Earlier this year, the International Monetary Fund (IMF) worried publicly about a storm brewing for the global economy if government policymakers don't match the coordinated easing of monetary policy with complementary fiscal policy—in other words, more spending.
In its second biannual report of the year, the IMF is now warning about dwindling bank profits as a potential risk factor for global financial instability.
While the difficulty—to some analysts, the impossibility—for central banks to unwind extreme monetary policy has been a recurring concern throughout 2016, the focus for the IMF seems to be turning to the private banking sector. Part of the reason for the shift is the belief that the short-term risks associated with emerging markets (due to low commodity prices) have eased.
The problem the IMF sees with banks are not quite the same as during the financial crisis. The banks are better capitalized and more liquid than they were in the wake of the crisis. However, they have not been particularly profitable. In southern Europe in particular, banks holding onto bad loans remains a problem.
The effects of this lack of profitability are less lending and slower capital growth for banks, especially those in Europe and Japan. Low interest rates also eat into bank profits; in Japan and Europe, interest rates are actually negative. This also impacts the profitability of insurance companies and pension funds.
Elsewhere, the IMF worries that the growth of China's financial system in some ways poses the threat of contagion because these institutions are increasingly interdependent. If major banks in China or Europe fail, a ripple effect would put the entire system's stability in question.
Separate from its biannual report, the IMF has also pointed out the challenges associated with the mounting global debt. “Excessive private debt is a major headwind against the global recovery and a risk to financial stability,” Vitor Gaspar, the fiscal chief for the IMF, told reporters. These unprecedented debt levels encumber policymakers who have exhausted most available measures to kick-start global growth.
Right now, global debt stands at $152 trillion. This is 225% of global GDP. There's no agreed-upon ideal ratio for debt-to-GDP measurements, but when your debt load is more than three times the size of your economy, it's probably time to start worrying. It's also worth mentioning that debt levels have never been this high in human history, so it's difficult to predict what the potential fallout might be.
Some mainstream economists believe there is no real risk involved in ever-growing debt. This view takes the Keynesian recommendation of deficit spending during a recession to extreme proportions that even Keynes himself would likely have been skeptical of. Our debt hangover could have far-reaching and unforeseen consequences that no amount of deleveraging can remedy. In particular, the IMF recommends that China and Europe hasten their debt-reduction efforts while struggling emerging economies have more leeway to "avoid premature tightening" of fiscal and monetary policy.
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