Toothless truth tellers

GEORGE OSBORNE, the chancellor of the exchequer, must be sick of hearing about Britain’s most famous 20th-century economist. Presiding over a flatlining economy, he faces calls for “Keynesian” policies: code for using fiscal policy to boost demand. But whereas pundits are easy to ignore, the IMF, an institution John Maynard Keynes helped design, has more heft. As the IMF arrives in London to conduct its annual checkup on Britain’s economic policies, it seems to have turned from friend to foe, reversing its previous support for fiscal austerity. Its report, expected towards the end of May, is widely expected to dish out fresh Keynesian advice. Ignoring it will be painful.

The history of Britain’s relationship with the IMF is an unusual one, which helps to explain when the fund’s advice must be heeded and when it can be ignored. Things started well. In the aftermath of the second world war, new institutions were set up to oversee the global economy, trade and aid. The IMF’s role was to monitor the system of fixed exchange rates, spotting policies that might lead to instability and bailing out countries that got into trouble with short-term loans. During the talks that set the bodies up, Britain’s position was strong. Its economy was battered by war but by 1944, when plans for the IMF were finalised, it looked likely to win. And it had Keynes, then the world’s most important economist, at the table.

Three decades later the IMF was calling the shots. The global fixed exchange rate system had collapsed and sterling was unstable. An oil shock in 1973 quickly fed through to rampant inflation, which exceeded 25% in 1975. To offset this, official interest rates averaged over 10% for five years, dulling growth. This mix of stagnation and inflation—“stagflation”—eroded investors’ confidence and the pound fell sharply. In 1976 Britain became the IMF’s first big debtor, borrowing $3.9 billion. In exchange, the fund demanded deep cuts.

Today things are different. Although Britain is once again suffering from a form of stagflation, its problems are long-run rather than acute. It does not need the IMF’s short-term emergency funding. Ireland, Portugal and Greece have been granted IMF loans running to $100 billion, and must, in exchange, heed its advice.

Indeed, the size of those loans strengthens Mr Osborne’s hand. Since the IMF is set up like a credit union rather than a bank, its loans cannot exceed the deposits creditor nations make. When the euro crisis intensified in 2010, the list of potential borrowers suddenly lengthened and the IMF needed extra cash. Britain contributed its fair share and pushed hard for other countries to stump up, too.

And Mr Osborne’s credit is high with the IMF in other areas. Britain’s freely floating exchange rate is precisely the kind Washington’s wonks prefer. Its monetary policy is thick with new efforts to get credit flowing to small businesses: just the kind of targeting the IMF likes. And Britain’s longer-term structural reforms—things like sharp competition enforcement, flexible labour markets and private rail operators and ports, read like an IMF textbook. In many areas, Mr Osborne’s mid-term report should glow.

The pinch point is fiscal policy. From the IMF’s perspective, the economic argument is simple. Britain can sell debt to investors cheaply: its latest auction offered debt with an interest rate that was negative, once inflation is accounted for; even then demand outstripped supply. This suggests more borrowing is unlikely to cause market pandemonium. For the IMF, a nudge towards borrowing a little more than planned to invest and boost growth may well look sensible.

But Mr Osborne is sticking to his deficit-reduction plans. Faced with a choice between a politically painful U-turn or a lukewarm write-up from the IMF he will certainly choose the latter. But the fund’s report could well harm him anyway. Under the last, Labour, government, the IMF repeatedly warned that Britain’s deficit was too big and its projections too optimistic. Ed Balls, then the government’s top economic adviser and now Labour’s shadow chancellor, ignored the fund, a fact that provided Mr Osborne with plenty of ammunition. If he too ignores the IMF, part of his political arsenal will be neutralised.