Outlook The International Monetary Fund is often accused of failing to foresee the global financial crisis of 2008. And there's an element of truth in that criticism. The Fund's Global Financial Stability Report which was published in April 2007 was hardly a klaxon of alarm, yet it wasn't a soothing lullaby either.
The document cited the possible spill-over perils from developing problems in the American subprime mortgage markets. It also mentioned the potential fragility of global banks owing to their high leverage.
The trouble is that these accurate warnings were surrounded by a pack of dogs that didn't bark in the following year's meltdown. The IMF also cited risks from, among other things, leveraged buyouts and the massive US current account deficit. Someone carefully reading the document at the time, even if they had not been lulled into a false sense of security, would not have been particularly well informed about which parts of the global financial system were likely to blow up.
Which brings us to the matter of where the next financial crisis is likely to come from. The IMF outlined some areas of concern yesterday in its latest report. And, as in 2007, the Fund offers a broad menu.
It mentions the dangers resulting from the normalisation of monetary policy in advanced economies. It warns on elevated public and private debt levels and possibly over-valued stock markets. Like Andy Haldane of the Bank of England last week, the Fund refers to potential risks from the herd-like behaviour of large mutual or index tracking funds. It outlines the fragility of some emerging market financial systems, singling out Chinese banks. And so on. But which of these concerns are prescient and which are going to be sleeping dogs of the next crisis? We are essentially left in the same condition of uncertainty as in 2007.
Macroprudential policy (curbing risk-taking in specific parts of the financial markets) has become the new lodestar of regulators and monetary policymakers. It's attractive because it promises to allow officials to take targeted corrective measures, rather than requiring them to hike interest rates and crushing activity across the board (something they are understandably loathe when advanced economies are still relatively weak and unemployment is still elevated).
Macroprudential policy is certainly preferable to the old "let them rip and mop up afterwards" approach to asset and financial markets that the likes of Alan Greenspan advocated. But because macro-prudential policy rests on the somewhat doubtful premise that regulators have a good idea where threats are materialising, it could also prove dangerous if regulators over-rely on it. Surgical strikes are fine, but policymakers should spend more time making the broad financial system itself robust to shocks. And that's robust not only to shocks they think they can see building on the horizon, but (just as important) the ones they can't.