IMF to Washington: Don't Let Up on Stimulus

As forecasters update their economic predictions for the year, the majority view seems to be that the recovery is fragile and it is not yet time to withdraw emergency fiscal stimulus. The International Monetary Fund, in its January 26 forecast, says "A premature and incoherent exit from supportive policies may undermine global growth and its rebalancing."

The IMF says that, led by China, the world economy is bouncing back strongly from its 2009 decline. US growth is projected to reach 2.7% this year, a nice rebound from last year's 2.5% decline. Mike Mussa, a top forecaster at Washington's Peterson Institute for International Economics is more optimistic. Citing the axiom that the deeper the downturn, the steeper the recovery, Mussa sees the US economy expanding by 4% this year.

The IMF says that emergency government spending undertaken by the United States, China and most European nations, what it calls "extraordinary policy support," forestalled another great depression. The stimulus measures were coordinated through the Group of 20, the new policy forum that has met three times at the leaders level in the past 14 months. The G20 includes the US, Japan, and Western Europe, plus China, Russia, Brazil and other emerging economies. While greatly expanding government debt, the fiscal stimulus is credited with having compensated for the collapse in consumer spending that followed the subprime credit squeeze and stock market tumble that began in 2007.

Hans Timmer, an economic forecaster at the World Bank, says the challenge now is making the recovery broad based and sustaining. "Fiscal stimulus," he says, "doesn't create growth. It merely sustains it at previous levels." He told a Washington forum this month that output in the advanced economies is still 12% below pre-crisis levels. He believes that it may be several more years before the financial system is fully repaired.

The IMF, in its latest financial stability report, says there is an urgent need for more regulation of financial institutions. A top priority, it says, is to get banks to resume normal lending.

Few forecasters are predicting a slippage back into recession. But there is disagreement over how strong and enduring the recovery will be. Phillip Suttle of the Institute of International Finance believes the recovery will be subdued, mainly because of the severity of the damage that was inflicted on business and consumers. Desmond Lachman of the American Enterprise Institute agrees that the US recovery is likely to subpar. He believes unemployment will remain over 10% for most of the year.

The global forecast would have been far less upbeat absent rapid growth in Asia. IMF forecaster Jorg Decressin says "the emerging markets of Asia really surprised us on the upside." China, says the IMF, hardly missed a beat from the global recession and is expected to register 10% growth this year. Japan meanwhile continues to lose ground, having slumped by over 5% in 2009.

All this fiscal stimulus comes at the price of greatly expanded debt. The Congressional Budget Office this week said the US deficit will for the second straight year exceed $1 trillion, an amount equal to about 10% of gdp. This explosive volume of debt will at some point have to be halted and rolled back. But, says the IMF, not yet. Olivier Blanchard, the MIT professor who is the IMF's chief economist, says the exit from stimulus towards fiscal balance should come only when there is a tangible pickup in consumption, investment and exports. None of these element, he says, are yet present.

"When you see private demand starting to grow," he says, that is the time to remove stimulus. "If you do it before private demand has recovered," he says, "then you back to where you were before."