The International Monetary Fund said today that the euro-area debt crisis has exacerbated global financial instability and an orderly adjustment process is likely to be prolonged and costly.
The Washington-based IMF’s assessment came today in a pilot report intended to make external monitoring more effective. The IMF announced changes to its surveillance of members’ economies to better account for the effects of their domestic and financial policies on other countries.
“Unsustainably large intra-euro area imbalances were part of the global boom-bust cycle, and the failure to resolve the euro-area crisis is causing heightened stresses that are spilling over to other countries,” the IMF said.
The IMF, which is participating in bailouts of Greece, Portugal and Ireland, has been criticized for missing signs of fragility that led to the 2008 global financial crisis. A report last year showed it also faced “dissatisfaction” about how it assesses exchange rates, prompting a pledge to include data such as capital flows when reviewing member nations’ external stability.
The IMF’s new report discusses the range of spillovers from a country’s policies on global stability and adds guidance on domestic policies. The fund will now focus on both exchange rates and domestic policies when assessing a country’s economy.
“Despite having narrowed through crisis, external imbalances are unlikely to be resolved by themselves but will require decisive policy actions across a wide range of countries,” Tamim Bayoumi, IMF assistant director for surveillance, said in a conference call. “In many evolved countries medium-term fiscal consolidation is needed.”
The IMF is allowing six months for the adoption of the new monitoring to allow time for both staff and member countries to become familiar with it. The IMF will be taking public comment on the monitoring addition.
The lender said the new report is needed because the existing “framework for bilateral surveillance does not adequately capture economic realities, suffers from an exchange rate bias, and hampers the discussion of policy spillovers across countries.”
It also said bank flows are being displaced from the U.K. and euro area to the rest of the world. This bank capital flow “creates the potential for future instability if euro area banks repatriate funds” as they did in 2011.
Economic confidence in the euro area fell more than economists forecast to the lowest in almost three years in July, suggesting a slump extended into the third quarter as governments struggled to tame the debt crisis. An index of executive and consumer sentiment in 17-nation euro area dropped to 87.9 from 89.9 in June, the European Commission in Brussels said today.
For the U.S., the IMF said monetary policy is reducing the risks of a prolonged economic slump. With the U.S. and other major advanced economies likely to maintain and possibly expand monetary easing, “financial conditions are likely to remain choppy for the rest of the world.”
“Expansionary monetary policy in the United States and elsewhere is central to reducing the scale of the domestic credit crunch and risks of a prolonged global slump,” the IMF said.
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