Is the IMF repeating its mistakes from the global financial crisis?

Is the IMF repeating its mistakes from the global financial crisis?
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In 2008, the International Monetary Fund (IMF), along with the U.S. economic academic community, failed to anticipate the Great Recession. Today, as the Biden administration engages in the country’s largest peacetime budget stimulus on record, and as the Federal Reserve continues to inflate a global “everything” asset and credit market bubble, the IMF risks repeating its 2008 error. By so doing, it is failing to fulfill its mandate of promoting global economic prosperity.

One basic error that the IMF is making is to parrot the Federal Reserve’s mantra that current inflationary pressures are largely the result of transitory supply-side factors. To be sure, the IMF anticipates that by the end of this year, core price inflation, as measured by the personal consumption expenditure deflator, will rise to 4 percent, or double the Fed’s 2 percent inflation target. But it assumes that by the end of 2022, inflation will have retreated to 2.5 percent. 

In adopting its Panglossian inflation view, it does not seem to bother the IMF that this year the U.S. economy is receiving a budget stimulus equivalent of around 13 percent of GDP at a time when the Congressional Budget Office estimates that the country has only a 3 percent output gap. One would have thought that with such a high degree of government largesse, the IMF should be sounding the alarm about imminent demand-side inflation risks.  

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Nor does it seem to bother the IMF that fiscal policy-induced economic overheating might be compounded by several factors. Monetary policy conditions, in the form of low interest rates and high asset prices, are now the easiest that they have been in the last decade. As if that were not enough, there is also a massive amount of COVID-19-related pent-up demand in the economy that is being released as the economy returns to some semblance of a post-vaccinated normality.

Instead of cautioning the U.S., its largest member economy, to exercise some budget policy restraint when the budget deficit is around a staggering 15 percent of GDP, the IMF seems to be cheerleading the administration’s further massive public spending initiatives. And instead of calling for an early normalization of monetary policy, the IMF seems to be applauding the Fed’s tolerance of higher inflation levels.

More disturbing than the IMF’s seeming indifference to U.S. inflation risk is its deafening silence about the formation of asset price and credit market bubbles both at home and abroad.

The IMF seems not to have noticed that U.S. equity valuations today are over twice their long-term average and at very lofty levels experienced only once before over the past 100 years. Nor does the IMF seem to have registered that U.S. housing prices adjusted for inflation are now at the same very elevated level as they were on the eve of the 2006 housing market bust.

Worse yet, the IMF seems to be turning a blind eye to the fact that ample global liquidity has allowed the riskiest advanced country and emerging market borrowers to borrow at close to record-low interest rate spreads.

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Seeming to have learned nothing from the 2008-2009 global financial crisis, the IMF does not caution the Fed about the risks to the U.S. and world economies that its continued ultra-easy monetary policy poses by further inflating global asset price bubbles. In the context of a very frothy U.S. housing market, the least that one might have expected from the IMF would have been a call on the Fed to put an immediate end to its current program of buying $40 billion a month of mortgage-backed securities.

Perhaps most disappointing of all from an institution that is supposed to guard against the emergence of global payment imbalances is its seeming silence on how an overly expansionary U.S. budget policy is bound to widen the already wide U.S. external current account balance. One would have expected the IMF to be more alert than it seems to be about the likely emergence of a serious U.S. twin deficit problem. Maybe then it would have called for a more balanced U.S. economic policy mix and for serious thought to be given to long-term fiscal policy consolidation.

If anything is to be said in defense of the IMF’s seeming complacency about the troubling U.S. economic outlook, it is that the IMF is far from alone. Indeed, it is in the good company of the Biden administration and the Federal Reserve, which keep assuring us that there is no need to be worried about inflation and the risk of a hard economic landing.

Desmond Lachman is a senior fellow at the American Enterprise Institute. He was formerly a deputy director in the International Monetary Fund’s Policy Development and Review Department and the chief emerging market economic strategist at Salomon Smith Barney.