Thursday, July 24, 2008

IMF Warns of Tough Policy Choices for World Economy

"Tough Choices for World Economy, Says IMF's Lipsky"
"Perspectives on the Global Economic Landscape and the Role of the Dollar"

In a speech at the Brookings Institution in Washington D.C. on July 22, the first deputy managing director of the International Monetary Fund (IMF), John Lipsky, said that policymakers around the world faced tough decisions on how to react and correct the current economic climate. He stated that high oil prices had created imbalances throughout the global economy creating new risks and misalignment. Lipsky expressed his comments and recommendations on seven specific areas of the global economy; 1) advanced economies, 2) emerging markets, 3) financial markets, 4) reducing global imbalances, 5) oil markets, 6) exchange rates, and 7) prospects a reserve currency.

In addressing advanced economies, Lipsky stated that the key objectives of policymakers need to be managing inflation while stabilizing the financial system. If this is not accomplished, the efforts to control inflation over the past decades could be lost. For emerging markets, the focus should be on controlling inflation. Lipsky stressed that although many of these countries have tightened their monetary policy, real interest rates remain negative causing inflation to get out of control because of surging commodity prices and growth in domestic demand. Advanced economies such as the North America and Europe need to play a large role in the stabilization of the global financial markets. As the world economy worsens, credit deterioration is widening and banks are getting squeezed. Inflation concerns have reduced much of the flexibility of policymakers to ease stress on the financial markets but they still need to improve policies that allow the banks to deleverage and rebuild capital. To reduce global imbalances, Lipsky stated that countries need to achieve better balance in demand growth. This balance will reduce global payment imbalances and help boost confidence. To adapt to the high oil prices, emerging markets need to pass through the higher international prices without subsidies while advanced economies need to control demand through conservation and efficiency. Lipsky also noted that the depreciation of the dollar and inflation has led to increased stress on the countries with inflexible exchange rates. As far as the world reserve currency, Lipsky said the dollar will likely continue to play a large role as the most popular but forecasted more diversification, with the euro becoming a major player.

1) The goal of controlling inflation is often in direct conflict with increasing economic growth. With the global growth downturn, is it more important for policymakers to try to control inflation or attempt to increase growth?
2) The dollar has fallen 25% since 2002, making this one of the largest sustained depreciation episodes in its history. Will the dollar rebound, keep depreciating, or has it been overvalued in the past and the current climate is the correct valuation? If the dollar keeps depreciating, how long before the currencies that are pegged have to adjust?

No comments: