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

IMF News, September 2, 2011

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Purpose: strengthen policy analysis by enhancing assessment of interconnections between the world’s economies and how policies in the larger economies impact the rest of the world.
Context: the exercise responds to heightened awareness since the 2008 global financial crisis of risks and destabilizing effects that policies and shocks in major economies can have on other countries and regions.
Scope: a new “consolidated spillover report” synthesizes 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.
Quoted objective: 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.” (Ranjit Teja, Deputy Director, Strategy, Policy and Review Department)

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 other countries.
Historical interaction: at the outset of the current crisis, the benefits of fiscal stimulus were magnified by the associated easing of financial stress.
From the perspective of the rest of the world, the most positive spillovers would flow from resolving financial stresses from policy uncertainties.
Fiscal credibility:
- “The importance of fiscal policy credibility has only increased with recent developments.”
- Steps to enhance U.S. fiscal credibility tackle a key global risk and create space to support U.S. growth in the near term.
- Conversely, “if there were to be a sharp reduction in confidence in sovereign debt sustainability, the consequences for the rest could be enormous.”
Euro Area: policies to tackle financial stresses in the Euro Area have a direct and profound bearing on global banking flows—and hence on global economic outcomes.

The spillover exercise adds granularity to IMF surveillance by monitoring, assessing, and advising on economic and financial policies with a cross-border lens.
The exercise treats domestic economic policies as actions that “play out on a global scale.”
Analytical role: spillover analysis is intended to “fill a gap between the domestic focus of country/bilateral surveillance (Article IVs) and the broad sweep of multilateral (WEO/GFSR) surveillance.”
The interaction and cumulative effects of policies will need to be addressed by the Fund’s multilateral surveillance.

Process: the exercise began 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 and discussed detailed findings as part of the Article IV consultations with each of the S5 economies (in which then Acting Managing Director John Lipsky participated).
Country perspectives:
- Financial channels received much attention across consultations.
- Many of China’s trading partners identified potential spillovers through real (trade) channels, including the potentially far reaching consequences of an interruption in China’s so far steady growth and currency revaluation.
Trade-offs: while national and global interests were well aligned in terms of mitigating tail risks, near-term tensions exist—for example, “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.”

Status: “Spillover reports are still in their infancy and their value as a surveillance tool has yet to be established.”
Continuation: the exercise will be continued next year; modalities of the 2012 exercise—country coverage, products, and process—will be worked out in coming months.
Integration with IMF processes:
- The role of spillover reports within the range of IMF surveillance tools will be examined further in the forthcoming Triennial Surveillance Review.
- 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.

IMF Survey Online, September 2, 2011.