A wake-up call from the IMF

Anyone who thinks that the United States and world economies are well on the road to recovery from the worst economic recession in the past 90 years has not read the International Monetary Fund’s (IMF) latest World Economic Outlook update.

It is not simply that the IMF is offering us the most sober of baseline world economic forecasts. It is also that the IMF is pointing to potential downside risks that it believes could take a severe toll on global economic activity. More ominously yet, it is warning that in the event that those downside risks were to materialize, the resulting downturn could be amplified by world financial market turmoil and by an intensification of trade restrictions. 

Although the IMF has now slightly revised up its June 2020 World Economic Outlook on the basis of stronger than anticipated economic numbers, it hardly makes for comforting reading. In the IMF’s current view, in 2020 the advanced countries’ economic output is expected to decline by almost 6 percent and the emerging market countries’ output by over 3 percent. This would constitute by far these economies’ worst economic recession in the past 90 years.

While the IMF expects that both the advanced economies and the emerging market economies will rebound in 2021, it cautions that by the end of 2021 both sets of those economies will still fail to have regained their pre-pandemic level of activity. More strikingly yet, the IMF estimates that in 2020 and 2021, as a result of the pandemic, the world economy is likely to lose $11 trillion in output relative to what it would have produced in the absence of the pandemic. That is to say, in those two years the world economy is likely to lose around one half of a year of the U.S. GDP.  

As depressing as the IMF’s baseline economic forecast is, what makes it even more sobering is that the IMF identifies several risks that, if realized, would make for a very much darker economic picture than it is now currently painting. These include a second wave in the COVID-19 pandemic, emerging market debt difficulties, trouble in the global financial markets and an intensification in world trade restrictions. 

A disturbing aspect of the IMF’s downside risks is that they seem not to be so much a remote possibility as much as something very real that is unfolding before our eyes. Even before the onset of winter, Europe continues to be hit hard by the pandemic. In particular, the United Kingdom, France and heavily indebted Spain are all now seeing infection rates that exceed those experienced in the spring and that are now forcing them to roll back some of their earlier lockdown restriction easing. 

Meanwhile, major countries that have had among the world’s highest infection rates, such as the U.S., Brazil and Mexico, are yet institute coherent policies to bring the pandemic under control.

Similarly, the possibility that a wave of emerging market debt defaults could hit world financial markets next year is no longer remote. As the IMF notes, the debt-to-GDP levels of the emerging market economies were already high before the pandemic, which has now put these debts on an unsustainable path. Meanwhile these debt problems are now being compounded by a ballooning in these countries’ budget deficits and by a plummeting in their currencies.

Federal Reserve Chairman Jerome Powell has been warning that the U.S. economic recovery risks losing steam in the absence of additional fiscal stimulus measures. The IMF has highlighted the real risk of storm clouds gathering in the world economy that could constitute a further major headwind to our own economic recovery. American policymakers would be ignoring those warnings at our peril if they fail to agree on a new fiscal stimulus.

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