IMF embraces Keynes

Following last week’s dire World Bank report, the IMF has now released its latest six monthly update and the reading is less dour but still pretty gloomy. The bank slashed its global growth forecast for 2012 0.75% of a per cent to 3.25%. That is still over a per cent higher than the World Bank where gloom reigns supreme presently. The Fund described its downgrade thusly:

This is largely because the euro area economy is now expected to go into a mild recession in 2012 as a result of the rise in sovereign yields, the effects of bank deleveraging on the real economy, and the impact of additional fiscal consolidation. Growth in emerging and developing economies is also expected to slow because of the worsening external environment and a weakening of internal demand. The most immediate policy challenge is to restore confidence and put an end to the crisis in the euro area by supporting growth, while sustaining adjustment, containing deleveraging, and providing more liquidity and monetary accommodation. In other major advanced economies, the key policy requirements are to address mediumterm fiscal imbalances and to repair and reform financial systems, while sustaining the recovery. In emerging and developing economies, near-term policy should focus on responding to moderating domestic growth and to slowing external demand from advanced economies.

Is that all, one might ask? More seriously, though, one of the more remarkable things about this document is just how Keynesian it is. Although the Fund mutters about fiscal consolidation and balanced budgets a few times, it actually recommends going for growth via fiscal largesse:

In the near term, sufficient fiscal adjustment is in motion in most advanced economies. Countries should let automatic stabilizers operate freely for as long as they can readily finance higher deficits. Among those countries, those with very low interest rates or other factors that create adequate fiscal space, including some in the euro area, should reconsider the pace of near-term fiscal consolidation. Overdoing fiscal adjustment in the short term to counter cyclical revenue losses will further undercut activity, diminish popular support for adjustment, and undermine market confidence. Among the major economies, a specific concern is that political paralysis in the United States will lead to an excessively rapid unwinding of stimulus spending. Regarding the medium term, the United States and Japan should push ahead in formulating and implementing credible medium-term consolidation plans, because neither country can take for granted its status as a safe haven. Measures could include reforms to slow the growth of health care and pension spending, caps on discretionary spending, and tax system reforms to boost fiscal revenue. Putting in place credible medium-term plans also will create policy room to support balance sheet repair, growth, and job creation.

Although this is not quite a ringing the bell for more stimulus, it’s certainly not banging the drum for greater austerity either. And the document goes on as well to describe how the process of bank deleveraging should also be slowed, another recognition of Keynesian realities. All very sensible, really. Shame about the past 66 years!

The IMF also offers a downside scenario:

Downside risks stem from several sources. The most immediate risk is intensification of the adverse feedback loops between sovereign and bank funding pressures in the euro area, resulting in much larger and more protracted bank deleveraging and sizable contractions in credit and output. Figure 4 presents such a downside scenario. It assumes that sovereign spreads temporarily rise. Increased concerns about fiscal sustainability force a more front-loaded fiscal consolidation, which depresses near-term demand and growth. Bank asset quality deteriorates by more than in the baseline, owing to higher losses on sovereign debt holdings and on loans to the private sector. Private investment contracts by additional 1¾ percentage points of GDP (relative to WEO projections). As a result, euro area output is reduced by about 4 percent relative to the WEO forecast. Assuming that financial contagion to the rest of the world is more intense than in the baseline (but weaker than following the collapse of Lehman Brothers in 2008) and taking into consideration spillovers via international trade, global output will be lower than the WEO projections by about 2 percent.

Following the success of the LTRO, for this to come about we’re really going to have to see a country leave the euro, which remains a possible, but outlying event. One has the same sense for this report as last week’s World Bank shocker. It looks more likely to be ringing the bottom than the top.

Don’t get me wrong, I’m not predicting any growth bonanza but last night’s European PMIs showed we’re in for more of last year’s chronic decline rather than a sudden shock. Germany’s composite (manufacturing and services) rose nicely:

France’s composite rose a little too but was much more subdued at 50.9 from 50. And the periphery continues to shrink, if at a slightly less horrible rate:

Some of the internals were less encouraging. Employment indexes weakened suggesting some kind of business cycle is at work:

And export orders continue to fall everywhere. But with the removal of the risk of severe deleveraging in the banking sector, it all looks more insipid than terrifying. Europe’s perpetual recession continues:

But until we see some new magnitude of shock, the IMF’s downside scenario looks thankfully dated. I’m really rather coming around to the view that without credit-fueled asset markets to drive huge booms and busts in demand, the amplitudes of global business cycles may be much reduced. The remaining question mark over that is China.

P.S. It’s really time for the IMF to update its Australian forecasts. 2012 growth of 3.3%? Ahem…maybe. Unemployment rate of 4.8%? Fail.

IMF WEO