IMF Chief: Recovering Economy Still Vulnerable to Shocks, Policy Missteps

The global economy has made remarkable progress and now stands at the cusp of recovery, but it still remains highly vulnerable to shocks and policy missteps, says International Monetary Fund Managing Director Dominique Strauss-Kahn.

 

In a speech delivered at the annual conference of the Confederation of British Industries (CBI) in London, Strauss-Kahn says policy makers stand at a critical juncture where the sustainability of the global recovery will depend on the decisions they make in the months to come.

 

“Today the storm has passed. The worst has been averted. And yet the economy remains very much in holding pattern―stable, and getting better, but still highly vulnerable,” says Strauss-Kahn. For policymakers, the IMF chief says “the challenges are great. During the crisis, everyone was united by a common purpose. Going forward, this might dissolve. So the road ahead will be less clear cut. We will need some deft maneuvering, and perhaps some out-of-the-box thinking. We will certainly need continued collaboration.”

 

Four Key Challenges for Policy Makers

 

According to Strauss-Kahn, policymakers will face four main challenges: exiting from accommodative policies, adapting to increasing capital flows to emerging markets, developing a new global growth model, and designing and implementing financial sector reforms.

On exit strategies, Strauss-Kahn stresses the importance of waiting for a sustained recovery in private demand, as well as clear indications of financial stability before accommodative measures are withdrawn. “It is too early for a general exit. We recommend erring on the side of caution, as exiting too early is costlier than exiting too late,” he says. Plans for fiscal consolidation should be the top priority, especially in advanced economies. And monetary policy can afford to stay accommodative for some time, given little sign of inflation on the horizon.

 

A related challenge to exit strategies is managing capital flows to emerging markets. Strauss-Kahn says that in many countries, appreciation should be the key policy response. "Other tools include lower interest rates, reserves accumulation, tighter fiscal policy, and financial sector prudential measures. Capital controls can be part of the package of measures,” he says.

 

Moving to the challenge of creating a new global growth model, Strauss-Kahn says that the old paradigm of growth generation based on households in the U.S. is no longer effective. “If we are to have sustained global growth, somebody else needs to step into the breach. The leading candidates are the surplus countries. And we can see some shifts in the right direction. China and other emerging Asian economies are shifting from exports to domestic demand. But they have some way to go.”

 

Finally, Strauss-Kahn underscores the importance of forging ahead with a number of reforms to make the financial sector a more stable place. He stresses the challenge posed to policymakers by increased risk taking in the financial sector while financial institutions are still in poor shape while regulators seek to impose tough new standards that may jeopardize recovery. “How do we square the circle? One possible answer is to reduce regulatory uncertainty. It is throwing up some perverse incentives and might be encouraging a risk-taking culture,” he says.

 

Addressing risk management in the financial sector, Strauss-Kahn says that it was essential to break the link between risky behavior and compensation. “In this context, we have been asked by the G-20 to look into financial sector taxes. There are a number of ways to think about this, and we will look at it from various angles and consider all proposals,” he reveals.
 

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