IMF calls for action to address concerns over asset price bubble

Governments face 'difficult' trade-off between supporting economies and fuelling speculative boom, IMF's chief economist says

Gita Gopinath, chief economist at the IMF says the fund is "worried about the complacency in financial markets" amid stretched asset price. Reuters

The International Monetary Fund is "worried" about ballooning asset valuations in financial markets, urging policymakers to minimise the build-up of risk in the system while maintaining accommodative monetary policies to support economies, its chief economist said.

“In our opinion, we do believe that there are stretched asset valuations and over-valuations in risky assets,” Gita Gopinath said on Wednesday evening. “We are worried about the complacency in financial markets that there will somehow always be policy interventions that are needed to [push] stock prices up. So we are flagging that [to policymakers]”.

Given the current situation, where economies have yet to recover from the impact of Covid-19, central banks need to keep accommodative policies in place. However, the IMF is putting “a lot of emphasis” on saying that whatever measures that are necessary to avoid a further build-up of financial risks should be taken.

“It is a difficult trade-off,” she said.

“If anything goes wrong there [in financial markets], it’s a problem for advanced economies, but there will be very large spillovers to emerging and developing economies,” she told students at a webinar hosted by the American University in Cairo's School of Business.

Governments and central banks have provided more than $12 trillion in monetary and fiscal support to economies since the outbreak of the pandemic. Interest rates have been cut and liquidity injections and asset purchases by central banks have helped to prevent a financial meltdown. Global equity markets plunged in March last year but subsequently rallied and the US S&P 500 Index closed close to its all-time high on Wednesday. The index gained in value by about 15 per cent over the course of last year and is up a further 4 per cent this year.

The crisis needed an aggressive reaction, both on fiscal and monetary fronts and that is what was seen, especially in advanced economies. While these measures shielded financial markets, strengthened banks and protected lives and livelihoods, they also helped to make asset prices “almost exuberant”, she said.

“Markets are quite reliant on the best-case scenario for the pandemic ... that we will have a vaccine and things will get better … and interest rates will remain very low for a long time,” she said.

However, the world is entering 2021 in a “tricky situation in which we have this divergence in recovery, and [yet] you have to worry about building financial risks”.

There is a divergence in the global economic recovery and it is important to maintain stable financial conditions, Ms Gopinath said. While developed economies have managed to maintain spending to keep their economies stable, many emerging and developing countries, burdened by debts, have been unable to afford that.

Priority should be given to improve the capacity of healthcare systems and increase spending on economic recovery and providing lifelines to people who are unable to work.

The IMF expects the global economy to grow 5.5 per cent this year – 0.3 per cent more than its previous estimate in October – after contracting 3.5 per cent 2020, according to its latest World Economic Outlook released last month.

However, “it doesn’t look like it is a won-and-done affair” with the effects of the pandemic likely to last for some time as more virulent strains take hold, Ms Gopinath said.

Although the world is experiencing a second wave and the number of infections is much higher than in the first – which triggered widespread lockdowns, upending global travel and trade and making millions unemployed – the hit to economic activity is “significantly smaller” this time

“It tells you that the world has adapted [in terms of] living with social distancing and the virus,” she said.

“Keep in mind that we could have been in a much worse place. There is a hope that the world will be able to exit this crisis with less scars than we thought possible in 2020.”