The IMF does not have a good record in anticipating global economic crises. In 2008, it was caught totally flatfooted by the bursting of the U.S. housing and credit bubble that spawned the Great Economic Recession. Again in 2010, it was caught asleep at the wheel with the onset of the Eurozone sovereign debt crisis that had strong spillover effects on the rest of the global economy.
Judging by the latest upward revision to its World Economic Outlook, it would appear that the IMF will once again be caught flatfooted by the next global economic and financial market crisis.
In revising up its world economic growth forecast to 4.3 percent for 2021, the IMF appears to be overly sanguine about the substantial downside risks to its forecast. Indeed, the only real downside risk that it highlights is the current race between the Covid-19 vaccinations and the Covid-19 mutations. The IMF acknowledges that should the mutations win that race, there could be considerable downside risk to its forecast.
Among the more obvious downside risks that the IMF fails to mention is the risk of a major debt crisis in the emerging market economies, which now account for around half of the world economy. This omission is all the more surprising considering that, in the wake of the pandemic, these countries’ public finances and debt levels have never been as troubling than they are today. It is also all the more surprising considering that the World Bank keeps warning us that it is only a matter of time before we will have a major wave of emerging market debt restructurings.
Seemingly having learned little from the 2010 Eurozone sovereign debt crisis, the IMF is also silent about the risk of another such debt crisis. This is all the more surprising considering the present economic and political difficulties in Italy, a country that has an economy some ten times the size of Greece and the world’s third largest sovereign debt market.
The basic question that the IMF does not seem to be asking is why will Italy not have another sovereign debt crisis in the year ahead when its underlying economic situation today is very much worse than it was in 2010. Not only does Italy have a very much larger public debt level, a larger budget deficit, and a deeper economic recession than it had in 2010. It also still remains stuck in a Euro straitjacket that denies it the use of currency depreciation to offset the adverse effects on its economy from budget belt-tightening.
Yet another and perhaps more serious downside risk that the IMF does not mention is that posed by the major equity and credit market price bubbles that now characterize the global economy and that have been spawned by years of ultra-easy monetary policy. This is all the more surprising considering that US equity valuations today are at the very lofty levels last seen on the eve of the 1929 equity market crash. It is also all the more surprising considering that many risky borrowers around the world have been able to borrow money at interest rates not very different from those at which the United States can borrow.
A basic question that the IMF does not seem to be asking is whether its rosy economic forecast might not be inconsistent with the avoidance of the bursting of today’s equity and credit market bubbles. One would have thought that if the global economy were to recover along the lines that the IMF is anticipating, world interest rates would be forced higher as central banks would become concerned about economic overheating. However, higher interest rates would risk bursting the equity and credit market bubbles, which are premised on the indefinite maintenance of ultra low-interest rates.
To be sure, in its efforts to encourage a global economic recovery, the IMF is most likely right to put an optimistic spin on its World Economic Outlook forecast. However, by not even mentioning the major downside risks to its forecast that are in plain sight, it risks further tarnishing its credibility as a reliable economic forecaster.
Desmond Lachman is a resident fellow at the American Enterprise Institute. He was formerly a deputy director in the International Monetary Fund's Policy Development and Review Department and the chief emerging market economic strategist at Salomon Smith Barney.