We told you so

If the global economy continues to weaken, the International Monetary Fund will have the unsatisfying consolation of being able to say “we told you so”. For years, it has warned against getting stuck in a “new mediocre” state of weak growth. The latest World Economic Outlook, the fund’s flagship report, on Tuesday intensified the gravity of the warning.

IMF chief economist Maury Obstfeld’s synopsis is here, but the WEO’s core message is summed up in this single sentence: “Not only is the central WEO scenario now less favorable and less likely [than before]; in addition, the even weaker downside outcomes have become more likely.”

The numbers make for depressing reading. The IMF has, again, shaved its forecasts for growth by a few decimals, and much more in some cases. The risk of a regional recession has gone up since previous WEOs: the IMF puts it at 35-40 per cent in the eurozone and Japan, and at one-fifth in the US. The fund takes very seriously the possibility of “secular stagnation” in the form of self-fulfilling expectations of weak growth.

The main reasons for the pessimism are themes Free Lunch has covered over the past year. Most fundamental is the weakness of investment everywhere, which has a number of causes. The slowdown in China, and its vulnerability to a disorderly currency crisis, has spooked financial markets. Confidence has been further undermined by concern that policymakers are unable to do more to boost growth — a negativity we have argued is gratuitously self-inflicted.

Finally, the huge fall in commodity prices has not so far produced a rebound in growth. My colleague Chris Giles has rounded up the possible reasons why this may be. And IMF researchers have on Wednesday published their analysis, which points out that when central banks cannot (or as I would argue, choose not to) cut interest rates, an oil price collapse can raise real interest rates and hold back demand. Relatedly, we have previously discussed why passive monetary policymakers may be the reason why oil price falls seem to lower inflation expectations far into the future.

On top of that, there are geopolitical risks with economic consequences, from the Syrian refugee crisis to Britain’s potential own goal of Brexit.

In its discreetly technocratic way, the WEO is a huge indictment of national policymakers. That is the flip side of its very constructive set of policy recommendations: if there are plenty of measures left for policymakers to take, then our current economic funk is entirely avoidable, and if things get worse, policymakers must squarely take the blame.

What are the recommendations? We shall return to the need for greater government demand stimulus later in the week; we focus here on the WEO’s analysis of structural reforms.

The IMF research department has good form on this topic. Its staff knows how to distinguish between the good, the bad, and the ugly in structural reform. The third chapter of the WEO builds on that previous work, and demonstrates that economics arrives at common sense in the end: structural supply-side reforms that boost aggregate demand more reliably generate growth than those that destroy it.

So product market liberalisation, which increases both people’s purchasing power and companies’ productivity, can be expected to boost growth whatever the economic environment. But with labour market reforms, it all depends. They don’t work well at times of fiscal tightening; and those labour market reforms that reduce demand are downright harmful in a recession. So reforms such as making it easier to fire workers or cutting unemployment benefits should be timed carefully to coincide with bouncy economic times. In today’s circumstances, the most promising labour market reforms are those that also stimulate demand, such as lower taxes on labour and bigger budgets for labour market policies to get more people (back) to work.

In sum, this is a rather progressive policy agenda. The fund endorses more generous family policies and a higher minimum wage in the US; policies to weaken the control that vested interests exert on product markets; more infrastructure and research spending; and a postponement of policies that are likely to harm workers most in the short run.

Why the IMF is seen as the arch-enemy by some people on the left is getting ever harder to understand.

Other readables

  • Enlightenment from Chris Dillow on inheritance taxes. A particularly important point: holding constant public spending, lighter taxation of inherited wealth entails heavier taxation of other income. More generally, “a lot of the defences of inheritance look pathetically weak”.
  • The New York Fed has launched its own “nowcast” — a real-time estimate of how the economy is doing. Its nowcast of first-quarter growth in the US economy is a 1.1 per cent annualised rate, in contrast with the Atlanta Fed’s well-established GDPNow, which estimates a virtual standstill in the same quarter with growth at just 0.1 per cent. It will be interesting to see which of the two performs best.

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