IMF: Central banks ‘must' ease if inflation expectations drop

Central banks in advanced economies "must" continue easing policy to prevent a rise in real interest rates if falling oil prices cause inflation expectations to drop further, the International Monetary Fund (IMF) argues in an update of its World Economic Outlook report.

This should be done through "other means" if benchmark rates have reached the zero lower bound, adds the Fund in the report, published today.

Meanwhile, lower oil prices could alleviate inflation pressures and external vulnerabilities in many emerging markets, giving room to central banks to delay raising policy interest rates, according to the report.

Global oil prices have fallen sharply in the past few months, transforming the macroeconomic backdrop of both developed and developing economies.

"[But] even with the sharp oil price decline – a net positive for global growth – [the] economic outlook is still subdued," according to the Fund, which revises down its global growth forecast for 2015 by 0.3% to 3.5% due to a decline in potential output.

"Factors supporting growth – lower oil prices, but also depreciation of euro and yen – are more than offset by persistent negative forces, including the lingering legacies of the crisis and lower potential growth in many countries," the Fund adds.

"The cross currents make for a complicated picture," says Olivier Blanchard, the IMF's director of research. "It means good news for oil importers, bad news for oil exporters... Good news for countries more linked to the euro and the yen, bad news for those more linked to the dollar."

In advanced countries, cheaper oil is delivering a "welcome" boost to demand, but could also increase the risk of deflation, the IMF warns.

"If the further declines in inflation, even if temporary, lead to additional downdraft in inflation expectations in major economies, monetary policy must stay accommodative through other means to prevent real interest rates from rising," the report argues.

The IMF also foresees slower growth in emerging and developing economies, owing to a slowdown in China and Russia, and the related hit to commodity exporters' terms of trade.

In addition, the boost from lower oil prices to importers in the developing world "is less than in advanced economies, as more of the related windfall gains accrue to governments", for example in the form of lower energy subsidies, the report notes.

The weaker global growth forecast underscores the need to raise actual and potential growth "in most economies", according to the IMF. "This means a decisive push for structural reforms in all countries, even as macroeconomic policy priorities differ."