IMF Serves Up Lavish Banquet Of Doom

It’s not lookin’ good.

That’s the short version of the IMF’s new World Economic Outlook. The long version came in at a truly “impressive” 185 pages, most of which no one will ever read.

Global growth will be just 2.7% in 2023, the Fund projected. That’d mark the slowest pace of global expansion in more than two decades if you exclude the pandemic and the financial crisis (figure below).

“Overall, this year’s shocks will re-open economic wounds that were only partially healed post-pandemic,” the Fund’s director of research, Pierre-Olivier Gourinchas, wrote, in a blog post that featured a banner image of a massive storm enveloping a large city.

“In short, the worst is yet to come and, for many people, 2023 will feel like a recession,” he added.

I’d go a bit further. I’d suggest 2023 will be a recession “for many people.” Indeed, the IMF expects “about a third” of the global economy to experience two consecutive quarters of negative growth at some point. The new outlook described risks as “unusually large and to the downside.” Among them: Central bank “miscalculations” and the possibility that policy divergence across major economies could lead to “further US dollar appreciation and cross-border tensions.” On top of that, it’s conceivable that “more energy and food price shocks might cause inflation to persist for longer.”

That wasn’t the end of it. Tighter financial conditions could spark an emerging market debt crisis, curbs to European gas supplies might further depress output in the euro-area, China’s property crisis “could spill over to the domestic banking sector” and on and on.

Frankly (and I don’t want to come across as unduly abrasive), it’s never obvious why the IMF bothers publishing these reports. The Fund plainly needs to conduct all manner of internal research to inform lending decisions and it’s paramount that the world’s most important multilateral economic institution take a view on the outlook for the global economy. But attempting to project outcomes more than a year into the future for every major (and minor) nation on the planet, and then publishing those projections for the world to summarily ignore, is an exercise in futility almost by definition. And everyone is apprised of the risk factors. We don’t need the IMF to tell us that a shooting war in Europe’s breadbasket is a risk to food security or that a major energy supplier waving around nukes while screaming something about drug addicts and Nazis might be dangerous or that a Fed which raises rates 425bps in just nine months from a baseline of zero is a Fed that risks triggering financial crises.

In any case, the tension between, on one hand, the imperative of policy tightening and, on the other, the ever stronger dollar and risks to financial stability, was on full display. The IMF emphasized that “warding off” sundry risks “starts with monetary policy staying the course to restore price stability.” Only it doesn’t. The effort to protect the global economy “starts with” trying to convince Vladimir Putin to cease and desist from wars of conquest and, relatedly, discouraging Xi Jinping from getting any bad ideas from Ukraine about what is or isn’t possible vis-à-vis Taiwan.

But let’s pretend it’s all about rate hikes. “Front-loaded and aggressive monetary tightening is critical to avoid inflation de-anchoring as a result of households and businesses basing their wage and price expectations on their recent inflation experience,” the IMF said.

That’s at least partially true, but additional front-loading and “aggression” from the Fed will put upward pressure on the dollar and could conceivably destabilize… well, everything, really. Gourinchas’s well-meaning advice for vulnerable emerging markets accidentally veered into the comedic. “The appropriate response in most emerging and developing countries is to calibrate monetary policy to maintain price stability, while letting exchange rates adjust, conserving valuable foreign exchange reserves for when financial conditions really worsen,” he said. All that was missing was emphasis on the word “really.” A paraphrased, colloquial version might’ve read: “Just let your currencies sink for as long as you can absolutely stand it, because you’re gonna need those USTs here in about six months when Fed funds is 4.5% and the world’s on fire.”

Separately, the executive summary warned that “with tightening financial conditions, macroprudential policies should remain on guard against systemic risks.” In a separate blog post released as part of Tuesday’s deluge from the Fund, Tobias Adrian, the IMF’s director of monetary and capital markets, described risks to financial stability as having “increased substantially.” Adrian delivered the following stark assessment:

Financial vulnerabilities are elevated for governments, many with mounting debt, as well as nonbank financial institutions such as insurers, pension funds, hedge funds and mutual funds. Rising rates have added to stresses for entities with stretched balance sheets. At the same time, the ease and speed with which assets can be traded at a given price has deteriorated across some key asset classes due to volatile interest rates and asset prices. This poor market liquidity, together with pre-existing vulnerabilities, could amplify any rapid, disorderly repricing of risk, were it to occur in the coming months.

As I’m sure Adrian has noticed, markets have already experienced quite a bit in the way of “rapid, disorderly repricing of risk.” Just ask a UK pension fund.

Gourinchas served up what felt, to me anyway, like a remarkably forthright warning to Europe. The energy crisis, he said, “is not a transitory shock.” Rather, “the geopolitical realignment of energy supplies in the wake of the war is broad and permanent,” according to the IMF. Gourinchas continued, with what amounted to an exhortation against the kinds of policies currently en vogue across European capitals:

Winter 2022 will be challenging, but winter 2023 will likely be worse. Price signals will be essential to curb energy demand and stimulate supply. Price controls, untargeted subsidies or export bans are fiscally costly and lead to excess demand, undersupply, misallocation and rationing. They rarely work. Fiscal policy should instead aim to protect the most vulnerable through targeted and temporary transfers.

I’m not sure that’s going to win any applause among politicians pulling every conceivable lever to suppress price signals.

Fiscal initiatives, the IMF suggested, should focus primarily on increasing productive capacity in order to “make economies more resilient to future crises.” “Unfortunately,” Gourinchas lamented, “these important principles are not always guiding policy right now.”

For what it’s worth (so, not much) the IMF put the odds of an “adverse outcome or worse” at between 10% and 15%. In such a scenario, global growth would slow to 1.1%, the Fund said.

Given the distribution and scope of the macro and geopolitical risk factors currently in play, I don’t think I’m being needlessly pessimistic to suggest an “adverse” scenario could be considerably more onerous than a 1.1% global expansion. To be fair, though, it’s important to remember that we’re talking about aggregate global growth. In that context, a 1.1% expansion would indeed represent a very bad outcome.