Hidden almost all the way in the end of the first chapter of the IMF’s latest Financial Stability Report, is a surprisingly candid discussion on the topic of whether “Rising Medium-Term Vulnerabilities Could Derail the Global Recovery”, which is a politically correct way of saying is the financial system on the verge of crashing.
In the section also called “Global Financial Dislocation Scenario” because “crash” sounds just a little too pedestrian, the IMF uses a DSGE model to project the current global financial sitution, and ominously admits that “concerns about a continuing buildup in debt loads and overstretched asset valuations could have global economic repercussions” and – in modeling out the next crash, pardon “dislocation” – the IMF conducts a “scenario analysis” to illustrate how a repricing of risks could “lead to a rise in credit spreads and a fall in capital market and housing prices, derailing the economic recovery and undermining financial stability.”
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From the IMF’s Financial Statbility Report:
“Could Rising Medium-Term Vulnerabilities Derail the Global Recovery?”
This section illustrates how shocks to individual credit and financial markets well within historical norms can propagate and lead to larger global impacts because of knock-on effects, a dearth of policy buffers, and extreme starting points in debt levels and asset valuations. A sudden uncoiling of compressed risk premiums, declines in asset prices, and rises in volatility would lead to a global financial downturn. With monetary policy in several advanced economies at or close to the effective lower bound, the economic consequences would be magnified by the limited scope for monetary stimulus. Indeed, monetary policy normalization would be stalled in its tracks and reversed in some cases.
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