Jupiter Merlin Weekly: What the IMF Doesn’t Know
The Jupiter Merlin team look at inflation, interest rates and the "unknowns" that can undermine global economic forecasts.
First, good news: US headline inflation fell for the 9th consecutive month, and this time by a full point to 5%. It has nearly halved since its peak of 9.1% last May. It is still 2.5 times the Federal Reserve’s target of 2% but undoubtedly heading the right way.
Less good (and in the immediate future, the more important) is the political deadlock in Congress as negotiations make no tangible progress on the future level of the debt ceiling; having the world’s biggest economy effectively in special measures while global investors ponder the guillotine beyond which the US government can no longer support its day-to-day spending commitments and simultaneously meet its obligations to bond holders is not surprisingly putting strain on both the dollar and US government bond prices.
Invoking Galbraith’s First Law of Forecasting (“forecasters divide in to two types: those who don’t know and those who don’t know they don’t know”) on a five-year view and much more so beyond, the one thing that is virtually guaranteed is that both the IMF and the OBR will be wrong. The tendency of fickle human beings to go off-piste and wander their own way has an inconvenient habit of confounding economists’ tidy spreadsheets. And additionally in the case of the UK, in 2028 we will already be three-fifths of the way through a new parliament, more than likely with a Labour government and a very different fiscal agenda.
The IMF has already lost the integrity of its narrative thanks to laboured explanations allied with sloppy lay-journalism and the demand for easy soundbites (“rock bottom” sounds good, grabs headlines). When referring to the interest rate outlook, buried deep in the WEO report and couched in the technical double Dutch of economic-speak, rather than simple nominal rates of interest what the IMF is projecting is the future path of real interest rates (i.e. the nominal level adjusted for inflation) and where the ‘natural rate’ might settle. The ‘natural rate’ in this case is the inflation-adjusted rate of interest that neither stimulates nor impedes economic growth.
We have used the analogy before that predicting ‘natural’ or ‘neutral’ rates is akin to the children’s game of pinning the tail on the donkey while blindfold: only in this case the donkey’s backside is constantly on the move thanks to the twin prods of a dynamic economy and a shifting inflation rate. Compounding the problem, as we have discussed often in these columns, is that far from being a precision tool, interest rates are a blunt instrument. Often there is a lag of between 12-18 months between a change in the interest rate and a perceptible effect being measurable; when being used as a lever to change demand-side behaviours, there is the risk of overshoot because of the lag.
However, the IMF remains institutionally wedded to the established, lazy, consensus centre-left Keynesian fiscal bias (betrayed last year in its stinging criticism of Kwasi Kwarteng’s budget as “not what is expected of a major developed economy”). Nowhere does it suggest that to break out of the constraints of a ‘feeble’ growth tramline, a strong dose of monetarist fiscal policy might work wonders: lower state intervention; public sector reform hand-in-hand with lower tax rates (and higher tax revenues); a strong vibrant, match-fit private sector to drive economic prosperity and national wealth creation and attracting inward investment.
On the contrary: recognising the potential burden of national economies meeting the nirvana of carbon net-zero, the IMF advocates that public subsidies should be widely used to ease the path. Given the (eye watering) extent of the commitment, lumping much of the the financial risk onto governments’ balance sheets does not make the problem go away, it merely shifts it up the chain; but it still must be paid for, on which grounds it sits uneasily with ‘financial consolidation’ unless governments are prepared to make real fiscal compromises elsewhere. Politically (let alone ideologically) for most governments which are already fiscally incontinent (with the exception of Germany, not one single member of the G7 has produced a government surplus since before the Global Financial Crisis), those choices are a step too far when considering electoral prospects. The political path of least resistance is too often to spend your way out of trouble rather than confront hard choices.
Black Swans and Black Elephants
And as a reminder, debt is not a right or an entitlement: not to a government, a company or an individual consumer. It carries an obligation, it ought to have a cost and lenders should expect a right to a positive return on their investment or loans. We are in the risk business, after all.
As Einstein’s Parable of Quantum Insanity says: “the definition of insanity is doing the same thing over and over and expecting a different result”. QED.
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