IMF Report Decoded: Fed May Bring Doomsday

The IMF lowered its global growth forecasts .2 percent from its last forecast in April. All but three countries had their growth forecasts reduced. A key message from the IMF was a warning to the Federal Reserve that monetary tightening, if done too quickly, could create new "downside risks to global growth prospects."

By Evan Soltas
Jul 9, 2013 9:18 AM MT
Bloomberg

The International Monetary Fund lowered its forecasts for global growth today in an update to its annual World Economic Outlook report. It's worried.

Growth in world output will be 0.2 percent lower in 2013 and 2014 than it had projected in April, the IMF said. All but three countries had their growth forecasts reduced, with the sharpest rebukes going to the euro area and emerging markets.

The theme of the update is "growing pains," and the key message is a warning to the U. S. and the Federal Reserve, in particular: Your monetary tightening, if done too quickly, could bring the world economy to its knees. And so far, we don't like what we see.

Of course, the IMF would get in trouble if it actually wrote that. So it says it a little more politely, warning that U.S. policy is creating a new "downside risk to global growth prospects." The IMF is concerned about "possibly tighter financial conditions if the anticipated unwinding of monetary policy stimulus in the United States leads to sustained capital flow reversals."

The problem the IMF sees is that the Fed may want to tighten monetary policy, but the rest of the world (which still faces weak demand) isn't ready for it to do so. A tightening in the U.S. would put those countries in a bind: if they tighten, they weaken their domestic economies; if they don't, investment capital will depart for higher returns in dollar-denominated assets.

The IMF fears, too, that turmoil in financial markets over the past month -- mostly brought on by the Fed's changing plans -- is costly in itself. What it hopes was a "one-time repricing of risk" was a setback to growth.

And if markets continue to rumble, it warned, it is prepared to lower growth forecasts even more in its next full economic outlook report in October. "If underlying vulnerabilities lead to additional portfolio shifts, further yield increases, and continued higher volatility, the result could be sustained capital flow reversals and lower growth in emerging economies," the IMF said.

To prevent that, it wants to see two things from the Fed: sustained monetary stimulus until the recovery is "well established" and "clear communication" on the exit. The implication is the Fed is doing neither one well.

Christine Lagarde, the IMF's managing director, said recently that the world can cope with a Fed stimulus withdrawal -- but only if done responsibly. It's not just financial markets that are skittish.

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