The cold water Yankee crowd is not going to like the latest word from the IMF, which sees the US economy at close to a stall level on growth for the next six months. It believes that diminished demand will alleviate inflationary pressures and endorsed the idea of standing pat on interest rates for now.
I’d be inclined to support the IMF’s view, with one caveat: the Fed is working overtime to impede the deleveraging process, which ultimately is inevitable. Having a recession, even a deeper or more protracted one than usual, is better than the alternatives (trying to validate asset prices and providing undue monetary stimulus, which will only lead to either a worse downturn or a Japan-like lost decade). Serious credit contraction is deflationary (that’s what high interest rates are intended to achieve in inflation-fighting: make credit so costly that its use falls sharply).
From the Financial Times:
The International Monetary Fund yesterday warned that the US economy was likely to stagnate in the second half of this year, pouring cold water on hopes that recovery could soon be under way.
It said that continued economic weakness would result in inflation risk going down, not up, in the coming months, and urged the Federal Reserve to keep interest rates on hold for the time being. The statement challenges market expectations that rate increases will soon be required.
The IMF also suggested that the dollar had declined to a level at which it was close to its medium-term equilibrium value on a broad trade-weighted basis, if not all the way there.
John Lipsky, the number two IMF official, said: “We anticipate the economy will slow to virtual stagnation in the second half of the year.” The IMF is forecasting no growth at all in the US this year, measured from the final quarter of 2007 to the final quarter of 2008.
The IMF growth forecast is far below the average of private sector and US authorities’ forecasts. The mainstream view at the Federal Reserve – set out in projections in April – is for growth of between 0.3 per cent and 1.2 per cent this year.
However, the IMF was equally far from consensus when it forecast serious US weakness earlier this year, since when the Fed and private forecasters lowered their projections.
Mr Lipsky said rising energy prices were weighing on household real incomes. A slowdown in jobs and income growth would reduce purchasing power, while strains in the financial system were restricting the flow of credit to US households.
He said the IMF did expect that growth would start to pick up in 2009 but said that recovery would be “gradual rather than aggressive”.
The IMF first deputy managing director added “our expectation is that the sluggishness in growth we foresee in the coming quarters will create greater economic slack and reduce inflation fears”.
In its official review of the US economy released yesterday, the IMF said that US interest rates – currently at 2 per cent – should be kept “on hold”.
At the same time Mr Lipsky said the Fed would have to be “attentive” to the possibility of a deterioration in inflation expectations.
The US central bank may have to take rates back up quite quickly when the economy starts to recover, he added.
The IMF reiterated its controversial suggestion that the US authorities might need to provide “increased direct support” for the housing sector to stop house prices falling below fair value. This view is popular among congressional Democrats but opposed by the White House and US Treasury.
It also said additional public support for the financial sector might be necessary.
Note that the concept of “fair value” is not defined. Housing prices need to fall further to come into thier historical relationship with incomes.
If the IMF means that the US authorities should intervene to prevent housing from overshooting on the downside, that is not an awful idea in the abstract. However, given the already-considerable support the housing market already has (Fannie, Freddie, FHA, Federal Home Loan Banks), I’m leery of administering more of the medicine that helped get us in this mess (in fact, one argument against further intervention is the substantial government role in housing limited profits there for banks, which led them to pursue the areas where the government played a lesser role, namely higher risk credits).