IMF World Economic Outlook: Cloudy With A Chance Of Rain

The International Monetary Fund is out with its latest World Economic Outlook. The document goes to great lengths to contradict itself, leaving the reader to wonder if the global financial situation is getting better or worse.

The initial statement from the report is

“The global recovery is proceeding better than expected but at varying speeds—tepidly in many advanced economies and solidly in most emerging and developing economies. World growth is now expected to be 4¼ percent. Among the advanced economies, the United States is off to a better start than Europe and Japan. Among emerging and developing economies, emerging Asia is leading the recovery, while many emerging European and some Commonwealth of Independent States economies are lagging behind. This multispeed recovery is expected to continue.”

Shortly after that opening, the agency says “but stability is not yet assured.” In other words, a little more than a tap on the breaks could bring the progress to a halt.

The World Economic Outlook echoes the analysis that most global forecasts written in the last quarter have made. The credit crisis is probably over. Regulation can prevent future disasters if governments will only create new restrictions on banking activities. Regulators can reign in bank risk by applying taxes to financial firms as a way to raise money as dry powder for future catastrophes. If any banks do eventually do fail, and the pool of capital created by the levies protects taxpayer money that was used at great risk in the last bailout.

The IMF writes “Policymakers must strike the right balance between promoting the safety of the financial system and keeping it innovative and efficient.”

The other puzzle that governments must put together is that sovereign debt is becoming too high. This is not just among the weak economies like Greece. It has recently come to include the US and UK which have rising national debts in comparison to GDP. The aging populations of these nations will put a stain on the future tax base. Unemployment has undermined that size of that tax base and will do so for some time.

The IMF writes “The key task ahead is to reduce sovereign vulnerabilities. In many advanced economies, there is a pressing need to design and communicate credible medium-term fiscal consolidation strategies. These should include clear time frames to bring down gross debt-to-GDP ratios over the medium term as well as contingency measures if the deterioration in public finances is greater than expected.”

There is, of course, no contingency plan if sovereign debt becomes unmanageable in uneven capital markets. Nations can say they will raise taxes, which is sometimes regressive, or cut entitlements, which is often impossible.

That leaves the most difficult puzzle of all. The economic expansion relies to a very large extent on the hundreds of billion of dollars nations have invested in stimulus packages,  the largest of which were the $787 billion created in the US and $585 billion approved by the Chinese government. The IMF is aware of the fact that if this stimulus is withdrawn too soon, improvements to GDP could falter. But, the stimulus benefits come with the great risk of extraordinary future deficits. The most important threat to a long-term recovery is unemployment, and governments must be prepared to handle the problem even if there is a large cost to the solutions.

The IMF writes: “To limit damage to the labor market, macroeconomic policies need tobe appropriately supportive of the recovery where possible. At the same time, policies need to foster wage flexibility and provide adequate support for the jobless.”

In summary,  it is expensive to fix the world, particularly if the work is being done with money the world does not have.

Douglas A. McIntyre