Building Defenses Against the Next Economic Downturn
IMF Blog, January 17, 2019
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- Authors: David Lipton
- Published: January 17, 2019
Overview of risks and fragmentation
- The global economy faces complex challenges from technological change, globalization, and the lingering effects of the 2008-9 financial crisis.
- Declining trust in core institutions over the past 40 years risks fragmenting the international order that has governed the global economy.
- Symptoms of fragmentation include rising trade tensions, discord with and within some multilateral institutions, and diluted efforts to address cross-border challenges such as climate change, cyber-crime, and refugee flows.
- Recent signs of slowing global growth underline the imperative to prepare for unexpected developments; "History suggests such a downturn is somewhere over the horizon."
Monetary policy constraints and considerations
- Past U.S. recessions have been met with "500 basis points or more" of Federal Reserve easing.
- During the global financial crisis, central banks used their balance sheets extensively.
- Current challenges:
- Policy rates remain "so low in so many countries."
- Balance sheet normalization is "still underway."
- Conventional responses used in past crises "may not be available."
- Unconventional measures discussed include negative rates, forward guidance pledges to hold rates at lower levels longer than justified by inflation targets or policy rules, and other innovations.
- The effectiveness of these unconventional ideas is "at best uncertain," raising concern about the potency of monetary policy.
Fiscal policy room and trade-offs
- Public debt has risen in many advanced economies; the U.S. increase followed tax cuts and spending increases.
- In many countries, deficits "remain too high to stabilize or reduce debt."
- If a slowdown creates unemployment and economic slack, fiscal multipliers should grow, which could restore some fiscal potency even at high debt levels.
- However, governments may lack the budgetary room to respond as they did ten years ago; with high sovereign debt levels, fiscal stimulus "may be a hard sell politically."
- Supporting households, small businesses, or homeowners in a future recession could further strain public finances, but failing to act could deepen political divides.
Financial sector resilience and regulatory frameworks
- Post-crisis reforms shift recourse away from bailouts toward bail-ins of owners and lenders; these new systems remain "underfunded and untested."
- The global financial crisis showed that impairment of key U.S. capital markets was contained by unorthodox central bank actions supported by backstop funding from national treasuries.
- The capacity to repeat that level of coordinated support "is unlikely to be readily available."
- Conclusion: national policy options and public financial resources may be much more constrained than in the past, implying the need to sustain growth, limit vulnerabilities, and prepare proactively.
Multilateral preparedness and the IMF's role
- Multilateral preparedness and action are essential; institutions like the IMF have played a crucial role in responding to crises and keeping the global economy on track.
- The IMF increased its lending capacity during the Global Financial Crisis to "about one trillion dollars."
- The G20, at the November meeting in Buenos Aires, restated commitment to support the global financial safety net with "a strong and adequately financed IMF at its center."
- IMF Managing Director Christine Lagarde has called for a "new multilateralism" aimed at improving lives broadly and sharing the benefits of globalization and technology more widely.
- Continued IMF reform across lending, analytical, and research activities is necessary to meet the core mission of supporting global growth and financial stability, especially if national tools prove insufficient.
Policy implications and recommendations
- Countries should shore up defenses now by:
- Building and preserving financial firepower.
- Strengthening policies to fight crises and maintaining robust regulatory regimes established after the Global Financial Crisis.
- Sustaining growth and limiting vulnerabilities to reduce reliance on constrained national policy options in a downturn.
- Multilateral action should be reinforced by:
- Continuing IMF evolution and reform across lending, analysis, and research.
- Ensuring the IMF remains strong and adequately financed to serve as the center of the global financial safety net.
- Address political economy considerations:
- Anticipate calls to relieve debt burdens of small businesses and homeowners in a downturn and plan for the fiscal implications.
- Recognize that political constraints may limit fiscal stimulus even when multipliers increase.
Source: David Lipton, "Building Defenses Against the Next Economic Downturn", IMF, January 17, 2019 — https://www.imf.org/en/blogs/articles/2019/01/17/blog-building-defenses-against-the-next-economic-downturn
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