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IMF Uses Spring Meeting to Warn of The Danger of Worldwide Stagnation

The IMF has, yet again, downgraded forecasts for global growth - from 3.4pc to 3.2pc in 2016.

Published: 17th April 2016 08:23 AM  |   Last Updated: 17th April 2016 08:25 AM   |  A+A-

The patient is in a critical condition. The International Monetary Fund is concerned that the global economic recovery has taken too long. Kaushik Basu, chief economist of the World Bank, says the financial crisis has left a "festering wound" that is "refusing to heal".

Growth is too weak, resulting in the equivalent of a compromised immune system that has left the economy vulnerable to fresh diseases.

The IMF has, yet again, downgraded forecasts for global growth - from 3.4pc to 3.2pc in 2016 - and increased its estimate of the chances of a recession to as much as 40pc in the eurozone and Japan.

The question now facing the global economy's physicians: is the ailment chronic or acute?

This matters. Continually weak economic growth and productivity lower confidence, which, in turn, can lead to companies and investors sitting on their money rather than putting it to work. Christine Lagarde, managing director of the IMF, said last week: "Some parts of the world are downright chilly and that makes it hard to spread economic warmth around the world."

Low inflation persists and debt burdens continue to rise. According to IMF calculations, public debt is expected to be 107.6pc of GDP on average in 2016, higher than during the Great Depression and approaching levels only ever seen just after the Second World War.

Much more of this and the prospect of low growth will become a self-fulfilling prophecy. The economic term for this ailment - part real, part psychosomatic - is secular stagnation.

The IMF used its spring meeting last week to deliver a clarion call to governments that financial turmoil and economic stagnation will spread unless decisive action is taken soon. Such advice hasn't always been welcomed. Insiders describe pushback by some governments who have warned the IMF and World Bank not to fuel the doom and gloom.

"Some in the past weeks and months have asked us why we're so pessimistic," says one. "They say: 'There isn't a crisis, there isn't a recession, so why is there such a need to act?'

"They have, in their oblique way, hinted that calls for action would lead people to be more pessimistic and that would have a mutually reinforcing negative effect."

"Often what you get are policymakers saying: 'I didn't agree with your assessment of my country, but everything else is on the money'," says one official.

The IMF's message is also very simple. Central banks around the world have been doing the heavy lifting for more than seven years. Monetary policy - lowering interest rates and buying assets through quantitative easing programmes - has become "overburdened". It is time for governments to step in.

Those that can plough money into higher investment, should. And all countries must do more to make their economies more productive by improving education, making it less costly to hire or fire people and supporting innovation and competition. The message is not new. Maurice Obstfeld, the IMF's chief economist, admitted last week that the fund had been "a little repetitive" over the years with its message of reform. "Maybe one could characterise it more charitably as 'consistent'," he joked.

Policymakers have found all sorts of ways to get across their message about the need for the right blend of monetary policies, fiscal measures and structural reforms. The IMF calls it a "three-pronged approach". The Organisation for Economic Co?operation and Development (OECD) describes the remedy as a "three legged stool".

Branding aside, the consequences of inaction, or getting the policy mixture wrong, are serious. Jose Vinals, head of the IMF's financial stability division, said a prolonged slowdown could reduce expectations of global output over five years by 4pc. "This would be roughly equivalent to forgoing one year of global growth," he said.

This is partly because weak growth also leaves the global economy vulnerable to a host of threatening pathogens. The IMF's latest World Economic Outlook identified the most troubling: emerging market weakness, Chinese jitters, Brexit, terrorism. The list goes on.

Households are seeing the impact of these threats in their pay packets and on the news. Some believe these threats could now lead countries to shun globalisation and co-operation.

Hung Tran, executive managing director of the Institute of International Finance (IIF), which represents the world's biggest banks, describes this as worrying. "If you look around, each country has its own version of populism - in the US with the presidential election campaign, in Europe with the Brexit vote," he says. "It is worrisome because the impact is further unravelling of the post-war international economic financial structure and framework. The very thing that helped the global economy to prosper now is being pulled apart at the seams."

Prescription

The mood was sombre. Caio Megale was standing at the bar of the Marriott hotel in Washington, but there was nothing to celebrate. It was a Friday night during the IMF's 2008 annual meeting, and Megale, who worked for a hedge fund, was worried.

Megale and his colleagues stood in front of the television as Hank Paulson, then US Treasury Secretary, held a rare Friday night press conference. In a move not seen since the Great Depression, Paulson announced that America would take stakes in the country's banks. Co-ordinated action earlier that week had failed to lift markets. Many felt that this would also underwhelm.

"I remember it well," says Megale, who now works as an economist for Itau, Brazil's second biggest bank. "We were watching the TV, waiting for them to announce measures. And they announced weak measures. Everybody just looked at each other and said: 'Oh my god, there will be no Monday'." But Monday arrived, and the world didn't implode.

Today, Megale says the situation isn't like in 2008, but that doesn't mean there won't be a crisis. "I tend to believe that this time around there will be more caution," he says. "But maybe the global economy is skating on thin ice. There has been panic in recent months. The prospect of $20 oil, China's renminbi depreciation, that is still on the back of our minds.

"The question is: are we really OK - or are we only OK because we have massive stimulus from central banks?"

The IMF and the World Bank don't want policymakers to wait to find out. The institutions are a bit like the United Nations of economics. But for all the languages being spoken in the corridors and meeting rooms of their offices in Washington, one phrase seems to be uttered more than any other: "structural reforms". Indeed it is so ubiquitous - intoned almost like a mantra - as to have been rendered practically meaningless.

"Very often, people talk about the importance of 'structural reforms', which for economists is very safe advice because no one quite knows what it means," says Basu of the World Bank. "We use it much too often. But what is happening is that conventional policies, in particular monetary and fiscal policies are not working well, we can see this from around the world."

Angel Gurria, the OECD's secretary general, has a starker message. He says the cost of inaction is the "highest of all". "It is very clear today that using monetary policy only is not going to do the trick because we've used it already to such a great extent that we have negative interest rates," he says.

Mario Draghi, the president of the European Central Bank, Janet Yellen, the chairman of the Federal Reserve, Mark Carney, Governor of the Bank of England and Haruhiko Kuroda, the governor of the Bank of Japan, "can't do all the heavy lifting", according to Lagarde. That is why she believes countries need to adopt "growth-friendly" fiscal policies and structural reforms that "might mean crossing political red lines for some".

Gurria is broadly in agreement: "A little bit more QE by Mr Draghi, yes. A little delay by Yellen and Carney, yes. Mr Kuroda should continue to use the first arrow of Abenomics.

"The only problem is, steam runs out. Central banks are heroes, but ministers of economy, finance, technology need to play their part."

However, the Mexican appears to be sceptical of the extent to which countries can spend their way out of trouble - one of the prongs of the IMF's three-pronged approach. "Many people also talk about fiscal policy: 'Let's spend, spend, spend'," says Gurria. "But gross debt in the OECD club of advanced economies has climbed from 60pc of GDP to 110pc. That is another constraint."

This increases the importance of structural reforms. "That means education, competition, jobs, tax structures, infrastructure," says Gurria. "They are all needed to get the economy going."

The IMF's World Economic Outlook is also not short of advice. The supply-side reforms (that is those that come from investment and the removal of barriers on the production of goods and services) it lays out are designed to boost total demand and hence generate growth. Some reforms are certainly more contentious than others. Product market liberalisation - which increases competition, makes companies increasingly productive and ensures consumers get more bang for their buck - is generally seen as a good thing. But even the kinds of reforms that bring this about can have negative short-term effects.

With labour market reforms - making it easier for companies to hire and fire staff - the secret is in the timing; at times of fiscal tightening or in a recession they could actually reduce demand. Last April, Olivier Blanchard, then the IMF's chief economist, said "structural reforms are no miracle cure - the effects are very often uncertain".

And there's no one-size-fits-all solution.

Punam Chuhan-Pole, the World Bank's top economist looking at Africa, thinks, for example that the most important reforms for the continent she spends most time studying are boosting cross-border trade by building better roads, ensuring that the whole population is connected to power supplies and increasing "domestic resource mobilisation", which is a fancy way of saying "raise taxes".

This is a different wish list than would be required in east Asia or Europe, for example. It also raises the problems posed by many structural reforms.

Building roads and extending power grids costs money. And increasing tax revenues - either by hiking rates or collecting more efficiently - is politically unpalatable.

Augusto de la Torre, the chief economist for Latin America and the Caribbean at the World Bank, says it is all very well for his organisation and the IMF to tell countries that they need structural reforms: "That's correct. But it's not very helpful." What is also needed is advice on how to enact those reforms in ways that are less socially painful.

Prognosis

They say that time is a great healer and, above all, governments, businesses and households need to be patient.

In a world that has succumbed to short termism, this may prove difficult. However, Gurria believes it is the only way forward.

"The common thing with all structural reforms is that they take time. Germany implemented them 10 years ago and it has been relatively stable through the crisis. Spain introduced reforms [that introduced unilateral changes to working conditions, such as working hours or wages] a few years ago and after a difficult period is now feeling the benefits."

Gurria suggests leaders will have to look beyond vote-winning policies to secure long-term growth. "It takes time to get the results," he repeats. "It needs patience, communication, and courage by leaders to build a bridge between the difficult decisions and the time to get good results."

But last week the IMF left everyone in no doubt: without that leadership from governments to carefully select and enact the necessary structural reforms, the prognosis for the global economy does not look good.

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