal and monetary policies, underpinned by transparent medium-term policy frameworks as well as sustained implementation of structural reforms, have contributed to these achievements. They noted that, after maintaining a brisk pace for most of last year, output growth appears to have slowed to around trend, with inflation remaining subdued and few signs of significant imbalances. At the same time, a number of Directors expressed concern about the high real exchange rate, underscoring the need for the authorities to remain alert to the implications for competitiveness and the policy mix.
Looking forward, Directors expected that output growth would remain robust, with a substantial increase in public spending from measures announced in last year’s budget offsetting slower private consumption growth. With risks of further downward adjustment to global growth and equity prices, they observed that the risks to the outlook appear, on balance, to be tilted to the downside, although consumer confidence and private consumption growth remain buoyant. Directors agreed that prospects for inflation remain benign, given the strong sterling and subdued wage growth so far.
Directors observed that the challenge in the short term is to sustain the economic expansion through an appropriate macroeconomic policy mix. Given the continued favorable prospects for price stability, they welcomed the recent cut in the policy rate by the Bank of England. Directors expressed their appreciation for the authorities’ demonstrated readiness to respond judiciously to changes in the inflation outlook, and encouraged them to stand ready to cut the policy rate further if signs of weakening domestic activity emerge and wage pressures remain moderate.
Directors noted that, even after taking into account recent spending decisions, the fiscal position remains sound and fully consistent with the authorities’ medium-term fiscal framework. They considered that the authorities’ investment plans would improve the U.K.’s competitiveness and its attractiveness for investors. Directors also welcomed the likely strong overperformance on last year’s budget. While Directors expressed a variety of views on the short-term fiscal policy stance, on balance, many of them underscored that it would be prudent to abstain from introducing significant new spending commitments or tax cuts in the March 2001 budget. They noted that the budget measures in 2000 had already introduced significant spending increases that are now coming on stream and will result in a sizable fiscal impulse this year. These Directors also cautioned that additional fiscal stimulus would limit the room for further interest rate cuts, and, at a time when interest rates might decline elsewhere, this would tend to cause further upward pressure on sterling. Other Directors, however, noted that the course of the exchange rate in response to a fiscal expansion is hard to predict.
Directors welcomed the priority that the authorities are placing on boosting the productivity performance of the U.K. economy over the medium term. They broadly supported their approach to this issue, agreeing that macroeconomic stability and strong policy frameworks are likely to contribute to maintaining the current high levels of investment and enhancing growth prospects. Directors also agreed that plans to increase public investment in infrastructure and human capital are justified in light of the evidence that past underinvestment in these areas has been a factor underlying the United Kingdom’s comparatively weak productivity performance.
Directors considered the authorities’ medium-term fiscal strategy to be broadly appropriate. At the same time, many Directors suggested that there may be scope for the public sector to play a more ambitious role in promoting national saving and investment. More specifically, they considered that it would be preferable to fund all public investment through higher public saving, i.e., to maintain a surplus or broad overall balance over the cycle, as is now the case. These Directors stressed that this objective could be achieved within the existing three-year spending plans by saving the likely revenue overperformance over the coming years.
Directors also broadly endorsed the authorities’ approach to boosting productivity by aiming microeconomic reforms and structural policies at identified market failures, such as the difficulty of financing private research and development activity. They welcomed the authorities’ efforts to enhance competition, innovation, and entrepreneurship, in view of the need both to foster the New Economy and boost productivity growth in the rest of the economy. Directors encouraged the authorities to implement promptly the Competition Act and welcomed the strengthening of the powers of the Office of Fair Trading.
Directors commended the authorities for a decade and a half of labor market reforms which have underpinned the remarkable achievements with regard to the expansion of employment and reduction in unemployment. Although the authorities’ objective of achieving high levels of employment is being met, employment rates among specific groups such as young, low-skilled men remain an area of concern. Directors therefore agreed that the priorities are to increase the incentives of such groups to work and close the skill gaps between the U.K. workforce and those of other major industrial countries. In this connection, Directors observed that the New Deal programs appear to be working well on the whole. However, they saw room for tapering unemployment benefits in a manner that increases disincentives to remain unemployed for long periods, and for linking unemployment and welfare benefits more closely with job search. The introduction of the National Minimum Wage (NMW) appears to have had little adverse impact on employment and inflation, but Directors cautioned against significant increases in the NMW or raising the youth minimum wage rate to a level of the NMW.
Directors welcomed the progress in implementing pension reform and noted that the experience under stakeholder pensions bears watching for lessons that could be learned on private pension provision for lower income groups. They also cautioned against further public pension-related commitments—particularly those indexed to earnings in future budgets—given the implications for long-term public liabilities.
Directors also welcomed the progress in consolidating the role of the Financial Services Authority (FSA) as the single financial system regulator, and noted that the U.K. banking system is profitable and well capitalized. They encouraged the authorities to remain vigilant in the somewhat riskier environment in the period ahead, particularly if possible global financial market weakness were to feed into domestic market confidence. In this regard, they noted that the concentration of banks’ exposures to specific risks, such as the telecommunications sector, deserves close monitoring as the FSA is already doing. Directors welcomed the United Kingdom’s intention to participate in an FSAP.
Directors considered that the decision to join EMU remains a key medium-term issue for the United Kingdom and concurred that the five tests or criteria established by the authorities reflect the economic considerations central to this decision. With regard to the criterion of sustained convergence, a few Directors observed that recent experience suggests that cyclical synchronization between the United Kingdom and the euro area appears to be increasing.
Directors praised the authorities’ initiative to relieve the debt burden of the poorest countries, including through the full bilateral debt write-off in the context of the HIPC Initiative as well as their commitment to raise official development assistance over the next three years. They encouraged the authorities to accelerate progress toward the U.N. target for overseas assistance of 0.7 percent of GNP. Directors also welcomed the authorities’ support for the European Commission’s proposal to grant duty and quota-free access for exports from least developed countries.
The United Kingdom publishes data on a sufficiently timely and comprehensive basis to permit effective surveillance.
Public Information Notices (PINs) are issued, (i) at the request of a member country, following the conclusion of the Article IV consultation for countries seeking to make known the views of the IMF to the public. This action is intended to strengthen IMF surveillance over the economic policies of member countries by increasing the transparency of the IMF’s assessment of these policies; and (ii) following policy discussions in the Executive Board at the decision of the Board.
Selected Economic Indicators
Staff projections, except where noted.
Labor force survey basis.
September - November 2000.
Fiscal year beginning April 1.
Includes 2.4 percentage points of GDP in 2000/01 corresponding to the auction proceeds of spectrum licenses.
December 2000.
Based on relative normalized unit labor costs in manufacturing.
Selected Economic Indicators
| 1996 | 1997 | 1998 | 1999 | 2000 1/ | 2001 1/ | ||
|---|---|---|---|---|---|---|---|
| Real Economy (change in percent) | |||||||
| Real GDP | 2.6 | 3.5 | 2.6 | 2.3 | 3.0 | 2.7 | |
| Domestic demand | 3.0 | 3.8 | 4.6 | 3.8 | 3.9 | 3.4 | |
| CPI (excluding mortgage interest) | 3.0 | 2.8 | 2.7 | 2.3 | 2.1 | 2.5 | |
| Unemployment rate (in percent) 2/ | 8.1 | 7.0 | 6.3 | 6.0 | 5.3 3/ | … | |
| Gross national saving (percent of GDP) | 16.8 | 18.0 | 17.9 | 16.4 | 16.4 | 16.2 | |
| Gross domestic investment (percent of GDP) | 16.9 | 17.2 | 17.9 | 17.5 | 17.8 | 18.1 | |
| Public Finance (in percent of fiscal year GDP) 4/ | |||||||
| General government balance | -3.8 | -0.7 | 0.7 | 1.7 | 3.6 5/ | 0.5 | |
| Public sector balance | -3.6 | -0.7 | 0.6 | 1.7 | 3.5 5/ | 0.4 | |
| Public sector structural balance | -3.0 | -0.3 | 0.6 | 1.7 | 1.1 | 0.4 | |
| General government gross debt | 52.2 | 49.2 | 46.5 | 43.6 | 40.2 | 37.4 | |
| Public sector net debt | 45.4 | 43.2 | 40.6 | 37.6 | 33.1 | 31.3 | |
| Money and Credit (end-year, percent change) | |||||||
| M0 | 6.6 | 6.3 | 5.8 | 11.7 | 4.8 | … | |
| M4 | 9.5 | 5.7 | 8.3 | 4.1 | 8.0 | … | |
| Consumer Credit | 13.6 | 13.8 | 16.2 | 13.0 | 16.0 | … | |
| Interest rates (year average) | |||||||
| Three-month interbank rate | 6.0 | 6.9 | 7.4 | 5.3 | 5.9 6/ | … | |
| Ten-year Government bond yield | 7.8 | 7.0 | 5.5 | 5.4 | 4.9 6/ | … | |
| Balance of Payments | |||||||
| Trade balance (goods, in percent of GDP) | -1.7 | -1.5 | -2.4 | -2.9 | -3.1 | -3.8 | |
| Current account (in percent of GDP) | -0.1 | 0.8 | 0.0 | -1.1 | -1.4 | -1.9 | |
| Reserves (national valuation of gold, end of period, in billions of SDRs) | 31.6 | 27.5 | 26.5 | 30.5 | 36.9 | … | |
| Reserves cover (months of imports of goods and services) | 1.1 | 0.9 | 0.8 | 0.9 | 1.1 | … | |
| Fund Position (As of December 31, 2000) | |||||||
| Holdings of currency (in percent of quota) | 69.4 | ||||||
| Holdings of SDRs (in percent of allocation) | 13.1 | ||||||
| Quota (in millions of SDRs) | 10,738.5 | ||||||
| Exchange Rate | |||||||
| Exchange rate regime | Floating exchange rate | ||||||
| Present rate (January 31, 2001) | US$1 = £0.685 | ||||||
| Nominal effective rate (1995=100) | 101.7 | 118.5 | 122.5 | 122.3 | 126.7 | … | |
| Real effective rate (1995=100) 7/ | 102.4 | 124.6 | 137.3 | 142.4 | 154.4 | … | |
Staff projections, except where noted.
Labor force survey basis.
September - November 2000.
Fiscal year beginning April 1.
Includes 2.4 percentage points of GDP in 2000/01 corresponding to the auction proceeds of spectrum licenses.
December 2000.
Based on relative normalized unit labor costs in manufacturing.
Selected Economic Indicators
| 1996 | 1997 | 1998 | 1999 | 2000 1/ | 2001 1/ | ||
|---|---|---|---|---|---|---|---|
| Real Economy (change in percent) | |||||||
| Real GDP | 2.6 | 3.5 | 2.6 | 2.3 | 3.0 | 2.7 | |
| Domestic demand | 3.0 | 3.8 | 4.6 | 3.8 | 3.9 | 3.4 | |
| CPI (excluding mortgage interest) | 3.0 | 2.8 | 2.7 | 2.3 | 2.1 | 2.5 | |
| Unemployment rate (in percent) 2/ | 8.1 | 7.0 | 6.3 | 6.0 | 5.3 3/ | … | |
| Gross national saving (percent of GDP) | 16.8 | 18.0 | 17.9 | 16.4 | 16.4 | 16.2 | |
| Gross domestic investment (percent of GDP) | 16.9 | 17.2 | 17.9 | 17.5 | 17.8 | 18.1 | |
| Public Finance (in percent of fiscal year GDP) 4/ | |||||||
| General government balance | -3.8 | -0.7 | 0.7 | 1.7 | 3.6 5/ | 0.5 | |
| Public sector balance | -3.6 | -0.7 | 0.6 | 1.7 | 3.5 5/ | 0.4 | |
| Public sector structural balance | -3.0 | -0.3 | 0.6 | 1.7 | 1.1 | 0.4 | |
| General government gross debt | 52.2 | 49.2 | 46.5 | 43.6 | 40.2 | 37.4 | |
| Public sector net debt | 45.4 | 43.2 | 40.6 | 37.6 | 33.1 | 31.3 | |
| Money and Credit (end-year, percent change) | |||||||
| M0 | 6.6 | 6.3 | 5.8 | 11.7 | 4.8 | … | |
| M4 | 9.5 | 5.7 | 8.3 | 4.1 | 8.0 | … | |
| Consumer Credit | 13.6 | 13.8 | 16.2 | 13.0 | 16.0 | … | |
| Interest rates (year average) | |||||||
| Three-month interbank rate | 6.0 | 6.9 | 7.4 | 5.3 | 5.9 6/ | … | |
| Ten-year Government bond yield | 7.8 | 7.0 | 5.5 | 5.4 | 4.9 6/ | … | |
| Balance of Payments | |||||||
| Trade balance (goods, in percent of GDP) | -1.7 | -1.5 | -2.4 | -2.9 | -3.1 | -3.8 | |
| Current account (in percent of GDP) | -0.1 | 0.8 | 0.0 | -1.1 | -1.4 | -1.9 | |
| Reserves (national valuation of gold, end of period, in billions of SDRs) | 31.6 | 27.5 | 26.5 | 30.5 | 36.9 | … | |
| Reserves cover (months of imports of goods and services) | 1.1 | 0.9 | 0.8 | 0.9 | 1.1 | … | |
| Fund Position (As of December 31, 2000) | |||||||
| Holdings of currency (in percent of quota) | 69.4 | ||||||
| Holdings of SDRs (in percent of allocation) | 13.1 | ||||||
| Quota (in millions of SDRs) | 10,738.5 | ||||||
| Exchange Rate | |||||||
| Exchange rate regime | Floating exchange rate | ||||||
| Present rate (January 31, 2001) | US$1 = £0.685 | ||||||
| Nominal effective rate (1995=100) | 101.7 | 118.5 | 122.5 | 122.3 | 126.7 | … | |
| Real effective rate (1995=100) 7/ | 102.4 | 124.6 | 137.3 | 142.4 | 154.4 | … | |
Staff projections, except where noted.
Labor force survey basis.
September - November 2000.
Fiscal year beginning April 1.
Includes 2.4 percentage points of GDP in 2000/01 corresponding to the auction proceeds of spectrum licenses.
December 2000.
Based on relative normalized unit labor costs in manufacturing.
Under Article IV of the IMF’s Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country’s economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board. At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country’s authorities. This PIN summarizes the views of the Executive Board as expressed during the February 23, 2001 Executive Board discussion based on the staff report.