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IMF Says Markets Losing Faith in Central Banks' Ability to Hit Inflation Targets
DOW JONES & COMPANY, INC. 9:13 AM ET 9/27/2016
WASHINGTON -- The International Monetary Fund warned Tuesday that rich countries risk exposing their economies to large job losses if they aren't able to stoke inflation soon, bolstering its long-argued case for central banks to be more aggressive and use globally coordinated action.

"Faith in central banks' ability to combat persistent disinflationary forces might be diminishing," the IMF warned in part of its latest World Economic Outlook.

If advanced economies face a sudden weakening in demand -- such as from a hard deceleration in Chinese growth, for example -- limited room to juice output with lower interest rates could leave their economies vulnerable to a sharp rise in unemployment, the IMF said.

Investors are increasingly skeptical that monetary policy makers will be able hit their inflation targets, the fund said. Their evidence is medium-term inflation expectations have become more sensitive to inflation surprises, such as oil-price movements.

In central-banking parlance, inflation expectations are becoming unanchored. In layman's terms, markets increasingly don't trust central banks to have enough firepower.

"The scope of monetary policy to further stimulate demand is perceived to be increasingly constrained," the IMF said.

A souring global outlook and softening commodity prices have been the primary drivers of low inflation, or in some cases, falling prices, the IMF says.

A "marked overcapacity in a range of industrial sectors" is worsening the problem, the fund said, pointing to China's excess production capacity as a prime culprit. By keeping the credit and other subsidies flowing to companies that otherwise would have been restructured or gone belly-up, Beijing is exacerbating the disinflationary pressures central banks in the U.S., Europe and Japan are fighting as they try to rev up their economies.

Weak global demand, cheap prices and waning central bank firepower could conspire to pitch those economies into a downward spiral.

"If medium-term inflation expectations drift down significantly, a deflationary cycle may emerge in which weak demand and deflation reinforce each other," the IMF warned. "Eventually, the economy may end up in a deflation trap -- a state of persistent deflation that prevents the real interest rate to decrease to the level consistent with full employment."

Even if deflation is avoided, the IMF said a persistent downward shift in inflation to very low levels could inflict long-lasting damage on the economy, especially with rates already so low. With little room to ease further, "the economy would still not be far from slipping into deflation and, given stickiness in wages, a weakening in demand would be more likely to cause large job losses," the IMF said.

That is why the IMF has been pleading with the U.S. to hold off on another rate increase, why it has pushed Europe to more aggressively juice the region with cheap cash and why the fund has urged Japan to restructure its economy.

"The breadth of the disinflation and evidence of meaningful cross-border spillovers of disinflationary forces through import prices also point to the value of a coordinated approach to supporting demand across the larger economies," the IMF said.

Previous calls by the IMF for joint action have largely been ignored, however, by the world's largest economies.


(END) Dow Jones Newswires
09-27-160913ET
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