The Outlook for Global Financial Stability

As the 2021 year enters its fourth quarter, economists around the world are engaging in the annual ritual of developing forecasts of key economic indicators for 2022 and beyond. Concerns for financial stability are being reflected in the outlook for inflation, interest rates, taxation, and currency exchange rates. Economic stimulus policies that were put into effect in reaction to the global COVID-19 pandemic are impacting the trends in each of these key economic factors. From the outset of the COVID-19 pandemic, governments have extended massive fiscal support that has saved lives and jobs. As a result, public debt has reached a historic high, although it is expected to decrease marginally in the next few years. The policies of the United States Federal Reserve and the European Central Bank are significant contributors to the assessment of the outlook for financial stability. The International Monetary Fund (IMF) undertakes surveillance of financial and economic conditions and provides policy advice to its member nations to assist with the management and control of financial stability. The IMF aims to reduce vulnerability to financial crises, enable sustained economic growth and improved standards of living by providing technical assistance to help member nations’ capacity to maintain financial stability. The IMF will also, as appropriate to circumstances, make resources available to facilitate adjustments in the event of a balance of payments crisis. Economic and financial stability is both a national and multilateral concern. National economies have become more interconnected with the result that vulnerabilities can spread easily across economic sectors and national borders.

The October 2021 Annual Meeting of the IMF and the World Bank included two major topics, namely, the World Economic Outlook and Global Financial Stability. Gita Gopinath, IMF Chief Economist, speaking on the topic of the world economic outlook, drew attention to the challenge to monetary policy from the increased risk-taking in financial markets and rising fragilities in the non-bank financial institutional sector. She emphasized that monetary policy will need to walk a fine line between tackling inflation and financial risks while supporting the economic recovery; she added a comment that while monetary policy can generally look through transitory increases in inflation, central banks should be prepared to act quickly if the risks of rising inflation expectations become more material in this uncharted recovery. Fabio Natalucci, IMF Deputy Director, Monetary and Capital Markets, speaking on the topic of global financial stability, reported that financial vulnerabilities remain elevated in a number of sectors and there is concern that if there is a sudden repricing of risk in markets as investors reassess the outlook for the economy or for policy initiatives, then repricing of risk could interact with financial vulnerabilities. He commented that this points to deterioration in the underlying financial stability foundation and that if this vulnerability evolved into legacy structural problems, the result would be to put growth at risk in the medium term, and potentially, at the extreme, test the resilience of the global financial system.

Coincidentally, the International Actuarial Association held a virtual colloquium during the week of October 11-15 to review the challenges of the post-pandemic economy for the actuarial profession. While actuaries will focus on the impact of population mortality during and after the pandemic, there are important aspects of the post-pandemic economic outlook that require careful research and evaluation, particularly relating to national programs of social insurance, including pensions and healthcare. The actuarial profession will be challenged to address the implications to be drawn from various epidemiological metrics and how to modify traditional actuarial modeling techniques. The impact of potential sustained high inflation and increasing interest rates will require particularly close attention and application to actuarial methodology to ensure the solvency and sustainability of the financial framework of social insurance programs.

As a result of the adverse effects of the pandemic, the United States has engaged in monetary and fiscal policies that greatly expand the national debt, increase inflation and interest rates, devalue the dollar, and require additional tax revenues, while putting at risk the US dollar role as the world’s principal reserve currency. The United States has enjoyed the “exorbitant privilege” of being the sole reserve currency globally for several decades, but many financial experts now believe that current US policies are putting the dollar on a downward path at risk towards losing its reserve role eventually.

World Bank Chief Economist Carmen Reinhart is an advocate for developing countries to take on new debt to help fight the economic impact of the COVID-19 pandemic, even though this policy may subsequently produce a wave of debt crises and restructurings. Reinhart and her colleague Kenneth Rogoff are highly respected for their work on the risks of high debt levels throughout history in both developed and developing countries. How to deal with the sharp rise in government indebtedness that occurred during the global pandemic crisis will be an ongoing major issue to be addressed by central banks and national policymakers in attempting to maintain future financial stability.

Ken Buffin, Editor