The big question for the IMF meetings

As international economic policymakers gather on Washington for this year’s International Monetary Fund (IMF) annual meeting, there will be no shortage of issues for them to discuss. Outside of the United States, the world economic recovery is sputtering, geopolitical risks are on the rise, deflation risks are all too evident in Europe and Japan, and emerging market economies now have to deal with sharply falling international commodity prices. However, from the point of view of the long-run health of the global economy, the one issue that would appear to deserve the most attention strangely does not seem to be on the IMF meeting’s agenda: How are the world’s major central banks to coordinate their monetary policies in a manner that does not create excessive asset price bubbles and that does not heighten the risk of a currency war?

The potential importance of the monetary policies of the major industrialized countries at this stage of the global economic cycle can be gauged by developments over the past two years. In response to the Federal Reserve’s third round of massive quantitative easing beginning in September 2012 and to the Bank of Japan’s following suit at the start of 2013, there has been an unprecedented increase in international liquidity. As the Bank of International Settlements has recently noted, this liquidity has given rise to the emergence of overextended prices in a broad range of international asset markets that has to be a matter of considerable longer-run concern for the future health of the global economy. It has also led to very large capital flows to the emerging market economies and until very recently to a weakening in both the U.S. dollar and the Japanese yen.

{mosads}Highlighting the need for a serious discussion of monetary policy issues at this year’s IMF annual meeting is the fact that it coincides with a major inflection point in the monetary policies of the major industrialized countries. Whereas over the past few years, the monetary policies of these countries were largely synchronized, they now are on the point of sharply diverging. After having increased the size of its balance sheet to more than $4.25 billion, the Federal Reserve is now about to end its quantitative easing program and it is beginning to contemplate how U.S. interest rates will start to be normalized sometime next year. For their parts, the European Central Bank is now under enormous pressure to engage in massive quantitative easing to stave off the deflationary threat that now haunts Europe, while the Bank of Japan might soon be forced to step up its already large-scale quantitative easing program in response to a stalling domestic economic recovery and a renewal of disinflationary pressures.

From a global point of view, the prospective monetary policies of the major industrialized countries raise two fundamental questions regarding the long-term health of the global economy that one would think should be at the heart of this weekend’s deliberations in Washington. How might one mitigate the risk that large-scale quantitative easing by the European Central Bank and by the Bank of Japan might take global asset prices well into bubble territory? How can one minimize the risk of a global currency war as divergent monetary policies of the United States on the one hand and of Europe and Japan on the other give rise to a sharp weakening in the euro and the Japanese yen?

Too often in the past, IMF meetings have focused on the smaller issues confronting the global economy, rather than on the elephant in the room. This was certainly the case in the run-up to the 2008 U.S. housing and credit market bust as it was to the 2010 onset of the eurozone debt crisis, which the IMF managed to totally miss. It would be the greatest of pities if little was learnt from the past and if this IMF annual meeting did not pay due attention to the potential of asset price bubbles and disorderly currency movements that could substantially undermine the prospects of long-term global economic prosperity.

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