IMF Downgrades Australia’s Growth Prospects

The latest IMF forecast is still expecting a growth rate of around 3% in 2018, but they revised down 2017 in the latest Global Financal Stability Report.

Our first half result in 2017 was 1.2%, so the second half is circa 1%, hardly stellar, and the sudden rebound to 3% next year, some might say appears courageous.

They also revised up the unemployment rate, remaining at 5.6%, rather than falling to 5.3% as estimated last time.

This plus slow wage growth highlights the issues underlying the economy.

Financial Stability Improves, But Rising Vulnerabilities Could Put Growth at Risk

From The IMF Blog.

It seems like a paradox. The world’s financial system is getting stronger, thanks to healthy economic growth, buoyant markets, and low interest rates. Yet despite these favorable conditions, dangers in the form of rising financial vulnerabilities are starting to loom. That is why policymakers should act now to keep those vulnerabilities in check.

As we explain in the latest Global Financial Stability Report, the recovery from the global financial crisis isn’t yet complete. Central bankers rightly maintain easy policies to support growth. But this is breeding complacency and allowing a further build-up of financial excesses. Non-financial borrowers are taking advantage of cheap credit to load up on debt. Investors are buying riskier and less liquid assets. If left unattended, these growing vulnerabilities will continue to mount, threatening to derail the economic recovery when shocks occur.

Capital buffers

To be sure, there are reasons for optimism. Low interest rates and rising asset prices are spurring growth. Big, globally systemic banks – so called because the failure of just one of them could shake the financial system – have added $1 trillion to their capital buffers since 2009. Overseas investment into emerging market and low income economies has increased. The global economic upswing is laying hopes for a sustained recovery and allowing central banks to eventually return their monetary policies to normal settings.

So why should policy makers be concerned?

Let’s start with risks in financial markets. Before the crisis, there were $16 trillion in relatively safe, investment-grade bonds yielding more than 4 percent. That has dwindled to just $2 trillion today. There is simply too much money chasing too few high yielding assets. The result is that investors are taking more risks and exposing themselves to bigger losses if markets tumble.

New risks

Then there are rising levels of debt in the world’s biggest economies. Borrowing by governments, households and companies (not including banks) in the so-called Group of 20 exceeds $135 trillion, equivalent to about 235 percent of their combined gross domestic product. Despite low interest rates, debt servicing burdens have risen in several economies. And while borrowing has helped the recovery, it has also created new financial risks. For example, chapter two of the Global Financial Stability Report showed growth in household debt relative to GDP is associated with a greater probability of a banking crisis.


In China, the size, complexity, and pace of credit growth points to elevated financial stability risks. Banking sector assets have risen to 310 percent of GDP, nearly three times the emerging-market average and up from 240 percent at the end of 2012. “Shadow” lending, including wealth management products, remains a big risk for smaller banks. The authorities have taken welcome steps to address these risks, but there is still work to do. Broader reform measures are necessary to reduce the economy’s reliance on rapid credit growth.

Low-income countries have also benefited from easy financial conditions by expanding their access to international bond markets. While borrowing has generally been used to fund infrastructure projects, refinance debt, and repay arrears, it has also been accompanied by an underlying deterioration of debt burdens as measured by the debt service ratio.

Policy implications

Overall, investors are growing complacent about potential shocks that could cause turmoil in markets. These include geopolitical risks, a surge in inflation, and a sudden jump in long-term interest rates. How should policymakers respond? There are several steps they can take:

  • Major central banks can avoid creating market turbulence by thoroughly explaining their plans to gradually unwind crisis-era policies.
  • To discourage riskier lending, financial regulators should deploy so-called “macroprudential” policies, such as limits on loan-to-value ratios for mortgages, for macro critical objectives.
  • Emerging-market and low income countries should take advantage of benign external conditions to reduce vulnerabilities and enhance resilience by enhancing underwriting standards, building capital and liquidity buffers, and increasing reserves.
  • Supervisors should focus more on the business models of banks to ensure sustainable profitability. We estimate that almost one-third of systemically important banks, with $17 trillion in assets, will struggle to achieve the profitability that’s needed to ensure their resilience to shocks.
  • The global regulatory reform agenda should be completed and fully implemented. Global cooperation remains essential.

With the right measures, policy makers can take advantage of these benign times to keep a lid on mounting vulnerabilities and ensure that the global economic expansion remains on track. This is not the time for complacency. The time to act is now. Otherwise, future growth could be at risk.

Global Economic Upswing Creates a Window of Opportunity – IMF

From the IMF Blog.

The global recovery is continuing, and at a faster pace. The picture is very different from early last year, when the world economy faced faltering growth and financial market turbulence. We see an accelerating cyclical upswing boosting Europe, China, Japan, and the United States, as well as emerging Asia.

The latest World Economic Outlook has therefore upgraded its global growth projections to 3.6 percent for this year and 3.7 percent for next—in both cases 0.1 percentage point above our previous forecasts, and well above 2016’s global growth rate of 3.2 percent, which was the lowest since the global financial crisis.

For 2017, most of our upgrade owes to brighter prospects for the advanced economies, whereas for 2018’s positive revision, emerging market and developing economies play a relatively bigger role. Notably, we expect sub-Saharan Africa, where growth in per capita incomes has on average stalled for the past two years, to improve overall in 2018.

The current global acceleration is also notable because it is broad-based—more so than at any time since the start of this decade. This breadth offers a global environment of opportunity for ambitious policies that will support growth and raise economic resilience in the future. Policymakers should seize the moment: the recovery is still incomplete in important respects, and the window for action the current cyclical upswing offers will not be open forever.

Global recovery still incomplete

Why do we say that the recovery is incomplete? It is incomplete in three important ways.

First, the recovery is incomplete within countries. Even as output nears potential in advanced economies, nominal and real wage growth have remained low. This wage sluggishness follows many years during which median real incomes grew much more slowly than incomes at the top, or even stagnated. Drivers of growth including technological advances and trade have had uneven effects, lifting some up but leaving others behind in the face of structural transformation. The resulting higher income and wealth inequalities have helped fuel political disenchantment and skepticism about the gains from globalization, putting recovery at risk.

Second, the recovery is incomplete across countries. While most of the world is sharing in the current upswing, emerging market and low-income commodity exporters, especially energy exporters, continue to face challenges, as do several countries experiencing civil or political unrest, mostly in the Middle East, North and sub-Saharan Africa, and Latin America. Many small states have been struggling. About a quarter of all countries saw negative per capita income growth in 2016, and despite the current upswing, nearly a fifth of them are projected to do the same in 2017.

Finally, the recovery is incomplete over time. The cyclical upswing masks much more subdued longer-run trends of productivity and demographics, even correcting for the arithmetical effect of more slowly growing populations. For advanced economies, per capita output growth is now projected to average only 1.4 percent a year during 2017–22 compared with 2.2 percent a year during 1996–2005. Moreover, we project that fully 43 emerging market and developing economies will grow even less in per capita terms than the advanced economies over the coming five years. These economies are diverging rather than converging, going against the more benign trend of declining inequality between countries due to rapid growth in dynamic emerging markets such as China and India.

Window for action

These gaps in the recovery challenge policymakers to action—action that should take place now, while times are good. Success requires a three-pronged approach in the context of completing and refining the important financial stability reforms undertaken since the global crisis, without weakening them.

Needed structural reforms differ across countries, but all have ample room for measures that raise economic resilience along with potential output. Our research has shown that structural reforms are easier to implement when the economy is strong.

For some countries that have returned close to full employment, the time has come to think about gradual fiscal consolidation to reduce swollen public debt levels and build buffers against the next recession. Higher infrastructure and educational spending, which are needed in some countries that do have fiscal space, can have the added benefit of boosting global demand just as consolidation measures elsewhere subtract from it. This multilateral fiscal policy mix can also help reduce excess global imbalances.

Critically important to growth that can be sustained and shared by all is investment in people at all life cycle stages, but especially the young. Better education, training, and retraining can both ease labor market adjustment to long-term economic transformation—from all sources, not only trade—and raise productivity. In the short term, the excessive youth unemployment that afflicts many countries urgently deserves attention. Investing in human capital should also help push labor’s income share upward, contrary to the broad trend of recent decades—but governments should also consider correcting distortions that may have reduced workers’ bargaining power excessively.

In sum, structural and fiscal policy together should promote economic conditions conducive to sustainable and more inclusive real wage growth.

The third policy prong, monetary policy, still has a key role to play. Earlier deflation threats in advanced economies have receded considerably, but inflation has remained puzzlingly low even as unemployment rates have come down. Clear central bank communication and the smooth execution of monetary policy normalization, where and when appropriate, remain crucial. Success will help prevent market turbulence and sudden tightening of financial conditions, which could disrupt the recovery with spillovers to emerging market and developing economies. Those economies, in turn, face diverse monetary policy challenges but should continue where possible to use exchange rate flexibility as a buffer against external shocks, paying due attention to implications for price stability.

Numerous global problems require multilateral action. Priorities for mutually beneficial cooperation include strengthening the global trading system, further improving financial regulation, enhancing the global financial safety net, reducing international tax avoidance, and fighting famine and infectious diseases.  Also crucially important are to mitigate greenhouse gas emissions before they do more irreversible damage, and to help poorer countries—which are not themselves substantial emitters—adapt to climate change.

If the strength of the current upswing makes the moment ideal for domestic reforms, its breadth makes multilateral cooperation opportune. Policymakers should act while the window of opportunity is open.

Rising Household Debt: What It Means for Growth and Stability

From The IMFBlog.

Whilst increased household debt gives an economy a boost in the short term, the IMF has found it creates greater risk 3-5 years later, lifting the potential for a financial crisis, as household struggle to repay.  Given the ultra-high debt levels in Australia, this is an important observation.

Debt greases the wheels of the economy. It allows individuals to make big investments today–like buying a house or going to college – by pledging some of their future earnings.

That’s all fine in theory. But as the global financial crisis showed, rapid growth in household debt – especially mortgages – can be dangerous.

A new IMF study takes a close look at the likely consequences of growth in household debt for different types of economies, as well as steps that policy makers can take to mitigate these consequences and to keep debt within reasonable limits. The overall message: there is a tradeoff between the short-term benefits and the medium-term costs of rising debt, but there is plenty that policymakers can do to ease this tradeoff, according to Chapter Two of the IMF’s October 2017 Global Financial Stability Report.

Given the widespread misery the crisis caused, you might think people have become skittish about borrowing more. Surprisingly, that’s not the case. Since 2008, household debt as a proportion of gross domestic product has grown significantly in a sample of 80 countries. Among advanced economies, the median debt ratio rose to 63 percent last year from 52 percent in 2008. Among emerging economies, it increased to 21 percent from 15 percent.

Reversal of fortune

In the short term, an increase in the ratio of household debt is likely to boost economic growth and employment, our study finds. But in three to five years, those effects are reversed; growth is slower than it would have been otherwise, and the odds of a financial crisis increase. These effects are stronger at the higher levels of debt typical of advanced economies, and weaker at lower levels prevailing in emerging markets.

What’s the reason for the tradeoff? At first, households take on more debt to buy things like new homes and cars. That gives the economy a short-term boost as automakers and home builders hire more workers. But later, highly indebted households may need to cut back on spending to repay their loans. That’s a drag on growth. And as the 2008 crisis demonstrated, a sudden economic shock – such as a decline in home prices–can trigger a spiral of credit defaults that shakes the foundations of the financial system.

More specifically, our study found that a 5 percentage-point increase in the ratio of household debt to GDP over a three-year period forecasts a 1.25 percentage-point decline in inflation-adjusted growth three years in the future. Higher debt is associated with significantly higher unemployment up to four years ahead. And a 1 percentage point increase in debt raises the odds of a future banking crisis by about 1 percentage point. That’s a significant increase, when you consider that the probability of a crisis is 3.5 percent, even without any increase in debt.

The good news is that policy makers have ways to reduce risks. Countries with less external debt and floating exchange rates, and which are financially more developed, are better placed to weather the consequences.

Mitigating risks

Better financial-sector regulations and lower income inequality also help. But this is not the end of the story. Countries can also mitigate the risks by taking measures that moderate the growth of household debt, such as modifying the down payment required to purchase a house or the fraction of a household income that can be devoted to debt repayments. So, good policies, institutions, and regulations make a difference – even in countries with high ratios of household debt to GDP. And countries with poor policies are more vulnerable – even if their initial levels of household debt are low.

The Disconnect Between Unemployment and Wages

There is an assumption that as employment rates and growth picks up,  the much needed wage growth will follow. We discussed this on ABC’s The Business last week, with HSBC’s Chief Economist who held the view that the RBA won’t lift the cash rate here until wages growth comes through. We were not so sure.

But an interesting piece from the The IMFBlog suggests there are more fundamental forces at work, especially in terms of employment patterns and the rise of part-time work, which suggests that unemployment and wage growth is more disconnected now. We think underemployment is one of the most critical drives of wage stagnation. If this is true, then wages may be lower for longer, which is not good news for those households with heavy debt burdens, especially if rates rise. We release our September analysis of mortgage stress next week. Here is the IMF commentary:

Over the past three years, labor markets in many advanced economies have shown increasing signs of healing from the Great Recession of 2008-09. Yet, despite falling unemployment rates, wage growth has been subdued–raising a vexing question: Why isn’t a higher demand for workers driving up pay?

Our research in the October 2017 World Economic Outlook sheds light on the sources of subdued nominal wage growth in advanced economies since the Great Recession.  Understanding the drivers of the disconnect between unemployment and wages is important not only for macroeconomic policy, but also for prospects of reducing income inequality and enhancing workers’ security.

Job growth picked up, wage growth less so

In many cases, employment growth has picked up and headline unemployment rates are now back to their pre-Great Recession ranges. Still, nominal wage growth remains well below where it was prior to the recession. Sluggish wages may reflect deliberate efforts to slow down wage growth from unsustainably high levels, as was the case with some countries in Europe. But the pattern is more widespread.

There are several factors at play in explaining this pattern, both cyclical and structural – or slow-moving – in nature.

A key cyclical factor is labor market slack – that is, the excess supply of labor beyond the amount that firms would like to employ.

First off, however, it is important to recognize that headline unemployment rates may not be as indicative of labor market slack as they used to be. Hours per worker have continued to decline (extending a trend that began before the Great Recession).

Several countries have also experienced higher rates of involuntary part-time employment (workers employed for less than 30 hours per week who report they would like to work longer) and an increased share of temporary employment contracts These developments in part reflect continued weak demand for labor (itself a reflection of weak final demand for goods and services).

Another key driver of wage growth is the widely-recognized slowdown in trend productivity growth. Sustained weakness in output per hour worked can squeeze business profitability and eventually weigh on wage growth as firms becomes less willing to accommodate fast increases in compensation.

Slower-moving factors

Besides these forces, slower-moving factors such as ongoing automation (proxied by the falling relative price of investment goods) and diminished medium-term growth expectations also appear to hold back wage growth. However, our analysis suggests that automation may not have made a large contribution to subdued wage dynamics following the Great Recession.

The analysis also indicates sizable common global factors behind wage weakness in the aftermath of the Great Recession and especially during 2014–16. In other words, labor market conditions in other countries appear to have a growing effect on wage setting in any given economy. This points to the possible roles of the threat of plant relocation across borders, or an increase in the effective worldwide supply of labor in a context of closer international economic integration.

Putting it all together

The relative roles of labor market slack and productivity growth vary across countries. In economies where unemployment rates are still appreciably above their averages before the Great Recession (such as Italy, Portugal, and Spain), high unemployment can explain about half of the slowdown in nominal wage growth since 2007, with involuntary part-time employment acting as a further drag on wages. Wage growth is therefore unlikely to pick up until slack diminishes meaningfully—an outcome that requires continued accommodative policies to boost aggregate demand.

In economies where unemployment rates are below their averages before the Great Recession (such as Germany, Japan, the United States, and the United Kingdom), slow productivity growth can account for about two-thirds of the slowdown in nominal wage growth since 2007. Even here, however, involuntary part-time employment appears to be weighing on wage growth, suggesting greater slack in the labor market than headline unemployment rates capture. Assessing the true degree of slack in these economies will be important when determining the appropriate pace of exit from accommodative monetary policies.

Broader changes in the labor market

Our research further indicates that sluggish wage growth has occurred in a context of broader changes in the labor market. The increase in involuntary part-time employment itself, for example, is in part explained by cyclically-weak demand.  Accommodative policies that help lift aggregate demand would therefore lower involuntary part-time employment. But it is also associated with slower-moving factors such as automation, diminished medium-term growth expectations, and the growing importance of the service sector.

Some of these developments represent persistent changes in relationships between firms and workers that mirror underlying shifts in the economy – with the emergence of the gig economy and shrinkage of traditional sectors such as manufacturing. Policymakers may therefore need to enhance efforts to address the vulnerabilities that part-time workers face. Examples of possible measures include broadening minimum wage coverage where it does not currently include part-time workers; securing parity with full-time workers by extending pro-rated annual, family, and sick leave; and strengthening secondary and tertiary education to upgrade skills over the longer term.

House of Cards

From The IMFBlog.

In some countries, owning a home is a rite of passage: a symbol of a stable life and a sound investment.

However young adults in the United Kingdom, United States, and Europe have experienced declining home ownership rates.

Our chart of the week, drawn from research by Lisa Dettling and Joanne W. Hsu, senior economists at the US Federal Reserve, in the June issue of Finance & Development magazine , shows that millennial home ownership rates are nearly 10 percent lower than those of their baby boomer and Generation X counterparts of the same age.

For millennials who have purchased a home, net housing wealth—the value of the home, minus mortgage debt—is about the same as that of their baby boomer parents at the same age.

It remains to be seen if millennials are delaying home purchases or forgoing home ownership all together. New research suggests barriers to financing a home, such as borrowing constraints, are at least partially to blame for falling home ownership rates and rising co-residence rates.

Whether these barriers will ease in the future is unknown. However, a recent study in the UK finds that groups experiencing low home ownership rates at age 30 tend to catch up later in life.

To read more research and find data on housing markets around the world, check out the IMF’s Global Housing Watch .

You can also read more blogs about global house prices and our recent chart of the week on the housing price boom in Norway .

China’s Growth Sustainable Says IMF

The results from the 2017 Article IV consultation with China have been published. The IMF acknowledged that China’s continued strong growth has provided critical support to global demand and they commended the authorities’ ongoing progress in re-balancing the Chinese economy toward services and consumption.

They noted that economic activity had recently firmed and saw this as an opportunity for the authorities to accelerate needed reforms and focus more on the quality and sustainability of growth. They supported the importance of reducing national savings to help prevent domestic and external imbalances and emphasized the need for greater social spending and making the tax system more progressive. Stronger domestic demand helped further reduce China’s external imbalance, though it remains moderately stronger compared to the level consistent with medium-term fundamentals

Amid strong growth, the authorities have pivoted toward tightening measures, reflecting a greater focus on containing financial sector risks.

Debt is now expected to continue to grow as the IMF now assumes that the authorities will broadly maintain current levels of public investment over the medium term and not substantially consolidate the “augmented” deficit, reaching 92 percent of GDP in 2022 on a rising path. Private sector credit is projected to continue increasing over the medium term. Thus, total non-financial sector debt reached about 235 percent of GDP in 2016 and is projected to rise further to over 290 percent of GDP by 2022.

They say downside risks around the baseline have increased. A key consequence of the new baseline is that it envisions China using up valuable fiscal space to support a growth path with slower rebalancing and a higher probability of a sharp adjustment. Thus, if a sharp adjustment were to materialize, China would have lower buffers with which to respond. Such a potential adjustment could be triggered by several risks, including:

  • Funding. A funding shock could come from at least two (related) pressure points. The first is the mostly short-term, “interbank” wholesale market (which includes banks’ claims on each other and on NBFIs). The second is a loss of confidence in short-term asset management products issued by NBFIs, or a run on the WMPs which fund them.
  • Retreat from Cross-Border Integration. Should higher trade barriers be imposed by trading partners, the impact would depend on their coverage and magnitude, how exchange rates respond, and whether China retaliates. For example, an illustrative simulation in the IMF’s Global Integrated Monetary and Fiscal Model suggests that if the U.S. puts a 10-percent tariff on Chinese exports and China allowed its real exchange rate to adjust, real GDP in China would fall by about 1 percentage point in the first year. If China retaliated with similar tariffs on U.S. imports, its GDP would contract further. However, given the complexity of global trade relationships and uncertainty regarding how  exchange rates would adjust, the effect could be larger and more disruptive.
  • Capital Outflows. Pressure on the exchange rate could resume because of a faster-than-expected normalization of U.S. interest rates, much weaker growth in China, or some other shock to confidence. In an extreme scenario, the pressure could lead to renewed large reserve loss and eventually a potential disruptive exchange rate depreciation. However, this risk is likely small in the short run due to the stronger enforcement of CFMs, the prominence of state-owned banks in the foreign exchange market, and ample foreign exchange reserves.

While agreeing on the growth outlook, the authorities disagreed about the associated risks. The authorities agreed that 2017 growth was likely to exceed marginally the 6.5 percent full year target. This implied some deceleration during the course of the year and would result in inflationary pressure remaining contained and a broadly unchanged current account. For the medium term, though the authorities shared the view that their 2020 target of doubling 2010 real GDP would likely be reached, they viewed the debt build-up thus far as manageable and likely to slow further as their reforms take effect. They also explained that their “projected growth targets” were anticipatory and not binding. They underscored that reaching the desired quality of growth was a greater priority than the quantity of growth. The authorities viewed domestic concerns, such as high financial sector leverage, as manageable considering ongoing reforms and Chinese-specific strengths, such as high domestic savings. They saw the external environment as facing many uncertainties, such as an unexpected fall in global demand or a retreat from globalization.

The IMF conclude that:

China continues to transition to a more sustainable growth path and reforms have advanced across a wide domain. Growth slowed to 6.7 percent in 2016 and is projected to remain robust at 6.7 percent this year owing to the momentum from last year’s policy support, strengthening external demand, and progress in domestic reforms. Inflation rose to 2 percent in 2016 and is expected to remain stable at 2 percent in 2017. Important supervisory and regulatory action is being taken against financial sector risks, and corporate debt is growing more slowly, reflecting restructuring initiatives and overcapacity reduction.

Fiscal policy remained expansionary and credit growth remained strong in 2016. Growth momentum will likely decline over the course of the year reflecting recent regulatory measures which have tightened financial conditions and contributed to a declining credit impulse.

The current account surplus fell to 1.7 percent of GDP in 2016, driven by a sharp recovery in goods imports and continued strength in tourism outflows. It is projected to further narrow to 1.4 percent of GDP this year, due primarily to robust domestic demand and a deterioration in terms of trade. Capital outflows have moderated amid tighter enforcement of capital flow management measures and more stable exchange rate expectations. After depreciating 5 percent in real effective terms in 2016, the renminbi has depreciated some 2¾ percent since then and remains broadly in line with fundamentals.

A Dip into Subzero Policy Rates

From The IMF Blog.

Zero was gradually adopted in the ancient world—both east and west—as the ultimate point of reference, a point above and below which things change. For the ancient Egyptians, zero represented the base of pyramids. In science it became the freezing point of water, in geography the altitude of the sea, in history the starting point of calendars.

In the realm of monetary policy, zero was typically seen as the lower bound for interest rates. That has changed in recent years in the context of a slow recovery from the 2008 crisis. Several central banks hit zero and began experimenting with negative interest rate policies. Most did so to counter very low inflation, but some also were concerned about currencies that were too strong.

Financial stability

Questions arose. Should we worry about the effectiveness of negative rates and their potential side effects? Would such policies support demand? Would they undermine financial stability? Would rate cuts below zero have different effects than above zero? We offered some answers in a recent paper drawing on the initial experience of the euro area, Denmark, Japan, Sweden, and Switzerland.

Our paper confirms and builds on initial discussions in IMFBlog by José Viñals, a former director of the IMF’s Monetary and Capital Markets Department, and some of his colleagues. Among our conclusions: the mechanics of monetary policy’s effect on the economy is similar above and below zero, and so far the overall impact on bank profits and lending has been small. But there are limits to the policy.

Why consider the effects of negative rates now, when talk is shifting to interest rate normalization? For two reasons. First, we have accumulated enough experience—two years in most cases, more in others—to gauge the effects with greater certainty. Second, with rates expected to be generally lower in the new normal, the odds of hitting zero if monetary policy needs to be eased again are likely to be higher.

Why worry?

The fear is that negative rates could squeeze bank profits. Banks make money by charging borrowers more than they pay depositors. This margin could be compressed if deposit rates don’t fall as fast as lending rates or ultimately bottom out at zero. This scenario could put financial stability at risk because lower profits would make banks less resilient to shocks. It could also undermine the impact of monetary policy on lending, growth, and price stability.

Banks will hesitate to impose negative rates on depositors who have the option to withdraw their money and stash it in a safe. While storing, moving, and insuring cash is costly, it could be cheaper than paying the bank to hold money if rates are pushed very far below zero. Where is the tipping point? No one knows for sure. Depositors with larger cash balances and higher liquidity needs—such as companies—will tolerate more negative rates before switching to cash. Banks can thus afford to pass on negative rates to some of their depositors, and they have.

Banks can also cushion their margins by lowering lending rates by less than the policy rate cut. This will happen automatically if their portfolios consist primarily of long-term and fixed-rate loans and other assets. (At the same time, this more limited pass-through will reduce the impact of the policy rate cut.) Banks that rely more on large deposits and wholesale funding may gain ground against those relying primarily on retail deposits.

Further, even if margins compress somewhat, profits will not necessarily drop. Banks can support profits by charging fees and commissions, lowering provisioning charges as borrowers become safer, switching to cheaper wholesale funding, cutting costs, and booking capital gains from policy rate cuts. In addition, lower rates will spur economic growth and thus demand for bank services, which will ease the pressure on margins.

Early days

A review of early country experiences with relatively small cuts below zero supports this more benign view.

Overall, the policy seems to have worked well: money market rates and bond yields fell in every country we looked at. Currencies also weakened somewhat, at least temporarily. Deposit rates mostly remained positive, except those of large companies. Lending rates declined somewhat, though less than policy rates. Banks benefited from lower wholesale funding costs, and some raised fees. Bank profits have generally been resilient. Lending has held up.

But some banks suffered. As predicted, negative rates weighed on profits of banks with a greater share of deposit funding, small retail clients, short-term loans, and loans indexed to the policy rate (for example, in some southern members of the euro area). Banks facing tougher competition from lower-cost lenders and capital markets were also hurt.

Not the whole answer

So far, so good. Negative-rate policies appear to have helped domestic monetary conditions somewhat, with no major side effects on bank profits, payment systems, or market functioning.

However, if policy rates remain negative for a long time, or if a deeper dive below zero is contemplated, the effectiveness of the policy and the stability of the financial system could be at risk. Further, the ability of depositors to switch to cash limits how much rates can be cut. Other monetary support, combined with fiscal policy and structural reforms, remain critical to support recoveries.

All Hands on Deck: Confronting the Challenges of Capital Flows

From The IMF Blog.

The global financial crisis and its aftermath saw boom-bust cycles in capital flows of unprecedented magnitude. Traditionally, emerging market economies were counselled not to impede capital flows. In recent years, however, there has been growing recognition that emerging market economies may benefit from more proactive management to avoid crisis when flows eventually recede. But do they adopt such a proactive approach in practice?

In recent research, we analyze the policy response of emerging markets to capital inflows using quarterly data over 2005–13. Our analysis shows that emerging markets do react to capital flows—most commonly through foreign exchange intervention and monetary policy, but also using macroprudential measures and capital controls. Ironically, the most commonly prescribed instrument for coping with capital flows—tighter fiscal policy—is the least deployed in practice.

Menu of policies

Policymakers in emerging market economies have potentially five tools to manage capital flows: monetary policy; fiscal policy; exchange rate policy; macro-prudential measures; and capital controls. In deploying these, there is a natural correspondence (or mapping) between risks and instruments.

Monetary and fiscal policies can help address the inflation and economic overheating concerns raised by capital inflows. When the currency is not undervalued, foreign exchange intervention can be used to limit currency appreciation that threatens competitiveness; and macroprudential measures (such as reserve requirements, capital adequacy ratios, dynamic loan loss provisioning, etc.) can be applied to curb excessive credit growth and related financial stability risks.

Capital inflow controls can buttress these policies by limiting the volume of capital inflows or by tilting the composition of flows toward less risky types of liabilities. Countries with controls on capital outflows can also relax these restrictions to lower the volume of net flows, reducing overheating and currency appreciation pressures.

Proactive central bank response

Capital flows to emerging markets have been particularly volatile over the last decade. But emerging markets’ central banks have not been indifferent to this volatility.

Foreign exchange intervention, for example, follows the ebbs and flows of capital, with a strong correspondence between reserve accumulation and net inflows. On average, emerging markets’ central banks purchase some 30–40 percent of the inflow, but some central banks, especially those in Asia (such as India, Indonesia, Malaysia) and Latin America (Brazil, Peru) tend to intervene more heavily, while others (such as Mexico and South Africa) tend to intervene less.

In terms of monetary policy, capital inflows elicit higher policy rates in emerging markets on average, though the impact depends on the behavior of inflation, the output gap (a measure of economic slack), and the real exchange rate. Policy rates are thus raised in response to higher inflation or a larger output gap—implying a counter-cyclical monetary policy stance—but lowered in response to real exchange rate appreciation.

Procyclical fiscal policy

When it comes to fiscal policy, however, the stance is strongly procyclical in the face of capital inflows. Thus, government consumption expenditure rises as capital inflows surge, and falls as capital inflows decrease—presumably because of political economy constraints, and/or because emerging markets face difficulty in accessing international credit markets in bad times.

Less orthodox policies

Turning to macroprudential measures and capital controls on inflows, our analysis shows that these measures are generally tightened as inflows surge and relaxed when flows recede. There is, however, considerable cross-country variation in response. Some countries, such as Brazil, Korea, Turkey, tend to use these measures more often than others.

For capital outflow controls, the reverse is true. Measures are relaxed when inflows surge—though it is only countries without fully open capital accounts, for example, India and South Africa, that tend to do so.

Natural mapping

Not only do emerging markets respond to inflows through various tools, their choice of the policy instrument also corresponds to the nature of the risk posed by capital flows.

Thus, foreign exchange intervention is generally used when the real effective exchange rate is appreciating, while what matters more for monetary policy tightening is the output gap. Macroprudential measures are typically deployed in the face of rapid domestic credit growth, while inflow controls are tightened when both credit growth and currency appreciation combine as a concern.

Bottom line

Following the repeated boom-bust cycles in capital flows, many emerging markets have internalized the lessons that they must manage capital flows if they are to reap the benefits of financial globalization, while minimizing the risks. They typically deploy a combination of instruments, with some correspondence between the nature of the risk and the tool deployed.

Nevertheless, there are important differences in policy response across countries, even in similar macroeconomic circumstances. This suggests that structural characteristics and political economy considerations may be at play in shaping a country’s specific policy response. An equally relevant question is whether the active policy management pursued by emerging economies has contributed to fewer financial crises in recent years. We hope that future research can shed light on these issues.

Global Growth IS Recovering – IMF

Latest estimates from the IMF suggest global growth is gaining momentum. But US growth estimates are down because of the slower growth agenda being prosecuted there thanks to the current political dynamics.

Overall, there is a more consistent pattern of upswing.

The recovery in global growth that we projected in April is on a firmer footing; there is now no question mark over the world economy’s gain in momentum.

As in our April forecast, the World Economic Outlook Update projects  3.5 percent growth in global output for this year and 3.6 percent for next.

The distribution of this growth around the world has changed, however: compared with last April’s projection, some economies are up but others are down, offsetting those improvements.

Notable compared with the not-too-distant past is the performance of the euro area, where we have raised our forecast. But we are also raising our projections for Japan, for China, and for emerging and developing Asia more generally. We also see notable improvements in emerging and developing Europe and Mexico.

Where are the offsets to this positive news on growth? From a global growth perspective, the most important downgrade is the United States. Over the next two years, U.S. growth should remain above its longer-run potential growth rate. But we have reduced our forecasts for both 2017 and 2018 to 2.1 percent because near-term U.S. fiscal policy looks less likely to be expansionary than we believed in April. This pace is still well above the lacklustre 2016 U.S. outcome of 1.6 percent growth. Our projection for the United Kingdom this year is also lowered, based on the economy’s tepid performance so far. The ultimate impact of Brexit on the United Kingdom remains unclear.

Overall, though, recent data point to the broadest synchronized upswing the world economy has experienced in the last decade. World trade growth has also picked up, with volumes projected to grow faster than global output in the next two years.

There do remain areas of weakness, however, among middle- and low-income countries, notably commodity exporters who continue to adjust to reduced terms of trade. Latin America still struggles with sub-par growth, and we have lowered projections for the region over the next two years. Growth this year in sub-Saharan Africa is projected to be higher than last year, but remains barely above the population growth rate, implying stagnating per capita incomes.


There are risks that the outcome could be better or worse than we now project. Near term, there is the possibility of even stronger growth in continental Europe, as political risks have diminished.

On the downside, however, many emerging and developing economies have been receiving capital inflows at favorable borrowing rates, possibly leading to risks of balance of payments reversals later. Strains could emerge if advanced economy central banks show an increasing preference for monetary tightening, as some have in recent months. Core inflation pressures remain low in advanced economies and measures of longer-term inflation expectations show no indications of upward drift beyond targets, so central banks should proceed cautiously based on incoming economic data, reducing the risk of a premature tightening in financial conditions.

Supportive policy has promoted China’s recent high growth rates, and we have upgraded our 2017 and 2018 forecasts for China, by 0.1 and 0.2 percentage point, respectively, to 6.7 and 6.4 percent. But higher growth is coming at the cost of continuing rapid credit expansion and the resulting financial stability risks. China’s recent moves to address nonperforming loans and to coordinate financial oversight therefore are welcome.

Finally, the threat of protectionist actions and responses remains salient in the near and medium terms, as do geopolitical risks.

The longer horizon

Despite the current improved outlook, longer-term growth forecasts remain subdued compared with historical levels, and tepid longer-term growth also carries risks.

In advanced economies, median real incomes have stagnated and inequality has risen over several decades. Even as unemployment is falling, wage growth still remains weak. Thus, continuing slow growth not only holds back the improvement of living standards, but also carries risks of exacerbating social tensions that have already pushed some electorates in the direction of more inward-looking economic policies. In emerging economies in contrast, despite generally higher inequality than in advanced economies, substantial income gains have accrued even to those low in the income distribution.

The current cyclical upswing offers policymakers an ideal opportunity to tackle some of the longer-term forces behind slower underlying growth. Suitable structural reforms can raise potential output in all countries, especially if supported by growth-friendly fiscal policies including productive infrastructure investment, provided there is room in the government budget. In addition, investment in people is critical—whether in basic education, job training, or reskilling programs. Such initiatives will both increase labor markets’ resilience to economic transformation and raise potential output. The same policy measures that can help economies adjust to globalization—as described in the recent report we co-authored with the World Bank and World Trade Organization—are more broadly necessary to meet the challenges of technology and automation.

Strengthening multilateral cooperation is another key to prosperity, in a range of areas including trade, financial stability policy, corporate taxation, climate, health, and famine relief. Where domestic developments have a strong international impact, policies based narrowly on national advantage are at best inefficient and at worst highly damaging to all.