The IMF’s Outlook: Less Growth, Inadequate Policies

The IMF is out with a global update and a statement on Europe.  Unsurprisingly, it has revised its outlook down (again).  It still, optimistically, expects a return to growth in Europe next year, but it recognizes the risks are on the downside.  A few points to highlight.

1.       We are all in this together. The largest downward revision is to emerging markets (-0.3% revision this year and next).  While there are idiosyncratic factors (e.g., credit squeeze in China, infrastructure in India, lessened policy support in Brazil), the common issue affecting the emerging world is a weaker external environment due to slow industrial country growth.  I’d emphasize here, of course, that these countries can depreciate their exchange rates, ensuring a faster recovery than we will see in the periphery of Europe.

2.      Downside risks dominate.  The reports candidly acknowledge the downside risks, including the upcoming debt-ceiling fight in the United States and deteriorating financial conditions in Europe.  The overall sense is of a Fund frustrated with policies across the major industrial countries (except Japan, where it has revised growth up on Abenomics)

3.      A boost to macroprudential  regulation.  The Fund continues to support  accommodative monetary policies in the G3; thus its not surprising that they emphasize regulatory and macroprudential policies to deal with potential bubbles.  This ties in with earlier Fund work suggesting a more positive view of macroprudential measures and capital controls to address financial imbalances.

4.      For Europe, easier fiscal and monetary policies.   They support further rate cuts from the ECB (including negative ECB deposit rates) and endorse the ECB’s recent forward guidance.  Further fiscal “flexibility” is likely to be needed in Europe, as current targets are unlikely to be met. I don’t think there is much new here, but it’s still the right call.

5.      The path to European union must be accelerated. More aggressive measures to repair bank balance sheets, a faster move to banking union, and stronger ECB efforts to reduce fragmentation are needed.  On the latter, they support new long-term lending (LTRO) coupled with an easing of collateral requirements to provide a greater incentive to lend to the periphery.  This approach mirrors the “funding for lending” scheme in the United Kingdom.  They also would support ECB purchase of private assets, a more full-throated quantitative easing (QE).

The Fund clearly is increasingly unhappy with the policy framework in Europe.  The question is what, if anything, they will do about it.  The test will likely come this fall on Greece, Portugal, and Cyprus--all programs that seemed destined to fail without stronger European support.