The IMF should not support the Biden stimulus

In cheerleading President Biden’s massive budget stimulus proposal, the International Monetary Fund (IMF) is doing a disservice not only to the United States but also to the rest of its 190 member countries. That’s because the Biden stimulus is likely to result in a disruptive emerging market capital flow reversal and a considerable worsening in international payment imbalances. 

In contrast to naysayers such as former Treasury Secretary Larry Summers, the IMF is giving its full backing to Biden’s proposed $1.9 trillion budget stimulus package. Kristalina Georgieva, the IMF’s managing director, is urging the U.S. to use its fiscal space to go big. Meanwhile, Gita Gopinath, the IMF’s chief economist, is assuring us that it is highly unlikely that the Biden stimulus will cause U.S. inflation to rise beyond the Federal Reserve’s 2 percent inflation target. 

It does not seem to faze the IMF that, coming on top of December’s $900 billion budget stimulus, the $1.9 trillion Biden budget stimulus would be several times larger than the degree to which U.S. output currently falls short of the country’s potential. Nor does the IMF seem to be concerned by either the considerable pent up consumer demand that now characterizes the U.S. economy or by the fact that the U.S. budget stimulus would come at a time of extraordinary monetary policy ease.

In particular, it seems to have escaped the IMF’s notice that the U.S. broad money supply is now growing at 30 percent, or at around three times its previous highest rate in the past 60 years. With the Federal Reserve emphasizing that it won’t raise interest rates or slow the pace of its bond buying, there is every prospect that the U.S. money supply will keep growing at its unusually fast pace. How quickly we seem to forget Milton Friedman’s famous dictum that inflation is always and everywhere a monetary phenomenon. 

While the IMF might not be fazed by the extraordinary U.S. fiscal and monetary policy support, the same might not be said of the U.S. bond market. Since the start of the year, the key 10-year U.S. Treasury interest rate has jumped from 0.9 percent to 1.6 percent. Meanwhile, the market’s inflationary expectation for the next five years has jumped to 2.4 percent or to a level above the Federal Reserve’s inflation target.

In 2013, the emerging market economies suffered from a so-called “taper tantrum” that shook the global economy. They did so as then-Federal Reserve Chairman Ben Bernanke intimated that the Fed was considering an end to its bond-buying program. That announcement heightened fears that U.S. interest rates would rise, which would cause capital to be repatriated from the emerging market economies back to the United States.

Today, something similar may happen but on a larger scale as the prospect of excessive budget stimulus causes U.S. interest rates to rise and emerging market capital to be repatriated. This should be a major concern to the global economy since the emerging market economies now constitute around half of the world economy and are now in a much worse economic position than they were in 2013 to withstand a large-scale capital flow reversal. Not only are these economies more indebted than they were in 2013, they also are now running record budget deficits that need to be financed from abroad. Little wonder then that the World Bank is warning of a new wave of emerging market debt defaults. 

Another way in which excessive U.S. budget stimulus might contribute to global economic instability is that it could lead to a worsening in global payment imbalances. It could do so by reducing the U.S. saving level and thereby increasing the U.S. external current account deficit. That in turn could in time invite a U.S. dollar crisis as markets increasingly come to focus on the large and growing U.S. external debtor position.

The IMF’s very reason for being is to promote economic policies in its member countries that might contribute to global economic prosperity. By supporting an excessively expansive budget policy in the United States, the IMF’s largest member country, one has to wonder whether the IMF is faithfully executing its mandate. This is especially the case when the U.S. budget policy must be expected to cause a disruptive capital withdrawal from the emerging market economies and a worsening in global payment imbalances. 

Desmond Lachman is a resident fellow at the American Enterprise Institute. He was formerly a deputy director in the International Monetary Fund’s Policy Development and Review Department and the chief emerging market economic strategist at Salomon Smith Barney.