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Expect the news from the IMF-World Bank annual meetings next week to highlight worsening economic projections for this winter and next year and the difficult decisions facing finance ministers over inflation, energy, the cost of living and Ukraine, against threats of economic and public finance crises in an increasing number of countries.
But I find equally important the analytical work done by the IMF which, true to form, has started releasing it ahead of the meetings. It’s not that the fund is necessarily right. But its role as a guardian of global economic policy orthodoxy means that its thinking influences what passes for responsible policymaking — witness its unusual public concern with the UK’s tax-cutting “mini” Budget last week.
Paying attention to the IMF’s research perspective becomes all the more important when the orthodoxy it expresses is evolving. And as I have written in the past, this is a time of just such an intellectual evolution — if not revolution: the return of the activist state is now the establishment’s house view.
Reading the chapters released so far from this autumn’s World Economic Outlook and the Global Financial Stability Report, it looks to me like the fund’s paradigm shift is not being blown off course by current economic storms. The chapters I have looked at, which all have user-friendly blog versions for those short of time, are two from the WEO on climate policies and growth and on the risk of wage-price spirals (blog versions here and here), and one from the GFSR on the dangers of open-ended investment funds (blog version here).
The IMF shows consistency: these chapters, in part, reflect longstanding themes (on climate) and fit with a greater willingness to shape markets and outcomes they produce than the old Washington Consensus did. Indeed, the chaos following the “mini” Budget could well mean that markets are more comfortable with the fund’s style of progressivism than the new UK government’s 1980s throwback views. I also detect a gentle pushback from the fund at some of the more unreconstructed voices in the economic policy debate.
Here are my main takeaways:
Bigger (and faster) is better (and cheaper)
The fund estimates that the costs of cutting carbon emissions enough by 2030 to reach net zero by 2050 are trifling for the optimal policy, which consists of budget-neutral carbon taxes, set to increase gradually and combined with transfers to households, subsidies to low-carbon technologies, and lower labour taxes. Such a policy mix would achieve the required cuts at a cost to annual growth of 0.05 to 0.2 percentage points for four years in the US, the eurozone and China. Inflation would be 0.1 to 0.4 points higher in those years. This is in line with previous fund research, if slightly less optimistic, since it argued that spending on carbon-free infrastructure could add to growth over the next decade and a half. Presumably, this could offset the small cost from carbon taxation identified in the latest work. That growth cost is admittedly a little higher in the rest of the world, but that is mostly down to energy exporting countries that would obviously stand to lose significant export earnings as carbon consumption drops.
Dithering is costlier: the near-term cost in growth and inflation only becomes worse by delaying action. There are two reasons for this. One is that the longer you wait, the more abrupt the structural changes have to be. Another is that if governments are credibly committed to decarbonisation, the private sector will adjust its behaviour in ways that make the process go smoother. In contrast, if governments are not thought to be serious about climate change, companies will invest in the wrong capital, at greater cost to the economy when the adjustment finally happens.
Quite simply: committing now to a gradually rising path of carbon taxes sufficient enough to cut carbon use is better for growth than not doing so.
Don’t panic about inflation
The other WEO chapter takes on an extremely topical debate on whether there is a risk that the current price rise drives up wage demands, in turn leading employers to raise their prices and so on as everyone expects high inflation to persist. Should we fear such wage-price spirals? The short answer is “no”. The fund’s economists looked at a set of historical inflationary episodes that resemble the current one — in particular in that price pressures don’t originate within the labour market (because real wages are flat or falling). These did not tend to lead to wage-price spirals, with nominal wages growth modest and price growth quickly peaking and returning to normal.
The chapter on climate policies has a “keep calm and carry on” message on inflation too. There are worries about central bankers that making carbon-emitting activities more expensive, as net zero requires, makes monetary policy harder. But the fund’s modelling “shows this is not the case . . . When policies are gradual and credible, the output-inflation tradeoff is small. Central banks can choose to either stabilise a price index that includes [carbon] taxes or let the tax fully pass through prices.” Either way, inflation remains stable and growth impacts are limited.
There is a cloud to this silver lining, as it were. The results rely on central banks keeping inflation expectations under control. So there is something here for the hawks as well.
Financial intermediation is scary stuff
September’s flash crash in UK government bonds (gilts) can’t have been on IMF economists’ minds when they decided to include in the GFSR a chapter on how open-ended funds can “amplify shocks and destabilise asset prices”. It is exquisitely timely, even if the UK episode related to pension funds. The basic problem was the same as that identified by the IMF (and so was that behind the flash crash in US Treasuries at the start of the pandemic). When investment products that are to some extent illiquid by construction need urgent liquidity, they may have to liquidate what they can in little time, accelerating the market movements. These should worry us as central banks are bent on raising interest rates fast — could they be forced to put tightening on pause (like the Bank of England postponed its sale of bonds, temporarily buying them instead) by financial instability brought on by a rising interest rate?
The IMF is willing to consider some quite interventionist solutions, “like limiting the frequency of investor redemptions” and forcing more trading into central clearing. That is sensible. It is also a far cry when, not so many years ago, financial deregulation was all the rage.
My colleagues take a deep dive into the causes and consequences of China’s property crash.
Talking about China, Noah Barkin’s newsletter on China-Europe relations is always worth a read — one nugget in the latest issue is how “Chinese diplomats have removed their talking points blaming Nato for the conflict in Ukraine and made clear that the use of nuclear weapons by Russia would be viewed as totally unacceptable in Beijing”.
The gilt flash crash is just one symptom of a deeper disease in how financial markets work today, argues Eric Lonergan: “the volatility virus”.
Today is the inaugural summit of the “European Political Community” — Franz Mayer, Jean Pisani-Ferry, Daniela Schwarzer and Shahin Vallée have a paper on how to give it substance.
Do sign up to the FT’s Unhedged newsletter — I particularly liked my colleagues’ exchange with our great ex-colleague Matthew Klein on the pros and cons of the Bank of Japan’s policy to target the 10-year interest rate. For the record, I’m with Matt and see no reason it should stop doing this.
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