IMF warns on monetary policy

The International Monetary Fund issued a report warning to finance ministers cautioning against continued stimulus.

Here’s the story from the Financial Times:

 Extraordinarily loose monetary policy risks sparking credit bubbles that threaten to tip the world back into financial crisis, the International Monetary Fund warned on Wednesday.

In its global financial stability report, the fund cautioned that policy reforms were needed urgently to restore long-term health to the financial system before the long-term dangers of monetary stimulus materialised.

Without more progress, the IMF said “the global financial crisis could morph into a more chronic phase, marked by a deterioration of financial conditions and recurring bouts of financial instability”.

In the short term, however, the fund was more upbeat. José Viñals, IMF head of financial stability, said: “Spring has arrived to global financial markets where after very rainy days and threatening clouds, we are beginning to see some blue skies and more sunny days.”

The IMF believes unorthodox monetary policies to encourage growth are better than other options, but is concerned that the long-term consequences of such strategies represent a “new risk” to financial stability.

“When the patient is still under treatment, you should not suspend the medicine, but you should always be vigilant about the side-effects of this medicine,” Mr Viñals said, adding that central banks could not be the “only game in town” to support economic growth.

The report warned that when the time came to end extraordinarily loose monetary policy, the effects could expose vulnerabilities among companies and households facing higher long-term interest rates, destabilise credit markets and reverse capital inflows to emerging economies.

According to the New York Times, the warnings echo the debate that the Federal Reserve is having itself:

The International Monetary Fund is urging the Federal Reserve and other central banks to closely monitor their extraordinary efforts to jump-start economic growth, warning that the policies could inflate asset bubbles and destabilize financial markets.

The global lending organization said in a global stability report released Wednesday that the low interest rate policies, which are intended to spur borrowing, spending and investing, are providing “essential support” for economic growth and should continue. But it noted that the policies could have “adverse side effects,” including excessive corporate debt, a stock market bubble and risky investments by pension funds.

The fund says there are few signs of asset price bubbles yet.

The global stability report was released in advance of spring meetings of the IMF and World Bank in Washington this week.

The IMF’s warning echoes recent debates among Federal Reserve policymakers, who have pursued aggressive measures intended to help lower still-high unemployment.

The Fed has said it plans to keep short-term interest rates at record lows at least until unemployment falls to 6.5 percent. And it is purchasing $85 billion a month in Treasury and mortgage bonds to lower long-term rates and encouraging more borrowing.

The Wall Street Journal took the angle that the IMF is trying to keep the global recovery on target and moving forward:

Seeking to keep a fragile global recovery on track, the International Monetary Fund on Tuesday called on countries that can afford it—including the U.S. and Britain—to slow the pace of their austerity measures.

The fund warned that “overly strong” belt-tightening in the U.S. will slow growth this year. Across-the-board government spending cuts, known as the sequester, were the “wrong way” to shrink the budget deficit, it said in its semiannual report on economic growth.

Those cuts should be replaced by more targeted reductions that would take effect further down the road—after the economy gains more strength, the report said.

The U.K. government, which in 2010 embarked on a closely watched effort to escape its slump through tax increases and spending cuts, also should consider easing up on its austerity drive amid a weak recovery there, it said.

And it warned euro-area policy makers against focusing too much on hitting tough deficit targets, saying they risked further deepening their downturn.

“Fiscal adjustment needs to proceed gradually, building on measures that limit damage to demand in the short term,” the IMF said.

The IMF also called on countries like Germany that have traditionally relied on exports for growth to lift spending to stimulate their economies and, hopefully, imports from its struggling neighbors.

“There is a need for higher demand” in countries with big trade surpluses, IMF Managing Director Christine Lagarde said in a speech last week. “For countries in Northern Europe, like Germany, it means doing more to boost investment.”

The IMF’s message chimes with that of the Obama administration and highlights a continuing gulf between leaders of major economies over how best to recover from the crisis that began five years ago.

It’s this last sentence that I find the most interesting. There are many varying opinions about how the global economy should recover from the financial crisis, and it’s hard to say which one is correct. Since everything is so intertwined in the economy many different ideas can take credit for the same outcome, which is why it’s important the business media continue to cover all these differing opinions on how to keep things going.