Need to 'think the unthinkable'

The IMF, in a report published Wednesday, did not predict an international financial crisis or an international financial decelerator, IMF First Deputy Managing Director John Lipsky outlined, but the fund underscored that policy makers around the globe need to "think the unthinkable" to be better-prepared for worst-case scenarios.

Further, the IMF also underscored that, for now, it believes existing national policies will be able to deal with current financial market stresses and adverse economic conditions and it also praised the actions taken Tuesday by the world's major central banks, led the U.S. Federal Reserve, to increase liquidity by more than $200 billion to ease stressed credit markets. The Fed's action, which also involves swaps with the European Central Bank, Bank of England, Swiss National Bank, and the Bank of Canada, effectively allows private banks and bond dealers to exchange mortgage-backed securities and other instruments for U.S. Treasuries; the action also contained other liquidity-enhancing provisions.

A tool: fiscal policy

While not advocating that member nations use public funds for individual banks, Lipsky said governments should be prepared to use public funds, or what he called "countercyclical fiscal policy" and the adoption of "temporary fiscal measures, if needed" to safeguard the international financial system. The IMF adopted this stance after concluding that "monetary policy may be less effective than in past episodes." Lipksy cited the United States as an example where "temporary and targeted fiscal stimulus" should help support demand, but reiterated that members nations "consider whether they have room to adopt temporary fiscal measures, if needed."

The IMF added that the financial crisis that started in a relatively small part of the U.S. financial system - - the subprime mortgage market of its housing sector - - has now become a global problem. Further, although the problem is essentially financial in origin, the linkages between financial markets and the economy, and the interdependence among nations that has increased during the globalization era's start, "has put the global economy at risk."

Lipsky added that the IMF now expects the U.S. economic slowdown and recent financial market turbulence to reduce global GDP growth to 4.1% in 2008 from about 4.9% in 2007, but that the world should be ready to deal with a further deterioration.

Economic Analysis: Candid and frank analysis by the IMF, but analysis that's also appropriate, timely, and ultimately, in the long-term interests of nations, markets, and citizens alike. There's an axiom that argues 'forewarned is forearmed' and the IMF's report should be viewed in that context. As the IMF outlined, conventional monetary policy - - or even fiscal stimulus by one industrialized nation or region - - may not be adequate in today's interconnected economy and policy makers need to develop options to address a potential global downward credit spiral / vicious cycle.

Further, that the IMF is even breaching the subject of a coordinated and/or multi-nation fiscal intervention also should give investors/readers pause to reflect: typically, the IMF limits itself to recognizing pro-market policies/changes by nations, such as limiting government spending, balancing budgets, and reforms that boost private sector growth. With this report, the IMF is saying in no uncertain terms that the risk of further escalation of the current credit market crisis is real, and policy makers - - monetary, fiscal, executive - - must be prepared to act to maintain market liquidity, if conditions warrant it.