The IMF overstates the risks for Eurozone and downgrades the threats for the US economy

Christine Lagarde, Managing Director of the International Monetary Fund (IMF), and José Manuel Barroso, President of the European Commission attending the 68th session of the United Nations General Assembly (UNGA) in New York. (in the background, from left to right). (EC Audiovisual Services).

Once more, the International Monetary Fund, with its latest issue of World Economic Outlook, comes back to criticizing Eurozone’s low inflation rate calling it, a ‘key downside risk’ to global growth. Last week IMF’s managing director Christine Lagarde had also singled out Eurozone as the dark growth spot in the developed world threatened by super low inflation, and consequently comparing poorly with the prospects of the US economy. This last WEO issue estimates that the American economy will expand at an above trend annual rate of 2.75% in 2014–15. Overall IMF’s latest World Economic Outlook (WEO) forecasts global growth at 3.6% this year ―up from 3 percent in 2013―and to rise to 3.9% in 2015.

In more detail, this latest issue of IMF’s WEO when it talks about the developed world, doesn’t refrain from praising the US and reprimanding Europe in many ways. Starting with the presentation of the economic outlook of the advanced countries, the report states that, “A major impulse to global growth has come from the United States, where annual growth in 2014–15 is projected to be above trend at about 2¾ percent”. There is more to it though. In identifying the engines of the strong US economic expansion the report sites exactly the sectors where Eurozone lags behind.

Comparing poorly with the US

It finds that in the US the growth impetus comes from “More moderate fiscal consolidation…; support also comes from accommodative monetary conditions, a recovering real estate sector, and higher household wealth”. In all those accounts Eurozone is clearly lagging behind. In the euro area fiscal consolidation is still strong, monetary conditions are much less accommodative than in the US, while the real estate sector and household wealth are on the average not recovering. The IMF allows it to be understood that for all those reasons Eurozone is a growth laggard.

However, there is not a word of criticism about the super relaxed monetary easing that the American central bank, the Fed, has pursued over the past five years. Now, the much needed and imperative monetary tapering by the Fed, threatens the world with an abrupt adjustment. There is not a word on the fact that the New York banks thrived on this five year dangerous monetary expansion, and now after the American banks cropped the profits they needed to recapitalize themselves, the Fed calls back this risky expansion without paying attention to the woes it may cause to the developing world.

The IMF also omitted to appreciate the positive repercussions on the world markets, from the latest announcement by Mario Draghi, the ECB President, about its unanimous Governing Council decision to support growth in Eurozone with extraordinary monetary measures. As Draghi said last Thursday, the ECB is ready to apply “More monetary easing, including through unconventional measures”.

ECB depresses interest rates

This announcement has suppressed borrowing interest rates in south Eurozone and countries like Ireland, Italy and Spain are now able to borrow at near pre-crisis rates. The prospects of more quantitative easing in Eurozone have helped even Greece to contemplate a return to capital markets, reportedly with a small bond issue of around €2 billion and a five year maturity. Athens is expected to borrow at a 5.5% – 6% interest rate. Despite all that, the IMF didn’t see anything positive happening in Europe. Instead its WEO report states that growth in Eurozone is barely above zero and only a “strong reduction in the pace of fiscal tightening” can lift growth.

The truth is tough that Eurozone is not preparing a generous relaxation of fiscal tightening, and everybody knows that. In reality, with this above mentioned observation, the IMF undermines Eurozone’s growth prospects. Then, while addressing the problems of south Eurozone the IMF is inexorable. It says, “However, growth in demand is expected to remain sluggish (outside the core area), given continued financial fragmentation, tight credit, and a high corporate debt burden. Growth performance will therefore continue to lag the core euro area”.

Analyzing risks

Analyzing the downside risks in the world economy, the Fund chose to first cite the danger of low inflation in Eurozone. IMF’s report reiterates “the risk from persistently low inflation in advanced economies, especially in the euro area. Inflation is projected to remain below target for some time, as growth is not expected to be high enough for economic slack to decline rapidly. Longer-term inflation expectations are then more likely to drift down in response, and risks of lower-than-expected inflation, or even deflation, will increase, because interest rates are already close to zero and only limited options remain for using monetary policy to respond. The result would be premature increases in the cost of borrowing and higher real debt burden. The lingering danger is that the longer inflation remains weak, the more vulnerable the region is to damaging debt deflation in the event of adverse shocks to activity”.

This whole paragraph is a masterpiece of deceptive facts and half- truths. For one thing, it insists that the ECB has nothing left in its monetary policy arsenal and avoids mentioning last Thursday’s unanimous decision in its Governing Council to use “More monetary easing, including through unconventional measures”. The IMF doesn’t even hesitate to draw conclusions for the false assumption that the ECB is powerless in front of the deflation danger. The report argues that Europe is threatened by a “damaging debt deflation in the event of adverse shocks to activity”. This simply means that Europe will drown in its own debts, in the eventuality of the slightest fall of GDP.

Malignant criticism

This is not just unfounded criticism; it touches the limits of malignancy. Probably in this way the IMF is trying to hinder the recently consolidating large inflow of capital into Eurozone, out from the dollar. It is also an attempt to make the redressing of Eurozone banks a bit more expensive by overstating the risks.

In any case, the latest issue of IMF’s World Economic Outlook is an open attempt to overstate the risks threatening Eurozone and minimize the shortcomings of the US economy.

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