IMF Managing Director Kristalina Georgieva/Atlantic Council

By Kevin Lynch and Paul Deegan

April 16, 2024

“Without a course correction, we are indeed heading for ‘Tepid Twenties’ – a sluggish and disappointing decade.” While International Monetary Fund Managing Director Kristalina Georgieva was speaking to the global community in her “curtain raiser” remarks in advance of the IMF/World Bank Spring 2024 meetings, her comments certainly apply to Canada’s diminished prospects, particularly for growth in real GDP per capita and in living standards.

With the Canadian budget released during the 2024 IMF Spring Meetings, it raises the obvious question: how does its policy priorities and fiscal actions align with the IMF’s advice? Fiscal consolidation and rebuilding “rainy day” fiscal buffers were not a focus of a budget containing new spending accompanied by new taxes to avoid increases in already-large deficits. Nor was productivity. Despite a strong rhetorical commitment in the budget to improving productivity, the words were not matched by substantive measures. Overall, the IMF will probably find more alignment with the language of the budget than its policy actions.

With fiscal and monetary policy rowing in opposite directions, the Bank of Canada has been left to rein in inflation, which has been coming down very gradually, according to Governor Tiff Macklem, on its own. While Macklem has faced some criticism from politicians in this “higher-for-longer” period, he has been an effective central bank governor, doing an admirable job managing Canada’s fight against inflation. The Bank’s independence and commitment to low and stable inflation is fundamental to our long-term prosperity.

With the prospect of a “soft landing”, the outlook for global growth may be brighter, but it is modest by historical standards. As global growth is poised to slow to a 2.8 % growth path — a full percentage point below the average growth over the first two decades of the 21^st century — the IMF has set out a number of “policy tests” for governments if they are to reverse this steady decline in growth and its damaging impacts on living standards. As with other G7 countries, the 2024 Canadian budget would likely not get high marks on these IMF “policy tests.”

Foremost among the policies to pull out of this tepid growth trap is the need for countries to undertake major structural reforms to boost productivity. These reforms, according to the IMF, include: more investment in research and corporate innovation, stronger competition policy, greater trade openness, enhanced labour market flexibility, better access to financing, and widespread utilization of Artificial Intelligence. Based on its scenario analysis, the IMF is quite bullish on AI’s potential to substantially enhance labour productivity, provided it is deployed strategically. The Canadian budget includes $2.4 billion for AI, including a new AI Compute Access Fund and Canadian AI Sovereign Compute Strategy.

Next up is finishing the job of returning inflation to its target levels. Not only does low and stable inflation anchor price expectations and reduce uncertainty for savers and investors, it allows monetary authorities to reduce nominal and real interest rates. The IMF is rather subtle in its warning to governments that chipping away at central bank independence will make anchoring inflation expectations more challenging, with consequences for long term interest rates. But it is much sharper in its advice to governments to support central banks in their inflation fight by reining in spending growth and deficits. The budget added almost $53 billion in new spending, raised taxes to maintain an already high deficit, and showed no credible path to medium term fiscal consolidation.

Related is the strong admonition by the IMF that governments need to work harder at putting their fiscal houses back in order. Not only would this speed up getting inflation sustainably back within target ranges, it is needed to rebuild fiscal buffers for future shocks and, in a number of countries, debt levels are simply too high. In short, the pandemic crisis has passed and it is no longer time for large and continuing fiscal stimulus – economies now need structural stimulus to increase supply not demand stimulus. Indeed, faster growth and lower real interest rates are key to debt stability, while slowing growth and inflation (and fiscal) uncertainty, which keep real rates above “normal,” place long-run debt stability at risk.

Trade fragmentation is a downward drag on longer-term growth, both globally and particularly for trading economies. It is not surprising that a Bretton Woods institution would always advocate for more liberalized trade. However, the depth of the IMF’s concerns relate to the scale and scope of protectionist measures introduced by major economies which, combined with geopolitical tensions and populist politics, risk de-globalization and the creation of de facto trading blocs.

Overall, the IMF will probably find more alignment with the language of the budget than its policy actions.

The IMF also points to the renewed focus on industrial policy with growing alarm, noting “industrial policy is not a magic cure for slow growth.” Again, on the basis of its analysis, the IMF warns: “Most industrial policy relies on costly subsidies or tax breaks, which can be detrimental for productivity and welfare if not effectively targeted… In addition, discriminating against foreign firms can prove self-defeating, as such policies can trigger costly retaliation.”

That global coordination is on the wane along with multilateralism is hardly a surprise. But the growing lack of cooperation and adherence to common international rules will not only harm growth in trade, particularly digital trade, where protocols are essential, it will make achieving progress on quintessentially global issues such as climate change that much more difficult. Yet, with the G20 riven over Russia’s invasion of Ukraine, U.S-China strategic competition and security tensions, large developing countries including India, Brazil and South Africa less willing to follow America’s lead and more open to China’s courting, finding common ground — let alone a consensus — is hard to imagine these days.

Now, what did the IMF’s latest forecast — a bellwether for financial markets and government policy makers around the world – have to say about the global economy? The starting point is that the IMF believes the “risk of a hard landing has faded”. Despite the inflation surge, sharp increases in central bank policy rates and the ongoing conflicts in Ukraine and Gaza, “The global economy remains remarkably resilient, with growth holding steady as inflation returns to target” according to the IMF.

That resilience does not translate into stronger global growth, which the IMF pegs at a modest 3.2% for this year and next.

The global bright spot – economically not politically – is the United States, with 2.7% growth forecast for this year before moderating to just under 2% in 2025 as its enormous fiscal stimulus begins to fade. This is more than double the average growth of the other G7 economies, including Canada, which is expanding at a 1.2% pace. Next year, Canada should experience some moderate pickup in economic activity as monetary policy begins to ease. The IMF foresees China not only falling short of its official target of 5% growth for this year and next, but cautions that its unbalanced growth of weak domestic demand and rapidly expanding exports could generate further trade frictions with the US and Europe. India is the emerging-markets growth star this year, with its economy expected to expand 6.8% as it is a major beneficiary of supply-chain realignments within Asia in response to US-China frictions and tariffs.

Overall, the IMF is relatively optimistic about inflation trends in the advanced economies including Canada, projecting inflation returning to 2% by 2025, provided central banks hold to their policy course and fiscal policy turns to consolidation, not stimulus. The IMF is quite pointed in its criticism of American fiscal policy, cautioning that the US is running unwarranted fiscal deficits given the strength of the economy and accumulating debt at an unprecedented pace that could rise to future debt-stability risks. While geopolitical tensions are clearly elevated, the IMF notes that financial markets have absorbed this uncertainty better than expected, as have energy markets, and global supply chains have been resilient in adjusting to tariffs, tensions and attacks.

Hon. Kevin Lynch was Clerk of the Privy Council and Executive Director for the Canadian, Irish and Caribbean constituency at the International Monetary Fund

Paul Deegan is CEO of Deegan Public Strategies, and he served in the Clinton White House’s National Economic Council