Should We Worry About Higher Interest Rates?


Hamid FaruqeeBy Hamid Faruqee

Global interest rates will eventually move higher. We do not know precisely when,  how fast, or how far, but we do know the direction. After a long period of very low interest rates following the global financial crisis, some central banks (mainly, the U.S. Federal Reserve and the Bank of England) are planning to “normalize”—that is, to gradually tighten their easy monetary policies as their economies improve. And when U.S. and U.K benchmark interest rates go up, interest rates tend to go up elsewhere, too.

So should we worry if and when global financial conditions tighten?

The 2014 IMF Spillover Report prepared by IMF staff looks into this important issue—what to watch out for and who to watch out for as interest rates begin to normalize. The answer depends on two sets of factors. First, what is going on in the originating source countries in terms of the underlying drivers behind higher yields—for example, whether or not stronger growth, say in the U.S. and U.K., is the main force behind higher interest rates.  Second, what is going on in the receiving countries—that is, how vulnerable they might be to higher borrowing costs.  Both these factors matter for spillovers as highlighted in the report.

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The Slow Recovery Continues


WEO

By Olivier Blanchard

(Versions in Español中文,  日本語Русский )

The recovery continues, but it remains weak, indeed a bit weaker than we forecast in April.

We have revised our forecast for world growth in 2014 from 3.7 percent in April to 3.4 percent today. This headline number makes things look worse than they really are. To a large extent, it reflects something that has already happened, namely the large negative US growth rate in the first quarter. But it is not all due to that. It also reflects a number of small downward revisions, both in advanced and in emerging economies.

The overall story remains largely the same as before:

Advanced economies are still confronted with high levels of public and private debt, which act as brakes on the recovery. These brakes are coming off, but at different rates across countries.

Emerging markets are slowing down from pre-crisis growth rates. They have to address some of their underlying structural problems, and take on structural reforms. At the same time, they have to deal with the implications of monetary policy normalization in the US.

Let me take you on the usual tour of the world.

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Asia’s Seismic Shift: How Can the Financial Sector Serve Better?


Min ZhuBy Min Zhu

(Versions in  中文)

Asia is set to be the powerhouse for growth in the next decade, just as it was in the last one. The size of its economy is expected to expand more rapidly than the other regions of the world, and its share in the world output is expected to rise from 30 percent to more than 40 percent in the coming decade. The structure of the economy is expected to continue to transform from a narrower manufacturing hub to a group of vibrant, diverse and large markets with a rising middle-class population.

The role of the financial sector is critical in the success of this seismic transformation. Let me explain by focusing on three areas:

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Fiscal Policy’s Evolving Role


Fiscal policy makers have faced an extraordinarily challenging environment over the last few years. At the outset of the global financial crisis, the IMF for the first time advocated a fiscal expansion across all countries able to afford it, a seeming departure from the long-held consensus among economists that monetary policy rather than fiscal policy was the appropriate response to fluctuations in economic activity. Since then, the IMF has emphasized that the speed of fiscal adjustment should be determined by the specific circumstances in each country. Its recommendation that in general deficit reduction proceed steadily, but gradually, positions the IMF between the fiscal doves (who argue for postponing fiscal adjustment altogether) and the fiscal hawks (who argue for a front-loaded adjustment).

All this is highlighted in a  recently released book Post-Crisis Fiscal Policy, edited by Carlo Cottarelli, Philip Gerson and Abdelhak Senhadji,  that brings together the analysis underpinning the IMF’s position on the evolving role of fiscal policy.  The book underscores how the global financial crisis has reshaped our understanding of the role of fiscal policy with topics that include a historical view of debt accumulation; the timing, size, and composition of fiscal stimulus packages in advanced and emerging economies; the heated debate surrounding the size of fiscal multipliers and the effectiveness of fiscal policy as a countercyclical tool and more.

Check out this book, which is written for a wide audience, and watch the webcast of the book launch hosted by the Peterson Institute for International Economics on July 14 .

Slowdown in Emerging Markets: Not Just a Hiccup


By Evridiki Tsounta and Kalpana Kochhar 

(Versions in Español)

Emerging market economies have been experiencing strong growth, with annual growth for the period 2000-12 averaging 4¾ percent per year—a full percentage point higher than in the previous two decades. In the last two to three years, however, growth in most emerging markets has been cooling off, in some cases quite rapidly.

Is the recent slowdown just a hiccup or a sign of a more chronic condition? To answer this question, we first looked at the factors behind this strong growth performance.

Our new study finds that increases in employment and the accumulation of capital, such as buildings and machinery, continue to be the main drivers of growth in emerging markets. Together they explain 3 percentage points of annual GDP growth in 2000–12, while improvements in the efficiency of the inputs of production—which economists call “total factor productivity”—explain 1 ¾ percentage points (Figure 1).

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Fixing International Corporate Taxation—Not Just a Problem for Advanced Economies


Mick KeenBy Michael Keen

It’s hard to pick up a newspaper these days (or, more likely for readers of blogs, to skim one online) without finding another story about some multinational corporation managing, as if by magic, to pay little corporate tax. What lets them do this, of course, are the tax rules that countries themselves set. A new paper takes a closer look at this issue, which is at the heart of the IMF’s mandate: the way tax rules spill over national boundaries, and what this means for macroeconomic performance and economic development. These effects, the paper argues, are pretty powerful and need to be discussed on a global level.

Follow the money

Take, for instance, international capital movements. Though tax is not the only explanation, the foreign direct investment (FDI) positions shown in Table 1 are hard to understand without also knowing that  tax arrangements in several of these countries make them attractive conduits through which to route investments. In its share of the world’s FDI, for example, the Netherlands leads the world; and tiny Mauritius is home to FDI 25 times the size of its economy.

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Emerging Market Corporate Sector Debt: A Stitch in Time Could Save Billions


By Julian Chow and Shamir Tanna

(Versions in Español)

Much has been said lately about growing private sector debt in emerging market economies. In our recent analysis, we examined the corporate sector in a number of countries and found their rising levels of debt could make them vulnerable.

Low global interest rates in the aftermath of the global financial crisis and ample amounts of money pouring in from foreign investors have enabled nonfinancial corporations to raise record levels of debt.

figure 1

Credit was readily available in the aftermath of the crisis, and economic expansion enabled earnings to grow healthily, thus helping to prevent leverage from rising too far and too fast.  Recently though, slowing growth prospects are beginning to put pressure on firms’ profitability. Moreover, higher debt loads have led to growing interest expense, despite low interest rates. As a result, the ability of firms to service their debt has weakened (Figure 1).

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Era of Benign Neglect of House Price Booms is Over


Min ZhuBy Min Zhu

(Versions in  عربيEspañol, 日本語中文, Français, and Русский)

House prices are inching up.  But is this a cause for much cheer?  Or are we watching the same movie again? Recall how after a decade-long boom, house prices started to fall in 2006, first in the United States and then elsewhere, contributing to the 2008-9 global financial crisis. In fact, our research indicates that boom-bust patterns in house prices preceded more than two-thirds of the recent 50 systemic banking crises. Real Estate Boom.Chart1

While a recovery in the housing market (Figure 1) is surely a welcome development, we need to guard against another unsustainable boom. Housing is an essential sector of every country’s economy and has systemic implications, which is why we at the IMF are focusing on it not only in individual countries but on a cross-country basis.

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Banking on the Government


By Jesus Gonzalez-Garcia and Francesco Grigoli

(Version in Español)

Government ownership of banks is still common around the world, despite the large number of privatizations that took place over the past four decades as governments reduced their role in the economy. On average, state-owned banks hold 21 percent of the assets of the banking system worldwide. In Latin American and Caribbean countries, the public banks’ share is about 15 percent, with some of them showing very large shares, for instance, Argentina, Brazil, Uruguay, and Costa Rica are all over 40 percent (see Figure 1).

State-owned banks play an important role in the financial system. They fulfill functions that are not performed by private banks, provide financing for projects that benefit the rest of the economy, and provide countercyclical lending (lending more when the economy is weak). But public banks usually respond to the needs of governments owing to the state’s obvious involvement in their administration. As a result, government’s participation in the banking system may weaken fiscal discipline by allowing the public sector to access financing that they would not obtain from other sources.

In our recent study, we use a panel dataset for 123 countries to test whether a larger presence of state-owned banks in the banking system is associated with more credit to the public sector, larger fiscal deficits, higher public debt ratios, and the crowding out of credit to the private sector. 

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The Secret Weapon for Fiscal Strength—Strong Budget Institutions


Holger van EdenBy Holger van Eden 

Most economists would agree that institutions in general are incredibly important in helping to shape countries’ overall economic and fiscal outcomes. But which institutions really matter, and to what extent, is less clear.

A team of staff at the IMF recently completed a study, along with detailed country evaluations, that explores the G-20 countries’ efforts to strengthen their budget institutions in the wake of the global financial crisis, and evaluates their impact on fiscal policy. We ask whether strong budget institutions helped these countries to cope with the substantial fiscal consolidation needs that arose after the Great Recession. The evidence suggests that these institutions have indeed been important.

Budget institutions matter

In the study we identify 12 institutions (see figure1) that are commonly viewed as important for the effectiveness of fiscal policy. To be clear, the term “institution” is used in a broad sense—it encompasses processes, procedures, systems, legal frameworks, and organizational entities which contribute to the budget process.

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