Typical street scene in Santa Ana, El Salvador. (Photo: iStock)

Typical street scene in Santa Ana, El Salvador. (Photo: iStock)

IMF Survey: IMF Connects Dots in Spillover Analysis of Major Economies

September 2, 2011

  • New reports enhance IMF analysis of economic flows, risks between countries
  • Financial channels most important for transmitting global shocks
  • Resolving U.S., Euro Area financial stresses critical for rest of world

A new report by the International Monetary Fund underlines the importance of financial links in spreading risk and how policies in major economies impact financial markets.

IMF Connects Dots in Spillover Analysis of Major Economies

A trader on the New York stock exchange. Financial channels are central in transmitting financial shocks, says IMF report (photo: Justin Lane/epa/Corbis)


The report is part of the IMF’s effort to strengthen policy analysis, by enhancing its assessment of interconnections between the world’s economies, and how policies in the larger economies impact the rest of the world.

Since the 2008 global financial crisis, economists and policymakers have become more aware of the risks and potential destabilizing effects that policies and shocks in major economies can have on other countries and regions.

The new focus on “spillover effects”—the impact of policies in one country on another because of the large volume of trade and financial linkages in today’s economy—has been a major element of the IMF’s work agenda in recent months.

This work culminated in a new “consolidated spillover report”. According to Ranjit Teja, Deputy Director of the IMF’s Strategy, Policy and Review Department, spillover reports are “aimed at improving our understanding of the interconnected nature of the world economy in order to support better policy collaboration at the global level.”

Telltale financial stresses

The consolidated report was discussed by the IMF’s Executive Board in late July and follows new detailed assessments of the impact of economic policies in the world’s five largest economies—China, the Euro Area, Japan, United Kingdom, and the United States—on their partner economies. The consolidated report focuses on overarching messages relevant for the global policy debate.

Key among these messages, the report highlights that “short-term policy spillovers hinge on their effects on financial markets” (rather than traditional trade channels). Policies that alleviate financial stress have a powerful and positive effect on the others. Thus, at the outset of the current crisis, the benefits of fiscal stimulus were magnified by the associated easing of financial stress.

Although the reports were completed before the recent bout of market turbulence, the findings illustrate that, “from the perspective of the rest of the world, the most positive spillovers would flow from resolving financial stresses from policy uncertainties,” Teja said.

“The importance of fiscal policy credibility has only increased with recent developments,” Teja added. Steps to enhance U.S. fiscal credibility tackle a key global risk and create space to support U.S. growth in the near term. By contrast, if there were to be “a sharp reduction in confidence in sovereign debt sustainability, the consequences for the rest could be enormous,” the study found.

The same logic applies with regard to policies to tackle financial stresses in the Euro Area, which have a direct and profound bearing on global banking flows—and hence on global economic outcomes.

More comprehensive analysis

The spillover exercise brings added granularity to the way IMF monitors, assesses, and provides advice on economic and financial policies—an activity referred to as surveillance.

Teja expects that the exercise could help gain added traction for the IMF’s work “because it views domestic economic policies as something that plays out on a global scale.”

According to the report, spillover analysis will “fill a gap between the domestic focus of country/bilateral surveillance (Article IVs) and the broad sweep of multilateral (WEO/GFSR) surveillance.” The report explained that the matter of how policies add up and interact “will have to be tackled by the Fund’s multilateral surveillance.”

The needs of members

The exercise began early this year by asking each of the five major—or S5—economies, as well as many emerging market and advanced economies, to specify how the policies of their main S5 partners impact them. IMF staff examined these concerns with a range of analytical tools. The detailed findings were discussed as part of the Article IV consultations with each of the S5 economies, in which then Acting Managing Director John Lipsky participated.

This wider consultation process ensures that IMF surveillance considers issues of the most immediate concern to a range of member countries.

While financial channels received much attention, many of China’s trading partners identified potential spillovers through real (or trade) channels. This included the potentially far reaching consequences of an interruption in China’s so far steady growth and currency revaluation.

While the report found that national and global interests were well aligned in terms of mitigating tail risks, there were nevertheless near-term tensions and trade-offs. For example, the report argues that “promotion of lending and risk-taking through easy monetary policy makes sense in sluggish advanced countries but has complicated macroeconomic management in booming emerging markets.”

Next steps

“Spillover reports are still in their infancy and their value as a surveillance tool has yet to be established,” the report noted.

Building on this early work, the exercise will be continued next year. The modalities of the 2012 exercise—country coverage, products, and process—will be worked out in coming months.

More immediately, the role of spillover reports within the range of IMF surveillance tools will be examined further in the forthcoming Triennial Surveillance Review. Also, the main findings of the spillover reports, together with the IMF’s flagship multilateral surveillance reports, will be discussed by finance ministers and central bank governors during the IMF’s Annual Meetings later this month.”