On April 12, 2023, the IMF issued a warning, urging member countries to continue tightening monetary policy in order to combat stubbornly high inflation, saying that hidden financial system vulnerabilities could explode into a new crisis and crush global economy this year.
The warnings cast a gloomy shadow on the IMF and World Bank’s spring meetings this week in Washington, where competing economic and market forces are obscuring the policy course as GDP slows in response to swift increases in interest rates by central banks.
With its baseline assumptions excluding, for the time being, a significant new escalation of financial system turmoil following the failures in March of U.S. lenders Silicon Valley Bank and Signature Bank and Switzerland’s forced sale of Credit Suisse, the IMF on Tuesday slightly lowered its projections for global growth in 2023.
Real GDP growth was forecasted by the Fund’s Global Economic Outlook to be 2.8% in 2023 and 3.0% in 2024, which is 0.1 percentage points less than what the Fund had predicted in January for each year. In 2022, the world economy expanded by 3.4%.
A greater performance in the United States and a shallower decline in Britain were offset by weaker performances in other of the world’s largest economies, including Japan, Germany, India, and Brazil. Also, the IMF mentioned forecasts for tighter financial conditions this year.
Their predictions were heavily influenced by downside risks, such as even greater inflation, a worsening of the war in Ukraine, and a catastrophic negative scenario of a new financial crisis that may cause substantial cuts in credit and consumer spending as well as a rush toward safe-haven assets. The latter might force this year’s global growth back to only 1%, thereby causing a recession based on per-capita GDP.
According to the IMF’s Global Financial Stability Report, some players had not fully prepared for the effects of interest rate increases, creating a “perilous combination of vulnerabilities” in the financial markets.
Tobias Adrian, the head of the IMF’s Monetary and Capital Markets Department, told Reuters that “even if you assume that banks have a lot of capital and liquidity on average, there could be some weak institutions that then flood back into the system as a whole.”
Following the instability in the global financial system last month, these risks quickly escalated as investors remained on edge and some searched for the next weak point that would cause a chain reaction, according to IMF officials.
Notwithstanding the cautions, the head economist of the IMF, Pierre-Olivier Gourinchas, claimed that inflation is still a greater concern and that for the purposes of central banks’ monetary policy, price stability should take precedence over threats to financial stability. These priorities should only be switched around in the event of a very severe financial catastrophe, he stated at a news conference.
At a separate news conference, U.S. Treasury Secretary Janet Yellen disputed the IMF’s forecast, saying it was “fairly bright,” but she added that she was “vigilant” about potential downside risks like financial strains and the conflict in Ukraine.
I would not be overly pessimistic about the global economy, Yellen said, noting that a number of economies, including the US, were demonstrating resilience thanks to robust labor markets, improved supply chains, and lower energy prices. After the bankruptcies of SVB and Signature Bank, Yellen claimed she had not observed any evidence of a credit crunch and that the American banking system was robust, with good capital and liquidity levels. She continued by saying that changes made in the wake of the 2008 financial crisis have made the world financial system more resilient as well.
