IMF warns central banks not to keep policy ‘too tight for too long’

The International Monetary Fund (IMF) says central banks are at risk of keeping monetary policy “too tight for too long” in its latest flagship report on the global economy.

The World Economic Outlook, published today (October 22), celebrates the worldwide decline in inflation, which has come without a major hit to economic growth.

IMF chief economist Pierre-Olivier Gourinchas nevertheless warns in the report’s foreword that downside risks are rising and “now dominate the outlook”. The world faces the risk of monetary policy staying too tight. This, he says, would add to the squeeze on the financial markets – and particularly on government bond markets – at a time when growth in China is slowing down and countries are “ratcheting up” trade barriers.

The report forecasts “stable yet underwhelming” growth of 3.2% in 2024 and 2025, little changed from the IMF’s previous two outlooks. Its forecast for five years ahead is 3.1%.

Under its headline findings, the IMF says it has made some important revisions. US growth forecasts have been revised up, while those of commodity-reliant nations in the Middle East, central Asia and sub-Saharan Africa have been cut. Emerging Asia is expected to grow faster owing to “surging demand” for semiconductors and electronics. This, in turn, is being driven in large part by the wider adoption of artificial intelligence.

Meanwhile, the inflation outlook is improving. The IMF says “cyclical imbalances have eased” since the start of 2024, which has helped align economic activity with potential output and has thus led to reduced inflation. The fund expects global inflation to fall from 6.7% in 2023 to 5.8% this year and 4.3% in 2025. Central banks in advanced economies are expected to reach their inflation targets sooner than those in emerging markets.

Speaking at a press conference, Gourinchas said advanced economies and emerging market economies had made different amounts of progress in bringing inflation down. Many advanced economies are expected to meet their inflation targets in 2025, he said.

Among emerging markets, there has been an “increase in dispersion”, the chief economist said. Many economies in Asia are seeing lower inflation, while some in the Middle East and sub-Saharan Africa still face double-digit inflation.

“We see an increased divergence that reflects some of the shocks that are specific to these regions,” Gourinchas said.

‘Triple pivot’

In a blogpost accompanying the report, Gourinchas calls for a “triple pivot” in monetary, fiscal and structural policies.

The chief economist warns that monetary policy “could remain too tight for too long, and global financial conditions could tighten abruptly”. He notes that advanced economy central banks have already pivoted towards easing, which should support labour markets at a time when many are “showing signs of cooling”.

He adds that lower policy rates in advanced economies should ease the pressure on emerging market economies. If currencies in emerging market economies were able to strengthen against the dollar, he says, this would cut imported inflation and make it easier for their central banks to achieve disinflation.

Fiscal policy-makers need to consolidate their finances, Gourinchas says. The IMF is particularly concerned about the US and China, where the authorities’ current fiscal plans “do not stabilise debt dynamics”. Other economies have also shown signs of fiscal “slippage”.

He believes the third policy area – structural reforms – is the one in which it will be hardest to achieve a pivot. Countries need to move towards “growth-enhancing” policies that support innovation, improve competition and resource allocation, deepen economic integration, and stimulate private investment.

The IMF report acknowledges that such reforms are often unpopular. It says countries need to develop a two-way process of policy design that helps build trust between governments and citizens.

“Building trust is an important lesson that should also resonate when thinking about ways to further improve international co-operation and bolster our multilateral efforts to address common challenges,” Gourinchas says.