THE IMF’S BIG-PICTURE ANALYSIS

Global economic growth is slowing, the International Monetary Fund announced yesterday in its new World Economic Outlook (WEO).
“The global expansion is losing speed in the face of a major financial crisis,” WEO advises. The leading offender is the U.S., the report says, thanks to the correction in the housing market. “The emerging and developing economies have so far been less affected by financial market turbulence and have continued to grow at a rapid pace, led by China and India, although activity is beginning to moderate in some countries.”


How bad will it get? Judging by IMF’s estimates, the outlook is more about a slowdown rather than an outright contraction. Last year, global GDP rose by 4.9%, according to the IMF. The projection for 2008 is 3.7% growth, followed by 3.8% in 2009.
If the prediction proves accurate, the deceleration will still bring pain to various segments of the world economy. Then again, world GDP rising by 3.7% is hardly a disaster. Indeed, 3.7% growth is the upper range that’s prevailed since 1970, as the chart below shows.
041008a.GIF
Source: IMF’s World Economic Outlook (April 2008)
But no one should ignore the other risks bubbling that aren’t obvious in estimates for GDP. Inflation remains a threat, for example, particularly in the developing world (see chart below). The trend threatens the ability of the developing world to export disinflation to the U.S. and the developed world generally, as has been the case in past years. At some point, if prices keep rising, might the emerging markets export inflation? In fact, that seems to be the case now for certain items, starting with oil, which yesterday touched another new record high of $112 a barrel in New York. The U.S. is the world’s biggest consumer of oil, and more than half of its crude is imported, much of it from the developing world.
041008b.GIF
Source: IMF’s World Economic Outlook (April 2008)
Meanwhile, monetary policy threatens to fan inflation’s fire. According to the IMF, real short-term interest rates have turned negative in the U.S., Europe and Japan, as the third chart below shows.
041008c.GIF
Source: IMF’s World Economic Outlook (April 2008)
Of course, the argument for such a loose monetary policy is that the global economy needs an antidote to the deleveraging that’s sweeping financial systems from New York to London to Tokyo. The IMF report warns that a “further broad erosion of financial capital in a climate of uncertainty and caution could cause the present credit squeeze to mutate into a full-blown credit crunch, an event in which the supply of financing is severely constrained across the system.”
In fact, one could argue that a fair degree of the global economy’s future path over the next year or so is tied to whether or not the credit crunch mutates into something worse from this point onward. The challenge for policy makers is that addressing each scenario requires different medicine. If greater liquidity troubles are coming, central banks may feel compelled to act by effectively printing more money than is otherwise prudent. The danger is that the liquidity injections turn out to be unnecessary, in which case inflationary pressures will be that much more troublesome and difficult to control. If and when that becomes the leading issue for central banks, the easy money party will end, perhaps for an extended period.
The IMF report leans toward the conclusion that the credit crunch may yet get worse before it gets better. Unfortunately, no one really knows and so the risk of dispensing the wrong policy medicine remains higher than usual at the moment. Risk, in short, is still with us even if the world economy is set for modest growth.

Leave a Reply

Your email address will not be published. Required fields are marked *

You may use these HTML tags and attributes: <a href="" title=""> <abbr title=""> <acronym title=""> <b> <blockquote cite=""> <cite> <code> <del datetime=""> <em> <i> <q cite=""> <strike> <strong>