IMF & World Bank should focus on three transitions

Annual meetings this week must be devoted to sustaining the global economy

It is generally accepted in economics that financial variables tend to adjust more rapidly than real and policy variables. This seems to be the case this year with the three major transitions that are critical to the longer-term well-being of the global economy and markets.

While this process is ongoing, policy makers would be well advised to put these changes in operating regimes front and center at the spring meetings of the International Monetary Fund and the World Banks in Washington this week.

The first shift involves equity markets, which have settled into a regime of more frequent and larger two-way movements after an unusually prolonged period of very low volatility and seemingly endless investment gains. Critically, markets have generally performed well, notwithstanding some initial pains in the vol-selling segment.

Stock valuations haven't collapsed, but have been largely range-bound since early February after the initial leg down. The repricing of the front end of the Treasury yield curve, which hasn't caused any major dislocations, has been accompanied by more subdued rises in interest rates for longerterm maturities due in large part to the dampening role of non-commercial purchases by central banks and liability-matching investors. Meanwhile, moves in the currency market have, if anything, been muted.

The second major transition — of the dominant economic policy approach gradually moving away from prolonged reliance on unconventional monetary instruments and market involvement by central banks — is also going well so far (though, outside the U.S., the process is at a much earlier stage).

The Federal Reserve, which has already hiked rates six times, including last month, has prepared the markets for two more increases this year. And it has done so without derailing economic growth or unduly disrupting markets. Also, there have been no negative reactions to its plan to reduce the $4.5 trillion balance sheet. And unlike many prior bouts of unsettling financial volatility, the Fed and its counterparts in other advanced economies have wisely refrained from verbal interventions to calm investors.

But the real test of this policy transition is yet to come.

It is only a matter of time until other systemically-important central banks (such as the Bank of Japan and the European Central Bank) join the Fed in normalising monetary policy. They will start by halting their programs of large-scale asset purchases, raising important questions about how the global economy and markets will respond to a significant reduction in highly predictable and reassuring injections of liquidity, both direct and indirect.

All of which takes us to the third and most important transition: the change in the global growth regime.

After a frustrating and protracted period of “new normal” growth that was too low and insufficiently inclusive, the global economy has been experiencing an encouraging synchronised pickup. The recent update of the IMF’s World Economic Outlook suggests that, notwithstanding “escalating risks,” the pickup is expected to spill over to the rest of this year and 2019. Yet its sustainability is far from assured.

As I have argued, the synchronised pickup in global growth is the result of the happy coincidence of a set of unrelated factors, rather than the product of comprehensive pro-growth policies and their interactions.

While policy has been an important driver in the US, Europe’s heartening improvement is primarily due to a natural economic and financial healing process. Along with China’s successful growth soft-landing, other emerging-market economies are being boosted by recoveries from distinct shocks: from politics in Brazil, demonetisation in India and commodities in Russia.

The opportunities and risks associated with global growth should feature prominently in the policy discussions in Washington. The key will be to strengthen both the individual and collective resolve to move forward more aggressively with pro-growth policies, many of which have been identified but not implemented. There also is a need to take on the risks that, in the majority of cases, are a direct outcome of too many years of too low and insufficiently inclusive growth.

How this growth transition is handled will have an amplifying effect. Not only will it prove an important determinant of the ultimate success of the other two transitions — creating scope for either virtuous or vicious cycles for growth, financial stability and policy rebalancing — but it will also feed into politics and social integrity, including whether and how fast trust is restored in institutions and expert opinion.