The IMF has published two chapters of the World Economic Outlook (WEO): Slowing Growth, Rising Risks (September 2011).
Chapter 3: Commodity prices swings and monetary policy. This chapter examines the inflationary effects of commodity price movements and the appropriate monetary policy response. Commodity prices tend to have stronger and longer-lasting effects on inflation in economies with high food shares in the consumption basket and in economies with less firmly anchored inflation expectations. The chapter’s analysis suggests that central banks in these economies should set and communicate monetary policy based on developments in underlying inflation rather than headline inflation, where underlying inflation means a measure that reflects the changes in inflation that are likely to be sustained over the medium term. Because shocks to commodity price inflation are typically beyond the control of policymakers, hard to predict, and often not sustained, central banks seeking to establish credibility are generally better off setting and communicating their monetary policy in terms of underlying inflation rather than headline inflation. A headline framework may be preferred, however, if economic agents place a much higher value on the stability of headline inflation than on the stability of output. Finally, in emerging and developing economies with excess demand pressures and inflation already above target, a food price shock is likely to have larger secondround effects and require a more aggressive policy response than in the absence of such preexisting demand pressures.
Chapter 4: The twin budget and trade balances. How do changes in taxes and government spending affect an economy’s external balance? Based on a historical analysis of documented fiscal policy changes and on model simulations, this chapter finds that the current account responds substantially to fiscal policy—a fiscal consolidation of 1 percent of GDP typically improves an economy’s current account balance by over a half percent of GDP. This comes about not only through lower imports due to a decline in domestic demand but also from a rise in exports due to a weakening currency. When the nominal exchange rate is fixed or the scope for monetary stimulus is limited, the current account adjusts by as much, but the adjustment is more painful: economic activity contracts more and the real exchange rate depreciates through domestic wage and price compression. When economies tighten fiscal policies simultaneously, what matters for the current account is how much an economy consolidates relative to others. Looking ahead, the differing magnitudes of fiscal adjustment plans across the world will help lower imbalances within the euro area and reduce emerging Asia’s external surpluses. The relative lack of permanent consolidation measures in the United States suggests that fiscal policy will contribute little to lessening the U.S. external deficit.
