IMF Admits QE Encourages Excessive Risk-Taking; Warns "Sharp Downside Risks Are Rising"

With the Fed unleashing its bubble-watchers last week, on the heels of warnings from the Central Bankers' Central Bank (BIS), The IMF has decided it is time to chirp in. As Mises' David Howden notes, after promoting QE for years (see here and here), the IMF is finally coming to realize what has been apparent for years now to almost everyone who doesn’t work for the Fed or the IMF: that low interest rates encourage risky decisions. The Guardian reports, excessive risk taking and geopolitical hazards pose new threats to a global economy already experiencing an uneven and weaker than expected recovery, the International Monetary Fund has warned. In a report prepared in advance of the G-20 meetings, The IMF warns, "financial market indicators suggested investor bets funded with borrowed money looked “excessive” and that markets could quickly deflate if there were surprises in U.S. monetary policy or the conflicts in Ukraine and the Middle East."

Some key excerpts from the full report below:

Sovereign bond yields have edged further down and equity prices have generally risen. Sentiment toward emerging markets has improved, as reflected in resilient portfolio inflows and stable or stronger currencies. Implied volatility measures fell to the very low levels prevailing before the May 2013 tapering remarks. This raises concerns that excessive risk taking may be building up, which could sharply reverse in the run-up to U.S. rate hikes or should geopolitical events trigger higher risk aversion.


Implied volatilities across asset classes have continued to decline, reaching levels prevailing before the Fed tapering talk. This raises concerns of a buildup of excessive leverage and under-pricing of credit risk which could be abruptly corrected in the run-up to U.S. rate hikes or because of higher global risk aversion.



Financial stability risks related to a prolonged period of low interest rates bring macro-prudential policies to the forefront. Excessive risk-taking may be building in some sectors (U.S. corporate credit and insurance markets, housing price booms in a number of smaller advanced economies) after more than five years of exceptionally low rates (see annex). Completing the reform of financial regulation and deploying macro-prudential tools as a first line of defense, as needed, are essential to limit financial risks. This will also reduce the risk of premature monetary policy tightening not warranted by the cyclical position. It will also make systemic institutions more resilient, help contain pro-cyclical asset price and credit dynamics, and cushion the consequences of liquidity squeezes if volatility spikes.


Misperception of policy intentions in source countries or an autonomous slowdown in EMs may trigger larger spillover effects. Should market participants misperceive central banks’ policy intentions—which could potentially bring about financial volatility and temporary disruptions in short-term interest rates, as during the May 2013 taper episode—spillovers may be amplified, at least initially. Moreover, a deceleration in EMs would exacerbate the global shock. Such a downside scenario is analyzed in the spillover report, which concludes that GDP could fall at the through by 1½–2 percent compared to the baseline.

As Reuters reports,

The global economy faces a growing risk from big financial market bets that could quickly unravel if investors get spooked by geopolitical tensions or a shift in U.S. interest rate policy, the International Monetary Fund said on Wednesday.




But it also warned that financial market indicators suggested investor bets funded with borrowed money looked "excessive" and that markets could quickly deflate if there were surprises in U.S. monetary policy or the conflicts in Ukraine and the Middle East.

And The Guardian adds,

In an assessment prepared for finance ministers and central bank governors of the G20 countries, the Washington-based fund said problems in the US, the eurozone, China, Japan, Russia and Latin America meant growth would not meet the 3.6% pencilled in for 2014 in April.


The IMF said it expected the world economy to pick up speed during 2015 because long-term interest rates were low, central banks were supporting activity and share prices were rising. But it issued a warning that new threats could be building even before the global economy had recovered fully from its biggest downturn since the Great Depression of the 1930s.


"New downside risks associated with geopolitical tensions and increasing risk taking are arising," the IMF said. It said other risks stemmed from low inflation, a permanent slowdown in growth rates in the west, lower growth in emerging economies and the possible disruption to financial markets that might be caused when the US Federal Reserve starts to raise interest rates.




It said the main challenge in the US was to judge the appropriate speed at which monetary policy – interest rates and the asset purchase programme known as quantitative easing – should return to normal, given the state of the economy and the impact of higher interest rates on consumers and businesses.

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As Mises' David Howden concludes,

It’s reassuring that after years of prodding people to borrow and spend by taking advantage of low interest rates, the IMF now wants to warn us of the risks involved. Oh well, better late then never.

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So it seems only The Fed is left unaware of the implications of its policies?

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Full report below:

IMF Warning