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Emerging Markets

Early warnings will focus politicians’ minds, officials hope

A new IMF early warning system to warn of potential crises will force politicians to make a “social choice” – between intervening too early and jeopardising growth, and risking allowing a bubble to grow too big, according to a senior central banker.

The IMF has run exercises with the Financial Stability Board to assess the risks of “unlikely but plausible” events that could cause huge damage to the financial system – so-called tail-end risks.

The results of this Early Warning Exercise were presented to senior officials behind closed doors at the Annual Meetings in Istanbul.

At a seminar on the fringes of the meetings, Jean-Pierre Landau, deputy governor of the French central bank, said: “You have to get leaders to make the explicit social choice. It is not a technical choice.

“If you prick [a bubble] too soon, you might disturb the economy,” he said. “If you prick it too late, you might get what we have now.”

Stephen Cecchetti, chief economic adviser to the Bank for International Settlements, said that if regulators did issue warnings, these would require immediate policy actions but that in fact they were “unlikely to be heeded”.

“You are going to stop people from getting rich, you are going to stop people from buying homes and from engaging in activities that are rewarded by the market,” he said.

“The systemic risk manager in my view faces the same challenges that are faced by a risk manager in a financial institution, which is to say – stop people from making money. This is a very serious challenge to any early warning systems.”

Landau said that regulators and politicians faced a risk that if they communicated the findings publicly they might trigger a crystallisation of the scenario they were worried about. “You would then deprive yourself of the market’s self-correcting function.”

Jonathan Ostry, deputy director of the IMF’s Research Department who is leading the EWE programme, agreed this was a real concern. “Obviously this is something we are very conscious of,” he said.

He said there was already a discussion of risks in the public documents the Fund produced, such as the World Economic Outlook, the financial stability report and individual country reports produced through the Article IV process.

“It is early days, [...] but going forward I would see the fruits of this exercise to be apparent in the multilateral products,” he said.

John Lipsky, the Fund’s first deputy managing director, insisted that the aim of the early warning exercise was not to predict crises. He told a press conference on Sunday: “The idea is, in effect, to take a look in a multilateral framework at the stress, call it a stress test of the global system, and to ask, are there potential vulnerabilities.”

Youssef Boutros-Ghali, the IMFC’s chairman, agreed that it did not attempt to predict crises but rather to “evaluate any risks” that may come from outside the borders of any one country.

“It helps establish the probabilities of what we call tail risks, events that come out in the periphery that look innocuous to most countries but in fact have massive impact on the world economy.”

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