Sri Mulyani Indrawati, Indonesia’s finance minister and chairman of the Group of the Top 20, summed up the mood in one of the darkest IMF-World Bank meetings since the financial crisis.
“The global economy has become increasingly challenging,” she said Thursday in her closing remarks before the meeting of finance ministers and central bank governors in Washington, DC. “The world is in a dangerous situation.”
Indrawati and others have been full of conversations about geopolitical disagreements, negative economic spillovers from one country to another, and the unintended side effects of the IMF’s message that countries should “stay on track” in fighting inflation by raise borrowing costs rapidly.
Kristalina Georgieva, Managing Director of the IMF, said the world is witnessing a transition from predictability, where interest rates and inflation are low, to instability.
“Shock after shock after shock”, she characterized the situation of the participants. “We really need to work on changing our mindset to be a lot more precautionary and prepared for a lot more uncertainty.”
She advocated “identifying countries [the] problems and then find the will to solve them”.
At least the former was traded.
The participants shared the IMF’s view that the world economy is in a difficult position – and that the worst is yet to come. Indeed, many still thought the fund’s most recent growth projections of 2.7 percent next year, down significantly from estimates made in the spring, were still overly optimistic. The global economy was headed for a recession that could be exacerbated by financial stability, as witnessed in the UK during the week. Inflation would remain uncomfortably high in 2023, forcing central banks to tighten further.
“We’re seeing developments and challenges that are either entirely new or unlike anything that’s been around for at least decades,” said Nathan Sheets, chief economist at US Bank Citi. “It causes stress and difficulty for policymakers as they develop approaches to achieve their goals, including inflation, macro stability and financial stability.”
A global problem, almost everyone agreed, was the rapid rise in US interest rates. While the Federal Reserve sought to tame rising domestic prices, the impact on the dollar’s strength caused trouble beyond US borders, spiking inflation elsewhere and raising the prospect of market volatility.
“A thorough understanding of the [cross-border] Effects of policy,” said Mark Carney, former Bank of England Governor.
However, the Fed is poised to extend its string of outsized rate hikes for another session after new data released on Thursday showed a worrying acceleration in underlying inflation. It will next meet in early November. Economists now consider a fourth straight rate hike of 0.75 percentage points — which would move the federal funds rate to a new target range of 3.75 percent to 4 percent — as a foregone conclusion. The Fed is also expected to keep interest rates at levels actively dampening the economy for longer than originally expected.
Bringing inflation back to central banks’ long-term 2% targets will take time, Marcelo Carvalho, global head of economy at BNP Paribas, has warned and will prove difficult.
The general view was that central banks, including the Fed, should continue raising interest rates. However, economists acknowledged that it was difficult to strike the right balance between containing price pressures and destroying demand.
Politicians need to “proceed with a lot of hope and heart because you really don’t know what’s going to work,” Sheets said.
Some economists even consider the political approach to date to be counterproductive. Measures to combat high inflation, a slowing economy, an energy and food crisis and the ongoing impact of Covid-19 have added to volatility and economic difficulties, according to Allianz chief economic adviser Mohamed El-Erian.
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Nowhere was this more true than in the United Kingdom. The chaos that followed the new administration’s “mini” budget was the talk of Washington and was widely cited as the perfect case study of what can happen when governments aren’t careful in coordinating fiscal and monetary policies. On Thursday, Kwasi Kwarteng, the British Chancellor, flew home early from meetings to hold emergency talks with Prime Minister Liz Truss.
The IMF had urged Britain to make changes quickly. “Don’t prolong the pain,” Georgieva said as her colleagues at the foundation discussed the situation in the UK in various motor metaphors. The government stepped on the accelerator while the BoE hit the brakes, IMF officials said. Alternatively, they said ministers would steer to the left while the central bank was pulling the steering wheel to the right. In both formulations they implied that the British economic vehicle was headed for a crash.
Few felt much sympathy.
As ministers prepared to return home after their first face-to-face meetings since the pandemic began, many connections had been reestablished and valuable discussions had been held. However, with domestic problems plaguing most members, the IMF’s usual calls for cooperation went unheeded.
Concrete findings on global economic management were so few and far between that Indrawati had difficulty when asked to name them. However, one thing came to mind: Business leaders “recognized the challenging tasks [ahead] for both fiscal and monetary policy,” she said.
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