George Osborne has rejected an IMF call to move to Plan B on the economy by toning down his austerity programme to revive growth.
He said at the World Economic Forum in Davos that Britain had built up credibility with harsh measure to reduce its massive deficit which allowed him to borrow money from markets at the lowest rate "perhaps of any Chancellor before me".
"I don't think it is right to abandon a credible deficit plan," the Chancellor said, when asked about the comments by IMF chief economist Olivier Blanchard.
Mr Blanchard said on Thursday that “slower fiscal consolidation" in Britain "may well be appropriate” after the fund cuts its UK growth forecasts for the second time in just four months.
Mr Osborne said his current plan was flexible enough and he had "been prepared to let the automatic stabilisers operate in the UK".
"Credibility is very hard won and easily lost," he said,"And I think it would be a huge mistake to put that at risk."
Over the past two years, the IMF has repeatedly warned the Chancellor he would need to change tack if the recovery failed to take off. Mr Blanchard has now judged the time to react has come.
“We said if things look bad at the beginning of 2013 which they do then there should be some reassessment of fiscal policy,” he told the BBC’s Today programme. “You have a Budget coming, and I think this would be a good time to actually take stock and see whether some adjustments should now be made.
Last May, the IMF called on the Government to consider temporary tax cuts and more infrastructure spending if the economy failed to grow in 2012. Official GDP figures due today (Fri) are expected to show that the economy contracted by around 0.2pc in the final quarter of last year, and by 0.1pc for 2012 as a whole.
At the time, IMF insiders suggested that the scale of the fiscal loosening could be as much as £30bn, about 2pc of GDP, accompanied by a clearly defined path to get the deficit back under control.
Mr Blanchard’s comments will put Mr Osborne under enormous pressure, as he has previously hitched his plan’s credibility to IMF endorsement.
Adam Posen, president of the Peterson Institute for International Economics and a former Bank of England rate-setter, said at the World Economic Forum in Davos , Switzerland: “Professor Blanchard is right and he has the research to back it up.”
Mr Posen has previously called for a state-owned business lending bank and greater spending on infrastructure.
However, another leading economist urged the Chancellor to stay the course. Ken Rogoff, Harvard’s celebrated economist and an expert in government debt, told The Daily Telegraph that a fiscal stimulus would be “deeply misguided”.
He said the UK deficit reduction plan was the “right” policy. “The whole idea of a Keynesian stimulus is deeply misguided,” he said at the World Economic Forum.
Mr Rogoff added that the Government’s use of its balance sheet to guarantee infrastructure projects and boost private sector investment was “very clever”, and should be used more extensively.
Echoing Bank of England Governor Sir Mervyn King earlier this week, however, he said patience was needed due to the scale of the UK’s debts alongside the economy’s dependence on financial services and the struggling eurozone.
On Wednesday, the IMF cut its UK growth forecast for this year from 1.1pc to 1pc and for next year from 2.2pc to 1.9pc. It estimated that the economy shrank by 0.2pc in 2012.
Last May, the IMF set out a raft of proposals to boost growth. They included the Bank of England increasing money printing above £325bn, relaxing banking rules to boost lending, and providing banks’ state-backed funding support.
It also suggested the Government should adjust its spending plan by cutting public sector wages and investing more in infrastructure. If all those failed to revive growth, then more drastic actions would be needed.
The Bank and the Chancellor have effectively followed the IMF’s guidance to the letter so far, even though it meant the Government missed its deficit reduction rules. Mr Osborne has drawn the line at changing his plan, however, although it is now scheduled to last three years longer than originally envisaged.
Ed Balls MP, Labour’s Shadow Chancellor, said: “David Cameron and George Osborne must finally heed the IMF’s advice. They have repeatedly warned that a change of course would be needed in Britain if the economy turns out worse than expected. After two and a half years of flatlining and a double-dip recession the IMF is now clearly losing patience.
“The IMF has said such a plan B should include policies Labour has long called for including temporary tax cuts, such as a VAT reduction, and bringing forward long-term infrastructure investment.
“The longer the Government clings on to its failing plan, the more long-term damage they will do to our economy. David Cameron and George Osborne must now put political pride aside and put the national economic interest first.”
The Treasury was sanguine about Mr Blanchard's comments. A senior figure said: "He has been saying the same thing for two years."