IMF Cuts Global Growth, Warns Central Banks, Whose Capital Is An "Arbitrary Number", Is Only Game In Town

"The recovery continues but it has weakened" is how the IMF sums up their 250-page compendium of rather sullen reading for most hope-and-dreamers. The esteemed establishment led by the tall, dark, and handsome know-nothing Lagarde (as evidenced by her stroppiness after being asked a question she didn't like in the Eurogroup PR) has cut global growth expectations for advanced economics from 2.0% to only 1.5%. Quite sadly, they see two forces pulling growth down in advanced economies: fiscal consolidation and a still-weak financial system; and only one main force pulling growth up is accommodative monetary policy. Central banks continue not only to maintain very low policy rates, but also to experiment with programs aimed at decreasing rates in particular markets, at helping particular categories of borrowers, or at helping financial intermediation in general. A general feeling of uncertainty weighs on global sentiment. Of note: the IMF finds that "Risks for a Serious Global Slowdown Are Alarmingly High...The probability of global growth falling below 2 percent in 2013––which would be consistent with recession in advanced economies and a serious slowdown in emerging market and developing economies––has risen to about 17 percent, up from about 4 percent in April 2012 and 10 percent (for the one-year-ahead forecast) during the very uncertain setting of the September 2011 WEO. For 2013, the GPM estimates suggest that recession probabilities are about 15 percent in the United States, above 25 percent in Japan, and above 80 percent in the euro area." And yet probably the most defining line of the entire report (that we have found so far) is the following: "Central bank capital is, in many ways, an arbitrary number." And there you have it, straight from the IMF.

The full details are below. 

Summing it up (via Reuters):

Global growth is too weak to bring down unemployment and what little momentum exists is coming primarily from central banks, the International Monetary Fund said in its World Economic Outlook, released ahead of its twice-yearly meeting, which will be held in Tokyo later this week.

The keyword is momentum. Or rather lack thereof:

Policy tightening in response to capacity constraints and concerns about the potential for deteriorating bank loan portfolios, weaker demand from advanced economies, and country-specific factors slowed GDP growth in emerging market and developing economies from about 9 percent in late 2009 to about 5¼ percent recently. Indicators of manufacturing activity have been retreating for some time (Figure 1.3, panel 1). The IMF staff’s Global Projection Model  suggests that more than half of the downward revisions to real GDP growth in 2012 are rooted in domestic developments.

  • Growth is estimated to have weakened appreciably in developing Asia, to less than 7 percent in the first half of 2012, as activity in China slowed sharply, owing to a tightening in credit conditions (in response to threats of a real estate bubble), a return to a more sustainable pace of public investment, and weaker external demand. India’s activity suffered from waning business confidence amid slow approvals for new projects, sluggish structural reforms, policy rate hikes designed to rein in inflation, and flagging external demand.
  • Real GDP growth also decelerated in Latin America to about 3 percent in the first half of 2012, largely due to Brazil. This reflects the impact of past policy tightening to contain inflation pressure and steps to moderate credit growth in some market segments—with increased drag recently from global factors.
  • Emerging European economies, following a strong rebound from their credit crisis, have now been hit hard by slowing exports to the euro area, with real GDP growth coming close to a halt. In Turkey, the slowdown has been driven by domestic demand, on the heels of policy tightening and a decline in  confidence. Unlike in 2008, however, generalized risk aversion toward the region is no longer a factor. Activity in Russia, which has benefited various economies in the region, has also lost some momentum recently.

IMF isn't happy about Europe:

Notwithstanding policy action aimed at resolving it, the euro area crisis has deepened and new interventions have been necessary to prevent matters from deteriorating rapidly. As discussed in the October 2012 Global Financial Stability Report (GFSR), banks, insurers, and fi rms have swept spare liquidity from the periphery to the core of the euro area, causing Spanish sovereign spreads to hit record highs and Italian spreads to move up sharply too (Figure 1.2, panel 2). Th is was triggered by continued doubts about the capacity of countries in the periphery to deliver the required fi scal and structural adjustments, questions about the readiness of national institutions to implement euro-area-wide policies adequate to combat the crisis, and concerns about the readiness of the European Central Bank (ECB) and the European Financial Stability Facility/ European Stability Mechanism (EFSF/ESM) to respond if worst-case scenarios materialize.


These concerns culminated in questions about the viability of the euro area and prompted a variety of actions from euro area policymakers. At the June 29, 2012, summit, euro area leaders committed to reconsidering the issue of the seniority of the ESM with respect to lending to Spain. In response to escalating problems, Spain subsequently agreed on a program with its European partners to support the restructuring of its banking sector, with financing  of up to €100 billion. Also, leaders launched work on a banking union, which was followed up recently with a proposal by the European Commission to  establish a single supervisory mechanism. Leaders agreed that, once established, such a mechanism would open the possibility for the ESM to take direct equity stakes in banks. This is critical because it will help break the adverse feedback loops between sovereigns and banks. Moreover, in early September, the ECB announced that it will consider (without ex ante limits) Outright Monetary Transactions (OMTs) under a macroeconomic adjustment or precautionary program with the EFSF/ESM. The transactions will cover government securities purchases, focused on the shorter part of the yield curve.


Importantly, the ECB will accept the same treatment as private or other creditors with respect to bonds purchased through the OMT program. (ZH: not really - especually not when the ECB has to see its bonds incur losses - see Greece)The anticipation of these initiatives and their subsequent deployment set off a relief rally in financial markets, and the euro appreciated against the U.S. dollar and other major currencies. However, recent activity indicators have continued to languish, suggesting that weakness is spreading from the periphery to the whole of the euro area (Figure 1.3, panel 2). Even Germany has not been immune.

.. or the US:

The U.S. economy also has slowed. Revised national accounts data suggest that it came into 2012 with more momentum than initially estimated. However, real GDP growth then slowed to 1.7 percent in the second quarter, below the April WEO and July WEO Update projections. The labor market and consumption have failed to garner much strength.

Could have fooled the BLS and the brand spanking news "7.8% unemployment rate."

The IMF concludes there is little to worry about as a result of global QEternity, an observation that certainly explains the following statement: "Central bank capital is, in many ways, an arbitrary number." ... right.

Risks related to swollen central bank balance sheets


The concern is that the vast acquisition of assets by central banks will ultimately mean a rise in the money supply and thus inflation (Figure 1.5, panel 3). However, as discussed in previous WEO reports, no technical reason indicates this would be inevitable. Central banks have more than enough tools to  absorb the liquidity they create, including selling the assets they have bought, reverting to traditionally short maturities for refinancing, raising their deposit rates, and selling their own paper. Furthermore, in principle, central bank losses do not matter: their creditors are currency holders and reserve-holding banks; neither can demand to be paid with some other form of money. The reality, however, may well be different. A national legislature may see such losses as a symptom that the central bank is operating outside its mandate, Central bank capital is, in many ways, an arbitrary number, as is well illustrated by the large balance sheets of central banks that intervene in foreign exchange markets (Figure 1.5, panel 4). which could be of concern if it led to efforts to limit the central bank’s operational independence. A related concern is that economic agents may begin to doubt the capacity of central banks to fight inflation. Two scenarios come to mind:


  • Public deficits and debt may run out of control, causing governments to lean on central banks to pursue more expansionary policies with a view to eroding the real value of the debt via inflation. Similarly, losses on holdings of euro area, Japanese, and U.S. (G3) government securities may cause emerging market economies’ central banks or sovereign wealth funds to buy fewer G3 government assets, investing instead in better opportunities at home and triggering large depreciations of G3 currencies.
  • Policymakers may falsely perceive central bank balance sheet losses to be damaging to their economies. Such perceptions may make central banks more hesitant to raise interest rates, because doing so would decrease the market value of their asset holdings. The mere appearance of such hesitation may lead private agents to expect an increase in inflation.

And some absolute profundity:

Risks related to high public debt levels


Public debt has reached very high levels, and if past experience is any guide, it will take many years to appreciably reduce it (see Chapter 3). Risks related to public debt have several aspects. First, when global output is at or above potential, high public debt may raise global real interest rates, crowding out capital and lowering output in the long term.3 Second, the cost of debt service may lead to tax increases or cutbacks in infrastructure investment that lower supply. Third, high public debt in individual countries may raise their sovereign risk premiums, with a variety of consequences—from limited scope for countercyclical fiscal policies (as evidenced by the current problems in the euro area periphery) to high inflation or outright default in the case of very large increases in risk premiums.


Simulations with the GIMF suggest that an increase in public debt in the G3 economies of about 40 percentage points of GDP raises real interest rates almost 40 basis points in the long term (Box 1.2). This simulation and discussion necessarily abstracts from the potential long-term benefits of fiscal stimulus. The 2009 stimulus, for example, was likely instrumental in averting a potential deflationary spiral and protracted period of exceedingly high unemployment, macroeconomic conditions that general equilibrium models such as the GIMF are not well suited to capture. Bearing this in mind, the simulation suggests that in the long term the higher debt lowers real GDP by about ¾ percent relative to a baseline without any increase in public debt. This is because of the direct effect of higher interest rates on investment and the indirect effect via higher taxes or lower government investment. The GIMF simulations indicate that within the G3 the negative effects would be larger, with output 1 percent below baseline projections. The loss of output over the medium term would be even larger if, for example, savings were to drop more than expected because of aging populations in the advanced economies or if the consumption patterns of emerging market economies with very high saving rates align more quickly than expected with those of advanced economies.


Scenarios that involve very high levels of debt and high real interest rates may not only result in lower growth but may also involve a higher risk of default when fiscal dynamics are perceived to be unstable. This combination of high debt and high real interest rates can lead to bad equilibriums, when doubt  about the sustainability of fiscal positions drives interest rates to unsustainable levels.

In other words, according to the IMF's brain trust, soaring debt, and exploding interest rates may lead to default. And that is why they get paid the big SDRs.

To summarize:

Risks for a Serious Global Slowdown Are Alarmingly High


The WEO’s standard fan chart suggests that uncertainty about the outlook has increased markedly (Figure 1.11, panel 1). The WEO growth forecast is now 3.3 and 3.6 percent for 2012 and 2013, respectively, which is somewhat lower than in April 2012. The probability of global growth falling below 2 percent in 2013––which would be consistent with recession in advanced economies and a serious slowdown in emerging market and developing economies––has risen to about 17 percent, up from about 4 percent in April 2012 and 10 percent (for the one-year-ahead forecast) during the very uncertain setting of the September 2011 WEO.


The IMF staff’s Global Projection Model (GPM) uses an entirely different methodology to gauge risk but confirms that risks for recession in advanced economies (entailing a serious slowdown in emerging market and developing economies) are alarmingly high (Figure 1.12, panel 1). For 2013, the GPM estimates suggest that recession probabilities are about 15 percent in the United States, above 25 percent in Japan, and above 80 percent in the euro area.

Summary revised (lack of growth) table:





Full report here