IMF Warns of Threats to Financial Stability

Risks have risen in advanced economies, remain high in emerging markets

Market turmoil reflected setbacks to growth, greater uncertainty, weaker confidence

More balanced, potent policy mix can expand global output by extra 2 percent

Earlier in the year, financial markets reacted negatively to these developments. Global equities plummeted; volatility rose sharply; talk of recession in advanced economies increased; and bank equity prices came under renewed pressure. These developments reflected increased concerns about the ability of policies to offset the impact of higher economic and political risks.

The situation in markets appears significantly improved since February, according to the IMF, following some better news on the economic front, as well as intensified policy actions by the European Central Bank, and a more cautious stance toward raising rates by the U.S. Federal Reserve. China has also stepped up efforts to strengthen its policy framework to bolster growth and stabilize the exchange rate.

“A key question that this report addresses is whether the turmoil over the past months is now safely behind us, or is it a warning signal that more needs to be done?” said José Viñals, Financial Counsellor and head of the IMF’s Monetary and Capital Markets Department. “I believe it is the latter: more needs to be done to secure global stability.”

Policies to fix three global challenges

The IMF said policymakers need to deliver additional measures to create a more balanced and potent mix of policies to reduce risks and support growth. If not, market turmoil could recur and intensify, and could create a pernicious feedback loop of fragile confidence, weaker growth, tighter financial conditions, and rising debt burdens. This could tip the global economy into economic and financial stagnation. In such a scenario, the report estimates that world output could be almost 4 percent lower than the baseline over the next five years. This would be roughly equivalent to forgoing one year of global growth.

To avoid this downside scenario, policymakers must tackle a triad of pre-existing global challenges: namely crisis legacy issues still unaddressed in advanced economies, elevated vulnerabilities in emerging markets, and systemic market liquidity risks. By tackling these challenges, world output could be as much as 1.7 percent above the baseline by 2018.

First, policymakers in...