By Ian Talley
If the biggest engine of the global economy revs up faster than expected, that’s great for the global economy, right? Not necessarily, says the International Monetary Fund in its latest update to its flagship report, the World Economic Outlook.
If the U.S. grows a half-percentage point faster than expected, it would force the Federal Reserve to raise interest rates at a quicker clip. That would boost borrowing costs for emerging markets more than many governments and investors planned, raising serious questions about the ability of countries, households and corporations to pay off their debts.
(The IMF expects the U.S. economy to expand at a rate of 2.8% this year and 3% in 2015. The fund assumes the Fed will end its bond buying program by the end of the year and the first policy rate hike will take place in the third quarter of 2015, in line with market expectations.)
And if some key emerging markets slow faster than expected and investors pull their cash out of those countries en masse, it could send a shockwave through the global economy, the IMF said. Investment levels could drop by around 14% over five years, and growth could fall across the world.
China would likely get hit the hardest, given its close trade linkages with emerging markets. The IMF estimates growth there could fall by 1 percentage point of GDP. Among industrialized nations, Japan is the most exposed, the fund said.
With global demand dropping, commodity prices would fall and major oil exporters would also suffer.
There are several reasons why the fund conducted its “plausible downside scenario.” One is to warn emerging markets to shore up their economies to ward against investor flight.
Another is to signal to the Fed that it should consider the potential “spillback” consequences of its monetary policy.
World finance leaders have urged Fed officials to take greater care on the potential impacts of their monetary policy. The Fed says its mandate is the U.S. economy, not the world’s.
But the fund’s scenario shows that the Fed can meet its mandate by considering the global economic consequences of its policy strategies.