IMF Research Director Outlines Challenges to Sustaining a Global Recovery

Recently, International Monetary Fund (IMF) Economic Counsellor and Director of Research Olivier Blanchard opined that a global economic recovery had commenced, but that sustaining it could require “delicate rebalancing” during which public fiscal stimulus spending is phased out and private demand replaces public demand, and during which large trade imbalances that had previously persisted moderate. In his assessment, Blanchard highlighted supply-side issues, demand-side issues, and risks associated with a failure to rebalance effectively.

A summary of those issues follows:

Supply-Side Issues:
• Partly dysfunctional financial systems in the advanced countries.
• Capital flows to developing countries that decreased may take a few years to fully recover.
• In nearly all countries, the costs of the crisis have exacerbated the fiscal burden and tax hikes may be necessary.

Demand-Side Issues:
• A return of economic growth in 2009 may not be sufficiently strong to reduce unemployment leading to a peak in the unemployment rate in 2010.
• Initial growth will depend mainly on inventory rebuilding and the fiscal stimulus, not private consumption and fixed investment spending. When the fiscal stimulus is unwound and inventory rebuilding is completed, rebalancing will be required to sustain economic growth.

Risks Associated With A Failure to Rebalance Effectively:
• An anemic U.S. recovery.
• Possible efforts to extend the fiscal stimulus. Premature phasing out of the stimulus would undermine economic growth. Extension of the stimulus could lead to concerns about U.S. debt, sparking large capital outflows from the U.S. and a potentially disorderly decline in the U.S. dollar. In turn, that additional instability or uncertainty concerning such instability could derail an economic recovery.

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IMF Concludes Its Consultation with China

Earlier this week, the International Monetary Fund (IMF) announced that its Executive Board had completed its consultations with China. The IMF released a summary of the consultation. Key findings included:

• China’s robust fiscal and monetary policy stimuli facilitated an economic recovery. China’s policies have contributed to regional and global economic stability.

• Global economic challenges may make it difficult for the world’s economies to absorb China’s increased production capacity. As a result, the IMF expressed support for China’s measures aimed at boosting domestic consumption spending and reducing China’s reliance on exports.

• China’s low level of public debt should afford the country flexibility in pursuing additional targeted fiscal stimulus measures.

• The IMF called for China to closely monitor its financial system for indications of a decline in credit quality.

• The IMF welcomed China’s intent to participate in its Financial Sector Assessment Program to identify possible areas for financial system reform.

To date, the ongoing discussions in academic and regulatory circles in China concerning the possible deployment of monetary policy to mitigate the risk of an emergent real estate bubble should provide some degree of comfort when it comes to avoiding a serious deterioration in credit quality. Possible monetary tightening would tend to squeeze out marginal borrowers.

Nonetheless, given the limits of monetary policy, regulators will need to carefully watch bank lending for signs that loans are being concentrated disproportionately in any single economic sector such as real estate, down payments are being reduced significantly, or up-front inducements to encourage borrowing are being offered. Should capital inflows pick up dramatically in coming quarters, that situation would also warrant close monitoring, as such inflows could fuel a credit boom that provides access even to marginal borrowers. Those were some of the symptoms of the decay that took place in lending standards during the run-up of the recent U.S. housing bubble.

So far, China’s policy makers appear to have taken to heart a possible role for monetary policy in mitigating the rise of asset bubbles. It remains to be seen how China’s regulators will respond in seeking to preclude any material decline in credit quality, particularly as China’s economy experiences a return of robust growth.

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