The risks lurking in a benign global economy
IMF managing director Christine Lagarde, second from left, with other delegates in 2017. The IMF is relatively sanguine on the evolution of regulation since 2008, but that is not a unanimous view.
At the IMF annual meetings next week, delegates will survey a now familiar global economic landscape. The US economy is doing fine. For the moment the only question is how quickly, rather than whether, the Federal Reserve will continue to raise interest rates. The other two big central banks, the Bank of Japan and the European Central Bank, are rather slower to travel that particular path. The ECB is en route to withdrawing quantitative easing; the BoJ, for the moment, is keeping its foot pressed to the floor.
Meanwhile, emerging markets are facing a difficult external environment as a stronger dollar and higher US interest rates threaten those economies dependent on foreign financing.
But beneath that largely benign surface risks have been building up, as they did in the years before the global financial crisis in 2008. Whereas recessions used to follow a fairly familiar pattern, coming at the end of a Fed rate-raising cycle, the threat from financial crises is ever present. An episode of turmoil is not necessarily a good guide to the next one.
The long periods of super-low interest rates were the right course for central banks. But a long period when it was extremely cheap for financial institutions to borrow inevitably carries risks of excessive leverage and risk-taking. A chorus of concern came from ECB policymakers including Mario Draghi, its president, and Peter Praet, its chief economist, warning that the non-bank financial system had grown very rapidly and now seemed to be highly leveraged.
Unhelpfully, as Mr Praet pointed out, data are sparse in such areas. Despite huge amounts of research and debate on the area of macroprudential management, policymakers also admit they are short of ways to rein in risks in the shadow banking sector before they can blow back to the real economy. The IMF itself is relatively sanguine on the evolution of regulation since 2008, but that is not a unanimous view. The risk that the Chinese debt burden will blow up at some point also means policymakers can never truly relax.
Meanwhile, central banks and finance ministries are dealing with the shorter-term risks arising from the economic cycle, particularly the higher US bond yields and stronger dollar that traditionally affect emerging markets. Happily, the signs of a general weakness across the whole sector are limited. There is considerable differentiation not so much between one region and another as between those economies — Argentina, Venezuela, Turkey — that have made palpable policy mistakes and those that have not.
Research by IMF economists shows how the varying quality of policymaking across emerging markets determines their ability to deal with shocks. Currency depreciations in EMs are easier to cope with for countries such as Chile and Poland, where well-anchored inflation expectations mean weaker exchange rates do not pass through much into upward price shocks. It is tougher for economies such as Russia and Argentina, where a depreciation often demands tighter domestic monetary policy.
Excepting the likes of Turkey, few economic policymakers are making obvious howling errors at the moment. Monetary policy in the advanced economies is more or less where it should be. Even Donald Trump’s misguided trade war has not yet had serious macroeconomic impact. But unknown risks lurk in this apparently benign environment. If and when the next crisis comes, the real problem is less likely to be mistakes in reacting to it than the failure to have designed tools to prevent it arising in the first place.