EcoTVWeek - October 15 2021

The International Monetary Fund has very recently published its new world economic outlook. As always, it is an eagerly awaited document with plenty of interesting analyses on an important topic. This time around there is a very important chapter for instance on the inflation outlook. Now talking about the more broadly speaking economic outlook, the best way to summarize the view of the fund is perhaps to refer to the title of the blog post of the IMF‘s chief economist. She is talking about a hobbled economic recovery along entrenched fault lines. That’s good news but that’s also bad news. The key point that is being emphasized is that the divergence between countries has increased and may actually continue to increase indeed. When you look at advanced economies, output is supposed to move beyond the part that was projected pre-pandemic whereas when you look at developing and emerging economies output losses will probably be persistent. Key factors which are underpinning this sad observation is that the access to vaccination has been very different: 60% of the population in the advanced economies are vaccinated whereas in the developing and emerging economies up to 96% of the population has not seen a vaccine. In addition, there’s also been a massive difference in terms of policy support. Although the base scenario of the IMF’s forecast is actually quite satisfactory, it should be emphasized that there is unease about the distribution of risks. Risks to growth are tilted to the downside, this is related to concern that new variants could develop in countries where the level of vaccination is still very low. Another source of concern with respect to the growth outlook are the supply shocks and that is something that could also weigh on growth and push it lower. I’m thinking specifically about the energy supply shock that we are experiencing as of late. Then turning to inflation, the inflation risks are tilted to the upside here again.  We have the concern about supply-demand imbalances that could last longer than we currently expect and as a consequence generate more inflation and we should not forget that the recent significant increase in energy prices will also add to more inflation. Interestingly, the IMF is emphasizing how much uncertainty there is about the inflation outlook. This is something that really is creating some unease given the importance of the inflation prospect for monetary policy and for the behaviour of  financial markets. So why is there such a high degree of uncertainty? The first one reason is of course related to the pandemic: how long will it last? how long will it continue to influence demand and supply in the economy? Second reason why the uncertainty is so high is the other supply shocks that have been moved to the center of the radar screen. And finally an important factor is the behaviour of inflation expectations. Against the background of increased divergence in terms of economic performance between countries, ongoing concern about the pandemic situation and that very uncomfortable distribution of risks, the IMF is advocating that the absolute priority should be on vaccination in these countries where the levels of vaccination are still very low. In addition, the focus should also be on getting ready for climate change, on taking the necessary measures. It is an effort spread over many years but it’s also crucial to keep that incredibly important policy objective in mind. Then thirdly, there’s also the necessity to step up the multilateral efforts and to help countries that actually do not have enough financial means to tackle the pandemic situation and to tackle the necessary investments in the context of climate change. What is important to highlight is that the policy trade-offs are becoming more complex, think of fiscal policy where clearly the absolute priority is to make sure that the healthcare situation is benefiting from more financial means where that is necessary. At the same time we also have observed that the fiscal policy space has narrowed due to the efforts that have already been undertaken last year and earlier this year and it also means that governments should not forget that it is necessary in the conduct of their fiscal policy to keep a medium-term framework in mind. What that means is that they should make sure that their fiscal policy remains credible so as not to lose the confidence of financial markets because that would push up the cost of their borrowing. Monetary policy also has its challenges:  the challenge is to make sure that support continues to be provided to the economies in terms of growth but also to make sure that we reach the objectives in terms of inflation targets. But at the same time, it is important to be cognizant that very accommodative policy can actually generate financial stability risks. There’s also the necessity  not to be afraid of acting quickly when it would be necessary, when inflation would end up moving higher and actually moving beyond significantly the objective of the central bank. So many challenges out there for the world economy for the next several quarters and even beyond that for the next several years.