The Independent Evaluation Office (IEO) for the IMF released its evaluation of the Eurozone bailouts last week. Unfortunately, the excellent report was released on the Thursday of what was for Bureaucristan the last working week before September, and was released as a package with prebuttal of the recommendations by the Fund itself, which diluted its impact. And even in the financial pages of the newspapers, attention was more focused on the banking stress tests which came the following day [UPDATE: good attention to the IEO report from the New York Times]. Nevertheless, the report deserves a long shelf life; below the fold (direct quotes in italics), a selection from its more striking findings: note, these findings may have been documented elsewhere sporadically before, but one value of the report is collecting them all in one place and integrating them into a broader narrative.
IMF note to the G20 meeting in Shanghai in February —
The global recovery has weakened further amid increasing financial turbulence and falling asset prices. Activity softened towards the end of 2015 and the valuation of risky assets has dropped sharply, especially in advanced economies, increasing the likelihood of a further weakening of the outlook. Growth in advanced economies is modest already under the baseline, as low demand in some countries and a broad-based weakening of potential growth continue to hold back the recovery. Adding to these headwinds are concerns about the global impact of China’s transition to more balanced growth, along with signs of distress in other large emerging markets, including from falling commodity prices. Heightened risk aversion has triggered global equity market declines and brought a further tightening of external financial conditions for emerging economies. Strong policy responses both at national and multilateral levels are needed to contain risks and propel the global economy to a more prosperous path.
IMF note to the G20 meeting in Chengdu in July–
“Brexit” marks the materialization of an important downside risk to global growth. The global outlook, set for a small upward revision prior to the U.K.’s referendum, has been revised downward modestly for 2016 and 2017, reflecting the expected macroeconomic consequences of a sizable increase in economic, political, and institutional uncertainty. But with “Brexit” still very much unfolding, more negative outcomes are a distinct possibility.
The two notes, which are written barely 6 months apart, read together bizarrely. The earlier note sees anxiety in financial markets and searches around for any narrative that could justify that — to the point where even a fall in oil prices could be bad! The new note has the luxury of an actual negative shock — Brexit — to work with, but with one big problem relative to the doom-and-gloom narrative of February:– it says that if it wasn’t for Brexit, the IMF was ready to along with the evaporated panic from February, and anyway financial markets haven’t taken Brexit particularly badly!
Could it be that the financial market-led narrative in February was a panic in search of a problem, except that the markets — and thus anyone using that as their lens — missed the one problem that was actually on the horizon, namely Brexit? As it happens, financial asset prices could well be a bit player in the way Brexit eventually plays out.
The IMF Board considered the annual surveillance of the UK economy barely 2 weeks ago, and the associated report was published even more recently. And a couple of days after that, its main findings about fiscal policy — trumpeted by George Osborne during the visit — are effectively dead. Here’s what the Fund says (page 10) —
Relative to the last pre-election budget (March 2015), the authorities’ latest fiscal plans as announced in the 2015 Autumn Statement envisage a smoother path of deficit reduction. Consolidation is also now based somewhat less on spending cuts than previously projected, partly due to revised revenue and interest expenditure projections and new revenue measures. The consolidation path is appropriate in the baseline scenario. Continued consolidation is needed to rebuild buffers, thereby allowing more aggressive countercyclical policy during the next recession.
Similar language is peppered throughout the report. The problem is now out in the open in that Osborne used a G20 trip to Shanghai and a linked interview with the BBC’s Laura Kuenssberg to confirm what had been obvious to analysts for a long time: the revenue, growth, and modeling assumptions underlying the Autumn Statement cannot be met.
Imagine if an African country finance minister uncorked a worse economic scenario than he’d told the Fund just weeks after their visit!
The IMF World Economic Outlook update is out. Despite all the China and financial markets talk, the movement in the forecast is more about the uselessness of BRICS as an economic concept: deeper recessions than foreseen even 6 months ago in Brazil and Russia, extreme sluggishness in South Africa, what the Fund still views as an adjustment and not a crash in China, and strong growth in India.
But anyway, the projection contains its typical sentence from the post-2008 years: Risks to the global outlook remain tilted to the downside.
Why does it never say The projection remains tilted to the upside?
From the Davos-timed Oxfam analysis of global wealth distribution —
In 2015 the net wealth of the 3.6 billion people living in the bottom 50
percent was $1.75 trillion.
That means average wealth for those 3.6 billion people was US$486. It’s a wonder they’re not all trying to move to richer countries, but at that wealth level, they probably can’t afford to!
Unfortunately the dark and cold days of winter tend to bring some untimely departures and this season’s deaths now include our blogging colleague Edward Hugh, who we gather died yesterday in Spain. Edward’s posts here and on other platforms marked him out as someone with the fresh eyes of an economist who had made his own way to an analytical framework that found its ideal subject in the Eurozone financial crisis. The slow-burning demographic strains of which Edward had long written remain even as the banks get very slowly cleaned up, and are of course a subtext to the current migration crisis. Here’s a link to the New York Times profile of Edward from a few years ago which further broadened his audience. Our condolences to those who knew Edward best.
UPDATE: The New York Times has a nice obituary.
From UK Chancellor of Exchequer George Osborne’s opening statement at the joint news conference with the IMF yesterday, Mme Lagarde in attendance, to conclude the IMF assessment of the UK economy –
Yes, there are still risks. The IMF have identified the risks, and they are the same risks we’ve identified and are taking action to prevent. I take this as an endorsement of our plan to fix the roof while the sun is shining.
The table above is from the IMF’s July 2008 assessment of the UK economy. Bear in mind that the first tremors of the global financial crisis had happened nearly a year earlier. The debt and deficit are now over twice as high as these numbers. The IMF team of course doesn’t have much choice but to sit there politely when Osborne uses his 7 year old political slogan about fixing the roof etc. But by the IMF’s own standards, the roof was in good shape in summer 2008. The pile of rubble fell afterwards.
If George Osborne continues to be able to find enough new future cash via changed modeling assumptions to spread around, he might yet get the growth of GDP, and eventually the level, back to where it would have been before austerity started!
Figure source Office for Budget Responsibility Economic and Fiscal Outlook November 2015. Chart 2.1: Selected vintages of ONS real GDP estimates and OBR forecasts.
IMF statement on Ukraine, yesterday —
Despite these positive developments, in view of the larger than expected economic decline in the first half of the year, the mission revised down growth projections for 2015 to -11 percent.
IMF previously published growth projection for 2015 — in August:
The 2015 baseline growth projection has been marked down to -9 percent (relative to -5½ percent at the EFF approval), driven by a delayed pick up in industrial production, construction, and retail trade, and expectations of a weaker agricultural season.
So in 2 months, from a projection already set over half way into the year, another 2 percentage points has been knocked off the growth rate, which itself is now nearly 6 percentage points off its original assumption. And that’s in a context where the eastern conflict situation has been stable compared to the earlier part of the year.
With the business news industry about to fixate on every number that is uttered in Lima at the IMF-World Bank meetings, it’s worth considering the shelf life of these projections.
Paul Krugman writing in June 2012 on the UK-Spain interest differential, attributing it to the constraints of currency union –
Then there’s the lender of last resort issue, which turns out to be broader than even those who knew their Bagehot realized. Credit for focusing on this issue goes to Paul DeGrauwe, who pointed out that national central banks are potentially crucial lenders of last resort to governments as well as private financial institutions. The British government basically can’t face a “rollover” crisis in which bond buyers refuse to purchase its debt, because the Bank of England can always step in as financier of last resort. The government of Spain, however, can face such a crisis – and there is always the risk that fears of such a crisis, leading to default, could become a self-fulfilling prophecy. As DeGrauwe has pointed out, Britain’s fiscal outlook does not look notably better than Spain’s. Yet the interest rate on British 10-year bonds was 1.7% at the time of writing, whereas the rate on Spanish 10-years was 6.6%; presumably this liquidity risk was playing an important role in the difference.
At the Jackson Hole Federal Reserve Bank of Kansas City central bankers symposium yesterday, one of the more interesting papers, by Faust and Leeper —
Why, if Spanish debt was in safe territory, did its 10-year bond yields begin to rise in 2011? Figure 14 suggests that more than bond-market vigilantism was in play. During the decade of good fiscal housekeeping, Spanish inflation was chronically above union-wide inflation, at times by more than a percentage point. Thoughtful observers would note that in a monetary union, Spain’s persistently higher-than-union-wide inflation rates could damage the country’s competitiveness and future growth prospects. With weak future economic growth come lower tax revenues and higher social safety-net expenditures that reduce the expected flow of Spanish primary surpluses and shift the country’s fiscal limit in toward prevailing and growing debt levels. Whether from lack of competitiveness or some other source, Spain did experience a second dip in economic growth from 2011 through the middle of 2013. Unemployment continued the upward march that it began during the recession, rising well above 20 percent before peaking at 27 percent in February 2013. These developments raised concerns about Spain’s ability to finance government debt that rose from 69 to 92 percent of GDP between 2011 and 2013. Movement of debt toward Spain’s fiscal limit coincided with an inward shift in the country’s limit distribution, a combination that Bi’s (2012) fiscal limit analysis predicts would raise risk premia.
Fiscal limits tell us that debt-GDP ratios are an incomplete—and potentially misleading— summary of a country’s fiscal health. What matters is the distance between current debt and the fiscal limit distribution. The position and shape of that distribution, in turn, depend on the great many factors that determine the discounted value of future primary surpluses. As the Spanish and U.S. fiscal stress examples illustrate, interactions between cyclical outcomes (inflation and unemployment) and longer-run developments (fiscal financing and sustainability) run in both directions to compound the confounding dynamics.
Bottom line: the interest differential that seemingly favoured the UK over Spain is about more than the Bank of England’s ability to finance the government in a crisis. It’s also about the other factors which determine the likelihood of such a crisis in the first place.