IMF: European banks emergency asset sale accelerates

European banks are in the midst of an emergency firesale of assets worth more than €10,000 (£8,000) for every single household in the continent, it has emerged.

The warning from the International Monetary Fund came 24 hours after it slashed its growth forecast for Britain’s economy by more than any other major developed country. It said that political leaders – especially those in the Eurozone – are running out of time to put right the economic problems weighing them down.

In its Global Financial Stability Report, the IMF predicted that Europe’s biggest banks will need to sell off $2.8 trillion of assets in the coming months – some $200bn higher than its estimate in the spring. The sum is equivalent to €10,350 for each of Europe’s 210m households, and will mean there is less money available to be lent to consumers, worsening the credit crisis.

The Fund added that if the euro crisis worsens, the scale of these sell offs could mount to $4.5 trillion – equivalent to €16,634.78  for each of the continent’s households (£13,394.58).

The deleveraging warning is critical to the fate of the European economy, since its major problem at present is that households and businesses are struggling to survive without regular access to credit.

Despite the efforts of the European Central Bank and other regulators to keep the financial system afloat over the summer, the Fund warned that the outlook had deteriorated since it last surveyed it six months ago. Speaking in Tokyo, where the IMF is holding its annual meeting, its head of financial stability, José Viñals, said: “The stakes are high. For instance, if pressures were allowed to continue, major EU banks’ total assets could be forced to shrink by as much as 2.8 trillion dollars, and possibly leading to a contraction in credit supply in the periphery by 9% by the end of 2013. In a more adverse case, as illustrated in our weak policies scenario, EU banks‟ assets could shrink by as much as $4.5 trillion, and lead to a reduction in the supply of credit in the periphery by up to 18%. In contrast, a rapid move to complete policies would avoid this economic damage.”

Although the Fund said the UK remains vulnerable, because of its proximity to the euro crisis and because of the size of its banking system, its financial institutions had at least “made progress through continued divesting and by cutting back noncore activities.”

The Fund warned late last month, however, that the financial system remains just as vulnerable to a future crisis as it did before the collapse of Lehman Brothers in 2008. This latest report will add further pressure as policymakers aim to try to repair the banking system.

Here are three of the most important charts from the GFSR. Those deleveraging forecasts:

A country-by-country table of how indebted various parts of the economy are. Click it to enlarge it.

And finally a similar chart measuring different aspects of banking stability across nations:

The full text of the report can be found online at the IMF’s website.

IMF: We All Underestimated The Pain of the Cuts

What if the fundamental assumptions upon which we’ve based our economic plans were flawed?

What if Britain’s fiscal plan – the “plan A” we hear so much about – was predicated on an economic model which vastly underestimated the crippling economic impact of austerity?

Those are the questions buried away in the International Monetary Fund’s World Economic Outlook report. For while most of the attention over the WEO has been focused on those horrific downgrades to UK growth – and the even more striking fact that for the first time in the crisis Britain’s deficit is now bigger than Greece’s, the report also raises deeper concerns.

The basic point is pretty simple (though this being the IMF they couch it in economic jargon): the Fund and most other economists have for years been underestimating the knock-on effect of public spending cuts on economic growth. It goes back to something economists call multipliers, which give you a rule of thumb about how much you can expect a change in public spending to affect economic growth.

So, for instance, if you assumed a fiscal multiplier of 1, that would mean that for every pound you cut in public spending, you can expect a pound to come off Britain’s gross domestic product – the broadest measure of economic growth. And vice versa if you increased spending. Of course, in practice it’s slightly more complicated than that, with economists using lots of different multipliers for different elements of government spending and taxation.

The IMF’s point today is that economists, including at the Fund and also, by implication, at Britain’s Office for Budget Responsibility, have been using multipliers that are “systematically too low since the start of the Great Recession, by 0.4 to 1.2, depending on the forecast source and the specifics of the estimation approach.”

This matters.

Imagine you’re the OBR and you have a fiscal multiplier of 0.5 in place (in actual fact its multipliers range from 0.35 to 1 depending on what kind of spending you’re talking about). Let’s say the Government is due to cut public spending by £100bn: you would predict that this would knock £50bn off GDP. If, on the other hand, you were to use a multiplier of 1.5, the effect of those spending cuts would be three times bigger, knocking £150bn off GDP.

That’s a big difference – and the IMF’s report says that “the multipliers implicitly used to generate these forecasts are about 0.5. So actual multipliers may be higher, in the range of 0.9 to 1.7.”

It would help explain why economic growth has disappointed for so long and so repeatedly, not just for the UK but for other countries around the world as well.

The problem is that predicting the impact of fiscal measures is a very imprecise science – no two countries are alike, and no single spending cut is alike. But then again, the very foundations of the Government’s economic plans are built on multipliers like these.

Which brings us back to Downing Street, and the question of whether the Chancellor will change his fiscal plans in the Autumn Statement next month. He certainly looks likely to miss his “supplementary fiscal target” – that Britain’s national debt should be falling as a percentage of GDP by 2015/16: that becomes all the more difficult when both GDP is falling and the deficit is rising.

And, as Vicky Redwood of Capital Economics points out, “the fact that the fiscal squeeze is now estimated to have a bigger adverse effect on the economy could clearly be taken as support for the argument that the Government should ease off a little.”

But if he doesn’t want to do that, what other options are left to him?

Well, let’s go back to those multipliers. According to the OBR, the biggest impact on growth comes from cutting investment spending (probably the impact is even bigger, based on the IMF’s research). And yet this is precisely where most of the cuts are happening.

It might make sense, then to focus the cuts on areas which have less impact on economic growth. And what are those areas? Well, the smallest impact comes from raising VAT. That’s already been done. The next smallest impact comes from a cut in the personal allowance: but that’s out of the window given that there’s a coalition pledge to raise this towards £10,000.

Then there’s welfare, with a multiplier of 0.6 (at least according to the OBR).

Which might help underline why George Osborne and the Treasury are making so many noises about potentially cutting welfare benefits. Not merely does it play well with the public, it is also comparatively less economically damaging than some of the alternatives.

On another topic, I’ve examined the IMF’s rather peculiar relationship with Britain’s Plan A, which it seems to support even when the economic picture deteriorates, here.

IMF’s unwavering confidence in Plan A

A year ago, the International Monetary Fund said that Britain should only reconsider its fiscal plan if GDP was significantly worse than its forecast. At that point it was projecting economic growth of 2.3%.

Roll on to today and the Fund has slashed its forecast for the UK economy down to -0.4%. Most economists would consider that significantly worse than was previously being forecast; but the IMF’s verdict? That, once again, the UK has the “right mix” of policies and should only reconsider its fiscal plan if GDP is significantly worse than its forecast.

It begs the question of what exactly would constitute a GDP disappointment. But at least the IMF has at least been remarkably consistent in its comments on the UK economy.

Here is a quick recap of what it said in recent years, as its projections for economic growth collapsed.

Oct 2010

Medium term GDP  forecast: 2.5%

Verdict: “if growth threatens to be substantially lower than is currently forecast in any country, in the UK or any other country, then the fiscal plan should be revisited.”

June 2011

2012 GDP forecast: 2.3%

Verdict (John Lipsky): “We consider the current deviations from forecast represent temporary factors and that the current policy mix strikes us as appropriate.”

Sept 2011

2012 GDP forecast: 2.3%

Verdict (Olivier Blanchard): Policy should only be loosened if growth threatens to slow down substantially relative to what we are forecasting… There is a moment at which things are so bad, if they get there, when you actually have to revise your plans. We do not think that the UK is quite there yet.

May 2012

2012 GDP forecast: 0.2%

Verdict (Christine Lagarde): “If the economy turns out to be significantly weaker than forecast, fiscal easing should be considered.”

October 2012

2012 GDP forecast: – 0.4%

Verdict (Jorg Decressin): “Would expect the economy to pick up during the second half of this year and early next year, but if it doesn’t do so then maybe you would have to revisit the fiscal plans. But at this stage that’s not what we are forecasting.”