In its Global Financial Stability Report (GFSR), the International Monetary Fund warns that risks to global financial stability remain contained. However, as economic optimism fades and financial vulnerabilities intensify, it is time to carefully calibrate policies .
The team led by Tobias Adrián, chief financial advisor and head of the Fund’s Monetary and Capital Markets Department, calls on the world’s central banks, finance ministries and international financial institutions to develop strategies that confidently address the next phase of performance of monetary and fiscal policy .
“Amid still generally easy financial conditions, our analysis concludes that financial vulnerabilities remain high in various sectors, but are masked, in part, by huge policy stimulus,” warns this official.
In this regard, the GFSR notes that systemically important central banks know that any unintended consequences of their actions could jeopardize growth and could possibly lead to sharp adjustments in the world’s financial markets.
Furthermore, it shows that a prolonged period of extremely lax financial conditions during the pandemic, which has certainly been necessary to sustain the economic recovery, has allowed excessively high asset valuations to persist . “If that overload continues, it can, in turn, intensify financial vulnerabilities,” he clarifies.
Some red flags, such as increased financial risk taking, as well as the growing fragility of the non-bank financial institutions sector, point to a deterioration in the underlying fundamentals of financial stability . The Fund’s financial advisor insists that, if left unchecked, these vulnerabilities can persist in the long term and turn into structural problems.
In general, Adrian and his team ask governments and central banks to make their monetary and fiscal policy more specific and adapted to the circumstances of each country, given the different pace of recovery in different countries.
“The sense of optimism that had driven markets in the first half of the year is in danger of fading”
In this regard, central banks will have to provide clear guidance on their future approach to monetary policy, with the aim of avoiding an unjustified or abrupt tightening of financial conditions. In parallel, they must also remain vigilant and, if price pressures turn out to be more persistent than anticipated, act decisively to avoid dampening inflation expectations.
Fiscal support can evolve appropriately towards more specific measures and be adapted to the specific characteristics of each country. Of course, those responsible for economic policy must adopt early measures and harden certain macroprudential tools to attack sources of high vulnerability.
An optimism that fades
As the document presented today in Washington argues, the massive support of monetary and fiscal policy for the economy in 2020 and 2021 has helped limit the economic contraction that began at the beginning of the pandemic and that – for much of this year – supported a strong economic rebound. In many advanced economies, financial conditions have relaxed since the first months of the pandemic. However, “the sense of optimism that had driven the markets in the first half of the year runs the risk of fading,” Adrian warns.
In this sense, he reiterates that investors are increasingly concerned about the economic outlook, amid growing uncertainty about the strength of the recovery. Unequal access to vaccines, coupled with Covid-19 mutations, have led to a resurgence of infections, fueling concerns about more divergent economic prospects between countries.
At the same time, inflation readings have been above expectations in many countries. And new uncertainties in some of the major economies have put markets on alert. “These uncertainties are caused by financial vulnerabilities that could increase downside risks , rising commodity prices and political uncertainty,” emphasizes the IMF’s chief financial adviser.
The deterioration in market sentiment since the last issue of the GFSR, published last April, resulted in a significant decline in long-term global nominal yields in the summer, driven by falling real rates, reflecting concern by long-term growth prospects.
That said, in late September, investor anxiety over inflationary pressures drove yields higher, as price pressures began to be seen as potentially more persistent than initially anticipated in some countries, completely reversing previous declines. .
For Adrian, “if investors at some point sharply reassess the economic and political outlook, financial markets could experience a sudden revaluation of risk , and that revaluation, if maintained, could interact with underlying vulnerabilities, causing a tightening of conditions This could put economic growth at risk. “
Risks in other key areas also need to be closely watched. Cryptocurrency markets are growing rapidly and their prices remain highly volatile. The risks to financial stability are not yet systemic but the risks need to be closely watched, given the global monetary implications and inadequate operational and regulatory frameworks in most jurisdictions, especially in emerging market and developing economies.
Also, as the world continues to seek ways to accelerate the transition to a low greenhouse gas emissions economy for economic and financial stability associated with climate change, a promising opportunity is emerging in the financial sector .
Although assets under management in climate investment funds remain relatively small, inflows have increased and there is promise of lower financing costs for climate-friendly companies, as well as greater climate management by of funds.