The International Monetary Fund (IMF) has issued a warning of the potential negative consequences of sharp monetary tightening. The IMF’s economic counsellor, Pierre-Olivier Gourinchas, noted that “inflation is much stickier than anticipated” and emphasised that “financial risks have risen”. Gourinchas shared his global economic outlook in a blog post published by the IMF on Tuesday. He stated that “the economic slowdown is most pronounced in advanced economies. Inflation is falling more slowly than anticipated”. Gourinchas also warned that “recent banking instability reminds us, however, that the situation remains fragile. Once again, downside risks dominate and the fog around the world economic outlook has thickened”.
Gourinchas explained that core inflation, which excludes energy and food, has not yet peaked in many countries. He noted that “activity shows signs of resilience as labor markets remain very strong in most advanced economies” and that “our output and inflation estimates have been revised upwards for the last two quarters, suggesting stronger-than-expected aggregate demand”. Gourinchas stated that “this may call for monetary policy to tighten further or to stay tighter for longer than currently anticipated”.
However, Gourinchas expressed concern about the side effects of sharp monetary policy tightening. He explained that the financial sector had become too complacent about maturity and liquidity mismatches due to a prolonged period of low-interest rates and muted inflation. The tightening of monetary policy caused losses on long-term fixed-income assets and raised funding costs. Gourinchas warned that “we are therefore entering a tricky phase during which economic growth remains lacklustre by historical standards, financial risks have risen, yet inflation has not yet decisively turned the corner”.
Gourinchas stated that he was “unconvinced” about the “risk of an uncontrolled wage-price spiral”. However, he warned that the side effects of sharp monetary policy tightening were starting to have an impact on the financial sector, as the IMF had repeatedly warned might happen. Gourinchas described recent banking instability as a reminder that the situation remained fragile and that downside risks dominated.
The IMF’s warning comes as the global economy faces a number of challenges, including trade tensions between the US and China, Brexit uncertainty, and political instability in several countries. The IMF has already revised downwards its global growth forecast to 3.3% for 2019, the slowest pace since the financial crisis.
It remains to be seen how policymakers will respond to the IMF’s warning. Central banks have already begun to tighten monetary policy in some countries, including the US, where the Federal Reserve has raised interest rates several times in the past year. However, other central banks, such as the European Central Bank and the Bank of Japan, have maintained loose monetary policy in an attempt to stimulate economic growth.
The IMF’s warning is likely to be of particular concern to countries with high levels of debt, such as Italy, which is already grappling with a weak economy and political instability. It may also have implications for emerging markets, which are already facing a number of challenges, including rising debt levels and the impact of the US-China trade war.
In conclusion, the IMF has warned of the potential negative consequences of sharp monetary tightening, noting that inflation is much stickier than anticipated and that financial risks have risen. The IMF’s warning comes as the global economy faces a number of challenges, including trade tensions between the US and China, Brexit uncertainty, and political instability in several countries. The IMF has already revised downwards its global growth forecast to 3.3% for 2019, the slowest pace since the financial crisis. It remains to be seen how policymakers will respond to the IMF’s warning.