Press Release No. 08/48

Press Release: IMF First Deputy Managing Director John Lipsky Outlines Actions to Address Global Financial and Economic Challenges

March 12, 2008

John Lipsky, First Deputy Managing Director of International Monetary Fund (IMF), called today for "decisive policy action" to strengthen the global financial system, noting that authorities worldwide must also "think the unthinkable" so that they can better anticipate and react to potential global economic risks.

"By now, there is little doubt that risks of further escalation of this crisis are rising and decisive policy action will be required to put the global financial system and economy on a firmer footing," Lipsky stated in an address at the Peterson Institute for International Economics in Washington, DC. "The first priority must be to reverse the spreading strains in global financial markets, and to restore the normal functioning of the financial system in advanced economies," he said. Lipsky added, "The actions taken yesterday by several central banks are helpful, as they reflect recognition of the critical need to assure market liquidity."

Lipsky's speech "Dealing with the Financial Turmoil: Contingent Risks, Policy Challenges, and the Role of the IMF," outlines current IMF thinking on global economic and financial developments with the aim of focusing public attention on the importance of policy makers and regulators in advanced, emerging and developing countries taking steps to guard against contingent risks that could further deepen already significant policy challenges.

Though advanced economies are taking steps in the right direction, integration of financial markets globally implies more rapid and potent spillovers to other economies, Lipsky warned. Policy actions worldwide, so far, "may not prove to be adequate" to deal with the "low probability but high impact events" that may materialize and undermine global financial stability. "Policy makers as a matter of course need to `think the unthinkable,' and to consider how they would plan to react if contingencies arise. The need to prepare more systematically for potential risks has been demonstrated amply during the past few months."

Lipsky pointed to the potential for a "global financial decelerator" that could amplify the impact of financial turmoil on the real economy. "A downward credit spiral, driven by rising defaults or margin calls that forced asset sales even as the value of collateral deteriorates could produce new rounds of deleveraging and asset price deflation," he explained.

The senior IMF official underscored the role of the IMF in the current global environment, noting that that Fund has the expertise to help countries determine whether they have space for countercyclical policies. "At the IMF, we are giving serious thought to what can be done if contingent risks materialize," he said, adding that "we are using our expertise and many years of experience in helping our member countries through crises to think about what policies might prove most effective."

Lipsky stated that in the current environment, monetary policy may be less effective than in past episodes. For that reason, he explained, the IMF has looked at the role of countercyclical fiscal policy. "In United States, where growth has slowed significantly, the temporary and targeted fiscal stimulus should help support demand. Of course, the rest of the world will not be immune to the slowdown in the United States, especially if it becomes serious. In these circumstances, contingency planning is also required...we are advising our members to consider whether they have room to adopt temporary fiscal measures, if needed."

Other key points:

• Monetary policy is the first line of defense, especially in advanced economies. The Fed has appropriately taken aggressive action to help support the economy, and central banks in Canada and the U.K. have also reduced policy rates. The ECB has kept rates on hold, but would respond flexibly if circumstances shift.

• The Fund's preliminary assessment suggests that several major advanced and emerging economies—accounting for two thirds of global GDP—could let automatic stabilizers operate fully in the event of a deeper downturn and that a smaller number—accounting for nearly one half of global GDP—would be able to implement a discretionary stimulus.

• The policy plans developed in the context of the Fund's Multilateral Consultation on Global Imbalances are still relevant, and policies that are adopted should be consistent with the dual goals of sustaining growth while reducing global imbalances. In China, for example, a change in the policy mix to allow for tighter monetary policy through exchange rate appreciation and looser fiscal policy with an appropriate emphasis on social safety net spending reflects sensible macroeconomic management for a country facing rising inflation pressures. Fiscal stimulus in the United States must be strictly temporary—the longer-term fiscal problems are too significant to give up on the progress that has been made in recent years.