The International Monetary Fund (IMF) has released its updated forecasts for the global economy, and it makes for grim reading. Among the growth downgrades, however, is a point that most commentators are overlooking: the real dangers of the oil-price shock for Western economies.
Despite the tumbling of oil prices by over 50% since June, providing a welcome boost to consumers through lower prices of fuel and goods, the IMF has downgraded its forecast for global growth by 0.3% this year and another 0.3% in 2016. The downgrades reflect the ongoing weakness of the eurozone and Japan, as well as slowing growth in emerging markets (especially among oil exporters).
However, the report also contains a warning for advanced economies such as those of the US and the UK that are seeing relatively robust economic expansion. Lower oil prices are helping drag down inflation and could mean that even faster-growth economies experience a period of falling prices. If this is allowed to continue unchecked, the IMF warns, it risks becoming a self-feeding deflationary spiral.
With central bank interest rates already around zero, the ability of monetary policy to offset these price falls and help bring inflation back toward the 2% target is limited (at least according to mainstream economic theory).
As the international funding body puts it (emphasis added):
That is, the IMF is encouraging central banks to undertake precautionary easing and, where that is unavailable because of existing low interest rates, to use government spending on infrastructure to increase economic activity and push up the rate of price increases. Low government borrowing costs across much of the developed world mean in effect that states have room to do this at very limited (or even negative in the case of Germany and Switzerland) cost to taxpayers, despite heavy debt burdens following the financial crisis.
Not everyone is convinced. Numerous economists argue that a temporary period of deflation because of a positive supply shock — whereby prices are falling because more goods can be made for the same amount of money — does not require any action from a central bank. It should be a cause for celebration.
Many of those who hold this position also argue that central banks can simply undertake further rounds of asset purchases under their so-called quantitative easing programmes if they become concerned that expectations of price falls are becoming entrenched and people are holding off purchases.
However, the IMF’s intervention can be seen as a warning against the complacency of such a view. The effectiveness of QE in reversing price falls remains a matter of much debate in the economics profession and relying on unconventional central bank tools to reverse price falls after they have set in could be seen as too great a risk.