IFS urges no change in government cuts plans
The Institute for Fiscal Studies has said the government should not relax plans for spending cuts and tax rises to try to reduce the budget deficit.
The respected think tank also predicted that government borrowing would be less than the Office for Budget Responsibility (OBR) had forecast.
But it urged the chancellor to "resist the temptation to engage in any significant net giveaway" as a result.
It also said that spending cuts could be "formidably hard to deliver".
The warning comes in the IFS' Green Budget which aims to assess the government's position ahead of the March Budget.
Surprise news that the UK economy contracted at the end of last year prompted a debate about whether the government should change its plans to cut spending and raise taxes - which is known as fiscal tightening.
The IFS report suggests the government should stay the course and continue with the "fiscal repair job" that it aims to complete by the next general election.
"While last week's growth figures were disappointing, this year's Green Budget highlights that any fiscal loosening aimed at helping the economy could be ineffective," it said.
It said to do so would risk fuelling inflation. This could trigger higher interest rates, which in turn could stymie economic growth.
A change also "risks undermining investor confidence that the remainder of the fiscal consolidation plan, in which the chancellor has set such store, will be delivered", the report added.
Responding to the IFS report, a government source said the Green Budget was an endorsement of its policy.
However Angela Eagle, Labour's shadow chief secretary to the Treasury, said: "This report exposes the myth that George Osborne had no choice but to cut the deficit at this speed and scale.
"We have been clear that George Osborne has made a political choice to cut too far, too fast and that without a plan for jobs and growth you can't get the deficit down."
The BBC's economics editor, Stephanie Flanders, concluded that the IFS report was broadly supportive of the government's plans - but with "gloomy caveats".
"They [the IFS] think the downside risks are probably greater than the chancellor suggests. But, depressingly, the authors don't seem to think the government can do much to offset these risks - or mitigate the effects."
The IFS warned that the economy might not grow as quickly as expected, and "even if it does, the public finances might not bounce back as strongly as it [the OBR] forecasts".
The think tank added that although it does not want George Osborne to switch to an economic plan B, it thought that he should have one, and be clear about what it was.
"The chancellor would be best advised to consider how he would respond to a changing - and, in particular, a worsening - outlook for the economy, the public finances or the quality and quantity of public services being enjoyed," the report said.
However, the chancellor seems to think it would be risky even to mention one, Stephanie Flanders said.
Analysts from Barclays Wealth and Barclays Capital, which prepared the report in collaboration with the IFS, said the economy was likely to grow roughly in line with the OBR's 2.1% forecast for 2011, but was then likely to grow more slowly.
Official figures from the Office for National Statistics (ONS) showed gross domestic product (GDP) shrank by 0.5% in the last quarter of 2010.
Inflation, meanwhile, is running at 3.7%, well above the 2% target set by the government for the interest rate-setters at the Bank of England.
The IFS warned the next five financial years were "set to be the tightest five-year period for public spending since at least the Second World War".
The IFS pointed to forecasts from the International Monetary Fund, which said that of 29 leading industrial countries, only the Republic of Ireland and Iceland were expected to deliver sharper falls in spending than the UK, and only Greece deeper cuts in borrowing.
Stephanie Flanders said this "gives the lie to the suggestion that the government's cuts are similar to the consolidation plans being undertaken by other countries".
The prime minister's official spokesman added: "We have always been clear it is going to be a difficult process, but it is a necessary one, given the scale of the deficit."