22/09 Can the I.M.F. Save the World?

September 22, 2011, 5:00 AM

By SIMON JOHNSON

Simon Johnson, the former chief economist at the International Monetary Fund, is the co-author of “13 Bankers.”

The finance ministers and central bank governors of the world gather this weekend in Washington for the annual meeting of countries that are shareholders in the International Monetary Fund. As financial turmoil continues unabated around the world and with the I.M.F.’s newly lowered growth forecasts to concentrate the mind, perhaps this is a good time for the fund – or someone – to save the world.

TODAY’S ECONOMIST

Perspectives from expert contributors.

Yet there are three problems with this way of thinking. At least in a short-term macroeconomic sense, the world does not really need saving. If the problems do escalate, the monetary fund does not have enough money to make a difference. And the big dangers are primarily European — the European Union and key euro zone members have to work out some difficult political issues, and their delays are hurting the global economy.

But very little can be done to push them in the right direction.

The world’s economy is slowing, without a doubt. The latest quantification was provided Tuesday in the I.M.F.’s World Economic Outlook (see Table 1.1), perhaps the most comprehensive forecast of global growth and its main components. (Disclosure: I helped produce and present these forecasts when I was chief economist at the I.M.F., a position I left in summer 2008.)

The fund has reduced its forecasts for both 2011 and 2012, and while the latter is a more notable change, we can see the gloomy 2011 picture all around us. Compared with its view in June, the fund now expects global growth in 2012 to be one-half of one percentage point lower than previously expected.

Part of the pessimism is about the United States – total growth of gross domestic product in 2012 is expected to be only 1.8 percent, anemic at best. (Remember that our population typically grows at just under 1 percent annually, so this level of growth would barely put a dent in unemployment.)

But the really stark message is for Europe. According to the I.M.F., the euro zone as a whole will expand only 1.1 percent in 2012, and hopes that troubled countries will grow out their debts seem increasingly like a stretch. Just to take one example, Italy’s forecast for 2012 has been marked down to just 0.3 percent — and even in the best case, credit availability in Italy will probably get tighter over the coming months, which may further slow growth.

A potential recession in the euro zone and a weak recovery in the United States does not make for a world crisis. So beware people who demand that the world be saved; usually they are making the case for a bailout of some kind.

Don’t get me wrong — a serious crisis could develop. Plenty of warning signs regarding the situation in Greece and its potentially broader impact abound.

According to the fund’s Fiscal Monitor, also released this week (see Page 79), Greece’s general gross government debt is now forecast to rise to nearly 190 percent of G.D.P. in 2012 before falling back toward 160 percent by the end of 2016. At this point, Greece needs a global growth miracle — and there is no sign of this on the horizon.

If Greece pays less on its debt than is currently expected, this will push down the market value of other sovereign debt in Europe. As The Economistasserted last week, the government debt of some large euro zone countries has unambiguously moved from the category of “risk-free” to “risky” in the minds of investors.

The numbers involved are big. Italy, for example, had public debt of more than 1.84 trillion euros at the end of 2010 (using the latest available Eurostat data, “general government gross debt,” annual series). The G.D.P. of Germany is around 2.5 trillion euros, and there is no way German taxpayers would be comfortable in any way guaranteeing a substantial part of Italy’s debt.

The entire euro zone has a G.D.P. of around 9.5 trillion euros, but no one is volunteering to take on debt issued by someone else’s government (again, I use end-of-2010 data from Eurostat).

To put these issues in perspective, compare them with the International Monetary Fund’s ability to lend to countries in trouble. The technical term is the fund’s “one year forward commitment capacity,” which for “Q3 to date” is 246 billion special drawing rights, or S.D.R.’s, which exist only at the I.M.F. (see the Sept. 15 update).

On Sept. 20, one S.D.R. was worth 1.57154 United States dollars, so the fund could lend no more than $386 billion. With one euro worth about $1.37 this week, this is around 280 billion euros.

Or you could think of it as 15 percent of Italy’s outstanding debt. This is not the only way — and not a precise way — to think about what the fund could bring to the table, financially speaking. But it makes the right point. The European issue is way above the I.M.F.’s pay grade.

Germany, France, Italy and their neighbors need to sort out how to bring the situation under control – to decide who will definitely pay all their debts and who needs some kind of restructuring. About a quarter of the world’s economy therefore remains in limbo, beset by repeated waves of uncertainty. And financial market fears can spread to other places, including the United States.

Complaints may be heard this weekend, but no one at the I.M.F. meetings can persuade the key European players to move faster in their decision-making. The politicians will take their own time – prodded periodically, no doubt, by the financial markets.

Do not expect a fast resolution or a quick turnaround in the global economy.