A DEEPENING of the economic crisis in the euro zone represents the most serious threat to the global economy, according to reports published yesterday by the IMF. Despite this risk and others, the IMF’s baseline scenario for Europe and the wider world economy is marginally more upbeat than its last such assessment four months ago.
Top of the IMF’s policy prescriptions yesterday was the stepping up of the euro zone’s response to the debt crisis.
It urged European authorities to move expeditiously to restructure banks where necessary and to put in place legal mechanisms on a pan-European basis to allow failed banks to be wound down. It also said the main source of euro zone bailout funding, the Luxembourg-based European Financial Stabilisation Fund, should be given addition resources and powers by its member countries.
It said it was “essential” for those economies in which banking systems face stress to retain access to funding, even if that requires “non-national backstops”. It also recommended the ECB continue buying government bonds.
The call comes despite the fact that it plays an integral role in the euro zone’s temporary bailout mechanisms, from which both Ireland and Greece have received assistance. Differences between the IMF and the European authorities on how to handle the crisis have been ill-concealed in the past, including issues relating to the terms of Ireland’s bailout. The prescriptions made yesterday highlighted significant differences persist between the European authorities and the Washington-based organisation.
Among other policy prescriptions, the IMF warned of flagging impetus in the reregulation of the financial system globally, owing to “fatigue and the sheer complexity of the issues” and the possible need for developing countries to control destabilising inflows of capital.
The latter prescription represents a major change in the IMF’s views. Until recently it opposed capital controls and often included their removal as a condition of bailouts.
In its accompanying forecasts for growth in the global economy, and its largest regional economies, the IMF revised upwards its outlook in most cases in 2011. Among Ireland’s main trading partners, the only revision of note was to the forecast for the US economy. That country’s gross domestic product (GDP) is now expected to expand by 3 per cent this year, compared to 2.3 per cent last October.
Given the elevated risks to its forecasts, the IMF set out again a relatively detailed scenario in which the most serious of its identified risks come to pass – the eruption of a full scale financial crisis in the euro zone.
In such a scenario, European banks would cut lending “by a similar magnitude as during the collapse of Lehman Brothers in 2008”. As a result, the IMF estimates, euro zone GDP growth would be below its expectations.
