World Economic Outlook: Looking to the future - Mazars - Ireland

For anyone involved in business these are challenging times. Prospects look to be extremely difficult . The Euro will not collapse – although it may go to the wire as political efforts reach a conclusion.

“I would like to start with some relatively good news. Some optimism is necessary these days.”

Carlo Cottarelli
IMF

(Washington press briefing on IMF Fiscal Monitor report
20 September 2011)

It is that time of year when the IMF unveils, prior to its annual meeting, its health-checks for the global economy, public finances and financial stability (i.e. the health of banking). Mr Cottarelli was introducing the health-check of government finances, the Fiscal Monitor (FM). So what is his (relatively) good news? Well, generally speaking inroads have been and are being made in cutting into public deficits and public debt. The picture is of course uneven with for example Ireland and Portugal obvious outliers and Greece an extreme outlier in the Euro zone.  The IMF also takes comfort in the fact that things have not proven as bad for some countries as it was prudentially forecasting two years ago. That of course elides the question of how the public finances so collapsed in the first place. Cotterelli did acknowledge financial markets were currently ‘worried’ but that concern relates mainly to global growth prospects.  

Looking at the Fund’s latest World Economic Outlook (WEO) report Mr Cottarelli might be pushing his optimism somewhat. The new WEO is distinctly downbeat – more so than its update WEO published only last June. That did see ‘mild slowdown’ ahead but the world economy had continued to grow. Yes there were signs of emerging inflation, the US was weaker than expected but Germany and France were stronger than anticipated. Government finances were not yet robust and banks were still in some need of attention but relatively, the report was not one to spook. The latest full-dress outlook on balance emphasizes downsides but also their temporariness. However Olivier Blanchard (chief economist) at the press launch echoed Managing Director Lagarde and had a different and darker emphasis: “the global economy has entered a new dangerous phase. The recovery has weakened considerably and downside risks have increased sharply”.  When, he was asked, could things go wrong? ‘Anytime’ he replied.

And that’s the problem: the difference in tone between the IMF reports just recently completed on the one hand and on the other what is being said now by Fund executives, and what we can all see happening on the ground. Eurozone growth appears to be stalled for the moment; the currency is facing its existential moment; politics is paralysed (in Europe and America); and the ECB also is riven by policy disputes.

Production Manager Indices (PMIs), leading indicators, everywhere look suddenly to be in decline; central banks are again lining up to boost money supply; companies are replete with cash and keeping it on the balance sheet; interest rates are hitting the zero bound and likely to stay there for the next two years. Significantly at the IMF ‘austerity’ is slipping down the charts: to return to Carlo Cottarelli, “It is important to ensure that excessive fiscal tightening is not a source of instability, because if you raise taxes too rapidly, or if you cut spending too rapidly, there is a drag on domestic demand and this slows down the growth of output.” Also US, UK and German government bond yields are at previously unseen (low) levels. In the words of investment banker Roger Altman writing in the FT, “It is only the anticipation of negligible demand for capital and negligible inflation – both hallmarks of recession – that could drive rates this low.” He continues: “For the American and western European economies to decline again, when unemployment levels are already so high would be extremely negative. It would shock consumers, businesses and financial markets."

There is a little-understood point in the history of financial crises that is worth reflection: in the US the Great Depression had three distinct phases, 1929 – 1933 a period of severe slump (the Great Contraction); 1933 – 1937 sustained rapid recovery; and 1937 – 1938 a second slump. Economic historians see both down-waves as largely explained by public policy, specifically monetary policy. Roger Altman has a point, wavering though it may be. The downgraded forecasts of the WEO are critically predicated on financial turmoil not running beyond the control of policy-makers.